Monday Morning Quarterback
...if the squeeze has only just begun, can the worst be ahead for the consumer?
Good morning and welcome back to the flickering track. On the heels of an emotional week that saw Bernanke pull doves from his hat, an avalanche of earnings, the burial of July paper, technical levels galore, a round trip in psychology and incessant geopolitical headlines, it's time to power up anew and dive into the dew. We often talk about profitability residing in the chasm that is the disconnect between perception and reality and, as both sides of that ride are the definition of dynamic, the onus is on us to respect the former while staying grounded in the latter. So, without further adieu, hit me again Ike--and this time put some stank on it!
Of Value Traps and Multiple Contractions
Among the many stories jockeying for our collective attention last week were the fundamental updates from big cap tech. I've often opined that tech (and financials) has a steep slope to navigate as they're over-owned as a function of their former out-performance and, by extension, their increased weighting in fund land. Indeed, while Yahoo!, Intel and Dell earnings were somber reminders that past performance in no way guarantees future results, hope springs eternal for holders with a higher cost basis.
Minyan Michael Santoli, in his always excellent Barron's missive, noted that the NASDAQ is at the same spot as it was eight years ago. That's a whole lotta stress for a round trip to Nowheresville but it begs some questions as we attempt to fit together the pieces of our future profit puzzle. He took a look at analyst ratings in Microsoft, Intel, Dell, Oracle, IBM and Yahoo! and found 125 buy ratings and twelve sell ratings (boutiques, not bankers). Further, he found that the short interest on most of these names remains below 2%. That's cause for pause for those who intend to hold these four-letter freaks until they're back in the black.
We've spoken about the fatal flaws of each of our four primary metrics. Technicals dictate that a stock is "worse lower" (under resistance) and "better higher" (after it breaks out). Psychology works (momentum) until it doesn't (it's a contra-indicator at extremes). The structural dynamic is equity friendly (dollar devaluation, for instance) until it reaches a tipping point (debasement). And fundamentals, as we've discussed, are vulnerable to multiple contraction and value traps (see Intel).
The S&P is currently trading at fifteen times projected 2006 earnings, which is the same multiple as four years ago. It also happens to be the identical multiple from the end of '95 before it lifted on its eye-popping ascent that forever skewed our perception of the financial marketplace. It dipped to twelve times earnings towards the end of '94, just as the fed was finishing up a rate-hike cycle, prompting a few strategists to draw a comparison to our current day fray. They may be right, for a trade, but I don't--and won't--buy it as a long-term investment thesis.
The problem with assigning historical norms to the fundamental landscape is that we're coming out of a historical anomaly in tech. Think about it, if the NASDAQ bubble was twice as big as the Nikkei, from trough to peak. Is it truly realistic to believe that we'll break into a sprint on the heels of the powerful yet finite fiscal and monetary stimuli? This assertion drips with irony, no? All those who argued that 'this time is different' to justify mind-boggling valuations six years ago may indeed be right. But the new paradigm wasn't the cause of the ascent, it's simply the effect of it.
The sharpest rallies occur in the context of a bear market, we know, and only time will tell if last Wednesday's dove hug will be viewed through the same lens as the other one-and-done bovine runs. The weekend news, while not pleasant, wasn't the disaster some feared and that's given an early bid to the futures. Keep in mind that we'll be digesting expiration hangover (as traders square their option risk) so a true tone of the tape may not emerge until we get set to order lunch.
In commodity land, CRB 330-335 is a massively important zone for metal and energy players. As the multi-year trendline (from 2002), the 200-day moving average and a double bottom (June lows), it's the spot to trot if the bulls wanna get hot. As a long-term believer (but short-term side-stepper) of these arenas, I'll be watching them closely for signs of traction. For if they slip through that area, I'll lay dollars to donuts that deflation chatter will emerge from the lips of people who opine on those matters.
As the stock market is a leading indicator, can it be that the bad news is currently priced into the housing stocks? Dr Horton (DHI) fessed the mess last week after suffering an organic two for one stock split since we last spoke in Ojai. Professor Bennet Sedacca has been dutifully (and intelligently) tracking the homies relative to other bubbles and has recently eyeballed a potential bounce. I've wondered the same, which has put me in the classic trader conundrum. I don't believe in the upside but we should never let an opinion get in the way of making money.
According to Stock Trader's Almanac, all the net gains in the DJIA have come between November and April, a fact that many bulls are pointing to as we trudge through this summer pooh. While I respect seasonality trends, my sense is that we're on a race against the clock. With the consumer 70% of US GDP, I can't help but wonder how pervasive the pain will be with the interest on trillions of dollars of adjustable rate mortgages vulnerable to 'reset.' We've seen consumer fears manifest in the retail and homebuilder groups but, if the squeeze has only just begun, can the worst be ahead for the consumer?
Rotation Station? With tech, homies, retail and a litany of other sectors taking it on the chin, we've seen a staunch defense of certain sectors. Some of them make sense--consumers, drugs, healthcare and the like--but others, particularly the money center banks, don't jibe in my mind's eye. I'm not making a stand, I'm simply making a point. With the yield curve inverted, the consumer on the ropes and these stocks over-owned (the largest weighting in the S&P), I can't help but wonder when they'll have their day in Red Dye.
Long Distance Minyan, What You Standing There For...? With seventeen--count 'em!--days left until Minyans in the Mountains, we've officially SOLD OUT of the Vail Cascade. Our Sundance of Finance is gaining momentum in the marketplace, with over 215 Minyans having already circled their spot for the mountain trot. We've made alternative housing arrangements for those still interested---we still have space at all the activities (S'mores anyone?)--so it's not too late for you to climb aboard the Critter Adventure. Please ping Queen V and her working bee's with any or all questions as we get set for the purpose of the journey that is the journey itself.
Good luck today.
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