Weekday Commentary from Jim Puplava
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Market WrapUp for the Week
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Wednesday, October 16, 2002
Are We At the Bottom Yet?
‘Here today, gone tomorrow’ seems to be the pattern in today’s stock markets. Investors haven’t seen markets in this bad of shape since the Great Depression. That was the last time stock indexes fell more than three years in a row. At this point it looks like 2002 will be another year of double-digit losses for investors. You normally get year-end window dressing and asset pumping by mutual funds in December to spruce up performance. However, mutual fund cash levels are very low with very little room to boost prices, especially with withdrawals on the rise. This is turning out to be no ordinary bear market. The Dow was down close to 40% from its high as of last week. The Nasdaq has lost nearly 80% of its value while the S&P 500 is down close to 50%, and we still haven’t reached bottom yet.
How far will it go before a bottom is reached and how long will it take to get there? That is a question Wall Street has been wrong on for the last three years running. First it was a correction in 2001. Then it became a bear market after September 11th. This year it was supposed to be a recovery, which now looks impossible. It will take more than intervention to get this market going again. It will take a miracle. Chances are it may be more than a decade before stock prices ever approach their highs again which may be too hard for many investors to swallow. Historically, markets tend to swing to extremes in both directions. The mania of the 1990’s took stock prices to unbelievable heights. The new century should see the markets fall to incredible new lows. There have been three major bull markets in the last century: the 1920’s, the 1950-60’s, and the 1980-90’s. In each case, stock prices rose to extremes but none of these periods were as extreme as the 90’s bull market. After markets reach these levels, they take decades to correct. The 1920’s bull market took 25 years to surpass former levels and the 1950-60’s took 16 years. We have only undergone three years of corrections. Despite the fluff taken out of the market, stocks still remain expensive by any measure of value. History would suggest we might have another 4 to 9 years before we reach bottom.
How will investors know when a bottom is reached? When everyone is out of their mutual funds and when the industry has shrunk to a shadow of its former size, when dividend yields are at 6-7%, PE multiples are down to 7, and nobody you know will admit owning a stock or mutual fund will we have arrived at a bottom. In the meantime, all we are likely to see is tradable rallies that are brief and furious. Momentary excesses will punctuate the markets; violent upsurges followed by deeper plunges all the way down. In the end the market will have its way despite the best efforts to thwart its course. Valuations will become attractive and sound investment principles will be restored and become fashionable. Patience will one day become a virtue again. Quick fixes and momentary thrills will be unfashionable. When I got in the business in the late 70’s, the investment business lived on Graham and Dodd. I remember reading a speech given by John Templeton. Templeton extolled the virtues of buying when markets were low and stocks were cheap, and then holding on to the stocks for 3-5 years until the markets recognized their value. This stands in sharp contrast to today’s investment climate where 5 minutes, much less five days, can seem like eternity to most investors. Fashions come and go and it is no different in the financial markets. Today’s fad to ‘get rich quick’ will also fade as markets fall even further. As my mother-in-law is so fond of saying, “this too shall pass.”
The Fate of the Investor
For the markets and the fund industry the fate of the individual investor may about to change. Plagued by three consecutive years of losses investors may be ready to throw in the towel. In the last bear market rally this past summer investors pulled $5.8 billion out of stock funds as the major indexes rose. It was the first time in 14 years that stock funds experienced outflows at a time markets were rising. Large cap funds, the favorite type of fund outside index funds, have seen money outflows for their 20th consecutive month for good reason. In the third quarter only 62 funds out of a total of 8,400 actually had positive returns. Most of these were bear market funds that short the market, natural resource or precious metals funds. The financial industry has yet to recognize this trend, which I have written about in the “Next Big Thing.” Assets are slowly exiting the paper markets and heading back into “things” or real assets. The trend hasn’t quite caught on yet as Wall Street, the media and investors chase the last trend in the financial markets. There are still loads of investors still waiting for Intel and Cisco to return to their former heights. This trend has passed and another trend in real assets has taken its place. A look at the breakout in the CRB is a portent of this future trend.
