Like 1987, only worse
As a crisis of confidence looms for bonds and the dollar and the markets play out their recovery fantasy, the chance of a crash grows every day -- as does the depth of its consequences.
Fantasy has always found fertile ground on Wall Street, where folks have a knack for modifying the facts. This week, a knowledgeable market observer who meets them head-on will share her thoughts about secular bear markets. Turning to the technology arena, I'll start with my thoughts on Hewlett-Packard, whose recent news put a crimp in fantasies of a rebound in personal computer sales.
Hewlett-Packard's results last week were interesting for a couple of reasons with ramifications for the PC industry at large. First off, a comment about CEO Carly Fiorina's admission that the company "should have done better." Given its track record for serial restructuring charges and engineering numbers to meet earnings estimates, inquiring minds want to know why Hewlett did not do better. (In case you don't know, its revenues were a little bit light, its earnings were even lighter, and it lowered earnings guidance going forward.)
Losing the price wars
The company has been engaged in a price war in its aggressive attempts to move PCs. What one can conclude is that this strategy failed at some point during the quarter, which saddled Hewlett with inventory, including excess DRAMs (memory chips), and paved the way for disappointment.
I think that speaks volumes about the saturated, weak state of the PC industry, notwithstanding folks' excitement about a turnaround for the umpteenth time. Price-cutting and fanfare over Centrino, Intel's new processor with built-in wireless networking circuitry, has moved a few more units since last May. But with its effectiveness now a thing of the past, Hewlett appears to be backing off this strategy, though Dell Inc. last Wednesday turned up the heat when it announced a new round of price cuts for Centrino products.
Ramifications of drab DRAM demand
As for its acknowledged surplus of DRAMs, the problem occurs repeatedly in this market. For a variety of reasons, we had a moment in time where enough folks thought prices would go up, enough speculators bought parts and enough companies purchased extra parts. The next thing you know, a little uptick in price produces a self-fulfilling prophecy. Then prices tank once again as folks realize there's a tremendous amount of double-ordering and too much enthusiasm. The DRAM market basically hasn't been trading for weeks and is now starting to leak a bit. I've been watching closely for signs that this most recent speculative fantasy about PC demand surging would be undercut.
In cellphone land, meanwhile, it's "damn the excess inventory -- let's build more." We know a glut exists, yet lots of manufacturers there appear to think they'll take market share from the other guys. Once again we have a situation where companies are ignoring excess inventory and building anyway. Granted, stories have surfaced about an increase in some flash orders, and some of the parts makers are seeing a little bit of boost. But if meaningful increased demand fails to show up -- which is exactly my expectation -- this only sets the stage for an even bigger disaster down the road.
Turning from technology to some overall thoughts on the stock market, I have spent a lot of time over the years discussing the mania and its long-lived ramifications. My purpose has been to provide a voice not heard in the popular press or in the commentary of most other "market observers." They have been content to focus either on minutiae or the near term, rarely contemplating the present environment through the prism of what's happened in the last 10 or 20 years. This week, I'd like to share a like-minded voice, that of Susan Berge, whose excellent newsletter on Aug. 19 illuminated the differences between the 1982-2000 secular bull market and our current secular bear market.
The birds, the bees, the secular bear rallies
A prefatory word or two: I think some people have not paid enough attention to the difference between a cyclical (shorter-term) move and a secular (longer-term) move. If we are in a secular bear market, as I believe, there will be rallies like the one that we have had, but they will just be rallies. To repeat what I have said in the past, long- term investors should generally not expect to just sit on stocks and get bailed out for their patience. The long term may wind up being six to nine months, though if we could get stocks cheaply enough (which is not the case today), a rally of some longer duration might be possible. In any case, without further ado, here are Susan's thoughts, with an important message for both bulls and bears:
"During the 1982-2000 secular bull market, there were two declines of 20% or more. The first, in 1987, lasted two months in the DJIA, four months in the S&P 500. The second, in 1990, lasted three months from July to October. By contrast, the average duration of bear markets within the 1966-1982 secular downtrend was 16-17 months. Given that secular trends usually last about 16-17 years, we are going to have to adjust to an environment very different from what we got used to in the 1980s and 1990s. Instant gratification is likely to be rare, for either bulls or bears. When we get into periods like the last few months, trying to make money on the long side is like pulling teeth. It is equally frustrating for the bears, as the market conforms to expectation by failing to go up, but disappoints by failing to go down.
