Each day the markets go up or down and investors want to know why. On many days there is no reason. Things just happen. But we have a news industry and their job is to report the news and give insight as to why things happened the way they did. Stocks went up because of this or that. Or stocks went down because of that or this. Most of the time what happens on a short-term basis doesn’t make sense. Would you all of a sudden jump into stocks because one company beat estimates even though they lost money, or if a particular economic report was better than expected? The majority of the time, financial and economic reports are better than expected, even though the actual numbers aren’t all that great. That’s the financial business where there is always a reason to be bullish on the markets or the economy. Bad news doesn’t sell and Wall Street and the financial business are in the business of selling--selling financial products or selling financial news.
But there are days like today where the news just doesn’t sell. Alcoa reported its losses widened to $223 million in the fourth-quarter, up from a loss of $142 million a year ago. The loss was bigger than expected and worse than the year before. However, it was amusing how the news was spun. I listened to a TV reporter explain how they weren’t sure how Alcoa really did because their earnings may be interpreted in various ways by different analysts. One analyst might not count the losses from restructuring while others would, so they weren’t sure how the company did. Why the uncertainty? They lost money, period. And the loss was bigger than the year before. The aluminum business hasn’t been great which is why they laid off 10,000 workers. What is there to be uncertain about? Looking at the reports, it is clear that business is hurting. But in the financial business as I have said above, there is always a reason to be bullish, so the news must be spun. Bad news is dressed up to look better whether it is an economic report or an earnings report; there is always an array of sunshine.
What's Hot ~ What's Not All in the eyes of the beholder...
On the other hand, the financial industry has become almost hostile to the new bull market in “things.” If gold is the leading economic class two years in a row, it is considered a fluke, a mania, an anomaly, an aberration or any other thing but natural. Precious metals are disdained, disparaged or discarded by Wall Street and the mainstream financial media, in print or on cable TV. I actually heard one investment advisor here locally on talk radio warn investors to avoid gold. The rationale was that it had been the top performer last year so it was unlikely to perform this year. I don’t ever recall Wall Street ever telling investors that because stocks had gone up one year as an asset class to avoid them the following year. When an asset class goes up two consecutive years it usually indicates that asset class is in a bull market. This is the predicament that Wall Street now faces--the markets are transitioning from “paper” to “things.” Wall Street is not set up to handle “things.” Wall Street is in the business of selling paper assets—stocks, bonds, mutual funds, and annuities or other packaged paper financial products. Most major Wall Street firms have disbanded or sold their commodity trading business. They have very few analysts that even cover the business.
As this new bull market in “things” begins, Wall Street is unprepared and still looking at the markets through the rear view mirror. Something I have learned in my years in the investment business is that new trends, when they emerge, are seldom believed and are discredited by the status quo. The vast majority of the investment crowd is still busy chasing the last bull market. This has been obvious in every bear market rally we have seen in stocks over the last two years. When the markets rally, investors flock back into tech stocks, the leaders of the last bull market. But many of these technology products have become a commodity with falling prices and low profit margins. The personal computer business is a good example of this. The new bull market in “things,” whether it is precious metals, energy or food, is still vastly under-owned. The world’s entire market value of gold and silver stocks is less than the value of Coca Cola, Cisco, or GE. That is not the way it will be as this bull market gathers steam for we are still in the early stages.
Bull Markets = Three Stage Rocket
Bull markets have three stages to them. The first stage is characterized by the smart money that moves in recognizing an opportunity. The second phase develops when the institutional money discovers the new trend and becomes a firm believer in that trend. The final stage of a bull market is when the general public catches on to a long established trend. They provide the final impetus for the mania phase of the bull market. When the public finally catches on there is big money to be made because of the sheer volume of their entry into the market. By the time the crowd discovers the new trend, their very force propels that trend to new unforeseen highs as all rationality is abandoned by the collective mind of the crowd.
As far as precious metals, energy and food are concerned, we are still in the formative stages. The smart money has moved in, but the new trend has yet to catch on at the institutional level. Some funds own gold, but they mostly trade it. You will not find gold, silver, energy, or food making up large percentages of fund portfolios the same way that technology did in the last decade. However, when it comes to precious metals, the choices are few. There aren’t that many high quality stocks, and the number of shares outstanding is small. The same goes for the actual price of the metals themselves. There simply is not enough gold and silver on the commodity exchanges to handle investment demand. Both gold and silver have been running supply deficits for over a decade just from industrial demand. What a sight to behold when institutions, and finally the general public catches on to this new trend. One can only speculate where the price of gold, silver and precious metal equities will be when they discover this new trend. Suffice to say the prices will be much, much higher due to the scarcity of the metals and the metals stocks. This is a razor thin market that is not ready to handle large investment demand, especially when the public wakes up to the fact that the emperor has no clothes.
Speaking of “things,” it has been fascinating to observe the energy markets over the last six months. The price of the actual commodity shows that energy prices have experienced a stellar run up in 2002. The energy sector hasn’t done as well even though the sector has beaten the major indexes. The general consensus in the oil markets is that the US will experience a quick victory in the upcoming war against Iraq and the oil spigot will then flow freely out of Iraq, flooding the markets with cheap oil. The problems in Venezuela are still largely ignored even though what happens in Venezuela impacts the US more directly since it accounts for nearly 10 percent of our oil imports. Chavez has imported Cuban soldiers into the country to help suppress opposition. Opposition forces have launched a public relations campaign to win US support for their cause. However, the striking workers have only one plan, which is to strike. The Chavez government has more options since he controls the government and military. Army officers have refused to back the opposition unless Chavez attacks the people, so it has been a game of waiting. The longer Chavez waits, the greater chance the opposition will fall apart. That is why the opposition is waging a public relations campaign to enlist the support of the US. However, the Bush Administration has its hands full with managing the economy and the upcoming war with Iraq. Allegations that Chavez sent $1 million to support al Qaeda and importing Cuban troops into the country have fallen on deaf ears in the US. In the end, Chavez is expected to win and Venezuela oil is expected to flow freely again.
