got a ticket to ride,
got a ticket to ride,
got a ticket to ride,
she don’t care.
know why she’s ridin’ so high,
ought to think twice...."
the great collapse of 2000-2001, Nasdaq has cut back drastically on the
data services they once offered and we have had to do an immense amount
of legwork to keep up with our Dollar Volume Trading tallies. It
would be far simpler to use the measure focused on by Jim Bianco of Bianco
Research and by Ken Safian of Safian Investment Research, which simply
divides total stock market capitalization by Gross Domestic Product.
But the point is not only that stocks are expensive, it is that they are
traded to death! This is the nature of speculation and it is certainly
the epitome of a stock market mania. If stocks simply went up in
value rapidly and no one sold or traded (relatively speaking), that would
actually scream from the rooftops that higher prices were fair because
folks were reluctant to part with their shares. But that is not what
is occurring. In the month of January, Nasdaq traded nearly 2-1/4
billion shares per day, proof that participants were quite thrilled to
part with their shares. Yes, buyers stood ready but in all likelihood,
sellers could not bear to be out and just rotated their assets into other
holdings. The players all believe they have a ticket to ride the
gravy train and have no cares at all about this next phase of the greatest
mania of all time. They ought to think twice. They're not.
This is not the investment market that existed from post-World War II and
into the late 1960s. This is not the first stage of the great bull
market from 1982 to 1990. This is an animal with entirely different
stripes. Not a bull. Not a bear. A veritable stock market
mania and quite probably, the most profligate mania of all time.
- VELOCITY -
As it turns out, we were a bit more off on last
year's final estimate of DTV than we would have liked, but further examination
uncovered some data we could not previously find. Although we may
still be off by a tiny bit, we believe the year end tally for 2003 is now
quite accurate. It is our initial estimate for 2004 that we are unsure
of. However, if trading remains at the same pace and prices do not
range too far from where they currently are, the bar for 2004 will be about
as high as it now stands - in the stratosphere and second only to the year
2000. It is inconceivable that trading could again even remotely
approach the pinnacle of 2000. After the fallout of 2001 and 2002,
it is a fair assumption that some of the players were burnt sufficiently
and are now smart enough to remain gun shy. Thus, the bar you now
see representing what 2004 may generate is far more important than the
roughly equal level of 1999. Back in 1999, the sky was still the
limit. Who knew what the top could be? Now, we know.
It makes no sense to assume that the bar in 2004 can travel much higher
than it is now. Given the backdrop of the 78 years and especially
what occurred beyond 1999 and 2000, we believe it is quite safe to assume
we are still very much ensconced in a stock market mania.
DTV versus total market capitalization is another
measure of how intensely speculation has gripped participants. At
the peak in 2000, our measure ran to a higher peak than 1929, testament
to a market gone mad, driven by rapid trading and a constancy of higher
prices. We arbitrarily chose the 150% turnover level as the boundary
for an "official" mania but in truth, there is no official definition,
only an assumption. Although 2002 traded a tick below the mania level,
newsletters writers according to Investor's Intelligence displayed more
bears than bulls in only six weeks while stocks were down 45% from their
highs. Given the huge decline in prices, it appears that most participants
were still trying to pick the bottom. During this year, where
the Nasdaq Composite index fell as much as 43% and still finished down
32%, bulls were above the 50% level for twenty weeks. Bears never
ranged above 42.3% and were above 40% in only three weeks. Imagine
how sentiment might have been if prices had only fallen modestly!
Given that so much money is now devoted to the trading of derivative instruments
of index futures and stock options, it can be argued that without said
derivatives, trading in the underlying stock issues would be significantly
higher. Thus, DTV versus total stock market capitalization
could conceivably be understated in relation to where it soared in 1929.
