Sword of Damocles
Adam Hamilton May 12, 2000 1831 Words
The US equity markets, like the mythical Damocles, continued their great feast at the table of Dionysius this week. The razor sharp two-edged sword of a crash hangs over them, the lights from the party leaving dancing reflections careening off the hardened blade. The markets seem confident the single horsehair securing the massive weapon to the ceiling is not fraying. Unlike Damocles, they fail to recognize that disaster lurks just beyond the senses in even the most fortunate equity markets. The equity bulls look at the horsehair in awe, and in their minds it grows to be a mighty chain securing the dainty sword. The bears see the huge fearsome edge, and in their anticipation can almost hear the horsehair began to fray.
The thread looked a little stronger to the bulls this week. They stampeded on Thursday when the April retail sales report came out, dropping .2% in April. The Producer Price Index report was released this morning (12 May), showing a .3% reduction last month. With the release of the report, the bullish optimism continued this morning, but begin to taper off later in the afternoon. CNBC analysts trumpeted the data, proclaiming all is well, inflation is dead, and the LAST interest rate hike is coming next week. They pointed out that gold is confirming the absence of inflation. The feast continues for the bulls, and the thoughts of structural weakness in the thread fade…
From a bearish perspective, however, much happened this week indicating the thread was fraying. Volume continues to dry up on the major American exchanges, with Monday setting record-low volume days for the year on both the NYSE and NASDAQ. Volume has been low for several weeks, and the bulls should definitely take heed of this phenomenon. Although volume almost always has to increase to create a bull market in an equity, that same stock can easily sink under its own weight in light volume. Interest in trading continues to dry up, with both individual investors trading lots under 10,000 shares and massive institutional investors trading 250,000+ share mega-lots curtailing activity sharply in April. Volatility continued to be the rule, with the NASDAQ losing 430 points, or 11%, between Monday morning and the close Wednesday. Thursday and Friday the index was able to claw back a third of those losses on the Retail Sales and PPI reports, but tactical data continues to indicate serious problems in many of the underlying equity valuations.
The DJIA is hardly worth mentioning, still trading sideways at levels reached over 18 months ago. The market-capitalization weighted average price earnings ratio of the Dow 30 as of yesterday’s close was a still astounding 36, with Disney leading the extreme valuations trading near 90 times earnings. The contrarian play in the Dow remains battered and bruised Phillip Morris, trading at a mere 7 times earnings and sporting a dividend yield of 8%. The besieged giant has gained 25% since February.
A myriad of important individual equity issues continued to show strain. AT&T Wireless (AWE) was the biggest IPO ever a few weeks ago, raising over $10b for the company with an offering price of $29.50. Even with the cool symbol, investors refused to believe the stock was awesome. This morning it was trading well below those levels, at $28. Yesterday, 3% of the outstanding shares of the company changed hands. The failure of the syndicate which underwrote this flagship IPO to maintain a price above the offering brings serious doubts about the continued short-term viability of the IPO market. That surely will have dramatic consequences as the IPO weakness cascades through the market and closes off the taps of financing to the internet and biotech companies continuing to hemorrhage capital. If the profitless speculative deals we have seen in the last twelve months lose access to easy capital, the probability dramatically increases that the long-running equity bull market is nearing the slaughterhouse. The bulls continue to lead contrarians to question their sanity with events like the Land’s End earnings numbers release this week. LE reported earnings last quarter of a penny per share, down an astounding 96% from the year before. Sales dropped by 8% year over year. One would think a rational investor or two would sell a retailer with a 96% drop in profits, but, to everyone’s amazement, the stock was immediately bid up 17% on the day! Who needs profits anyway? What an antiquated concept! Market darling Cisco was hammered for 7% Monday on the heels of an excellent article in Barron’s highlighting exorbitant valuation levels and questionable merger accounting practices. Cisco continued to be liquidated even after it exceeded earnings estimates after the bell on Tuesday. As the largest capitalization NASDAQ stock and one of the three largest capitalized companies in the world, Cisco continues to be closely monitored as a proxy for the entire NASDAQ. If Cisco continues to slide south, which is highly probable at 170x earnings, watch out below for the entire NASDAQ. The Barron’s article should be required reading for every intelligent Cisco investor.
