Zeev's Turnips Patch-No Politics (ZEEV)

[gloe]

Market Rap
A Perspective, From the Precipice
By Bill Fleckenstein
Special to RealMoney.com

09/05/2003 06:37 PM EDT
URL: http://www.thestreet.com/p/rmoney/marketrap/10112061.html

"The overnight markets were totally unremarkable, meriting no further comment. This morning's economic data, though, were noteworthy. Folks had expected the economy to have generated 20,000 jobs in August. It turns out we lost 93,000. The Liscio Report described the ugly number as follows:

"The headline number, a decline of 93,000 in nonfarm payrolls, was a major disappointment, but the numbers under the surface offered no comfort either. Two months ago, we noted that we've never seen five consecutive months of job loss outside a recession; we've now got to up that to seven months. Since January, we've lost 595,000 jobs.

"In a real recession, we'd be losing that many every couple of months, but in a real recovery, we'd be adding that many every couple of months. Since the recession ended in November 2001, 1.1 million jobs have disappeared; were this a normal recovery, we'd have added 6.7 million." Those are the facts. "Spin" them at your peril.

Chimera of a Self-Sustaining Recovery: While employment is a lagging indicator, the continual loss of jobs and the low prospect that I see for a turnaround continue to bolster my belief that the economic recovery will not be self-sustaining. Yes, the tax cut helped. Yes, the rise in the stock market helped. Yes, up until recently, lower rates and the refinancing boom helped. Housing also saw another spurt as last-gasp interest-rate timers jump on board.

But all of this now lies in the past. There is no self-sustaining process at work in the economy -- in the face of the massive excess capacity that was spawned by the bubble, and the competitive nature of a post-cold-war NAFTA world. We continue to lose jobs to other countries. We are not able to export much that the world wants, witness the size of our trade deficit, at 5% of GDP.

We have piled up mounds of debt. Every year, it takes more debt to generate an incremental dollar of GDP, such that the national debt is now around $35 trillion, as compared to a $10 trillion economy. Consumers have leveraged up appreciating home values to live beyond their means. But they are so spent up that auto sales are flagging, even in the face of zero-percent financing and rebates. There has been some incremental good news from certain tech companies. But that's because they are the companies that sell to companies that may be building up inventory. There are no real signs of an improvement in end demand.

Dawning of Insight, Downside for Equities: This pretty much encapsulates where we were as we headed into today. In my view, the dislocation that I expect to see in the market will be precipitated by a change in folks' "macro view." They will realize that we do not have a self-sustaining recovery, that the Fed is not able to "bring it," and that here we are, as I described, with no cavalry to call and big problems to face. That is not the kind of environment in which the S&P can sustain itself at 30 times earnings of questionable caliber -- never mind that the level of public trust for the financial stewards and corporate chieftains is pretty low, as well. The only question is, what will break that psychology?

Coming into today, I thought a bad economic number could be that catalyst, though I could also see how, in the present environment, folks might ignore it for the time being. On that score, as I prepared my course of action for today, I had a mental checklist of what I wanted to see, and what I would do if I saw it (more about that below).

Diction on the Courage of Conviction: I've received a number of emails from folks who are agitated because they feel like they missed the rally. My comment is that you can't have it both ways. If you want to keep your risks down, you can't be upset that you didn't participate in a game of three-card monte (though the time to decide was last February/March, when the coming rally was obvious, as I noted in my Feb. 12 column , "War Anticipation and Rally Rumination." Occasionally, people win the lottery, and people win at the track, but just because they do that doesn't mean you should waste your money in that fashion, hoping to get lucky.

I would just add that the rally's duration has caused people to doubt whether anything bad can happen, which of course is what always happens after a long rally. In short, the psychology is just perfect for the rug to finally get pulled out from underneath the market. Exactly when that will occur is what remains to be determined.

Bearing and Bulling One's Soul: In any case, that summarizes what I believe unequivocally, just so there is no confusion. My investment position (coming into today) represented my views: Short Intel (INTC:Nasdaq) . Long Intel puts. Short Applied Materials (AMAT:Nasdaq) . Long Applied Materials puts. But I am also long more Advanced Micro Devices (AMD:NYSE) than short Intel, for reasons I have described , even though I think there is more money to be made by being short Intel than being long AMD. I am long silver, long Pan-American Silver (PAAS:Nasdaq) , where I am a director and interested shareholder. I'm long gold, long Newmont Mining (NEM:NYSE) , long Annaly Mortgage (NLY:NYSE) , long euros and Canadian dollars.

Bill Gross, Far From the MAD-ding Crowd: I offer this up as introduction to a piece recently penned by Bill Gross, titled "What, WE Worry?" As is often the case, I'm sure this will rapidly make its way around the Internet. That is a good thing, as his important points have not received much air time. Meanwhile, I would like to reprise a few of them today. First off, he says that his view "rests on the growing reality that the U.S. is overextended, not just militarily but economically. We are trying to do too much, borrow too much, spend too much, and sooner, perhaps later, we will have to suffer the consequences. We are a country in the beginning stages of what can be aptly described as hegemonic decay. But decay from a hegemon's perspective is something that more appropriately belongs in a Gibbon's Decline and Fall of the Roman Empire context.