- FINANCIAL WEAPONS OF MASS
Once or twice each year, we focus on derivatives,
those unwieldy beasts that Warren Buffet termed potential "financial weapons
of mass destruction." Those of you who have read our opuses for the
last few years well know our position on derivatives, which we firmly believe
pose the threat of a financial earthquake equivalent to a 9 on the Richter
scale. We began writing about these threats after the crash of 1987,
when the world was perhaps as little as fifteen minutes from a financial
collapse and wrote again at length after the LTCM fiasco in 1998, when
the world was certainly only a day or two from a financial collapse.
The principal threat from derivatives is that no one has any idea of how
intricately the daisy chain is linked or just how any potential problems
can unfold and like the most virulent of viruses, infect the financial
world both speedily and fatally. On October 19, 1987, when the futures
pits opened in Chicago, Wells Fargo stepped in and unloaded six separate
$100 million lots of S&P futures. That's all it took to catalyze
the worst day in stock market history. In the fall of 1998, Long
Term Capital management believed it was bigger than the market. And the
flawed strategy of just one hedge fund necessitated the brokering of the
Chairman of the Federal Reserve between major banks and brokerages to stave
off a financial collapse that was already reverberating through a daisy
chain of $2 trillion in derivative products. Although Mr. Greenspan
continues to believe that derivatives have changed the world for the better,
we believe otherwise. Given the rapid rate of expansion in derivative
use, their non-regulated status, and our relative ignorance of how they
are intertwined (like in 1987 and 1998), a disaster of enormous scope is
likely to surface at some point. It has been amply demonstrated that
the policy of the Federal Reserve is to deal with crises AFTER the fact,
not before. The measures of success to date offer us no confidence
that they can deal with what in the first place, must be unknowable.
Simply put, derivatives have grown far more rapidly than our comprehension
of how they work.
All our data is taken from the Office of the Comptroller
of the Currency and can be found at www.occ.gov. As our chart above
clearly illustrates, derivative growth is in a mania by itself. We
hasten to remind that the bars shown are only for the U.S., whereas it
has been posited that derivatives worldwide may now exceed $120 trillion.
The charts and numbers we show are just the OCC's "official" tally.
The Bank of International Settlements in Basel, Switzerland estimates that
nearly $170 trillion in notional values of OTC derivatives now exist!
The annualized rate of growth in the U.S. since 1991 is 20.1%, far exceeding
growth in the Dow Industrials at 10.5%, the S&P 500 at 9.6% and even
Nasdaq at 10.8%. You want to see a long term mania at work?
Just look at the chart below.
Belief in product fuels the fires of derivative
growth. New product means commissions and the pot at the end of the rainbow
for those financial engineers who are masters of the arcane craft of creating
"needs" where none need exist. An example of this sleight is the
options and futures contracts that are planned for the VIX, itself a mere
indicator of volatility with no tangible value whatsoever. Notional
values of U.S. derivatives now measure five times total stock market capitalization
and six times GDP. If a worst case scenario unfolds at any point,
the derivative market is now huge enough so that the fallout could be catastrophic.
Our next chart details the credit risk suffered
by the seven largest U.S. bank holders of derivatives. The vertical
line placed at 100% is equal to the entire risk based capital
of the bank. Although you might be tempted to ponder that only JP
Morgan might be in harm's way, consider that their derivative portfolio
has counter-parties, some of whom could conceivably drown if enough went
wrong. Now that JPMorgan/Chase is taking over Bank One, the picture
changes, but only to a minor degree. If you stare at the chart long
enough, you may see the real reason why the merger is taking place, so
that the capital of the surviving entity capital is no longer quite as
compromised as it was before. But all the same, the exposure is monumental.
Ironically, the combination will result in the bank “growing” into the
10th largest U.S. company, if our computation is correct. This
will mean even more indexing money thrown at JPMorgan/Chase/BankOne, blindly
and with absolutely no regard by indexers for the exposures maintained
by JPM‘s derivative portfolio. We would think a reasonable
investor would be put off by the sheer size of the portfolio, and invest
elsewhere, even if it meant giving up whatever “opportunity” was offered
by the new and larger JPM. In this case, larger via indexing equates
to more inefficiently priced shares and the larger derivative portfolio
exposure in any event, carries with it, the opportunity for higher risk.
