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10/21/02  

Extended Commentary- 5/28/02

I wanted to give a broader view and expression of feelings about this market than possible in a daily commentary. 

First, despite very aggressive Fed action and very low rates, this market has not responded to monetary policy. Japan peaked in 1987, and did not respond to very aggressive fiscal and monetary policy and it is still mired in a bear market, over 79% below its peak. Are we in for the same fate? To an extent..... yes! Japan lost its economic edge, having been built on process industries. We supplanted them by building new technologies faster than they could duplicate. 

Unfortunately, we overbuilt and overspent and created a monster hangover of overcapacity. We decimated our venture capital industry in the process. Unlike Japan, our banking system is in good shape, while the Japanese banking system is arguably bankrupt if honestly accounted for. So much of our growth and the dollar's strength was built on a foundation of tech and telecom innovation, which involved too much "profitless prosperity". Does that sound similar to the Japanese consumer electronics, banking, and real estate businesses.

We are overvalued, and even with low interest rates, it is hard to say we are below fair value, by any yardstick you choose to use. If we edit out tech and telecom, the picture improves, but other sectors are not exactly to "die for".  

Technically, the charts of most sectors are uninspiring or downright scary. While several days of strong rally can create some swing trade opportunities, the charts telling you that sailing without wind is a fruitless activity. For this market, mixed metaphors are appropriate. 

Wall Street may, in a fit of honesty and to defuse the crisis of confidence, may start issuing outright sell recommendations on equities. The perma-bull approach of some firms represented by the like of so-called "market gurus" is now anathema. While Barton Biggs has gotten this market right, he is almost persona non grata, illustrating that Wall Street is completely biased to be bullish. In other words, the principle guiding light of retail and institutional opinion is horrendous in a down market.  

What else? Our capital markets are bereft of a viable venture capital market, so important in establishing economic hegemony. Now, our investment banks may see legal challenges that will make the asbestos situation look mild. This could serve to increase the cost of capital and cripple innovation for some period of time. 

We clearly have a crisis of confidence with investors who now do not trust corporate America, the accounting firms, or the buy or sell side of the street. Where do investors turn? The mattress?

 The market must deal with a daily drumbeat of terroist warnings, which has little countervailing benefit, other than for defense stocks. Normally, there is tremendous value in solving problems, but not in this case, unless you own Raytheon. 

While gold is rising, other metals are not hot, suggesting gold is rising as a safe haven in a troubled world, and is not anticipating an impending and dramatic economic recovery. While a recovery from the dead economy is underway, it appears fragile and shallow. 

The economy had lower oil prices, easy money, mortgage refinancings, tax rebates, huge auto rebates, etc. to get the economy moving. What do we have now to keep us moving?

What about regressing to the mean return for the markets? Doesn't that imply future returns of, at best, 6% to redress the outperformance of the 80's and 90's? As we have seen in Japan, this adjustment can take years. While American business is lean and mean and any pickup could disproportionately drop to the bottom line, there is no pricing power, so that improvement must come from more units, not higher prices. Without any obvious impetus for dramatic economic improvement, there is no bright light for optimism.  

There is little on the positive side to inspire. We continue to suggest looking for the promising sectors and companies, set modest targets and keep tight stops. If you find good entry points without much overhead, rather than selling, raise your stops. Cash is not equivalent to the plague. If you cannot find reasonable values, head for the sidelines.  

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