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Wealth Effect Lays Rubber in Reverse

April 15, 2000

It is only on days like Friday that I can stomach a few minutes’ worth of the drivel that passes for market wisdom on CNBC. Still, during the short span that I tuned to the show, I did pick up one interesting statistic concerning margin debt: It currently totals about $278 billion, accounting for 20% of brokerage house revenues. So there it is, and now we needn’t wonder why the brokerage stocks in particular got pasted last week, notwithstanding the fact that we had already perceived the manic buying of those stocks recently by institutional investors as a bit unwise, if not to say misfeasant. Fund managers who are flush with Other People’s Money (OPM) -- as they all have been for years -- often do things that we as individuals would never deign to consider. Such as, snap up the shares of Merrill Lynch more eagerly at 115 a few weeks ago than they did just a few months back, when the stock was trading at a much more reasonable 72. It’s bad enough that this buying should have occurred in a sector that is probably doomed by electronic competition, but it is still worse that the rationale for the binge was simply that tech stock OPM had to migrate to somewhere else -- anywhere else -- due to growing perceptions, even among bulls, that Nasdaq stocks were getting too full of hot air.

The thing to remember about OPM is that, in order for fund managers to keep their jobs, the money’s got to be working somewhere, and the harder the better. That’s why the momentum stocks-of-the-month always get the lion’s share of 401(k) cash, while only a few crumbs find their way into Treasurys. My attention has momentarily drifted back to CNBC, and lo, the commentary is still downright interesting. Ron Insana is interviewing a 40-ish Yalie named Robert Shiller, whose book, “Irrational Exuberance,” sounds like my cup of tea. Unfortunately, it is in the nature of the television medium, and of CNBC in particular, that Shiller should finally have his five minutes in the spotlight on a day in which investors are probably tallying portfolio losses of as much as 30-40%. This ties to my most recent “Market Directions” column in The San Francisco Examiner. The point of it was to show how most investors -- especially the “smart” ones who have done nothing but make money the whole way up -- would fail badly when it came time to try to beat the bear to the exits. This was their game plan all along, I am sure, but as anyone knows who was around to observe the bear market of 1973-74, the notion of escaping unscathed was never more than a dangerous delusion.

Meanwhile, Black Box Forecasts subscribers ended the week in great shape, with many puts that gained 500-1000% or more. It was a gift insofar as last week’s devastation occurred in such close proximity to the April option expiration. We bought some of those puts for practically nothing, evidently from sellers who had given up on them as recently as Wednesday. The April 90 puts that we acquired in Merrill Lynch on Thursday for $50 traded for ten times that on Friday, and I have a hunch they may trade even higher before the bear’s rampage has quieted. And how about the OEX April 730 puts that we bought on Thursday for $125 apiece, off a “Gonzo” recommendation! They changed hands on Friday for as much as $2,200.

Well, this is about as much CNBC-watching as I’ve done in years, and I must admit that it is positively entertaining. Here’s another one of their guys with a supposedly important bulletin from the floor of the NYSE. His message: It could be a bad sign that no “white knight” -- his term, not mine -- stepped in to rally the market in the final hour. (In fact, volume dried up.) Cynical as we’ve become in this age, it is no longer a white knight in the image of J.P. Morgan to whom we look for buying support, but to the Plunge Protection Team, whose members presumably come to work in Black Helicopters.

Fortunately, we are in better shape than the gang at CNBC to guess about what might occur on Monday; for we have some crucial evidence that their pundits do not, based on the performance of the Nasdaq 100 index. As those of you who monitor the market closely will already know, the June futures contract for that index broke below the megabearish 3223 target we had been using throughout last week’s decline. According to my system, this means that lower lows lie ahead. The accuracy and importance of the target itself was corroborated to the extent that the futures had their biggest and most sustained bounce of the day from within just a few points of it. That it was eventually breached -- by more than 50 points! -- implies there is yet another wave of selling to come.

Over the weekend you should look for the usual gang of telegenic bulls to find solace in some factoids that are not even worth sneering at. One straw they will likely grasp at is that Friday’s collapse was not even in the same league as the October 19, 1987 crash. That knocked 20% off the DJIA, versus a mere 7% this time. Seven percent *so far* is more like it, though, and even at that, it was still the second biggest percentage loss in history, not to mention the largest point loss. To put it in the perspective of cash dollars, CNBC says the week cost shareholders about $2 trillion. Looking at individual stocks, from recent highs, Microsoft has shed $239 billion of shareholder value, Cisco $167 billion and Intel $100 billion. That’s the wealth effect laying rubber in reverse. As such, Black Box Forecasts subscribers who want to avoid surly crowds are advised to relax and spend some their new lucre at the caviar bars and marinas this weekend. Whatever you do, avoid the discount clubs.

Goldschläger and Goldwasser are liqueurs containing pure gold flakes.
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