Whatever profits JPM is capable of, we'll gladly forego ownership of the
shares in the interests of a more conservative stance.
Finally, consider that the seven banks shown comprise
derivative portfolios that total more than $64.2 trillion in notional values
while total assets are only $2.7 trillion. We have always surmised
that a worst case scenario could impact as much as 2% of the notional values
If we are correct, the worst case scenario
could impact roughly half of the seven major bank's assets.
- DOUBLE WHAT THEY'RE WORTH!
The most remarkable part of the indexing equation
is that professional investors are now totally convinced that valuations
have permanently changed. Inflows into large caps have
been incredibly robust for years and has lifted their valuations to extreme
levels. But the process did not take place overnight and the gradual
incline in valuations has gone on for so long that it has achieved a consensus
of acceptance. But if larger stocks can "rightfully" achieve these
valuations, smaller stocks can also achieve the same, or perhaps even higher
valuations - so the thinking goes. Thus, we see an environment where
the impossible has actually occurred! Professionals are now able
to throw 100 years of Tobin's Q ratio out the window, a measure devised
by James Tobin of Yale University, a Nobel Laureate in Economics. Mr. Tobin
hypothesized that the combined market value of all the companies on the
stock market should be about equal to their replacement costs. The individual
calculation is the market value of a firm's assets divided by their replacement
value. For close to a century and until the mania, such has been
the case, with the ratio offering solid proof of Tobin's theory by averaging
just 1.01. Note how the great Leveraged Buyout and Merger spree
of the early 1980s took place when Q values were under 1.
The impetus to buy undervalued stocks was then immense. But since
the mania began (by our count in 1995), Q has averaged a rather robust
2.05, meaning one would have to be literally quite crazy to buy something
one could replace for half as much! But that's what a mania is all
about, isn't it? At the current reading of 2.00, buying U.S. stocks
is about as reasonable as paying $30,000 for a 1998 Jeep Cherokee.
- A "HOT" MARKET -
Edson Gould passed away in 1985 but left this mortal
coil with a prophesy that would not be fulfilled until five years after
his passing. As early as 1974, when the Dow was laboring in the midst
of the worst bear market since the fallout of the 1929 crash, Gould offered
an interviewer a long term projection for the 1980s Dow to "perhaps 3000,
4000 or 5000." The Dow achieved a high print of 2745 on August 25,
1987, close enough. Gould later refined a November 1979 forecast
to "over 3000" in 1990. At the time, the Dow was trading at a tad
above 800 and gloom was widespread. Nevertheless, on July 16th and
17th, 1990, the Dow closed at 2999.75 and briefly traded above the 3000
mark for five consecutive days. Gould's prophesy may have been the
most incredible of all time. Gould's 1979 report entitled, "The Sign
of the Bull," focused on several fundamentals, one of which he called the
"Sentimeter." In the master prophet's own words, "One of our most
valuable concepts for projecting intermediate and long term stock market
tops and bottoms is our Sentimeter," also known as the price-to-dividend
ratio. Gould displayed his Sentimeter in the form of a thermometer,
detailing the yield basis at the price of each $1 in dividends. Today's
feature picture is Gould's Sentimeter as pictured in 1979, with a few minor
changes. Note Gould's description of the levels of emotion, stopping
at "Enthusiasm." We would venture that he never once believed that
emotions could surge as high as they did during the current mania.
Even at the 1929 peak in September, yields were higher than they were in
either 2003 or 2000. The Sentimeter stood substantially lower at
major bear market bottoms like 1982 and 1932. Although we have not
marked 1974, that bottom was at the 6% level. Although Gould's article
appeared 25 years ago, just to prove that some things are just as they
were then, he wrote, “Dividends are what a stockholder receives, that which
he can spend. Earnings, however, are often illusory, something
further confused by different and often changing accounting methods.