"When 20%-plus declines are over within a matter of a few months, bulls who failed to sidestep the decline are usually able to recoup their losses within several months after the market turns up again (unless they were hit with margin calls). In a secular bear market, the attempt to 'get even' with the market after suffering substantial losses is usually very difficult, if not impossible. This is the psychological hook that keeps traders trying to recapture the glories of the period when making money was so much easier. Because it is more difficult, the victory is sweeter on those rare occasions when it does occur, and this, too, is part of what keeps people in stocks long after the point when they should have gotten out of harm's way. Random, inconsistent reinforcement tends to be more effective in motivating repeat behavior than reliable, consistent reinforcement. This is why it often takes so long in a bear market to get to capitulation.
"We are likely to be in this secular bear market for many more years to come. In our opinion, the market is currently in the area of a distribution top, and the next significant move in stock prices is likely to be on the downside. We expect to see little or no net upside progress beyond the closing highs recorded in June and July before a decline begins. At the present time, we believe the pending decline will likely be 20% to 30% or more across the board, but if the market's technical condition begins to improve more rapidly than we currently expect, we will alter our downside expectations accordingly."
Wheezing to the upside
It appears to me that we are continuing to make a top in the market. The rally basically ran out of gas in late June. I know the Dow ($INDU) and Nasdaq ($COMPX) have reached minor new highs, and likewise a couple of subindices, but the progress looks very labored to me. It's fairly predictable that folks would try to party during the thick of the no-news period. Also, the bulls have enjoyed the wind at their back, with a rallying dollar and stock market feeding on each other to the upside.
But I think that sometime in the not- too-distant future, the dollar is going to come under pressure once again. I don't expect the stock market to see any meaningful gains from these levels, and I believe that the next big move will be on the downside. In my opinion, the chances of a crash grow with each passing day, though I will note that crashes or massive market dislocations are very low-probability events. But for those of you who weren't around in 1987, the backdrop was similar, in terms of bonds, the dollar and the stock market's flight of fantasy. Denial back then was nowhere near as egregious as it is now. The fear then was runaway inflation, which obviously isn't today's concern. And now, the fallout from the bubble looms far more dangerous than what was haunting the market in 1987.
Further, though we don't have portfolio insurance, we do have futures, as well as mutual-fund holders from coast to coast, able to dial 1-800-Get-Me-Out. So, the stage is set for a much bigger accident, should it unfold. But thus far, most players have gone "all in," hoping that the massive bluff will work. What happens when they realize it hasn't?
As a crisis of confidence looms for bonds and the dollar and the markets play out their recovery fantasy, the chance of a crash grows every day -- as does the depth of its consequences.
Fantasy has always found fertile ground on Wall Street, where folks have a knack for modifying the facts. This week, a knowledgeable market observer who meets them head-on will share her thoughts about secular bear markets. Turning to the technology arena, I'll start with my thoughts on Hewlett-Packard, whose recent news put a crimp in fantasies of a rebound in personal computer sales.
Hewlett-Packard's results last week were interesting for a couple of reasons with ramifications for the PC industry at large. First off, a comment about CEO Carly Fiorina's admission that the company "should have done better." Given its track record for serial restructuring charges and engineering numbers to meet earnings estimates, inquiring minds want to know why Hewlett did not do better. (In case you don't know, its revenues were a little bit light, its earnings were even lighter, and it lowered earnings guidance going forward.)
Losing the price wars
The company has been engaged in a price war in its aggressive attempts to move PCs. What one can conclude is that this strategy failed at some point during the quarter, which saddled Hewlett with inventory, including excess DRAMs (memory chips), and paved the way for disappointment.
I think that speaks volumes about the saturated, weak state of the PC industry, notwithstanding folks' excitement about a turnaround for the umpteenth time. Price-cutting and fanfare over Centrino, Intel's new processor with built-in wireless networking circuitry, has moved a few more units since last May. But with its effectiveness now a thing of the past, Hewlett appears to be backing off this strategy, though Dell Inc. last Wednesday turned up the heat when it announced a new round of price cuts for Centrino products.
Ramifications of drab DRAM demand
As for its acknowledged surplus of DRAMs, the problem occurs repeatedly in this market. For a variety of reasons, we had a moment in time where enough folks thought prices would go up, enough speculators bought parts and enough companies purchased extra parts. The next thing you know, a little uptick in price produces a self-fulfilling prophecy. Then prices tank once again as folks realize there's a tremendous amount of double-ordering and too much enthusiasm. The DRAM market basically hasn't been trading for weeks and is now starting to leak a bit. I've been watching closely for signs that this most recent speculative fantasy about PC demand surging would be undercut.
