The Charge Looks Strong, But It Won’t Last

The Dow first surpassed 600 on February 20, 1959. However, it would take until November 2, 1962 before 600 finally served as a proverbial ‘bottom’. After jumping above 1,000 in 1972 on October 3, 1974 the Dow busted below 600 yet again…

If the 1962-1974 period began repeating today we would see the Dow battling at roughly 12,500 5-years from now, 13,000 a decade from now, and 7,489 12 years from now. Does this sound ridiculous?  Perhaps. Then again, is it anymore ridiculous than someone claiming a solid bottom in the markets has been formed because prices have risen for a few sessions?

The Latest Dow ‘Bottom’: 7489.53 - July 24, 2002
The latest bottom in the Dow arrived following a flood of equity fund outflows, isolated corporate buy back announcements, and contagious short covering. Moreover, the latest bottom arrived a day after rumors of an emergency Fed meeting surfaced (Tuesday July 23, 02). Whether or not this meeting ever took place may be immaterial: the Fed did make a point of denying rumors that a secret meeting was held, and this may be the point:

With what little liquidity they had at their disposal did Wall Street use the Fed meeting rumor as a psychological springboard for squeezing shorts?  Perhaps.  All that is known is that when the Fed meets in private it is not to discuss how to efficiently pop asset bubbles, but how to keep them inflated.

Wish List Action
Although the Wish List did not see much activity last week (1 company added) there is reason to believe that more opportunities will unveil themselves in the coming weeks/months. Specifically, with gold stocks retreating and a possible retest of $300 an ounce looming certain producers are becoming attractive. That said, the XAU index was up strongly yesterday and potential investors should be mindful that the greater fool theory is alive and well: meaning that specific industries and stocks that rise and fall by double digits on a daily basis are probably not doing so for predictable reasons.

Predicting Bottoms
Morgan Stanley’s Barton Biggs is one of the Streets more objective minds. During the late 1990s he was bearish and remained bearish even as everyone turned bullish. However, since June 25, 2002 Biggs has, surprisingly I might add, changed his tune:

“Biggs figures that equity markets around the world are in the process of making a significant "double bottom." He says based on scientific and technical studies of the current markets, "important buying opportunities are developing." ... “My guess is that the bearishness and selling have been overdone,”
June 25, 2002  Reuters

On June 25 the Dow was at 9,380. Biggs forecasted that over the short term the Dow could see 10,800 to 11,000.

“At todays prices ... I do think that investors can make money in the short run and that this is no time to be selling stocks.”
July 11 (the Dow was at 8,801) Reuters

It will be interesting to see what Mr. Biggs has to say next considering that his ‘short run’ speculations have proved untimely.  That said, by using Wall Street’s warped logic he could argue that everything is going accordingly to plan simply because the markets have turned around (after all, only his clients will remember that the Dow plummeted 20% before his turnaround scenario began).

Biggs versus Buffett
Buying quality companies (assets) is completely different than buying (speculating on) the markets: whereas the stock markets can rise or fall for literally any reason once an asset is owned it either performs or does not perform. With this in mind, there are two differences between what the Buffett’s do and what the Bigg’s try to do:

1) Buffett expects and is willing to wait for return on assets whereas Biggs speculates about returns on investment.  The difference being that Biggs’s opinion (on the markets) can change from month to month while Buffett’s opinion only changes when his investment has reached full potential or he has changes his investment opinion (which usually takes many years).

2) Biggs studies the stock markets -- Buffett studies businesses.


With this in mind, when Buffett makes a mistake on an Airline company he blames himself for not recognizing the nuances of the industry. When Biggs (or others like him) errs he blames it on nervous investors, fraudulent CEOs, an incompetent Fed, a stock market/economy ‘disconnect’, etc.

Point being, Biggs is the one calling for a bottom in 1962 while Buffett is the one ignoring the markets completely and buying companies through 1974…

Bottoming Picking
Even during the most severe bear market there is always opportunities to be uncovered. To be sure, even during the 1930s depression select companies rewarded patient investors with annual dividend payments well beyond that of bonds. That said, one of the reasons why a similar scenario to that of 1929 has not unfolded quickly today is because investors have not given homage to the threat of deflation. Rather, deflation, or lack of inflation, is touted as a positive for stocks.

Accordingly, companies like Brown Forman (Jack Daniels), which have stable pricing power and a consistent yield, have tended to stay in favor during even the most tumultuous sell-offs.  For instance, last week Brown Forman touched its 52-week low but did not go any further.


When, and if, companies like BFb are languishing below their 52-week lows is when the investor knows the real bear market crunch has arrived. This analysis may appear to be a tad simplistic. However, that depends on whether or not you think that owning BFb at 20 times forward earnings and a mere 2.12% dividend yield is a screaming buy.

“My case is that if you wait for every indicator to flash green and all the stars to align, and Jupiter to merge with Mars, you may miss the buying opportunity, the main chance.”  Biggs, July 11, 2002.

I am unsure what Mr. Biggs is implying with this comment – especially since he waited so many years for the bear market to begin.  Suffice it to say, only time will tell if the ‘main chance’ to own a company like Brown Forman presented itself last week.

Another Crunch is Coming
Unlike Mr. Biggs, I am unable to predict an exact timetable. Quite frankly, August 14 (the date CEOs have to swear by their numbers) could be problematic for the markets, or it could mark another leg up in the bear market rally.  What’s more, with last weeks mini-panic being quickly contained this could allow sidelined money to return to the markets (as strange as it may sound many investors prefer buying in when prices are rising).

However, what should be remembered is that Corporate America does not have the pricing power needed to erect a bull market strong enough to take the Dow safely above its lows. Moreover, investors, although temporarily in awe of the swift turnaround, will not soon forget that share prices must vaguely reflect the balance sheet: with Moody’s and S&P more eager to begin cutting companies debt after being criticized for missing the boat on Enron and Worldcom, and with companies unable to tap the debt markets as readily as when 2002 began the threat of further balance sheet implosions remains (particularly in merchant energy and telecom).

Then again, perhaps the Fed cuts rates again and Fed and earnings/bond yield investment models brush off 2 years off terrific losses and begin to make sense?  Wasn’t that what the denial of the secret meeting was for -- to instill a belief that the Fed is on the case?

Three months ago the prospect of another Fed rate cut would have sent the markets crashing because the economic rebound was thought to be well underway. Today a Fed rate cut, or the rejuvenated belief that the Fed is prepared to cut rates to ensure the economic recovery continues, may be one of the only things that can help keep investor enthusiasm alive. That said, investor enthusiasm fashioned from the belief that the Fed will cut rates has proved temporary 11 times and counting.

“Even based on our conservative earnings expectations, we now see 15-20 percent upside to global markets to reach our end-of-year fair values… any inflation fears have dissipated. The probability of rate cuts, rather than rate tightening is rising,"
J.P. Morgan, July 30, 2002

Brady Willett
BWillett@fallstreet.com
www.wallstreetwishlist.com

July 30, 2002