If I hadn't learned, the hard way, in the late 1990s, that Lord Keynes was entirely correct to suggest that markets can stay irrational far longer than investors can stay solvent, I might be tempted to do something foolish, like call a top. Instead, I called Justin Mamis. My mission: to find out what clues his gimlet eye for technical trends and his vast experience in the market were providing him. What I found was a portrait of the analyst as a frustrated man.
The "good" news, Justin relays, is his wife's observation that his is the rare sort of frustration that has always, in the past, heralded truly significant changes in market trends. The bad news is not only that the change will likely be in a significantly negative direction, but that nothing he watches is giving Justin a clue on timing. -KMW
Justin, did I catch you muttering about a "flawed market"?
You and my wife. The thing is, all the indicators everyone has relied on for years to try to get a handle on what the market will look like in the future have become unreliable. And yes, I realize that to call the market flawed here reveals an "old" man's prejudices-make that his preference for what he's used to. Then again, what has changed about the NYSE Specialist System since I once roamed the floor is, indeed, flawed. And it does seem that a Pandora's box has been opened by the bursting of the bubble: Enron, Tyco, Parmalat and all the rest; the mutual fund malfeasances, the one-way Street kind of breadth days, penny spreads, the dominance of program trading and ETFs [exchange-traded funds], public disinterest (except from hardcore speculators), etc., etc. Then too, you see, I'm firmly convinced that all of the debris from the stock market bubble hasn't been washed away.
I detect no little frustration in your voice-
People – and institutions – simply are not trading or investing the way they used to. It's part and parcel of the ways so many hedge funds and trading desks work these days. I know someone who used to be a very active trader – and technician – in Boston. But his desk has no time – or use – for technical studies anymore. His traders don't day trade, they "moment-to-moment trade." He's invited me up there to watch, but I really don't want to see it. I wouldn't understand. Actually, I do. They make a trade here and a trade there, buying 5,000 of this or 50,000 of that-and then they sell it before you know it. That can generate a very profitable day, when they're trading for 13 cents and don't take any real risk. So they do it all the time. They buy virtually any stock that is down 5, figuring, simply, that it is sure to bounce-then they sell. That is all they do. They are not doing anything more than just scalping, really. Trading in pennies has made it all so easy, because there's almost no cost anymore to the way most of them do business. In the old days, even a floor trader had to figure on making at least a quarter-point on a trade to come out ahead. Now the institutions, the hedge funds, all trade for two or three cents a share.
Those pennies add up.
Absolutely. There is also a lot of ETF and program trading going on. Now, I haven't worked out yet exactly how either of those two affect the market – except that there are many more transactions than there used to be that are merely arbitrage; many more trades that are merely minute-to-minute; and a lot fewer that represent any commitment to any sort of long-term investment thesis. All this is supposedly wonderful; the computers let everybody do five different things at once and hedge every which way. But the ETFs have to be dangerous long-term.
Why do you say that?
Because if – when – the market turns down again, they will have to accelerate the selling – if someone is dumping ETF shares, someone else is going to be dumping the baskets of stocks those ETFs represent. That just has to accelerate a decline
A la program insurance?
Yes, that is the underlying problem with all derivatives. It's also part of what happens now, when the averages spike up so frequently. I know hedge fund people who do nothing anymore but trade ETFs. They can't be bothered trying to figure out which stock in a group is the right one to buy.
I know, all the program trading, derivatives and ETFs – if you listen to the hype -"enhance liquidity." But I suspect what they're actually enhancing is the illusion of liquidity – not to mention commissions and banking revenues – in certain quarters of the Street. I suspect, too, that the wide-spread dispersion of risk they entail could have a nasty side effect: turning specific market risk into systemic risk. Someone, somewhere, is still holding the underlying securities – and just might decide to sell. At which point, he, she or it may not be too pleased, if prices sink like stones before a buyer emerges. Pardon my soap box, but what's the point of all the financial rocket science if we let it undermine the market's – and investors' – ability to perform their basic function – the intelligent and efficient allocation of capital?
It is all cleverness.
"Too clever by half" is the way my mother would have put it.
It is all one-way Street stuff. Every little move is a peculiarity. Why is Avon down 5 points today? Because it said one little thing. Why was Wal-Mart just bludgeoned? Because earnings came in a penny less than expected. There should have been bidders ready to snap up WMT as an opportunity on the buyside, long before it dropped that far. But now there's nobody willing to take the other side.