Here one year, gone the next, through restatement or whatever.”
[italics ours] Maybe even frauds? And here we see one prime
reason why dividends are no longer important, because it makes life much
easier for corporate accountants. You cannot pay out what you do
not earn. Thus, the investment world has been stood upside down to
satisfy the manic dispositions of Wall Street analysts, corporate managers
and even the investment professionals who place the public's money into
equities at valuations never seen before in stock market history.
Is it any wonder that insider sales have outstripped purchases by a hundred
fold or more when stocks return so little, except claims of profits?
Is it any wonder that even these claims are no longer uniformly defined
for all companies and for all circumstances? Gould wrote, "Once a
stockholder gets his dividend check, the accountants can never take it
away." Currently, only 15% of the S&P 500 issues pay dividends
of 3% or more, the level at which Gould considered evidence of "enthusiasm."
Incredibly, and despite the brutal lessons taught by Enron and Worldcom,
the money managers of the world insist upon price performance, price performance,
price performance, at any cost, and without any regard to dividends.
New scandals such as that of Parmalat, will not end until the rationales
for investment revert to their historical norms. There is still far
too much pressure brought to bear on corporations to fudge their numbers
in order to lift their share prices, which makes everyone happy, especially
the Fed. For now, as Gould's Sentimeter clearly illustrates, this
market is about as hot as it can get.
- MASSIVE INEFFICIENCIES IN
STOCK PRICES -
We recently counted more than 130 different ETFs
ranging in size from the gigantic SPDRs, representing the S&P 500,
with $38.2 billion in assets, down to iShares Global Technology Sector
at a mere $6.7 million in assets. However, the top 25 ETFs comprise
more than $101 billion in assets and are destined to grab enormous chunks
from mutual fund companies in the years ahead. However, the unfortunate
problem with ETFs is the precisely the same despicable circumstance we
perceive with indexed mutual funds. ETFs are typically either index
funds or "sector" funds. Either way, stocks in the trust are usually
weighted by market capitalization. Like index funds, this means the
larger a stock is, the more likely it is to be purchased, either by the
trust itself, or by a firm that deposits the trust’s securities to take
delivery of trust shares. As a consequence, the massive inefficiencies
already visible in the pricing of U.S. stocks are not only likely to continue,
but will clearly worsen in the years ahead if this trend is left unchecked.
There can also be no question that the growth in index funds and ETFs accounts
for a large part of the increase in program trading activity, and there
can be no doubt that the influence of individual investors, like that of
individual company prospects, has simply faded from any vestige of importance.
ETF growth has amounted to 54% annualized over the last five years.
ETF growth remains steady at 50% for the next decade, these entities
will comprise more than 60% of total U.S. market cap. If
we only assume 35% growth, ETFs will still equal more than 20% of U.S.
market cap. How incredible has the ETF phenomenon become? Consider
that the Fidelity Structured Mid Cap Value fund's largest holding is the
iShares Russell Midcap Value ETF. That's right, folks, now you pay Fidelity
to manage your money to buy an ETF. Still more for the grist mill.
Of the top 25 issues traded by volume on the Amex in December, 16 were
stocks and 9 were ETFs. However, dollar trading volume for the 16
stocks was roughly $45.4 billion last year. DTV for the nine ETFs
was just over $2 trillion! Back in the heady year of 2000, total
DTV for the Amex was just a shade over $1 trillion. At current rates,
DTV in ETFs will equal $2.6 trillion this year. Maybe we're just
too old and don't get it anymore, but we can only shrug and declare we're
headed off the deep end. Soon.
- A BRAND NEW RECORD HIGH....IN
AUGUST 2012 -
We typically end each report with a view towards
the future and what the fates may have in store for investors over the
long term. We have shown this regression chart quite a few times
in the past, always pointing to the 5% line as our eventual target.
