Postcards From The Edge/ Heavyweight Champions


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4690 Postings, 8595 Tage proxicomiPostcards From The Edge/ Heavyweight Champions

 
  
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23.12.00 00:49
Postcards From The Edge


 

The Recycling Plant...On Tuesday we took a quick peek at the asset allocation characteristics of the American public as well as the institutional investor crowd in this fair land.  Time to shove off for foreign shores.  All aboard.  After all, since the US has the world export market on the dollar simply cornered at the moment, just what is happening to that exported contraband?  Well it just so happens that a heaping portion of our generous dollar exports, vis-à-vis our burgeoning trade deficit, have been "recycled" in financial assets in the U.S. over the past few years.  Let's look at some numbers, shall we?

U.S. Long Term Portfolio Capital Flows(billions of dollars, not seasonally adjusted)FOREIGN NET PURCHASES OF U.S. SECURITIES

       1994 1995 1996 1997    1998   1999   2Q/2000      Annualized   Through 2Q 2000
     Total    $140.4    $231.9    $370.2    $388.0    $277.8§ $352.3 $ 456.8
Treasuries      78.8     134.1     232.2    184..2      49.0     -10.0     -24.4          §
  Agencies      21.7      28.7      41.7      49.9      56.8      94.2     127.0          §
Corporates      38.0      57.9      83.7      84.4     121.9     160.5     174.4          §
    Stocks       1.9      11.2      12.5      69.6      50.0     107.5180.0

§
Clearly since 1995, foreign purchases of U.S. financial assets have more than doubled on an absolute dollar basis.  On the bond side of the equation, foreigners have most certainly been interested in "spread product".  Purchases of safe haven Treasuries during the scare periods of 1997 and 1998 have tapered off in favor of Agency and Corporate paper.  And why not?  That's where the absolute yield is the greatest.  Combine relative high yield with a rising dollar and you have many a foreigner only too happy to participate in US debt markets.  Albeit starting from a small base, foreign purchases of equities has simply exploded in the last half decade.  As you would only expect, the bulk of the money (on a rate of change basis) has come in this year.  Unlike a lot of the American public and institutional clan, foreign holdings of U.S. equities as a percentage of total foreign holdings of U.S. financial assets isn't off the charts from a historical standpoint:




It is quite interesting to note that the longer term experience of the foreign community is quite similar to the American public in terms of the ebbs and flows of equity ownership.  After the 1973/74 debacle in the U.S., the American public sold their mutual funds for eight straight years.  Likewise, the foreign community largely abandoned U.S. equity ownership from an overall portfolio standpoint.  As in the case of the American public broadly, foreigners again "found" U.S. equities during the 1990's and once again began committing serious money to an asset that had already experienced substantial appreciation.  Human nature is a riot, isn't it?  How come you holders of the QQQ's aren't laughing?

Scaredy Cats?...As foreigners have so kindly been recycling our seemingly never ending supply of exported dollars back into our own financial markets, what about quid pro quo?  What have we done for them lately?  Well, ever since the global economic scare during 1997, we have stuck to our own knitting, thank you.  We've been practicing the new era exercise of importing cheap (currency deflated) goods and exporting expensive paper.  Have a look at what U.S. investors and institutions have done:




Admittedly, while the bonfire of the global currencies has been raging well outside of the U.S. dollar containment zone, U.S. investors have been correct to avoid loading up on foreign denominated financial assets.  The question going forward is whether the contrary will be the appropriate action.  Clearly, that question hinges on the fate of the almighty dollar.

Our complete love and fascination with the financial markets is borne in the fact that change is the hallmark of the financial animal.  Although human nature and decision making characteristics rhyme over time, they never repeat in exact detail.  Having said that, we see a certain irony in the global rise of the dollar over the past few years.  Yes, the globe did need the U.S. consumer to become the global consumer of last resort to pick up the slack for a faltering global economy some years back.  And yes, the U.S. needed the dollar recycling operation to run full speed ahead to keep the financial markets and the U.S. consumer pulling the global economic load.  But, the Achilles heel in the circular interaction is that a rising dollar ultimately fosters a relative decline in U.S. dollar based corporate earnings momentum.  It takes some time to be realized, but isn't it an inevitability?  You bet it is.  In the recent trade deficit numbers reported a few days ago, import growth did slacken off a bit, but so did export growth.  Just ask the tech companies how foreign sales growth, or lack thereof, is progressing?  Plain and simple, a rising dollar sows the seeds of a domestic economic slowdown or contraction at some point.  The Fed and the Treasury aren't stupid.  They had to know this would happen eventually.  So here we are.  For what it's worth, it appears as though the dollar may be currently in the process of "getting it" in terms of the ramifications of the (temporary) financial new era:



The rising dollar has forestalled a more serious onset of inflation in the US over the past three or four years.  We have imported foreign deflation.  Now Greenspan faces a reversal of that process in his deliberations over easing monetary policy.  What's it going to be?  The stock market and the economy, or the dollar and inflation?  We're waiting.  In anticipating ease in monetary policy, bond market participants have bid up everything Treasury.  Now to the point where foreigners have some yield choices offset against currency choices.  Earlier this year, the spread between 10 Year Treasuries and similar government vehicles in many of the European currencies was quite large in favor of the Treasuries.  Not so as of today.  Just have a look at what a difference eleven months makes:



Spreads On 10 Year Maturity Paper Versus US Treasuries

      1/31/00 12/21/00
   Guilder§        -95bp -3bp
German Bund   -112   -17
     Franc§        -101 -2
    Kroner§        -77 11
     Pound§        -92 -9


As you can see, absolute yield spreads have almost disappeared between European denominated bonds and similar maturity Treasuries with the recent rally in UST's.  Question: Why would a European investor want to hold US Treasuries as opposed to home country government debt?  Although we can think of a few political reasons, the overriding rationale is relative currency strength.  At least a year ago, European bond buyers had spread plus dollar strength.  Now it's down to currency alone, and that is coming into question as the dollar approaches its 200 day moving average.  Clearly, a weakening US dollar from here would ring the selling alarm bells for the foreign holder of US Treasuries.  Foreigners have to be questioning the logic in holding US stocks now that the domestic equity markets have become a tiny bit uncooperative.  From here on out, isn't it just as clear as a bell that the dollar is the key to the cross border asset holding shooting match?

As we showed you on Tuesday, US investors (institutional and public/retail) have allocations to equities as a percentage of total financial assets at near record levels.  Well, over the last two years, foreign investors have gone on a veritable spending spree in accumulating U.S. equities.  They have also not done too badly in the credit markets either as foreign holdings now account for 10.6% of total domestic credit market instruments outstanding.  Suffice it to say that the foreign investment community has become a very significant player in the arena of US financial assets.  A player that could have a severe impact on domestic financial markets with actions taken simply "at the margin".  God forbid foreigners decide to dump U.S. financial assets in wholesale fashion.  Forget the worst case.  They just have to stop buying to create a huge impact.  It's actions at the margin that can change the direction of financial markets.  We'll keep you posted.

Operator, Can You Help Me Make This Call?...You know the old traders saying by now.  "Never meet a margin call."  Crazily enough, we are seeing a good number of margin calls be met these days.  Even more astounding is the fact that many calls are being met with debt.  The CEO of Safeguard Scientific.  Big Bernie and WCOM.  And what about the less well publicized players?  (You know who you are.)  Maybe this is what we should expect as initial reactions in a bear market.  Denial.  Disbelief.  Financial bravado.  It amazes us that these types of decisions are playing out when all the players have to do is simply have a good look at the following chart:



From the peak, the NASDAQ may be down 50%, but margin debt has only fallen about 20%.  As you would imagine, we firmly believe margin "reconciliation" has just a bit further to go.  Just a bit.  Don't you think?

Cash Is Trash, Except In A Cra....(Well, You Know The Rest)...As we showed you on Tuesday, the public is as fully invested in equities as at any time in the last 50 years.  Foreigners have been on a big buying spree.  In like manner, it sure appears that the professionals at the equity mutual funds have little fear at this point:



As of September quarter end, cash in equity oriented mutual funds stood at 5.1%.  Buy, with what?  It's quite a statement on professional confidence.  As you know, equity mutual fund managers have been taught to remain fully invested or risk missing the stock slingshot train as it leaves the station during the past half decade.  How else would you expect them to act in a world where the NASDAQ can move 10.5% in one day?  Miss it and you're dead.  New era "investing", we still don't "get it".