Research is precisely what you just told me your clients don't have time to do-
That's where you and I come in! And it may be that my complaints will largely resolve themselves, as the aftermath of the bubble recedes. I am inclined to think that we are not done yet with the downside. If that is the case, then much of this superficiality and illusory liquidity are just standard components of a typical intervening rally. It will only be clear in retrospect, but we might be experiencing something akin to the intervening rally in 1971-1972. Then along came the Nifty-Fifty and the market exploded-for eight weeks-and peaked. Then came 1973 and 1974.
Which are definitely not recalled fondly around the Street. Are you predicting a replay in 2004?
Not really. The markets were very simple then. That's the problem with looking at historical experience. The lessons we can learn from the Nifty-Fifty era or even from the 1929 Crash are quite limited. We've never had, in modern times, a bubble anything like the late 1990s. There's nothing of the same magnitude to compare it with, except Japan's bubble in the 1980s. There's an interconnectedness today and lots more layers of complexity. My sense is that it is just too soon for the aftermath of the bubble to be exorcised from the market. It is going to take time for it to work its way through. And if so, the Bush Administration likely gets re-elected-only to find itself in a very Herbert Hoover-like position. I know it takes just as long now for a top to form as it ever did. I know that stocks breaking a trendline is only a short-term signal. I know it's not until that is visible on the weekly charts that it's meaningful. Likewise, I know that for all of the yearend ugliness in Intel (INTC) and Texas Instruments (TXN) and KLA-Tencor Corp. (KLAC), they are not ready to go down in any meaningful way – because you can't see that terrible stuff on the weekly charts yet. It is just too soon. They are deteriorating. But this bit-by-bit deterioration can go on for months.
So you see the market just drifting, until then?
There really are almost no public investors left out there. Only some residual speculators who cling to the idea they'll do it right the next time. Some of whom even were reasonably successful in low-priced tech stocks last year, but they are now losing money in the Chinese techs, the SOHUs and the SINAs that were hot six months ago but now are not. Because they don't own the Chinese prosaics that have gone up instead. They are tech speculators; people who came into the market in the bubble days and in one way or another became addicted to the market. It is their opium.
Tech junkies. Another wonderful image.
Also a dying breed. Which makes it all the more interesting when my wife, who is a retail broker at Merrill Lynch, comes home with a big brochure her firm has just put together on ETFs. All of a sudden, ETFs have hit the mainstream. After all, who wants to talk about mutual funds now? Clearly, over the next two, three, four, five years, however long it takes, there is going to be an enormous change in the way brokers do business. Now, ETFs are being marketed heavily to individual investors. And reported trading statistics will become even more deceptive.
In what sense?
Deceptive because so much volume is involved in -"program trading" is such an abused term, means so many different things – but an enormous proportion of today's trades involve index arbitrage. An awful lot of buying and selling activity is "ganged" and executed mechanically, automatically.
And the resulting exposures hedged away, supposedly, in the blink of an eye.
All the upstairs desks are arbitraging this stuff constantly, because they can do it for pennies or less. Or just for something to do, to look busy. But they never hold a position overnight.
Your complaint, then, is that there's too much volume and too little investment?
It sounds a little glib and superficial. But it's fair to say that very little Wall Street activity now has to do with investing.
The whole society is hooked on instant gratification, why should portfolio managers be any different?
Good question. But I think it's more than that. The bubble changed the investment landscape in many ways, but one of the most significant is that an awful lot of experienced value managers retired. The portfolios they used to manage are now being run by a new generation, more specifically, by people who aren't at all used to acting like what you or I would call investors. Long-term is not their style.
No, it's all about momentum and short-term trading, in their book.
Right. Gains and losses, they understand. Being able to watch the market in the way everybody now watches it has only exacerbated this.
No kidding. No one wants to hold a position overnight.
They sell them at the end of the day. But what is the risk? A terrorist attack? The Fed is not going to act overnight. There is not going to be some kind of terrible economic number overnight. So there's also no volatility.
Just a couple years ago, everyone was complaining that there was too much volatility.
