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Fleckenstein: says the market is broken

Wall Street great says the market is broken


Investing pioneer John Templeton believes there is still huge downside risk to the stock market -- and he's almost as bearish on house prices.

By Bill Fleckenstein
Posted 7/14

Wall Street has its statesmen and its noisemakers. Into the former camp fall the likes of Warren Buffett, the late Leon Levy and John Templeton, the founder of the Templeton funds group. Their wisdom is there for the taking, but when it's deemed to be "pessimistic," folks turn away.

That's where the noisemakers come in, ready to rev up any story that gets people buying stocks. Some technology chieftains have demonstrated remarkable skill in that arena. After all, the performance of their stock options depends on folks' willingness to believe. Imagine, then, the scene behind closed doors when Microsoft (MSFT, news, msgs) announced its decision to show options the door.

Templeton’s take: The stock market is broken
Last week, a friend was kind enough to e-mail a copy of an interview that Sir John Templeton gave recently to Robert J. Flaherty of Equities magazine. I, in turn, would like to share its wisdom with readers of the Contrarian Chronicles.

During previous interviews with the publication in 1999 and 2000, Sir John said investors should expect a 1929-style crash in stocks. Flaherty notes that those earlier interviews prompted two very different responses. Some folks expressed gratitude for the money they'd saved by reading Sir John's comments (both at the time and later), while others opined that Sir John was "old and out of touch," and what did he know about today's market, anyway?

In his current interview, Sir John, who is now 90, devotes most of his thoughts to the housing market. What he tells Flaherty comes as surprise to the downside, since the writer had been expecting to hear more encouraging words: "Because I was hoping for good news," Flaherty writes, "I was personally taken aback and depressed by Sir John's short-term pessimism."

In that vein, Sir John offers this observation about Wall Street at large: "The stock market is broken, and it will take some time, maybe years, to repair it. Mass media, especially TV (read: Bubblevision) today is so short-term that few in its audience grasp the lasting damage and corrective impact which will continue to linger from the greatest financial crash in world history."

He continues: "It would be unlikely that the bear market is over when the American stock market is only down about 30%, when in the biggest boom ever, it had been up 10 times over where it had been years earlier. . . . Following such a large increase, a 30% decrease is small." (I am assuming that here, he was obviously not talking about the Nasdaq ($COMPX).)

I guess I like that passage because it's a refrain that I've often pounded away at in my daily column.

Bear markets and housing markets
Moving on to housing prices, Sir John comments: "Every previous major bear market has been accompanied by a bear market in home prices. . . . This time, home prices have gone up 20%, and this represents a very dangerous situation. When home prices do start down, they will fall remarkably far. In Japan, home prices are down to less than half what they were at the stock market peak." Sir John adds, "A home price decline of as little as 20% would put a lot of people in bankruptcy."

Sir John also had a few words about debt -- a four-letter word that folks seem not to care about: "Emphasize in your magazine how big the debt is. . . . The total debt of America is now $31 trillion. That is three times the GNP of the U.S. That is unprecedented in a major nation. No nation has ever had such a big debt as America has, and it's bigger than it was at the peak of the stock market boom. Think of the dangers involved. Almost everyone has a home mortgage, and some are 89% of the value of the home (and yes, some are more). If home prices start down, there will be bankruptcies, and in bankruptcy, houses are sold at lower prices, pushing home prices down further." On that note, he has a word of advice: "After home prices go down to one-tenth of the highest price homeowners paid, then buy."

Well, that's a pretty extreme view, even for me. But I guess it shows you how bearish Sir John is. I'm sure his latest comments will elicit the same kind of response as when he shared his bearish views during the bubble -- that he just doesn't get it. (It's certainly the earful that I and others heard on the back of our bearish sentiments.) Folks who make that argument, protesting that this time it's different, are generally in the unfortunate position of having confused a bull market/rising prices with brains.

Of restricted stock and the Microsoft flock
Last week's big news was Microsoft's announcement that it would replace stock options with restricted stock and treat remaining options as an expense. Microsoft's move is an intellectually honest one, in my opinion, and a rather brilliant one at that. By awarding restricted shares to its employees, it's basically issuing a form of golden handcuffs: the shares vest over time, and the employees must remain with the company in order to sell them. Since Microsoft's stock amounts to a pretty stable form of currency (which is not to say it can't go down, but that a total collapse is unlikely), I believe this will give the company an added edge in attracting top talent. Other companies interested in aping Microsoft may not have as stable a stock, and, of course, most stocks in technology remain wildly, wildly overinflated. Microsoft may be expensive, but I don't consider it to be as egregiously valued as several others. (And, yes, I know, Microsoft is the publisher of MSN Money.)

Microsoft’s move should put pressure on other companies to start expensing options and go the same route, though lots of companies will resist the change. The wampum kings, as represented by Cisco Systems (CSCO, news, msgs) CEO John Chambers, will certainly resist it, as will Craig Barrett at Intel (INTC, news, msgs). But over time, I suspect that these other companies will also be forced to expense options, and probably will be forced to do something like Microsoft has done. In any case, I applaud the move, as it obviously aligns everyone's interests more closely.

Silver shows signs of a rebound
Turning to an arena that I refer to in my daily column as "away from stocks," my contacts close to the silver market note that it's "changing" (and they continue to be bullish). Finally, we are seeing the earliest signs of investment demand, something that's been missing from the silver market thus far. Folks have already decided they want to own gold as protection from the Fed's printing presses, and it now appears that a little of the same kind of money is trickling into silver. As a much smaller market than gold, it stands to benefit disproportionately. That said, silver remains very volatile, and the uptick in investment demand is in its infancy. But this glimmer of change strikes me as a big deal.

Fixed income, too, may be witnessing an interesting change, on the back of last Wednesday's news that Peter Fisher will step down as Treasury undersecretary. Fisher had been adamant that 30-year bonds wouldn't be issued on his watch. Now that he's going, and, in view of our government's exploding deficit, perhaps the Treasury may start issuing 30-year bonds again. So, for anyone who has an interest in the long bond, this may turn out to matter.

Of please-wait mail and hate mail
Finally, a closing word or two on my e-mail. I continue to try to answer your questions as best I can, but a backlog of nearly 600 has thrown a wrench into responding in a timely manner. Please bear with me and keep sending in your questions to my site, Fleckensteincapital.com, as I do grind through them. If I don't answer your e-mail specifically, it may be lodged in my in-box (most of them now are older e-mails), or perhaps I've already answered a similar question.

Also, for those of you keeping score at home, my hate-mail indicator predictably went 'tilt' last week, indicating this phase of the rally might be on borrowed time. I'm not sure when it will end, but all the signs of speculative activity and sentiment changes are in place, and it could happen at any moment. I only short a little and very, very judiciously, until I see signs of a failed rally. (Last week’s sell-off was more like exhaustion. But I have been stepping up my purchase of fall puts, as I think we will see a total collapse before the fall is out.)

Meantime, I continue to be struck by the number of bulls given to end-zone dancing. This reminds me of the apocryphal story concerning advice by a football coach to one of his players: If you happen to get in the end zone, don't act like it's the first time it's happened.

Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At the time of publication, he held long positions in put options for Cisco and Intel. He is also short Cisco and Intel common stock. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC on MSN Money.

http://moneycentral.msn.com/content/p52744.asp