Monday the market came down with a case of the short term jitters, on
Tuesday the jitters grew a little more pronounced, on Wednesday the
market's safety net of deeply ingrained long term bullish sentiment
stepped in to save the day, and all eyes quickly returned to the quest for
new record highs and boundless prosperity.
Granted, there were other factors at
work on Wednesday that also contributed to the market's return to what
passes for health these days, with Yahoo and the NAPM survey leading the
list of 'factors that uplift'.
The announcement of wonder portal
Yahoo!'s induction into the ranks of the S&P500 started the turnaround
from the depths of jitterland despair. Now, while we will reserve
comment on S&P's decision to transform the benchmark S&P500 from
an index of large companies to one of small companies by giving $3.2
billion in revenues Laidlaw the boot in favor of the $453 million in
revenues analyst dream child Yahoo!, and we will reserve comment on
whether in the end it will be Laidlaw's school buses that remain standing
after today's portal fad fades into the technology dustbin currently
occupied by such one-time hot Internet technologies as Gopher, Archie,
Veronica, and WAIS, we will opine that S&P's decision to take a ride
on a peaking dotcom bubble rather than go shopping in the Benjamin Graham
bargain basement is yet one more sign that the top to end all tops could
be that much closer.
While a dip from 69.4 to 65.3 in the
prices paid component of the NAPM survey also was responsible for today's
market turnaround, the market's exuberant reaction to the number was
largely a result of a continued misplaced focus on present inflation
rather than a focus on the factors which could result in an inflationary
spike six months down the road.
Although the prices paid component
fell, the report showed that the manufacturing sector continues to
expand. The order backlog component rose to its highest level in two
years and the new orders component rose to 59.9 from 59.5, indicating that
manufacturing growth could pick up in coming months. Any additional
expansion of manufacturing activity will put further strains on an already
tight labor market.
As we have said before, and as Fed
Governor Meyer hinted in his Tuesday speech (see the complete
text of speech), it is the continued strength of the demand side of
the equation, and its effect on a shrinking pool of available workers that
bears watching going forward.
To quote one of the passages of Meyer's
speech that sent a tremor through the bond market, "... the key
message is that old rules still apply to the new limits. Overheating still
eventually results if the growth of demand exceeds the growth of supply
for long enough, driving the unemployment rate below the NAIRU (estimate
of potential output). Excess demand in labor markets still ultimately puts
upward pressure on nominal compensation...Once the unemployment rate falls
far enough below your best estimate of the NAIRU, for example, it would be
prudent to return to a more normal responsiveness of interest rates to
further declines in the unemployment rate. In my judgment, we are already
in a range in which such a normal response to further declines in the
unemployment rate is warranted.".
The focus thus turns to the release of
Friday's unemployment rate number, but a better than expected reading from
the number should not be taken as a sign that the dangers of wage
pressures bubbling to the surface have passed. Until the demand side
of the equation eases, the danger of upward pressure on wages can not be
considered to be over.
The demand side of the equation is
unlikely to ease anytime soon. Tuesday's jump in the Consumer
Confidence numbers confirmed one of our oft-stated missives, "there
is no escaping the strong correlation between the trend of consumer
confidence and the trend of the major stock market averages".
To put it another way, with the wealth effect driving the economy, it is
unlikely that rising stock prices and an economic slowdown will occur
Thus, as we have said many times, a
necessary precondition for reigning in economic growth will be a fall in
stock prices. This decline in the market will also have to go beyond
merely effecting short term market sentiment-- it will have to put a dent
in the deeply ingrained long term bullish sentiment that has built up
during this decade's run if the economy is to be slowed. Recent
declines in the market have only effected short term sentiment, resulting
in a v-shaped recovery as the long term sentiment quickly comes to the
forefront in the form of buying on the dips.
It should also be remembered that 1998's
second quarter market plunge was not of a large enough magnitude to put a
dent in the market's underlying safety net of long term optimism--the
market quickly regained its composure with a v-shaped recovery, the type
of recovery that allows economic activity to quickly return to the pace it
enjoyed before the decline.
In order for the economy to slow to a
sustainable pace of growth, and for the undercurrent of bubbling economic
imbalances to return to equilibrium, it is entirely possible that a
decline of 25% or more by the major averages would be required.
While we are not forecasting a decline
of this magnitude, a decline of this size or larger within the next year
cannot be summarily ruled out. The conditions that in the past have
preceded declines of a similar magnitude are all in place, and the list is
long: from rampant speculation in lesser quality issues to mass public
participation in the markets, from increasing euphoria to an accelerating
pace of margin debt growth, from increasingly narrow breadth focused on a
handful of crowd pleasers to a capitulation by the bears, from the
trotting out of the phrase "this time its different" to the
introduction of new valuation methods used to justify current price
levels, from the new economy to a technological revolution, we've seen
them all before--and we've seen what follows.
While these conditions can persist for
some time, in the past their appearance has always been a sign that the (up)trend
has seen its better days.
Finally, a certain large e-commerce
stock fell 5 points today after an analyst started coverage with a neutral
rating. The analyst's reasoning: the stock is fairly valued based on
projections of year 2009 earnings. Not that we would want to say
anything here, but earlier we mentioned Gopher and Veronica, so we will
Early this decade, before the World Wide
Web, the easiest means of finding documents on the web was by using the
menu driven Gopher system, and searches were performed using the text
based Veronica. Also at this time, anyone who dared mention the words
"Internet" and "Commercial Activity" in the same
phrase were quickly chased away from the Internet by angry users.
In the early years of this decade no one
could have accurately predicted the swift transformation of the Internet
from a command-line driven tool of the educational and scientific
communities into a mass-market commercial based browser-driven pastime of
the general public.
Our point--With the rapid pace of
technological change, and the short life cycles of both new technology
products and new technology mediums, it is impossible to accurately
predict the shape of the Internet, or the patterns of its usage, ten years
down the road.
In the early 90's, buying a stake in a
company that made products designed to help users utilize the resources of
Gopher and Veronica would have seemed like a sure fire bet. At the
end of this decade, it's apparent that the sure fire bet was a dud--and at
the end of the next decade many of today's seemingly sure fire bets will
also be duds.
Our words of advice: if you're buying
dotcom stocks based on 5 to 10 year projections that may never come true,
go buy a dart board--its cheaper than paying an analyst and its just as accurate a predictor of where
the Internet will be in 2009.