For Wall Street and Main Street, it hasn’t dawned yet that we are in a wartime economy. In war natural resources command a premium. Raw materials are used and expended in instruments of war. In war, things get blown up, broken, and destroyed. Ammunition is expended, bombs and rockets are exploded, and raw materials are commandeered for the production and prosecution of the war. In war faith in paper evaporates as governments inflate their budgets in order to pay for the cost of war. Wars in the past have always been inflationary. There is no reason this time to think that things will be different. We may see deflation in paper and the credit markets, but inflation will be the natural trend of raw materials. If you don’t have a war portfolio you may find yourself out of sync with the markets. This can be viewed by looking at IBD and the strength of sectors that are doing well this year. The US will soon be at war, and the reality of this has not been fully factored into the markets. Most who work on Wall Street were in diapers during the last war. Only the old-timers remember what war can do to a portfolio.
Today on Wall Street
Today credit problems once again surfaced to the front page as several banks and financial institutions reported problems with earnings or with their loan portfolios. J.P. Morgan Chase reported its net income plunged 91% to around $40 million from $449 million the year before. The bank plans on cutting an additional 2,000 personnel. The bank wrote down $834 million in bad loans, mostly in telecomm and in cable, and still has an additional $300 million at risk in Argentina; then there is Brazil. As one money manager put it, “They really don’t have a complete handle on the depth of what’s gone wrong on the credit side for them.” At risk now for investors is the banks hefty dividend, now at 7.5%. The bank isn’t earning enough to cover this dividend without dipping into capital. The smart thing to do would be to cut it. However, a lower stock price and another possible credit downgrade may then impact the bank’s derivative book and credit standing.
In addition to J.P. Morgan’s woes, S&P downgraded GM’s debt as notch from BBB+ to BBB, one level above junk bond status. GM has $187 billion of total debt. S&P said it is also reviewing Ford’s debt, which has total debt of $162 billion. Both GM and Ford have been hit hard by losses in their pension plan. Those losses will require both companies to make additional contributions out of earnings next year. GM’s pension shortfall is $28 billion, which is nearly double that of last year where it stood at $12 billion.
Capital One Financial Corp shares fell as much as 26% today after the fifth biggest issuer of MasterCard and Visa said credit card losses would climb through the remainder of this year and next. Capital One wrote off 4.96% of its loans in the third quarter. The company said that figure may rise to as high as 6% in the fourth quarter. In July federal regulators who monitor Capital One closely made the company boost its loan loss reserves and increase risk controls.
In other credit related matters, Brazil is drawing down its reserves to pay off debt that is maturing this month. Brazil has refinanced only about 20% of its loans coming due this month. A plunging currency and stock market, which has lost over 63% this year has made it difficult for the country to roll over its debt. Brazil must refinance another $20.8 billion by the end of the year. Raising money in the debt markets has become difficult because of a plunging currency and speculation that the Lula, the Socialist Workers Party candidate, has in the past advocated defaulting on the country’s massive ($250-$300 billion) debt. Brazil may become the next financial crisis as the dominoes continue to fall throughout Latin America heading their way North.
Today’s Market
Outside credit concerns markets fell as a result of more earnings warnings beginning with last night’s announcement by Intel. Intel said things still aren’t looking good. The Dow fell 2.7%, the S&P 500 lost 2.4% and the NASDAQ lost close to 4%. The market’s losses today were just as lopsided as yesterday’s gains. Declining stocks fell by a 3 to 1 margin on the NYSE and the Nasdaq. Volume was heavy with 1.6 billion shares trading hands on the big board. The VIX rose 2.23 points to 41.97 and the VXN rose .50 to 56.87.
Overseas Markets
European stocks fell as companies from Reuters Group Plc to Intel Corp. lowered sales forecasts, shaking optimism that corporate earnings and share prices will rebound this year. The Dow Jones Stoxx 50 Index shed 1.9% to 2536.71. All eight major European markets were down during today’s trading.
Asian stocks rose as a rally in U.S. equities spurred by higher corporate profits boosted optimism that the region's largest overseas market is recovering. Honda Motor Co., Hyundai Motor Co. and other exporters gained. Japan's Nikkei 225 Stock Average added 0.5% to 8884.87, completing a three-day gain of 5.3%.
Bond Markets
Treasuries have been under assault over the past few trading sessions amid mammoth gains for stocks. The 10-year Treasury note slid 12/32 to yield 4.04% while the 30-year government bond was off 15/32 to yield 4.995%. No economic news was scheduled for release on Wednesday. Thursday's data docket will be busy, and will include the release of weekly initial claims, September housing starts--seen coming in at a 1.63 million level--and the industrial production and capacity utilization figures for September.
© Copyright Jim Puplava, October 16, 2002