Now we largely see very tiny, and sideways, moves. Look at Anheuser-Busch (BUD). The stock has hardly budged. Nobody cares. If someone recommends a stock, it will go up a point for the first hour and then trading will dry up. Don't get me wrong. This is not boring. But it is challenging. At least there are a few groups where something is going on, like the homebuilders, gold and the semis, to keep people calling me. But in the vast majority of stocks, there's just no interest.
Are you suggesting that this is a calm before a storm?
I am worried now about the weakness in certain areas and I am not going to worry about Caterpillar (CAT) or Inco (N). Those stocks haven't had a correction, so when they do have a first correction, it will properly be called profit-taking and they will find buyers. They are not long-term vulnerable. But when you look, by contrast, at an Intel or Applied Materials or Adobe (ADBE) or Dell (DELL) – these stocks have not been acting well now for six weeks. They probably will violate some important uptrend lines that go back, not just to last October, but to last March, in the next correction. So that is where I can see some vulnerability.
What about the housing stocks?
What I see in the homebuilders' charts is that the group is somewhere in between those two extremes. The homebuilders have to make very large tops because they have had such a big move.
What's your bet?
I think we have to have a correction in the broad averages somewhere in here soon.
Just because trees don't grow to the sky?
About all I can say with confidence here is that we should have a short-term correction, and that we are overdue for something on the order of, not just 3-5 percent, but 10-15 percent. And in that case, the techs look like they'd be the weakest stocks, probably followed by many of the retailers: May Department Stores, (May) Federated (FD); you can see Target (TGT) and Kohls (KSS) weakening already. Wal-Mart would probably top the list. Of course, in a broad correction, my cyclicals would also be vulnerable to profit-taking, but that would be their first correction, and it's unlikely that they'll violate any support levels. Their long-term moving average lines will still be going up. It is stocks that have been doing well that you'd want to buy in a correction, and there are just two groups that spring to mind. The solid electric utilities, like a Duke Energy (DUK), which has gone from 17 to 21 or something like that, comprise the first group. If it comes back to 19, you want to buy it. Then there's a Merck (MRK), which went from 42 or 43 to 47. If it comes back to 44, you want to buy it.
Nothing else?
Well, the so-called laggards, the stocks that have been moving in some kind of basing way, are probably going to be okay. If we do get a 10 percent to 15 percent correction, they could look like relative strength stocks. If so, that would suggest to me that the market has changed. That the cyclicals have probably peaked. They might have another run or two, but that would mean the parabolic part of their rise is over. And in that case, I suspect the market's interest would shift into "safe" stocks like a Merck, the electric utilities, probably things like a Heinz (HNZ) or a Kellogg (K). If the transitional market lasts through the election-I am presuming that the Republicans win and that the transitional market of 2004 will likely feature a bout of optimism, as well as the correction I see in the not-too-distant future, what I expect to unfold after the election is the culminating leg of the bear market. Something that is very long term.
You sounded pretty high on China earlier.
Very long term. But before they can really come on again, the analogy I would make is that they have to have their 1929. There has been so much speculation in the stocks, I wouldn't be surprised to see it. Just look at the China Fund. It is trading 65 percent above its net asset value-even though the Shanghai market is scarcely up at all. All the Chinese people are betting here on their stocks. They are not buying locally. The movement is global. Just like the interest in commodities funds.
Care to single out any vulnerable Chinese stocks?
Well, Sohu.com (SOHU) and Sina Corp. (SINA) are the really obvious ones. And Netease.com (NTES). Also looking weak: China.com (CHINA), China Yuchai (CYD), Bonso Electronics (BNSO), and even Aluminum Corp. of China (ACH). By contrast, there were eight or 10 Chinese stocks that exploded recently on the upside, all prosaics. But even those look extended and vulnerable. There has been a real mini-bubble in these Chinese issues-and this sort of action just has to be warning us that we're coming to an emotional peak in here. Plus, profit-taking is going on just like it was in early 2000. Nobody wanted to recognize it then, either.
Just like the insider trading.
That's right. But portfolio managers keep telling me things like they can't afford to miss a move. That is the feeling you have when you get into this kind of gambling. You really, truly don't want to leave money on the table. You get too greedy. I can remember people taking that way in February and March of 2000.
Enough said. Thanks, Justin.
Kathryn M. Welling is the editor and publisher of welling@weeden, an independent research service of Weeden & Co., L.P., Greenwich, Conn. http://welling.weedenco.com