At The Wire...AMG reported the single greatest one week outflow from equity mutual funds in the history of the U.S. today.  $19.2 billion.  Wow!  Before getting too worked up about this, remember that it is capital gains distribution time and these distributions can be counted as outflows.  As you know, we have discussed many a time how cap gains distributions this year would most likely be a sight to behold.  Well behold you have.  You've lost money in your fund this year and now here is your tax bill for that wonderful experience.  Given that these "tax bills" were determined at October month end for the mutual fund industry, we have the sneaking feeling that pro forma taxable distributions for 2001 have already started growing significantly over the November-December period this year.  Unrealized gains...the dirty little secret of the mutual fund industry.  We have the feeling the secret is getting out.  Coming to a 1040 near you real soon.

The Long Ball...Tim has prepared another bird's eye view of the S&P for us.


As you can see, the last time we had this kind of elongated "red candle" on the S&P weekly, Junior Fire Marshal Greenspan doused the offending candle fire with liquidity (1998).  Rumors circulated in the pits today that an interest rate cut was imminent.  Sorry to be redundant, but critical to judging the future health of the financial markets will be investors reaction to the first interest rate cut.  Rate cuts do not change corporate earnings overnight.  Rate cuts do not immediately reconcile corporate or personal balance sheets.  Rate cuts do not change overweighted portfolio asset allocations to equities.  Rate cuts do not immediately change the direction of global economic growth.  Rate cuts, though, may change the relative value of the dollar and global capital flows.  Let's just hope the postcards we receive from abroad post that rate cut aren't sell tickets.  

--------------------------------------------------Heavyweight Champions 12/19                                                                                    


GRADU-AL...Well there you have it.  An unbiased call by the FOMC on the state of inflation and proclivities toward recession.  Even though the Fed may have had reason to go to ease or actually cut rates, it proceeded along its own historical path of gradualism.  We don't know whether you have been tracking this, but never in the Greenspan regime has the Fed gone to an easing bias from a tightening bias in one fell swoop.  Likewise there has never been a rate cut where the prior stance was a tightening bias.  Not even during the dark LTCM days.

The probabilities of an economic hard landing continue to mount day-by-day.  Just today it was announced that retail sales fell for the third straight week in a row.  It was reported that shopper traffic in malls for the week ended December 16 fell 9.6% from year ago levels.  As you know, there is one weekend left to make the Christmas retailing season.  It's simply now or never. Unfortunately, we just don't see how the retailers pull substantial year over year growth out of the bag at this point.  They'll probably be lucky to do 2-3%.  These numbers suggest that the economy is accelerating to the downside in rather unexpected fashion.  To top it all off, clearly the apple is not falling far from the tree. The Dollar Tree, that is.  Here's a company with a pretty nice string of earnings growth that sells individual pieces of merchandise for $1, and it's going to miss its earnings. (As you may remember from our Thursday discussion, DLTR was just booted out of the NDX 100 as of Monday.)  Clearly the lower income strata are feeling the pain of higher energy prices and the fallout of a rising CPI over the last twelve months.

Recent industrial production numbers don't just show slowing, they show broad based slowing.  With the recent slowdown in retail sales, these numbers are sure to get worse in the months ahead.



Lastly, the recent inventory numbers also suggest the nose of the economic plane is tipping ever more in the direction of the tarmac.  Once again, the current retail numbers suggest inventory growth accelerates ahead:


Even we have been surprised at the rate of acceleration in economic deceleration.  The Fed choosing its published wording to focus on "risks mainly weighted toward conditions that may generate economic weakness in the foreseeable future", is basically telegraphing the message that interest rates will be cut at the next meeting in late January.  As you know, six weeks in this type of market environment can seem like a veritable lifetime.

Heavyweight Champions...We told you last week that we would continue our review the Fed's recent Flow Of Funds publication.  We want to focus for a few minutes on the asset allocation numbers that can be found in this report.  You also may remember that we penned a piece a few weeks back called The Weighting Is The Hardest Part.  This piece laid out the numbers in terms of mutual fund allocations to technology and argued that these very weightings would need to be reconciled.  Well the weightings we are look at today are institutional and public allocations to equities as a percent of total financial assets of these two sectors. Despite the dramatic drop in the stock market this year, in most cases the weightings are still very near record levels.