"Empires take decades if not centuries to wither, and the perspective is more easily viewed from a rear-view mirror, as opposed to a windshield. Politicians, investors, and citizens alike no doubt would choose Alfred E. Neuman rather than Edward Gibbon as their spokesman. 'What, we worry?' is pretty much our national motto when it comes to our finance-based economy and its future prospects."

Those are very potent, frightening, and well-chosen words. I believe every one of them, I am sorry to say. I believe the die is pretty much cast. Had we pursued more intelligent options after the bubble burst, instead of trying to print our way through it, perhaps our potential outcome would be less dire. But we haven't, and it is.

Continuing on, he creates the metaphor of an American family called the Newmans (after Alfred E. Newman) to describe the situation faced by our nation. He writes: "For years, Americans have wanted to save money, but the savings rate has hovered close to 0. They have depended upon those 1990s capital gains to give the impression that their liquid assets were on the rise.

"In turn, U.S. citizens have had to borrow 4%, 5%, 6% of their annual income (GDP) in order to pay for what they want. Economists call that the trade deficit. . . . Add to that, new evidence that our government's deficit, the budget deficit, is running at $450 billion-plus, with few prospects for improvement (a new prescription drug bill and Alternative Minimum tax adjustment will add nearly $100 billion annually to the total, and Iraq perhaps $50 billion more).

"President Bush and his economic team claim that the $450 billion is well spent, that it is an investment in America, and after all, 'we owe it to ourselves.' Such nonsense belongs in Mad Magazine [the emphasis is mine] . The $450 billion is paying for overconsumption, for Hummers in L.A. and Hummvees in Iraq, and we increasingly owe it to foreign creditors. It is plain for all to see that we are living beyond our ability to pay." Again, powerful words, and sadly, they are true. We do not owe the money to ourselves. We owe much of it to foreigners.


So far, foreigners seem OK with this. We've recently experienced a nice rebound in the dollar as the world has acted on its faith in our economic growth prospects by chasing our currency. I believe that rally is history. According to Bill Gross, with whom I agree, it is from abroad that Americans will learn "discipline." He says, "The spending/savings discipline necessary to right their [the Newmans, i.e., the United States] financial ship has to come from the outside. They won't stop on their own." This is why I have been watching the dollar so carefully. As I have noted from time to time in my "away-from-stocks" comments, this is part of the mosaic for trying to determine when all these things may start to matter.

Next, Gross notes that for the moment, no one seems to care about our problems, because the economy "appears to be chuggin' right along." (Note the word "appears.") He sums up: "Are the Newmans worrying yet? Not if they bought stocks six months ago. Not if they refinanced their home in early June or bought that Hummer with 0% financing. But they will [my emphasis] . The Newmans represent your future, your country, and your money, and to think otherwise would clearly be MAD."

Folks can choose to ignore the truth in these mighty-sobering words. They can continue to chase stocks at 30 times earnings for the S&P, and hundreds times earnings for Nasdaq speculative playthings. Or, they can recognize what lies ahead and position themselves appropriately. The choice is up to everyone. The facts are there. The decision shouldn't be so hard. If you are a speculator who likes to play the game and feels capable, that's great. But for those who can't, they shouldn't try, and they shouldn't feel bad about not trying.

Outside Markets Under the Influence: Back to the market action, and to take things in reverse order from usual, the euro exploded higher after the employment report, to close on its high tick, up over 1.5%. I think that buoyed the metals, as silver was up over 2% and gold up better than 1%. Fixed income loved the weakness, to the tune of a buck-and-a-half gain for the 10-year.

All morning, I was paying keen attention to the metals and the euro as the stock market tried to shrug off the employment report. Its attempt at bravado fell apart about noon eastern time, and the rest of the afternoon saw a selloff, save for a late-day short-covering rally that set the prices you see in the box scores.

It was interesting to note that SOX stocks bucked the trend, and that housing stocks were the weakest area. However, I think the innards really don't matter. I had been looking for a poor employment number today, and planned on getting aggressively short if the market was unable to ignore it. That action was corroborated by the outside markets as previously described.

Therefore, I put on a pretty sizable short position in S&P futures, as opposed to individual stocks, because to my mind, it's "all one trade" at this moment. However, I think today's action in essence resulted in a hung jury.

The Odor of Exhaustion: I don't know if I will be chased out of this trade first thing Monday morning, or if this is the start of a big winner and I will be adding to it. But it's the first time I have done anything quite so aggressive in well over a year. My hunch, and it's just an educated guess, is that this may finally be the exhaustion I have been looking for and thought we might have seen on a couple different occasions.

The safest approach to shorting the market would be to wait for a decent decline and then sell a failed rally. But the setup is such that I felt it was worth risking a small amount to attempt to capture this inflection point. Obviously, I will be more interested than usual to see how the market action plays out on Monday and Tuesday."