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MORNING COMMENTS WEEK OF 8/2/99-8/6/99

 

8/6/99

Optimism resurfaced for a brief moment yesterday afternoon, the anticipated bounce in Internet stocks we mentioned on Wednesday pulling the market higher, buoying spirits, temporarily bringing traders out of hiding, sparking talk of a new leg up.

The rally occured despite a productivity report which showed a sharp deceleration in productivity during the second quarter, with annual growth slumping to 1.3% from 3.8% in the first quarter. The recent signs that wages are rising at an accelerating pace were once again present yesterday, as labor costs jumped 3.8%.

A sharp rally in the bond market, prompted by a flight to quality, cushioned the impact of yesterday's productivity data and allowed the market to put aside its recent worries. 

All hope for a rally died with this morning's release of July employment data, which reinforced the picture that had begun to emerge in the past week--that of an expanding economy with an inflationary gun to its head, of a labor market on the brink of experiencing a sharp escalation in wage pressures, of Goldilocks living on the edge of trouble.

Today's employment data showed a gain of 0.5% in average hourly earnings and 310,000 new jobs added during July, both figures far above the consensus estimates of 0.3% and 220,000 respectively.  Signs of the much hoped for slowdown were nowhere to be found in today's data.

Perhaps most worrisome was the renewed strength in the manufacturing sector, with the sector experiencing its first gain in a year as it added 31,000 jobs during the month and manufacturing overtime inched up to 4.8 hours from 4.7.

With the manufacturing sector springing back to life, we are likely to see labor market tightness escalate, and the pace of wage growth accelerate in the coming months unless the economy slows significantly.

The pressure is now on the Fed to act swiftly to prevent the gathering storm of economic imbalances from developing further. The market's next major tests will occur with the release of CPI and PPI, both of which we expect to surprise on the upside due to the recent rise in oil prices and continued tightness in the labor market.

 With a 1/4 point hike in rates at the next FOMC all but a done deal at this point, the question now must turn to whether the Fed's expected next move will be enough to slow the economy.  The consensus says yes, we say no.

As we have said before, to slow the economy the Fed must slow the consumer, a consumer who continues to spend beyond his means, a consumer whose thoughts and wallet remain locked in the age of Perpetual Prosperity despite the signs of trouble on the horizon.

We expect the pace of economic growth to pick up from last quarter's 2.3% as inventories are replenished and the consumer continues to spend.  This acceleration in growth will lead to an acceleration in wage pressures, and ultimately, to a third move by the Fed.

We would expect any additional move by the Fed to come sooner rather than later.  Y2K jitters will put pressure on the stock market in the last two months of the year, and the Fed will seek to avoid adding further to an unstable market environment.  Boxed in by rising economic imbalances gathering steam and nipping at the economy's heels and Y2K jitters on the immediate horizon, the Fed will have a short time frame in which to act, thus we would expect the third hike to come at the October meeting, or in-between FOMC confabs if conditions warrant.

As the Fed strives to slow the economy, and prolong the expansion, it must act quickly, but it will do so on a veritable tightrope, with any misstep causing chaos in the markets.  The odds of the Fed succeeding are stacked against it, historically the market's moves from states of "irrational exuberance" to the historical mean have over swung on the downside.        

8/5/99

Stocks are sliding, the .coms have turned from magic elixir to dreaded curse, yields are rising, and yet the consumer keeps smiling.

The latest chain store sales show that the consumer remains in top spending form despite the recent rise in interest rates and declines in the stock market.  The fear, uncertainty, and early stages of panic that now grips much of the street has yet to spread to Main Street.

The relative complacency of the individual investor remains both the market's greatest stumbling block to forming a bottom and its greatest asset.  The faith of the individual in the 17 year long bull market continues to act as a safety net under the market, cushioning the blows that it is being dealt by the twin evils of a negative interest rate environment and fading euphoria.

We are unlikely to see a meaningful bottom before the individual throws in the towel and joins the Jitter Brigade.  With consumer sentiment remaining near historic levels despite the market's recent downturn, we will likely need to see much lower stock prices before the fear felt by many pros spreads and reaches its final destination.