In cellphone land, meanwhile, it's "damn the excess inventory -- let's build more." We know a glut exists, yet lots of manufacturers there appear to think they'll take market share from the other guys. Once again we have a situation where companies are ignoring excess inventory and building anyway. Granted, stories have surfaced about an increase in some flash orders, and some of the parts makers are seeing a little bit of boost. But if meaningful increased demand fails to show up -- which is exactly my expectation -- this only sets the stage for an even bigger disaster down the road.
Turning from technology to some overall thoughts on the stock market, I have spent a lot of time over the years discussing the mania and its long-lived ramifications. My purpose has been to provide a voice not heard in the popular press or in the commentary of most other "market observers." They have been content to focus either on minutiae or the near term, rarely contemplating the present environment through the prism of what's happened in the last 10 or 20 years. This week, I'd like to share a like-minded voice, that of Susan Berge, whose excellent newsletter on Aug. 19 illuminated the differences between the 1982-2000 secular bull market and our current secular bear market.
The birds, the bees, the secular bear rallies
A prefatory word or two: I think some people have not paid enough attention to the difference between a cyclical (shorter-term) move and a secular (longer-term) move. If we are in a secular bear market, as I believe, there will be rallies like the one that we have had, but they will just be rallies. To repeat what I have said in the past, long- term investors should generally not expect to just sit on stocks and get bailed out for their patience. The long term may wind up being six to nine months, though if we could get stocks cheaply enough (which is not the case today), a rally of some longer duration might be possible. In any case, without further ado, here are Susan's thoughts, with an important message for both bulls and bears:
"During the 1982-2000 secular bull market, there were two declines of 20% or more. The first, in 1987, lasted two months in the DJIA, four months in the S&P 500. The second, in 1990, lasted three months from July to October. By contrast, the average duration of bear markets within the 1966-1982 secular downtrend was 16-17 months. Given that secular trends usually last about 16-17 years, we are going to have to adjust to an environment very different from what we got used to in the 1980s and 1990s. Instant gratification is likely to be rare, for either bulls or bears. When we get into periods like the last few months, trying to make money on the long side is like pulling teeth. It is equally frustrating for the bears, as the market conforms to expectation by failing to go up, but disappoints by failing to go down.
"When 20%-plus declines are over within a matter of a few months, bulls who failed to sidestep the decline are usually able to recoup their losses within several months after the market turns up again (unless they were hit with margin calls). In a secular bear market, the attempt to 'get even' with the market after suffering substantial losses is usually very difficult, if not impossible. This is the psychological hook that keeps traders trying to recapture the glories of the period when making money was so much easier. Because it is more difficult, the victory is sweeter on those rare occasions when it does occur, and this, too, is part of what keeps people in stocks long after the point when they should have gotten out of harm's way. Random, inconsistent reinforcement tends to be more effective in motivating repeat behavior than reliable, consistent reinforcement. This is why it often takes so long in a bear market to get to capitulation.
"We are likely to be in this secular bear market for many more years to come. In our opinion, the market is currently in the area of a distribution top, and the next significant move in stock prices is likely to be on the downside. We expect to see little or no net upside progress beyond the closing highs recorded in June and July before a decline begins. At the present time, we believe the pending decline will likely be 20% to 30% or more across the board, but if the market's technical condition begins to improve more rapidly than we currently expect, we will alter our downside expectations accordingly."
Wheezing to the upside
It appears to me that we are continuing to make a top in the market. The rally basically ran out of gas in late June. I know the Dow ($INDU) and Nasdaq ($COMPX) have reached minor new highs, and likewise a couple of subindices, but the progress looks very labored to me. It's fairly predictable that folks would try to party during the thick of the no-news period. Also, the bulls have enjoyed the wind at their back, with a rallying dollar and stock market feeding on each other to the upside.
But I think that sometime in the not- too-distant future, the dollar is going to come under pressure once again. I don't expect the stock market to see any meaningful gains from these levels, and I believe that the next big move will be on the downside. In my opinion, the chances of a crash grow with each passing day, though I will note that crashes or massive market dislocations are very low-probability events. But for those of you who weren't around in 1987, the backdrop was similar, in terms of bonds, the dollar and the stock market's flight of fantasy. Denial back then was nowhere near as egregious as it is now. The fear then was runaway inflation, which obviously isn't today's concern. And now, the fallout from the bubble looms far more dangerous than what was haunting the market in 1987.
Further, though we don't have portfolio insurance, we do have futures, as well as mutual-fund holders from coast to coast, able to dial 1-800-Get-Me-Out. So, the stage is set for a much bigger accident, should it unfold. But thus far, most players have gone "all in," hoping that the massive bluff will work. What happens when they realize it hasn't?