Let's look at some charts and we'll talk. First, let's see what mom and pop American investor are up to:


The household data presented above contains data for households and personal trusts (inclusive of equity mutual funds).  It is adjusted for pension funds (subtracted out) to get a purer personal accounts number.  As you can see, we are sitting very near all time highs.  We'll get to this in a minute, but the public really hasn't sold their equities during this bear market so far.  The drop is largely related to market decay offset against increasing equity purchases.  As always, the ultimate irony of human decision making can be found in the fact that individuals had one of their lowest allocations to equities in the last 40 years at the very beginning of the bull market in 1982.  Oh well, how else could it have been a bull market launching pad?  Of course now that stocks have catapulted to record heights, the public is as loaded down as they have ever been.  Simple question: If the public is finding it hard to sustain retail sales purchases, just where will the money come from for future stock purchases?  Also found in the Fed Flow of Funds report, the following chart may hold a few answers:

The answer is, "we don't have an answer".  Clearly, the public's largest allocation to equities is accompanied by the public's largest allocation to debt as a percentage of GDP anywhere in the last 40 years.  Will these two charts ultimately have a similar resolution.  Our bet is that this is exactly what will happen at some point.  In a tangential manner, these two charts also beg the question of the potential effectiveness of monetary policy at this point in the credit cycle.  Will household debt as a percentage of GDP go to 100% if excess liquidity enters the picture once again?  Chances are we'll find out in the next few months.

What about institutional money?  Pretty much the same story.  Allocations by the large institutional pools to equities is almost on top of an all time high.  (In the following graph we use the pension and insurance companies as proxies for the institutional market as a whole.)


It must be noted that the insurance complex drags this average allocation number down a bit by the very nature of the insurance complex.  Variable annuities and products like these include equity exposure, but by and large the insurance industry has had an historical base of significant bond exposure.  Just where do these fiduciaries go from here in terms of overall portfolio asset allocation?  

By no means do we mean to dump on the plan sponsor world, but from what we have seen and experienced, it is characterized as one of the classic "group decision making" forums.  Pension committees hire outside consultants with whom they collectively come to asset allocation decisions for large pools of money.  We have seen time and again the plan sponsor world allocating money to assets that have already appreciated.  It's just simple human decision making to want to go where the market is already acting well.  Rarely, if ever, do groups such as these make contrarian decisions unless one person is really a dominant or driving force in the group.  We're sure you remember us telling you of the CALPER's decisions over the last year to allocate money to VC funds (read: tech and dotcom).  Of course they have scaled back these plans since that time.  Somebody please clean off the rear-view mirror.

Where The Money Isn't...It wasn't more than one year ago that Ed Hyman of the ISI group documented that bond managers were at very low durations in their portfolios of fixed income.  Also, sentiment towards bonds was extremely low.  What else would one have expected at that time given a NASDAQ on its merry way to doubling?  Bonds?  We don't need no stinkin' bonds!  Of course in hindsight the low durations and rather lackluster optimism was a signal that perhaps bonds would make a dramatic comeback.  Clearly any competent discussion of the bond market must address the various sectors.  Junk bonds have acted like stocks in 2000.  Medium quality corporates not much better, and high grade corporates have largely held their own.  It's the Treasury end of the game where the action has occurred.  US Treasury Department buybacks, flight to quality, growing anticipation of a possible recession as the year wore on, and some potential unwinding of carry trade positions (short Treasuries and long spread product) was responsible for very respectable Treasury performance.  Especially in the last few months.

Now, we all know that the collective intelligence of investors everywhere has been heightened in this new age of information dissemination, productivity and technology in general.  We all know that stocks and equity based alternatives (private equity, VC, etc.) have historically taken the cake.  The contrarian in us suggests the following chart may contain a bigger message about the future:



By and large, the institutions have abandoned the bond market.  They really did so a number of years ago.  Interesting given that high quality bonds have outperformed everything in sight this year.  Of course what else would you expect now that the sellers are largely gone?  As we mentioned in a piece about junk bonds a few weeks back, we are at least academically interested in various neglected and bombed out fixed income sectors given they command the least attention by institutions in terms of overall asset allocation.  Crazily enough, the worse the economy decelerates, the better the investment opportunities become for buyers of corporate debt.  We are still not advocating jumping into the pool with both feet, but we're pretty close to getting our feet wet in some type of averaging strategy.  As you know, the market always looks ahead.  Nine months ago, the stock market was screaming that corporate earnings, cash flow and stock valuations were at risk.  Unfortunately at the top, the message of the market is usually the sound of a dog whistle.  It can only be heard by humans during subsequent in process bear markets.  Likewise there will come a point where the market will have largely discounted the risk in the debt of high as well as lower quality corporate borrowers and the dog whistles will be blowing once again.  Honest to God, when we showed the above chart to our family dog, his ears perked up.  Who let the dogs out?

The Final In Vinyl...We continue to study the asset allocation characteristics of the public as well as the institutions given our strong belief that decision making of the majority or the crowd is usually wrong at major asset price turning points.  Households are near record highs in terms of holding stocks as a percentage of total financial assets.  Institutions are near record highs in terms of holding stocks as a percentage of total financial assets.  At the moment, institutions are near record lows in terms of holding fixed income assets.  Corporate debt as a percentage of GDP stands at all time highs and household debt as a percentage of GDP likewise shares those honors.  In our minds, records are made to be broken...sometimes the hard way.

 

The Fingerprints Of Human Decision Making...We believe the following chart is one of the more important we have shown in some time.  It's basically a monthly chart of the Nikkei from 1984 through to a few months ago.  Overlayed on top is the monthly experience of the NASDAQ from 1994 until the present.  What we have done is "mark up" the NASDAQ by a multiplier that equates the top in the NASDAQ with the Nikkei and adjusted prices forward and back accordingly.  Have a good look:



This is not only a chart of supposed wealth creation and destruction, but more importantly a study in human decision making.  Collective decision making.  Clearly human greed and human fear cross the span of cultural differences.  Quite uncanny that the NASDAQ of the last 9 months has been a virtual mirror of the first nine months of Nikkei experience from the top of that market in the late 1980's.  As you would imagine, we will keep you updated on the action ahead.

One last comment, and we will be talking about this extensively in the future, the Nikkei is a demonstration of the concept of non-linearity we keep harping on.  Bear markets are a process of confidence destruction.  They do not happen in straight lines.  The 1990's chart of the Nikkei as well as other examples of our markets seen in the 1970's and 1930's suggest that when bubbles pop, the investor mindset needs to change from one of buy and hold to one of trading waves of subsequent optimism and pessimism in the following years.  Unless we are simply dead wrong, this is the only way money will be made for a time in the years ahead.  Be willing to challenge the most solemn beliefs of the consensus.

Is This A Legitimate Bear Market?...For the NASDAQ as a whole and most of its well know components, the characterization of bear market pretty much fits the bill.  For the Dow and the S&P, we're not quite there yet.  One distinguishing feature of this bear market so far is that public money is not leaving the market (except that money that has already gone to money heaven).  The public is not selling their funds.  Clearly, money is rotating among sectors in somewhat of a haphazard fashion.  In the last four weeks, equity funds experienced the two largest outflow weeks this year:



We're still not convinced that this is real selling at all.  We're still betting that this is simply tax avoidance.  Why not sell the fund to offset the cap gains distribution?  Or sell to offset other already realized gains.  For all intents and purposes, public money has not blinked despite some sizable hits in tech.  So far in this bear, that's what's different this time.  We'll continue to track this closely as these weekly numbers are where you will find changes in emotion and psychology.  How much pain can the public tolerate?  So far in this cycle, a lot.

 

Look To The East?...It's interesting in the chart of the Nikkei and NAZ above that in the Nikkei cycle it was right about now where the Nikkei rallied for a period.  Who knows what happens to the NASDAQ ahead, but we believe that keeping an eye on the charts in conjunction with  the fundamentals will be the key to making successful shorter term and bigger picture decisions.  As always, Tim's work is incredibly meaningful in keeping the everyday road ahead in perspective.  In a world where emotional decision making can drive daily action, having a good sense of the technical characteristics of the market is a major tool for controlling risk.



leider nur englisch aber sehr aufschlußreich.:)
gruß proxi
       
       
   




 

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