While the Dow is down 5% from its highs, and NASDAQ 10%, both indexes remain significantly above the rosiest of forecasts made by Market Seers at the beginning of the year.  At the beginning of the year, the average year end 1999 forecast for the Dow was 9500, a level which we will likely need to fall beneath before the consumer puts the breaks on spending and starts selling in earnest.  It is the consumer, and not the Fed, who holds the key to curing the uncertainty which is currently infecting the market.

As long as the wealth effect continues to chug along at an unrelenting pace, the market will remain in a state of fear, and the need for the Fed to be pre-emptive against building economic imbalances will remain.

While we expect the transformation of the individual from 'buy on the dipper' to 'sell at any pricer' to be a gradual one and the market to decline at an orderly pace, thus avoiding a crash, the record use of margin by many investors has created the potential for a slow letting out of air to turn into a decline that far overshoots on the downside.

Lesson number one when overusing leverage: Gravity exists. 

8/4/99

When the possibility of attaining a dream ceases to exist, the memory of what could have been lingers on, temporarily preventing the dejected dreamer from leaving the lost cause behind and moving on to greener more fertile pastures.

Thus the investor, entranced by a dream he has been sold, often stays long after the possible has been transformed into the impossible, clinging to hope on the descent into darkness, only giving up hope when the bottom is at hand.

The path from top to bottom, from dream to nightmare, is not a smooth one in the investment world, but rather it is one that proceeds in fits and starts, the path from departure to arrival strewn with a plethora of mirages that temporarily elevate hope and act to rekindle the emotional ties that the investor feels to the memories of what could have been, in the process lengthening the time needed before a final separation from the previous trend can occur.

For the neophyte, the investor or trader who has known nothing but the previous trend and fully believes that what he has experienced is the full extent of what the market has to offer, and who has been lured to the playing field by dreams of a better future, the dreams die harder and the losses grow wider before reality sets in.

In today's market we are witnessing this holding on to hope in the face of mounting adversity primarily among investors in the Internet stocks, where in many cases the dreams of Spring have been relinquished only by a forced exit from the playing field in the form of an unmeetable margin call.

The separation process from the unattainable dream of an easy path to riches began in April, with sentiment enduring an initial bone shaking rattle that endured into June, before the mirage of a benign Fed appeared to instill hope once again.  With each fit and start (some would say wave) that sentiment is subjected to on the downward path, the ability of hope to be elevated to former levels is diminished (and the ability of the effected sector of the market to rebound is similarly diminished).

With sentiment damaged from the initial thrust downward, the June-July rally was only able to retrace 50% of its fall from the top before fear once again set in and the now dominant down trend once again resumed.

The fear resulting from this latest wave down is now reaching a fever pitch, with the prior uptrend's pitchmen, from television commentators to quotable technicians, recanting their previous beliefs and now singing a different song, a song of doom.

With sentiment turning decidedly bearish towards the Internet stocks, but with panic still far away on the distant horizon, the stage is being set for the next countertrend move, a move that could retrace 25-38% of the decline from July.

The number of investors willing to participate in this final upward countertrend rally will be diminished from the number that took part in the last rally, with sentiment weakening on each false ray of hope that is offered.  After this one final countertrend rally, we expect the Internet stocks to start their final leg down, a leg that could see many of the weaker stocks in the sector break below their lows of last October as panic sets in and signals an end to the sector's decline.  

8/3/99

A morning short covering rally, and then an afternoon jitter-led fade marked a day when the majority of participants, buyer and seller alike, remained on an extended weekend.

The first of this week's major economic reports, the NAPM, provided a bit of early relief to the short term oversold market, but underneath the headline number the report proved to be a bit of a mixed bag, unlikely to move the Fed either way.  While the new orders and employment components of the report eased, signs of a pickup in pricing power were evident, with the prices paid compnent rising to 54.7% from 53.5% and the suppliers delivery component moving up to 54.2% from 53.1%.  While the pace of growth eased from the prior month, the report still painted a picture of an expanding manufacturing sector with increasing price pressures.

