Contributed by Bill
Publisher of: The
Fleet Street Letter
FRIDAY, 3 AUGUST 2001
Three Amigo Bottom Indicators
*** History, Recessions - and a 32% boost in the S&P...
Semiconductor Index on a tear...
*** "Talk is cheap and Wall Street gets it wholesale"...
Boobus Americanus contracts a quick and serious case of
*** The million-dollar divide in California real
estate..."You better hope you've got a live deal"...and
much, much more...
|*** Hmmmn...wasn't it just a week ago that we were |
lamenting the fact that "the only thing new in the
'news' these days" is the names of companies reporting
bad earnings and announcing layoffs...
*** Just yesterday, in fact, we reported 31,000 people
lost their jobs in one day. Wait, it only seems like
yesterday. In fact, it was last Friday.
*** Over a million have gotten the ax since January
first of this year. Intel reported profits for the 2nd
quarter had dropped 94%...computer-related industry
profits were down 66% across the board...
*** Yet, Craig Barrett, hombre numero uno at Intel, says
he believes the end of the global slowdown in demand for
tech products "is in sight," and "boom!" up the stock
*** The chip sector has been on a tear for the last
seven days...jumping 3% yesterday alone...Dell was up
4%...PMC Sierra leaped up a whopping 10.5%...
*** Has Boobus Americanus lost their collective mind?
(Thank you Doug Casey for that most affectionate term.)
Before we try to answer, let's check in with our man on
the scene in New York. Eric?
Eric reports from Wall Street:
- Ask most investors about the tough economic conditions
hovering over the stock market and they'll invariably
say, "Earnings will recover in the second half;" Or,
"The economy is bottoming;" Or, "Greenspan will cut
interest rates until the market recovers."
- And now, along comes Salomon Smith Barney equity
strategist John Manley with the comforting observation
that the economy and corporate profits are - at last -
deteriorating at a slower rate.
- Three cheers for slow deterioration!
- Yesterday, the rose-colored glasses crowd was out in
full force, proclaiming among other things that
semiconductor prices had hit bottom.
- "The industry has bottomed out," Intel's Chief
Executive Craig Barrett told reporters in Penang,
Malaysia. "There will be an uptick in demand in the
third and fourth quarters."
- The Semiconductor Industry Association seconded
Barrett's optimistic outlook. "Based on the inventory
reduction that has occurred in the first half of 2001
and the further reductions projected for the third
quarter, we believe the industry will return to
sequential growth in the fourth quarter of this year,"
said George Scalise, president of SIA.
- The Philadelphia Semiconductor Index (SOX) rallied on
the rosy forecasts and has now gained more than 19% over
the last seven trading days.
- The Dow backtracked from a 99-point midday advance,
but hung onto 41-points to finish at 10,551. The Nasdaq,
meanwhile, gave back nearly half of its early session
gains to finish up 19 at 2087.
- Even if the glass is suddenly half-full in the
semiconductor industry, Wall Street is just beginning to
feel the pain. "There is a major job recession on the
Street," writes the New York Observer's Landon Thomas.
"With at least 1,500 investment-banking jobs already
gone this year, it's going to get worse before it gets
- Dresdner Kleinwort Wasserstein's announced recently
that they will cut 1,500 banking jobs - with the knife's
sharpest edge to be felt in its New York offices.
- "No longer are just 'under-performing' bankers getting
the ax," Thomas continues. "These days, anyone can be
let go. Indeed, the joke within Merrill now is that if
you're not working on a live deal - even if you've just
closed a major one - you are liable to get fired."
- How's this for proof of a bubble in the real estate
market? Coldwell Banker released a report showing that
if you want a 2,200 square foot, 4-bedroom house in
Oklahoma, it'll cost you $134,275 in Tulsa...but only
$134,225 in Oklahoma City. A $50 dollar divide.
- In Palo Alto, your family digs would set you back $1.1
million, while just a few hours away, in Bakersfield,
that dwelling costs only $119k. Over a million dollars
separates the two...
[Here's a simple question: Does anyone really need a
house in Palo Alto that badly?]