Oil is Not Well
The problem in Venezuela is expected to go away. This leaves Iraq. However, Iraq has now had over a decade to study US fighting tactics and the mistakes that were made during the Gulf War. This time Saddam is expected to station his troops in key strategic areas that will minimize the advantage of US air superiority. Saddam hopes to force the US into a ground war that takes place in Iraqi cities, making it a street-to-street battle like Mogadishu. He has positioned his troops amongst civilians, around schools, hospitals and other high profile civilian areas. He hopes the western press will pick up images of high civilian casualties as US troops are forced to attack Iraqi troops. This will hopefully bring world condemnation of the US. He has also positioned his troops around major oil fields at Basra and Kirkuk. His troops are effectively dug in around key oil fields, putting them in a position to torch them and destroy oil wells in the same way he did as he evacuated Kuwait.
So this war will not be fought in the same way as the Gulf war. Saddam has had more than a decade to develop his weapons of mass destruction and refine his fighting tactics. It shouldn’t be assumed that this upcoming battle would be a cakewalk. Nor should it be assumed that oil would flow freely even if the US prevails. In many ways the oil markets have been far too complacent assuming a favorable outcome based on the past war.
Meanwhile oil and natural gas inventories are at strategically low levels here in the US. Oil prices have come down by close to 8 percent the last few days based on hopes OPEC will increase oil production and a report out today that inventory levels were higher than expected. The US Energy Department reported that oil stocks held by refiners and storage companies’ rose by 400,000 barrels to 278.7 million. This was higher than expected. Oil on the New York Mercantile Exchange fell by $.52 to $30.56 a barrel. The American Petroleum Institute in a separate report from the government showed that inventories fell by 2 million barrels inserted of the rise reported by the government. The DOE and the API have different samples. The oil markets went with the government report instead of the industry report that has consistently shown lower inventory levels. Whichever report the markets chose to believe does not take away from the fact that inventory levels are at low levels. Should a disruption of oil supply occur as a result of war, a continuing strike in Venezuela, or harsher weather there isn’t much slack in the system. Natural gas prices look like they are heading higher as supplies tighten due to winter drawdowns. The energy sector looks promising on both a fundamental and geopolitical basis due to a high degree of complacency. It has yet to dawn on investors that the US is now in a wartime economy.
Today's Market
The major averages all lost ground today as more earnings warnings begin to surface. Today it was Alcoa that disappointed. Last night after the markets closed, it was Gateway that said its numbers would be disappointing. Shares of Intel led tech stocks down after it reported that global technology spending will remain weak during the first six months of this year. GM warned that its pension expenses will be much higher this year as result of lower returns and the lowering of its 10 percent rate of return assumption on pension returns. Indeed, pension funding will be one of this year's big financial stories as most of the S&P 500 companies have underfunded pension plans. Other companies will be confessing their disappointments in the weeks ahead as the quarterly earnings game is replayed. Companies will warn of lower earnings, estimates will be lowered and then actual earnings will beat estimates when they are reported and the media will report that things are going much better than expected.
I believe that one of the realities that hasn’t been fully reflected in stocks this year is that earnings and the economy won’t be as strong as forecasted. Once this is realized, a large adjustment process should take place taking stocks down hard. The only wild cards could be a quick victory in Iraq, which would bolster market confidence and remove a big uncertainty. However, no matter which way you measure stocks, from a fundamental point of view stocks are still over valued as shown in this graph of pro forma P/E ratios of the S&P 500. Stocks still aren’t cheap and that remains the fundamental problem of the markets no matter which way valuations are spun by Wall Street and the financial media. Nobody talks about the bottom line because the bottom line isn’t in great shape nor is balance sheets. There is still a lot of worthless goodwill on corporate balance sheets that needs to be written off. There is still billions of off-balance sheet debt that will need to be paid down. It is debt and uncertainty that will keep a capital-spending boom from taking place which undermines one of the key assumptions of this years recovery in the economy and in the stock market.
Stocks ended the day on a down note as the dollar fell, gold prices surged, and commodity prices rose. Gold cleared the $350 level and finished the session at $353.55. Volume hit 1.43 billion shares on the NYSE and 1.44 billion on the Nasdaq. Market r4eath was negative by 20-12 on the big board and 20-11 on the Nasdaq. The VIX rose .94 to 28.42 and the VXN advanced 1.6 to 44.56.
Overseas Markets
European stocks fell on concern demand is weakening for products ranging from cars to personal computers. Dixons Group Plc, the biggest U.K. seller of consumer electronics, plunged after saying fiscal 2003 earnings will stagnate as shopper rein in spending. The Dow Jones Stoxx 50 Index fell 1.3 percent to 2471.41, cutting its 2003 gain to 2.6 percent.
Japanese stocks fell, sending key benchmarks to two-week lows. Toshiba Corp. and other personal computer makers slid after Gateway Inc. said sales dropped, raising concern consumers are putting off PC purchases. The Nikkei 225 Stock Average lost 1.6 percent to 8517.80 and the Topix index declined 1.7 percent to 839.55. Computer-related stocks were the biggest contributors to the Topix's slide.