With the NAPM out of the way, the next two days are virtual throw aways, days when the sidelines will be more crowded than the trading floor as traders await Thursday's productivity figures and Friday's employment data.

While today and tomorrow would be better spent at the beach than in the trading pit, there remain a few things to watch over the coming two days: AOL, IBM, the Internet stocks, and volume.

We would keep a close eye on both AOL and IBM in today's trading.  Both stocks closed at important support levels yesterday, AOL at its 200 day moving average and IBM just below its 55 ay moving average.  A break below these support levels by either stock could spark a renewed sell off in their respective sectors: the Earthbound Internets and the Richly Valued Big Cap Techs.

The Internets could enjoy a bit of upward movement today on the backs of a Yahoo/@Home rumored combo, but the sector has seen its better days, and is likely to resume its history lesson shortly (the lesson that parabolic rises always result in swifter parabolic declines). 

The most profitable opportunities for taking part in the sector's downward push are likely to be in the shares of the companies that benefited the most from the sector's rise to glory:  the online brokers. With average trading volume having tailed off from its early year pace, and the market now in an intermediate term downtrend, the online brokers could be in for a period of multiple contraction, the end of which will see their multiples fall into line with the rest of the traditional brokerage industry.  

8/2/99

Earnings season is gone, the expected share price boom gone bust, and with its passing the market's fate passes into the hands of The External Unbelievers.

Early this year, as Chatroom Cowboy Billy and his pals were gathering headlines with their daring Internet stock "trading" exploits and Mr. Quotablebearguru was prophesizing doom to any available camera in hopes of landing a client or two, another group sat quietly by watching the unfolding carnival.  The presence of this  group of partygoers, who had been swept ashore by the fast moving tides of a sea of liquidity, allowed the spectacle to continue and flourish.  

Distrustful of Goldilocks and her carnival entourage and increasingly fearful of the outcome of the last act,  and yet with no where else to go, The External Unbelievers remained at the show, their eyes remained firmly focused on the raging storms in the outside world, awaiting the inevitable calm and the appearance of a new less risky playing field.

Spring bloomed, and with it a sense of calm began to descend across the globe.  One by one, the opportunities began to sprout forth and beckon in the lands beyond the Fiefdom of Goldilocks.

As summer arrived, a clear divergence became apparent between the beliefs of the natives and those of The External Unbelievers.  The natives were fully caught up in the game, their excitement growing by the minute, rushing to place their money, sometimes earned and more often borrowed, upon the playing field, fully believing that the fun would never end.

The External Unbelievers meanwhile, had grown weary of the game, the pursuit of which they now saw as more fraught with risk than reward, and increasingly their eyes gazed homeward, to a land left behind which now beckoned with rekindled promise.

As the first trickle of non natives began to depart not an eye was raised by the euphoric natives. As the trickle gained force, the natives began to sense that something was amiss, that perhaps the headline grabbing Cowboy Billy and his friends were but minor players in the game, and it was the departing External Nonbelievers who held the deciding hand.  They began to fret as they realized that one of the primary drivers of their long lasting prosperity was now returning home, taking with them the suitcases stuffed with dollars which they had brought.

As the week begins, and the market moves from economic report to economic report, keep in mind that one of the market's primary supports: the inflow of foreign funds has now been reversed and is unlikely to return until the risk/ reward picture once again favors the U.S. market.  While the market may rally on weaker than expected economic figures, that alone will not be enough to turn the tides of liquidity.

 While valuation concerns have largely been forgotten by many U.S. investors, the historically high valuations of the U.S. market have increasingly weighed on the minds of foreign investors.  With many foreign markets now offering better risk/reward ratios than the U.S. market does, and with the game in many markets just beginning  rather than long in the tooth, the odds favor a continuation of the recent repatriation of funds, and with that continued outflow of funds the pressure will remain on the U.S. stock market.

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Last modified: April 02, 2001

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