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-----Original Message-----
From: owner-realtraders@xxxxxxxxxxxxxx
[mailto:owner-realtraders@xxxxxxxxxxxxxx]On Behalf Of Dick Webb
Sent: Wednesday, April 14, 1999 3:41 PM
To: RealTraders Discussion Group
Subject: inside out market??
Your opinion please...
For quite some time there has been a huge up move in
the Dow, NDX and S&P. The experts claim that this was
a small group of stocks when 70% of stocks are in a
down trend (below the 200 day ma)
Is it possible that we will now see a significant
decline by the same narrow group??
While the rest of the market goes up or sideways?
Does anyone have a memory of the nifty 50 and what occurred there???
===
Big Lucky Dick
______________________________
Below is the free update from David Tice at the Prudent Bear, a bear fund in
which I have, to-date, lost a pretty penny <g>...
JW
The End Game
Wednesday, April 14, 1999
It has been a truly extraordinary past few sessions in the stock market with
absolutely chaotic trading action in individual stocks and groups.
Inarguably, this is all consistent with a dislocated marketplace
increasingly vulnerable to an accident. Moreover, it certainly looks as if
an important inflection point has been passed, with the appearance today of
considerable portfolio shifting. This is likely in response to the
developing recognition of trouble approaching on the horizon. Certainly,
portfolio managers can not today be faulted for selling Internet stocks and
buying companies like Boeing and Caterpillar and we see this mentality much
explaining today’s extraordinary divergences. In what appears to be
safe-haven buying, investors flocked to cyclical stocks with the Morgan
Stanley Cyclical index and the Transports surging 4% in today’s remarkable
trading session. So far this week, the Morgan Stanley Cyclical index has
gained 8%, much outperforming the Dow and the Transports, that have gained
2%, and the S&P 500 with a 1% decline. The Morgan Stanley Consumer index has
declined 1% and the Utilities have dropped 3%. The small cap Russell 2000
has come to life gaining 3% the past three sessions and the financial stocks
continue to outperform, with the S&P Bank index and Bloomberg Wall Street
index both rising 1%. In a notable change of fortunes, the technology stocks
have come under heavy selling pressure. So far this week, the NASDAQ 100 has
declined 5% and the Morgan Stanley High Tech index and The Street.com
Internet index have dropped 6%.
We remain steadfast in our view that the market has been in the process of
putting in a major top, one that will likely hold for years to come. In this
regard, we have certainly not been dissuaded from this view by the nature of
recent stock market behavior. In fact, we can not imagine a market more
distorted than the current US stock market. Not only does wild speculation
abound at both the retail and institutional level, but also unprecedented
derivative trading proliferates, creating hidden leverage that has
artificially driven stock prices to unprecedented extremes. Truly
astonishing, however, is that this all passes for a sound and so-called
bullish marketplace.
Recently, bullish euphoria has come to absolutely permeate the consensus.
Indeed, opinion has become resolute that the Dow has begun a march with a
first stop at 12,000 and that buying Internet and tech stocks is as good as
free money. Truly, confidence reached a new extreme as the general market
successfully ignored the war in Yugoslavia and negative earnings news from
the likes of leaders Compaq and now Intel. Additionally, over the past few
sessions the small caps have even come to life, heartening the bulls as they
interpret this as the long-awaited market broadening, the last remaining
factor that now confirms, in the bulls eyes, another leg higher for the bull
market. Indeed, the celebratory bulls are again trumpeting the "Teflon"
market and a remarkable sense of invincibility has engulfed the bullish
camp. Viewed through their rose colored glasses, things just couldn’t look
better. Well, we couldn’t disagree more and certainly see such extreme
sentiment as indicative of an historical market top. Additionally, we see
many internal market dynamics also indicative of a market that could see its
fortunes change swiftly and dramatically and, in fact, we believe we saw the
initial signs this afternoon.
Instead of the "Teflon Market", an accurate description would be the "Great
Dislocated Market". Sure, the bulls see the market’s ability to easily brush
off bad news as signaling incredible underlying strength. A more objective
analysis, however, would recognize an almost complete breakdown in the
discounting mechanism throughout the marketplace. Stock prices no longer
reflect the value of underlying businesses, as prudent analysis and
rationality have been pushed aside by overwhelming speculative froth.
Amazingly, stocks today move 20, 30 or even 80 points on no meaningful news
or corporate developments. And this morning Charles Schwab traded with $63
billion in market value, not only 70% greater than Merrill Lynch but also
surpassing General Motors. Schwab gained 61 points, or about 65%, in just
eight trading sessions. E*Trade rose 83 points, doubling in prices, and
Ameritrade gained 126 points, or 200% in the same eight sessions. NetBank
surged almost 140 points in three sessions, or about 150%. And looking at
the market as a whole, prices have just marched higher with the Dow gaining
700 points in less than three weeks with nothing in the way of fundamental
developments to explain such a huge move. As has been the case all year,
strong market gains fly in the face of fundamentals as interest rates have
surprised on the upside and earnings prospects only continue to deteriorate.
We strongly sense that there has been more at play here than simply bullish
over-zealousness. We suspect that hedge fund trading and derivatives
continue to play havoc with the marketplace, not to mention the additional
influence from millions of online daytraders. Certainly within the Internet
sector, panic buying and an absolute meltup has been exacerbated by an
historic short squeeze and huge derivative related buying. For months now,
Wall Street derivative shops have been peddling products that provide the
owner leveraged long exposure to the Internet sector. And as the writers of
these options, Wall Street derivative trading desks must dynamically hedge
their exposure to these instruments. This hedging activity can be very
destabilizing as it leads, particularly during turbulent markets, to
self-reinforcing buying when prices start to rise. As certainly has been the
case of late, the writers of call options on Internet stocks have been
forced to buy the underlying stocks, at any price, in a frantic effort to
hedge exposure. And this frenetic derivative related buying only exacerbates
the huge losses being suffered by those short these stocks. This has led to
the current truly historic market fiasco. One thing is for sure, the forced
panic buying by derivative players and those short these stocks is done with
no regard to the underlying business fundamentals of the actual companies.
