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Stocks Add to Yesterday’s Gains

http://www.financialsense.com/Market/wrapup.htm

The high flying NASDAQ Composite Index added another 25 points today, which has extended the rally since the October lows of last year to make a new 14-month high. The Dow Industrials remained in negative territory for most of the day, but a late surge of buying pushed the Industrials into the plus column by six points with a close of 9,223, while the S&P 500 also added marginally to yesterday’s gains with an increase of three points to close at 1,007. The debate rages on; are we in a new bull market or are we at the tail-end of a bear market rally? It doesn’t really matter much what you call it; the question remains, will stocks continue to climb or roll-over to new lows?

What bothers me most about this rally is the fact that there is nothing out there that can justify the fundamental valuations. Stocks are still way too expensive for the amount of earnings they will generate for the shareholders. This rally is being driven by pure momentum, hope and hype. This is what the professionals refer to as a “technical rally.” Don’t even trouble yourself by looking at business plans, debt ratios, price/earnings ratios, sales growth, etc. Fundamentals don’t work when fund managers, individual investors and institutions are chasing returns to buy anything that’s moving up in price.

Buyer Beware

To jump into stocks on the long side requires some guts in my opinion! The lack of fundamental strength in this market and the fact that the individual investor is jumping back in with both feet are signs of trouble ahead. When I see momentum buying and sentiment indicators screaming euphoria, the contrarian in me says to stay away. As the NASDAQ moves higher, more people jump on board to get a piece of the action. The way I see it, the higher the market moves, the greater is the risk that it could move back down. Investors buying stocks in this environment can only be operating on “The Greater Fool Theory.” To buy a stock at today’s price means that you believe that there is a fool out there greater than you that will be willing to purchase the shares from you at an even higher price. I’m not quite sure where momentum investing stops and the greater fool theory begins, but somewhere in the middle there should be good fundamental reasons to own a company, otherwise it is pure speculation.

Some of you might consider me the greater fool for not participating in this rally, but I prefer to do without the risk. Money can be made in these markets without taking on inordinate risk. I guess I just dislike losing money more than I feel a desperate need to chase rising equities along with rising risk. I would rather work to preserve capital for now and deploy the capital more aggressively when the markets operate on fact instead of fiction and hope.

When you get right down to it, the stock market is telling us right now that investors believe the work of the government tax cuts and easy monetary policy from the Fed are going to rescue the economy. It’s that simple. The market believes all the stimulus will work. It has every time in the past. Every time we have had economic or financial problems, the Fed opens the money spigot and like magic it’s all fixed and we’re off to chasing riches again. Think about it folks, how many balls can the Fed keep juggling to impute value that just isn’t there? Now we have stocks, bonds and real estate, ALL THREE, with artificially high valuations driven by increasing debt loads.

Higher Interest Rates = Problem

The problem right now with the “assumed” economic recovery is that money is now flowing out of bonds and back to the stock market, which is effectively raising interest rates. In the last three weeks, interest rates have gone up over 60 basis points for the 10-year Treasury Note, which means mortgage rates are on the rise. I believe the Fed has been counting on long-term interest rates remaining low, to the point that they would intervene should it become necessary. Next week Alan Greenspan will address the House Financial Services Committee (on Tuesday) with his semi-annual report on the economy and monetary policy. Since interest rates have been climbing the last three weeks, there is a very good chance that Greenspan will target the long bond with RHETORIC (no real action) that will influence money to move back into bonds. The timing is just about perfect, since bonds are approaching an oversold condition which should correct to the upside, especially with a little help from Uncle Al.

Mergers and Acquisitions

I don’t usually go into detail on specific companies, but I thought this little “industry tidbit” was an interesting development. In Bloomberg news, the lead sentence to the article reads, “Yellow Corp., the second-biggest U.S. trucking company by sales, agreed to buy larger rival Roadway Corp. for $966 million in cash and shares to lower costs and broaden the combined companies’ customer base.” This follows just nine months after the third-largest U.S. trucker, Consolidated Freightways Corp., shut down their operations. If you like to buy companies that monopolize an industry, this could be a good one.

As of a year ago, there were only four companies that handle “LTL freight.” LTL stands for “Less than Truckload,” which means they are freight consolidators. Basically, they combine many small freight orders at terminals that are strategically located around the country. Orders traveling in the same direction go on full trucks to maximize efficiencies, where they are then delivered to a local terminal, broken down to local routes and then delivered. Now you are looking at one trucking company that has the combined strength of the two leaders, with the number three player out of business. The new company will only have to deal with one competitor, Arkansas Best Freight Systems (ABFS), which is much smaller since they were number four in the industry to begin with.

We are clearly seeing a consolidation in the trucking and distribution business. Somewhere down the road, the players that are left standing will inherit all the remaining freight in the USA. It makes me think of Warren Buffett’s purchase of the McLane Company (Walmart’s distribution network). Remember that McLane’s big competitor in food distribution was the Fleming Company, who went belly-up not too long ago. Mr. Buffett was really on his game when he identified the opportunity in the distribution business. He will have guaranteed business since the goods must get to the marketplace. Roadway Corp. added $16.08 per share today or a WHOPPING 53.6%, VERY NICE!!!

Out of time, gotta' run. Have a great week!

Copyright © 2003 Mike Hartman
July 8, 2003