From 1907 to 1995, which we mark as the unofficial beginning of the stock
asset bubble, ten year returns amounted to 4.37% annualized. With
the humongous effect of the bubble, ten-year annualized returns have soared
to 5.18% in stocks. Lower price levels than our 5% line are not only
possible, but since prices have traded under the 5% line almost 80% of
the time, they are quite likely to occur.
Interestingly, the target line was met briefly
on October 10, 2002 as the Dow Industrials traded down to a print low of
7197. But prices were below the target line for mere minutes before
surging higher once again.
As of January 23, 2004, our target line as shown
stands at 7708 and is rising at a rate of exactly 5% per annum. On
January 14, 2000, the Dow Industrials closed at 11722. If prices
match the 5% regression line that has contained 79.4% of all trading over
the last century, it will breach the record high sometime during August
Clearly, we were wrong last year and misjudged
just how far the mania for stocks could extend. Truth be told, the
mania has been heartily endorsed by the actions of the Federal Reserve
and is apparent in Alan Greenspan's recent testimony implying that asset
bubbles are of no consequence as long as the fallout from same can be successfully
managed. In our view, this gross assumption is unbelievably naive
and dangerous. Alan Abelson has written, "WHAT DO YOU CALL A FIRE
DEPARTMENT that concentrates not on putting out the fire, but on cleaning
up afterward? Different, if you're polite. Insane, if you're us."
So, we're confidently adding insane as well to the description of the Federal
Reserve policy of dealing with stock market manias.
Thus, all who profit from moving stocks into the
hands of investors and speculators are doing so with all haste and buttressed
by the conviction that the Fed will clean up every mess afterwards, no
matter how charred the remains of the market might be. In testament,
we offer the recent TV commercials and magazine advertisements from the
Fidelity family of mutual funds showing 1, 5 and 10 year returns for several
of their funds but somehow omitting the 3-year returns available
from the fuller disclosures available on their own website.
At least at that location, it is revealed that the Capital Appreciation
fund grew a mere 2.17% annually, that the mighty Magellan fund lost 6.18%
per year and that the Aggressive Growth fund lost a hefty 25.44% per year
for the last three years. Of course, investors don't go to fund websites
to get the lowdown. But they can be counted on to watch TV, right?
It's not right! But neither
was Enron, Worldcom, Adelphia, Tyco, the market timing scandals, analysts
pretending to like stocks hawked by investment bankers, and countless other
ways in which investors were taken for the ride of their lives; first up,
then down....and now, up once again. But they don't care.....
"Ah, she’s got a ticket to
She’s got a ticket to ride,
She’s got a ticket to ride,
But she don’t care.
My baby don’t care, my baby
My baby don’t care, my baby
My baby don’t care, my baby
Targets for 2004 (moderate odds):
Dow 10889 /// SPX
1175 /// Nasdaq Composite 2199
Targets for 2004 (high odds):
Dow 8500 /// SPX 900
/// Nasdaq Composite 1600
Term Targets for ultimate bear market low - now likely in 2006
Dow 6400 /// SPX 680
/// Nasdaq 1000-1100
OF THE ENTIRE WEBSITE ARE COPYRIGHT 2004 ALAN M. NEWMAN
I hope you have enjoyed your visit and please return
again. If you know anyone who might be interested in seeing what
we have to offer, we'd be happy to have them visit as well!
Alan M. Newman, February 7, 2004
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All information on this website is
prepared from data obtained from sources believed reliable, but not guaranteed
by us, and is not considered to be all inclusive. Any stocks, sectors
or indexes mentioned on this page are not to be construed as buy, sell,
hold or short recommendations. This report is for informational and
entertainment purposes only. Longboat Global Advisors, Alan M. Newman
and or a member of Mr. Newman’s family may be long or short the securities
or related options or other derivative securities mentioned in this report.
Our perspectives are subject to change without notice. We assume
no responsibility or liability for the information contained in this report.
No investment or trading advice whatsoever is implied by our commentary,
coverage or charts.