- "Wow!" is all I can say to another survey conducted
for the Securities Investor Protection Corporation
(SIPC) and the National Association of Investors
Corporation (NAIC). The survey was designed to test
"investor awareness"...and 4-out-of-5 investors failed.
- Fewer than one in five realize that there is no
"insurance" for stock market losses. When asked to
identify the "organization that insures you against
losing money in the stock market or as the result of
investment fraud," only 16 percent knew that there is no
- "We've been at this for 50 years now," says the NAIC's
Robert O'Hara "and we see the same problem over and over
again: new investors come in during bull markets and
then don't know what to do when things go sour later."
- "Informed is better," says James Grant.
Back to Addison in Paris...
*** Informed is better with respect to the perennial
search for the bottom, too. "Stock market gains lead
corporate earnings during a recession by an average of
11 months," writes John Mauldin. "The cycle begins when
it looks like there is no end to bad earnings reports."
*** Mauldin's research shows that, on average, the S&P
rises 32% from the market's bottom before the earnings
cycle bottoms out. (Mauldin suggests a few potential
*** Here at the Daily Reckoning...well, we're not so
sure. "Talk is cheap and Wall Street gets it
wholesale..." says Bill King, and we're inclined to
agree. "Until a requisite number never want to hear the
words stock and market again, the bottom is not in."
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The Daily Reckoning Presents: A Special Guest Essay in
which the author searches for serious signs of a
turnaround in the markets...
THE THREE AMIGO BOTTOM INDICATORS
By John Mauldin
The recent market action has a lot of people scratching
their heads. Of course, the cheerleaders tell us each
move down is the bottom. And one day they will be right.
But that does not explain the markets.
First, let's remember a basic fundamental. For every
seller in a bear market there is a buyer. Given the real
problems in the economy, however, the question to those
of a bearish persuasion becomes: "Why is anyone buying
The answer is they see the potential for real profits!
(Even though they have to ignore the S&P 500 selling at
an unbelievable historical high P/E ratio of 29 in a
According to Bank Credit Analyst, stock market rises
lead corporate earnings during a recession by an average
of 11 months. On average, the S&P has risen 32% from the
market's bottom before the earnings cycle bottoms out.
Note that the stock market rise does not begin after the
recession is over. It begins usually at the bottom of
the recession when things look the worst.
This market rise comes before things turn around and
before unemployment bottoms out. It begins when it looks
like there is no end to bad earnings reports. Thus the
search for: The Bottom. A 32% rise in less than a year
can salve a lot of bear market wounds.
Seems easy enough. Just invest when blood is running in
the streets. But the trick is to figure out when things
look the worst. Are we looking for ankle-deep or knee-
deep blood? Things may look pretty bleak today, but
there is no reason they cannot look worse tomorrow.
And that, dear reader, is what our assignment is today.
We are going to explore some of the signs that happen
when things are at their worst. We want to know what
month in the future earnings will turn up so we can
subtract 11 months and jump back in the market BEFORE
the 32% rise.
In the Fed Watcher section of his website, Dr. Ed
Yardeni, chief economist with Deutsche Bank Alex Brown,
gives us a number of charts which show the relationship
between certain factors and Fed funds rate. I take these
and overlay the S&P 500 data to help us see if we can
find something of market-predicting significance.
There are several items which are highly correlated with
Fed fund rates. They are also highly correlated with
stock market direction. And even more important, when
you go back to 1990-91 and pay close attention, some of
them even give us a hint at that most elusive of
moments: The Bottom.
As you might expect, the direction of the Fed funds rate
is closely related to GDP growth. In past recessions,
the Fed funds rate only started to come down after GDP
growth slowed down. But in our current economic cycle,
we see Greenspan and crew cutting rates only shortly
after the slowdown began. Faster than at any other
recent period, but not soon enough in the opinion of
many observers, including your intrepid analyst.
This is why so many analysts are bullish; they see that
chart and connect the dots which show the economy and
markets growing stronger next year. I think this
"correlation" is tentative, at best. Betting my economic
future on the effectiveness of rate cuts, let alone on
the likelihood that cuts actually produce magical
changes in exactly 12 months, seems questionable.
