Fear and Loathing on Wall Street
10/15/09
Just like last quarter, Intel pulled off a surprisingly strong quarter that caught bears and underinvested bulls by surprise. There was a scramble to reposition, which meant even a mild pullback was used as an opportunity to buy. There isn't much new that can be said about this market. It continues to be tremendously strong and is causing massive frustration for folks who are trying to add long exposure. I won't even bother to mention how frustrating it must be for the bears who keep focusing on the fundamentals that simply don't seem to matter. There are only 53 trading days left in 2009 and that is the only thing that matters right now. Fundamentals be damned, investment managers either need to risk their clients capital and chase performance or risk losing the accounts altogether. It is one thing to lose money when everybody else is losing money also. It is an entirely different thing, however, if your clients lose money while everybody is making money hand over fist. No professional can survive that argument. This, however, is occurring around the country right now. Managers are forced to throw in the towel (and caution to the wind) and are forced to find exposure to stocks no matter how. As long as this occurs (at least for the next 53 days) the market will not correct in a meaningful way. Every weakness will be used to put money to work. We have seen a series of higher highs and lows over the past few months with a very obvious pattern of peaks and troughs. Monday's intraday high, followed by Tuesday's very slight pullback, would have (should have) flashed a perfect "time to take profits" signal. The key equities indexes should have pulled back. But they did not and that is important. Broken price patterns are often more informative than completed price patterns. Dan Fitzpatrick explained it today like this: "The only reason the S&P; has not pulled back is because of all the scared money out there. No, not scared equity positions. Scared money looking for a decent opportunity to be exchanged for stock so that it can get into the game." Not much has changed in this respect for the last 3 months. Take a look at the following charts.
The above data underlying these charts have been obtained from the Securities Industry and Financial Markets Association (SIFMA). The red line shows the amount of money being held in equity mutual funds. The low point was reached in February at $3,105 billion. Since then, assets in equity mutual funds have increased to $4,511 billion. This amount lies about $2 trillion below the all time peak of $6.5 trillion, which had been reached in 2007. What I find most fascinating is the fact that bond fund assets have reached an all time high. Investors are seeking safety, i.e. return of investment (not necessarily return on investment) and therefore invest in fixed income mutual funds ... come again? Yes, they will never learn. Bonds may be less risky than equities, but Bond Mutual Funds are just as risky as Equity Mutual Funds! The last time we had a real life lesson to this effect was during the Orange County crisis in 1994 when investors and the pension fund of Orange County found out that Bond Mutual Funds were not the same as simply holding the bonds themselves. Although the funds were labeled "government bond funds" and therefore implied safety, they were anything but safe. It just depends how your money is used and if leverage is applied or not. In 1994 those government bonds funds not only bought government bonds. A fund could not shine with that. They also invested in interest only bonds (IO bonds) and other esoteric instruments, which gave them a higher yield as long as interest rates stayed stable or were falling. To further enhance the yield they did all that with borrowed money, too. When Greenspan raised the Fed Funds rate from 3% to 6%, all those instruments declined in price. The ensuing massacre in the fixed income markets wiped out Orange County's entire pension system. The bond funds fell in value because they had to trade around their positions a lot, especially to meet redemptions. Had investors bought the government bond outright, they would have survived the price decline by simply holding the bond to maturity. That was 1994. Today, investors are facing the same dilemma. They often do not know what positions their hedge funds are holding, how liquid they are and how prices are being determined. As long as they are holding Government Bond Funds, they may feel safe but they are anything but safe. Still, money keeps on accumulating in bond funds just when yields are approaching some historic lows again. Go figure. It seems that the shock to investors psyche will take some time to wear off. Good for the stock market bulls, bad for the bears.
The National Federation of Independent Businesses released its report for October. Only 8% of its members have job openings now, credit is still hard to get and many fear that they will need to cut prices of their goods and services in the near future. One hopeful sign was that, for the first time in three years, most independent business owners say that their inventories are not excessive. That is good news and is supported by the fact that business inventories (first chart above) fell 1.5% in August after falling 1.1% in July. Waiting for the inventory destocking to end is getting tedious, but, at the same time, the inventory number is good for many reasons. The inventory destocking should be completed sometime before year end and that alone should increase the annual GDP number by over 1%. Imagine what would happen if merchants regain their confidence and start restocking their inventories. This alone should increase our annual GDP by close to 3%. Third quarter GDP is now estimated to come in at 3% (with falling inventories), which is much less than what we normally see in the early quarters after a recession. Add to that the fact that the bulk of all government stimulus measures will be spent in 2010 and one can justify the continued optimism on Wall Street. Or was it forced optimism by virtue of rising stock prices? Either way, market participants (or better non-participants) are being dragged into the equity market kicking and screaming. As long as the inventory restocking has not even begun, we cannot estimate the speed and intensity of the inventory rebuild and therefore it becomes this big amorphous positive threat hanging over the markets and all who dare to defy this recovery cycle. It is true that the consumer in general is still overleveraged compared to historical standards and that continued high unemployment will dent our confidence just enough to prevent the rest of us on splurging away our earnings. It is also true, however, that 90% of the work force (or 84% if you use the U-6 numbers of "marginally attached workers) are still employed. Somehow those 84% to 90% of us have managed to keep this country going. They just might be able to pull the other 10% back into the boat.
Hermann Vohs
"For most investors, performance is better achieved with a telescope than a microscope."
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Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