The lack of underlying fundamentals will come back to haunt these stocks
come the collapse.
What makes the current environment so extraordinary, and what is certainly
an important factor behind the current extraordinary dislocation, is that a
proliferation of bullish retail and institutional momentum investors have
gravitated to exactly the types of stocks that many of the sophisticated
hedge fund players are short. Rarely has there been such a convergence of
stocks that are viewed with such ill repute by seasoned investors but, at
the same time, seen by the manic public and mutual fund industry as
absolutely must own securities. This circumstance is, indeed, quite
momentous. For now, the bullish speculators have won a battle against many
sophisticated hedge fund managers forcing them to cover their shorts at any
cost just to stem losses. And include the previously mentioned derivative
trading issue and here you have an extraordinary confluence of factors that
has created one of the great market speculative melt-ups of all time.
And while the bulls today celebrate, we see this as just the latest, and
definitely the greatest, episode of market dislocation. Clearly, such
traditionally atypical environments have occurred with way too much
regularity over the past few years in global markets. In this regard, we are
reminded of the dislocation in the US bond market back in the fall of 1993
that led to an astonishing "melt-up" just months before the Federal Reserve
raised rates and the bond market suffered its worst bear market in a decade.
We are also reminded of the dislocation in the emerging markets at the end
of 1993, especially in SE Asia, that put in what will likely be market tops
for years to come. Interestingly, the hot Wall Street derivative trades back
in 1993 were call options on emerging markets that provided leveraged long
positions in SE Asia and elsewhere. These instruments were certainly
contributing factors to the horrific booms and busts for these markets and
economies.
Today’s dislocated market also brings back memories of the first quarter of
1994 when the stock market, particularly the large NASDAQ stocks, were quite
resilient in the face of a dramatic rise in interest rates. In fact, as
rates moved higher, impacting the S&P 500, the bulls took great comfort when
the NASDAQ indices and many mutual funds set record highs on March 18th.
These higher prices, however, were actually much related to panic buying by
the hedge fund community that had shorted stocks anticipating a market
decline. When this covering dissipated, the NASDAQ was hit with a 10%
decline in just two weeks.
And finally, today we are reminded of the battle over the Thai Baht back in
the summer of 1997. The Soros group and other smart hedge funds accurately
recognized deteriorating fundamentals and the unfolding vulnerability for
the Thailand economy, and the overvalued Thai currency. The hedge fund
community had placed bets against the baht, but were hit with stiff
resistance from Thai authorities and other market players. The Baht
strengthened significantly and many hedge funds were forced to buy the baht
to cover losing short positions. There was considerable elation that the
hedge funds had been beaten, strengthening the perception that all was well
and that the funds had erred in their analysis. Well, just weeks later,
however, the Thai baht began its collapse that proved the beginning of the
worst global financial and economic crisis since the Great Depression.
Today, we see many disturbing similarities between the circumstances of the
Thai baht back in the mid-1997 and our market today, particularly the
Internet, telecommunications and technology sectors. It certainly appears
that some of the best minds in the investment business placed bets that this
US bubble would burst and have been forced to cover bearish positions with
significant losses. This unwinding of bearish bets has led to huge gains in
many stocks, particularly the large NASDAQ stocks and, certainly, the
Internets. In this regard, all of this is much a replay of the Thai baht
rally in the Spring of 1997, as a similar bearish unwind dislocated the baht
market, with surging prices completely failing to discount deteriorating
fundamentals and the impending debacle. Importantly, and clearly relevant to
today’s most extraordinary US stock market, bearish fundamentals actually
precipitated an environment where prices temporarily spiked higher before an
absolute collapse. The Thai central bank temporarily beat the hedge funds
but was powerless to change the actual fundamentals.
We expect fundamentals to begin to play a larger roll, as today had the
appearance of an important reversal in key sectors of the market. The NASDAQ
100, which traded at 2214 this morning, closed 5% lower at 2103. Many large
NASDAQ stocks that have been at the heart of recent dislocated trading,
broke hard this afternoon. Level 3 Communications traded at 97 this morning
and closed at 82 and one-half, and Qwest Communication fell from its
intraday high of 101 to close at 87. Ameritrade, which traded at 188 this
morning, closed at 148. The Street.com Internet index traded at 794 this
morning, only to close the day at 694, a decline of more than 12% from
earlier highs. This certainly had all the appearances of a key reversal for
this most amazing Internet bubble, likely precipitated by an unwind of
option positions ahead of Friday’s expiration.
Certainly, much of the recent melt-up in prices for Internet, telecom and
many NASDAQ stocks have been exacerbated by all the derivative trading. With
the proliferation of listed options trading as well as Wall Street-created
derivative products, untold numbers of speculators have aggressively
purchased call options to gain leveraged exposure to the bubble. With this
in mind, we suspect that massive unrecognized and unappreciated leverage
exists throughout the large NASDAQ and Internet stocks. And it is exactly
all this leverage that leaves our market very vulnerable to a debacle. As
always, the problems with speculative markets is they end in collapse. You
can call it a pyramid scheme or just a game of musical chairs, but when the
music stops and speculators attempt to cash out, panic will quickly develop
as liquidity disappears and few are able to get out.
The Market Commentary is brought to you by the Prudent Bear Fund every
Wednesday and Friday evening.
http://www.prudentbear.com/markcomm.htm
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