The first indicator I want to look at is the strong
connections between capacity utilization, the Fed fund
rate and the stock market. Interestingly, capacity
utilization bottomed in early 1991 and the stock market
found a bottom a few months later.
The second indicator is the NAPM Price Index (National
Association of Purchasing Managers). It also bottomed in
All the other graphs show the correlation to the Fed
fund rate with factors like industrial production, G-7
industrial production, profits, earnings, commodity
prices, metals, etc. While correlated with the Fed fund
rate, these did not seem to anticipate a turn around in
the stock market prior to the actual rise. (I should
note that these are my conclusions and are NOT to be
interpreted as coming from Dr. Yardeni.)
It makes sense why capacity utilization and the NAPM
Index would tend to be a pre-cursor to a turnaround.
Until factory production and purchasing turn around, how
can we say we are at the bottom? Unemployment, earnings
and such will still tend to look bad and get worse, even
as the stock market and the economy rise from their
graves, but something has to signal that we are at: The
Remember my earlier point: as bad as things are, they
can get worse? Until these indexes start to show some
signs of life, things can get worse, and probably will.
On Wednesday, the NAPM Index, after rising slightly in
May, fell out of bed in June. Every month brings a
decrease in capacity utilization.
But I promised one more indicator of The Bottom. And
that would be junk bonds, the current nuclear waste of
investments. Junk bond funds typically turn around at
the bottom of a recession. Again, this is logical, as
bond values are an extension of the ability of companies
to make their payments. When the prospect for re-payment
improves at enough companies, the bond funds themselves
begin to show signs of life.
Junk bonds are currently showing no signs of life. They
really are getting treated like nuclear waste. I could
quote some devastating numbers about how default telecom
bondholders are only getting 12 cents on the dollar and
about how many hundreds of billions of dollars of
telecom bonds are still waiting for the shoe to drop,
but space and time suggest not.
Someday, however, you will want to invest in junk bonds,
only then we will respectfully call them High Yield
bonds. High Yield bond funds rose almost 80% after the
last recession in 1990-91. I actually look forward to
the day, as it will be a once in a cycle trade that we
will get to brag about to our brothers-in-law.
But for now, the Three Amigos of capacity utilization,
the NAPM Index and junk bonds tell us we are not yet at
the bottom. When to get bullish? When these indicators
start to turn up for two months. (Or you can be
aggressive and start to increase your portfolio at the
first signs of life in all three indicators
You might miss a point or two in the following rise, but
history says you won't miss too much. And you could miss
more than a point or two in the market fall as we wait
for the economy to turn around.
Still searching for the Big Bottom...
for The Daily Reckoning
John Mauldin is an investment advisor, an authority on
hedge funds, and a frequent contributor to the Daily
Reckoning and the Fleet Street Letter. You can read his
latest writings or subscribe to his e-letter by going to
www.2000wave.com or sending him a note at:
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The Daily Reckoning:|
author Bill Bonner
Bill Bonner is,
in spite of himself, a natural born contrarian. Early each morning, Bill
writes The Daily
Reckoninghis take on the financial markets and whats going
on in the worldand sends it off by e-mail before most Americans
alarm clocks have buzzed. Many readers say it's the first thing they want
to read when they get upnot only because it's informative and thought
provoking, but also it's inspiring, in its own quirky and provocative way.
Of course, there's
much more to Bill than his daily market commentary. He's also the founder
and president of Agora Publishing, one of the world's most successful
consumer newsletter publishing companies. Bill's passion for international
travel and big ideas are reflected in the company he's successfully built.
In 1979, he began publishing International Living and Hulbert's
Financial Digest . Since then, the company has grown to include
dozens of newsletters focusing on health, travel, and finance. Bill has
vigorously expanded from Agora's home base in Baltimore, Maryland since
the early 90sopening offices in Florida, London, Paris, Ireland, and
subsidiaries include Pickering
& Chatto, a prestigious academic press in London and Les
Belles Lettres in Paris, best known as a publisher of classical
literature in bilingual editions.