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Hype from Stock Bubble Trumps News from Housing Bubble


That's the Rap


Amazingly enough, the pied piper of technology, a.k.a. Johnny Chambers, convinced folks that everything was wonderful at Cisco (CSCO) -- and that Cisco was in fact "specific" to the entire galaxy (or at least all tech stocks). What results precipitated that, you might ask? In essence, the company was able to win at beat-the-number for this quarter and next year's guidance was basically as had been expected (though the acquisition of Scientific-Atlanta caused its revenues to be projected slightly higher for 2007 than had been previously thought).

2-4-6-8, Whose Balance Sheet Don't We Penetrate?

Of course, dead fish being what they are, nobody asked: If everything is so wonderful, how come in the last year -- when revenue rose $1.4 billion -- receivables rose $1.1 billion? (Stated differently, revenues were up 21% year-over-year, but receivables were up 50%.) Sequentially, receivables grew only 10.7%, versus a 9% increase in revenues. Thus, making the number is a joke when laid against those receivables. Nevertheless, the bulls' verdict was: Buy everything in tech.

Take It From Your Uncle Polonius: Neither a Borrower Nor a Lender Be

Meanwhile, the financing mechanism of the ATM food chain saw some holes blown in it. Specifically, Accredited Home Lenders (LEND) was down over 20% on a poor quarter. As we saw with New Century (NEW) last week, LEND was forced to keep the loans that it was unable to sell. This time, no prisoners were taken, as not only was LEND pummeled, but NEW was hit for 8% and Countrywide Financial (CFC) (whose monthly comps were horrific) was roughed up for 10%. Adding to the angst: Toll Brothers (TOL) and WCI Communities (WCI) -- "building" blocks in the housing ATM itself -- reported poor results, which saw all the housing stocks under pressure.

Thus, early yesterday we were witness to quite a dichotomy: The unwinding of the structure that's powered the economy through and past the tech-bubble aftermath, even as one of the biggest cheerleaders from that original mania got the tape all excited. To quantify that disconnect: The early going saw tech on fire, with the Nasdaq up 1%-plus and the Sox up 3%, while housing and many financials were down 3% to 5%.

Momentum Gets the Memento-Mori Memo

For the first half of the day (until roughly noon Eastern time), we experienced a bifurcated tape as I described it. But as the afternoon wore on, the heavy undertow in the transports (down 3% to a new low), the housing ATM and its financial components succeeded (as it ought to, I might add) in dragging the rest of the tape lower and wiping out a good portion of the silly gains we saw earlier in technology.

Mazel Tov, Miners

However, there was one bright spot, at least, as both Newmont Mining (NEM) and Pan American Silver (PAAS) were up 3%. Newmont's performance today is the more important one, given that the stock has been unable to sustain much of any rally for the longest time. Even with gold a little weaker in the after-market, NEM managed to buck the trend of generalized stock weakness. Meaning that potentially, gold stocks may turn out to be a safe haven in the bear market. I don't want to read too much into one day's action, but I did think it was worth noting.

In any case, yesterday was extremely ugly. I continue to believe that the last few days' action, in the aggregate, is very ominous, and that somewhere in the not-too-distant future, a dislocation lurks.

Away from stocks, last night saw huge volatility. The dollar was quite strong at one point Tuesday night, in typical sell-the-news fashion. But that reversed and the dollar was weaker yesterday. Ditto the metals: Gold was down about $9 at one time Tuesday night, and silver was down over 20 cents. They too reversed, such that gold closed up 1% and silver closed up 3%. Rounding out the outside markets, fixed income was slightly lower and oil was 1% higher.

Pension Poaching

Turning to the news, I'd like to reprise a story from Tuesday's New York Times headlined "Public Pension Plans Face Billions in Shortages." Though literally Tuesday's news, it's a story you're going to read about a lot more. This one starts with the debacle in San Diego, whose shortchanging of worker pension funds was revealed thanks to the efforts of a whistleblower. These actions by the city have not exactly been a secret. It's just that no one cared for quite a while.

Arcane Accounting, Mundane Raw Sewage

And, besides illuminating similar problems in lots of places, the Times story points out what can go wrong when something as seemingly innocent and obscure as pension accounting wreaks havoc with its financing: "San Diego remains barred from raising money by selling bonds. Cut off from a vital source of cash, it has fallen behind on its maintenance of streets, storm drains and public buildings. Potholes are proliferating and beaches are closed because of sewage spills." Remember, folks, this is happening while times are good. Times are about to get worse.

According to calculations by Barclays Global Investments (cited in the story), if all of America's state pension plans had used the same accounting conventions that corporations do, the total benefits promised -- $2.5 trillion -- would only be backed by assets of $1.7 trillion, leaving a shortfall of $800 billion. Let me remind you again: That's while times have been good and the stock market is where it is. A decline in the stock market will only widen that gap, as the assets in these plans are a function of high stock prices.

Also, recall that many states borrowed money during the bust, gambling that they could bail themselves out by putting the proceeds into the stock market. While that has appeared to work temporarily, it won't work down the road.

Ploys by Jersey (and Illinois) Boys

Continuing on, the story says that some of the tricks used by San Diego are also turning up in such other places as Trenton, New Jersey. The neat little gambit there (made possible by using certain accounting conventions): Officials have been granting pension increases even as they've been cutting back on contributions.

Illinois has done the same, trying to "make its municipal pension plan [funding costs] cheaper by stretching its funding schedule over 40 years -- considerably longer than the 30 years that governmental accounting and actuarial standards permit, and more than five times what companies will get under a pension bill that has just passed Congress." Why did they stretch the funding schedule out? To make it look as though the plan is in better shape than it actually is, while contributing less.

The article points out one reason why all of this has been allowed to occur: There is no oversight. And, in a somewhat eerie development, though it fits with other generic abdications of responsibility, Art Levitt discusses the fact that the Office of Municipal Securities, an independent structure within the SEC that reported directly to the SEC chairman, was dismantled once Mr. Levitt left.

Why that should have occurred, I have no idea. But, as I said earlier, it's just another case of dangerous behavior occurring more or less in broad daylight, no one being concerned, and the authorities not bothering to pay any attention. As the recession unfolds, we will likely find out that such is the case in many more cities than the handful that are mentioned.
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Positions in NEW, CFC, NEM, PAAS

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