On the inflation front, the Wall Street cheerleaders continued to focus on the two backward looking April reports (PPI and Retail Sales) released this week and completely ignored the larger strategic picture. Behind the soundbytes, the underlying inflation fundamentals continue to deteriorate. The Commodities Research Board Index (CRB), representing a basket of 21 major commodities, continues its trek northward, eclipsing 2 year highs. Oil prices surged dramatically this week, approaching $29.50 a barrel, up 9%. The pundits on TV trumpeting the death of inflation surely must teleport home to the moon each evening and eat green cheese! Any American who actually eats or drives seems to see inflation everywhere. Even the stalwart Walmart announced it was going to raise general prices this week! I guess if we all ignore the general rise in prices, we can join the pundits in wishing inflation out of existence. See no inflation, hear no inflation, speak no inflation … voila! No inflation! Which brings up another point … why does anyone listen to Wall Street when it is touting stocks and the stock markets, and ranting about zero inflation? The analysts on TV are paid based on the number of dollars they can bring into the market. They have zero incentive to tell the truth or be even remotely realistic on future prospects. The whole spectacle reminds me of the proverbial used car salesman trying desperately to sell a lemon at the end of the month so he can have enough money to feed his family. Objectivity does NOT issue forth from Wall Street!
With the Federal Open Market Committee meeting next week, a 50 basis point interest rate hike seems inevitable, both to the bullish and the bearish. The Federal Funds Futures contracts, which have proven correct on anticipating 30 of the last 31 fed funds rate changes, are pricing in a half point increase. The Consumer Price Index report for April is due to be released Tuesday morning, and the FOMC decision in the early afternoon. As in every rate hike since last May, the equity bulls are certain this will be the last rate hike. A Reuters report out of Paris, however, indicated the Organization for Economic Cooperation and Development believe the US Fed will have to raise interest rates by at least another full percentage point to slow the economy and keep inflation at bay. Ssshhhhh. Don’t tell the bulls! With a 50% increase in M3 since 1995, even continued Fed aggression is unlikely to keep the excess money from pouring into the economy and increasing competition for scarce goods. I believe Alan Greenspan has to shock the market to end this speculative insanity, but I think there is too much external political pressure on the Fed for him to end this gradualism nonsense. If the market expects .5, and he raises .5, the market will laugh it off, proclaim it had been expected, and maybe rally moderately. It wouldn’t surprise me if he continues with another measly quarter point hike, though, in order to appease the shareholder bankers of the Federal Reserve who continue to have massive loans collateralized by obscene equity valuations. Tuesday will be interesting.
The dollar has been strong all week, but dropped over a percent and a half today. The Euro, that most unreal of currencies, regained some ground today and closed near $0.92. If the Euro, a bastard step-child of the EU, representing a composite of all the sovereign member countries’ currencies, continues to regain ground against the strong dollar, watch out. Once the historically anomalous returns in the US equity markets vaporize, foreign investors, which America desperately needs to finance our erupting trade deficit, will flee the markets at the speed of light. They will repatriate their local currencies, selling dollars and buying local currencies, initiating a vicious circle where other foreigners are forced to do the same to protect themselves from a plummeting dollar.
Physical gold had an incredibly boring week, although gold shares saw some abnormal volume action and price swings near the market close, especially Monday. Rumors of a merger between Durban Roodeport Deep and Randgold swirled in the middle of the week, but SA and American gold mines continued to be relatively flat in the stoic gold market. The increased volume and ticker visibility of the gold equities may herald forthcoming gold price increases or merger activity in the near future. The manipulation of the physical gold market continues to grow more obvious, with gold being completely listless in equity market situations that would have caused dramatic changes in the past. GATA marched on Washington this week with vast empirical evidence of collusion in manipulation of the gold price, and it will be interesting to observe the fruits of their valiant labors. If the dollar continues to drop, which is highly likely, gold should see some price action in response. With gold being the ultimate safe refuge and mortal nemesis of the dollar, it is sure to benefit as the dollar loses value in the fickle international currency markets.
From a strategic fundamental standpoint, this week sure seemed like the weight of the sword is becoming too heavy for the frail horsehair thread. Maybe a dramatic dollar decline will snap the thread protecting the US equity markets from doom. Maybe it will be an exogenous event that is inherently unpredictable, such as a war or terrorist attack. China continued to harass Taiwan this week, forcing the Miss Universe contest authorities to rename Miss Taiwan to Miss Chinese Taipei. China had no Miss Universe contestant of its own. On a more dire note, China announced large-scale amphibious warfare exercises to run on 20 days surrounding Taiwan’s initiation of its new pro-independence president. Not exactly the kind of news a jittery stock market welcomes, I thinks!
The sword of Damocles continues to hang precariously over the US equity markets. If you are very, very quiet, maybe you can hear it fraying…
Adam Hamilton, CPA May 12, 2000