|This is our
48th report on the ongoing mania since we first published our website on
January 15, 1999. Since that time, well over three million visitors
have perused our free offerings and well over one million have visited
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- TERMINAL VELOCITY? -
Keeping track of the data has never been easy but
our task is now more difficult than ever. Why? In the December
6th issue of Crosscurrents, we jokingly claimed, "Thank the top 100 Nasdaq
issues that are no longer the 'Qubes,' once symbolically noted as QQQ.
The entity has proved such a voracious vacuum of cash reserves that the
keepers of the flame had to add another Q to keep up with the demand, so
the QQQs are now the QQQQs. A full 33-1/3% better than before."
The reason for the symbol change was that trading of the Trust was shifted
over to Nasdaq. Although Nasdaq publishes data for its own trading,
it does not publish dollar volume trading data for the Amex, which it owns.
And the Amex does not publish the data, thus we have had to make estimates
for the last couple of years (up to 2002, the NYSE published data for the
Amex). We believe we are well within 2% of the actual total figure
for the Amex and the picture for the full year of Dollar Trading Volume
for 2004 is presented below.
DTV rose 26.2% from 2003 and appears headed for
a test of the record high of $32.6 trillion registered in the manic year
of 2000. Last year's activity was the second highest ever and coming
only a scant four years since the biggest collapse in seven decades, one
can only surmise that the mania must still be in play. Despite a
halving of the price of the S&P 500 and a 78% drubbing in the Nasdaq
Composite, traders still cannot get enough action and continue to clamor
for more. DTV finished at 204.8% of Gross Domestic Product, close
to the 219.1% recorded in 2001 and the 214% of 1999. If this is not
the rekindling of the greatest stock market mania of all time, it is clearly
an incredibly solid imitation of same. If there are any reasons why
DTV did not set new records this year, it is solely due to the fact that
the prices of Nasdaq's stocks are still well below their manic peaks.
The proof is seen in DTV for the New York Stock Exchange, 5% higher than
in 2000 and a brand new record.
It is totally illogical to expect an exact
replay of the year 2000,
so there is some merit to the belief that
current "velocity" may be terminal.
- "STOCKS ARE BEING RENTED"
Our second measurement pits DTV versus total stock
market capitalization. In this case, activity last year would have
been second only to the insanity witnessed in 2000 had market cap not expanded
by more than 9% in the final quarter. We arbitrarily defined "normal"
as levels of trading at 40% or under. This happens to be the precise
average of all years that were not manic and in fact, of the 78 years shown,
47 fall into the normal category, including the 34 consecutive year period
from 1938 to 1981. Clearly, the behavior of the markets during so
long a stretch can only be termed "normal."
We arbitrarily defined a "mania" as levels of trading
above 149.7% registered in 1930. Thus, only six years of the last
78 qualify; 1928, 1929, 2000, 2001, 2002 and 2004. Of course, there
is no actual and tangible boundary - we can easily make the case that the
action in 2002 precluded a mania and that the recovery of 2003 accentuated
manic behavior. The point is that speculation in the form of turnover,
is now the name of the game. Investment is simply no longer an option.
One proof of our conclusion is how mutual fund cash levels have contracted
since the end of the 1990 bear market, from over 9% to near all time lows.
In fact, the 12-month moving average of fund cash-to-assets is as low as
it has been at anytime since 1985, possibly the lowest ever. Anecdotal
proof is available in the amount of money traded that has nothing to do
with individual common stock issues (more on that below).
Finally, we offer the recently quoted wisdom of
Morgan Stanley's Byron Wein. It's clear that it is not about investing
anymore, it's all about trading and speculation.
“In 1960....annual turnover was 12%....as
recently as 1992....annual turnover was 54%....So far in 2004....annual
turnover is 104%. We are clearly living in a more frenetic trading
environment. More and more stocks are being rented, not owned."
- Byron R. Wein
The Changing Nature of Portfolio Management,
Morgan Stanley Strategy and Economics
We typically attempt to refrain
from repeating a subject covered in the most recent update, but ETFs are
growing at such an incredibly rapidly pace that we are compelled to update
the chart shown in November. The article below was presented in the
December 6th issue of Crosscurrents.
- BUYING ALL THE EGGS IN
THE BASKET -
Subscriber Jay Matulich asked if the huge increase
in ETFs meant "....a scarce supply of stocks." Mr. Matulich, who
toils for the Lexus Opportunity Fund LP, realized that between demand from
mutual funds and ETF trusts, the "float" for individual companies has diminished,
so we see a ramp up effect over time and even "melt up" moves on good news.
Shrewd observer. Even worse, so much of U.S. equity is now indexed
to one construct or another, bulls can always point to a bull market via
one index or another. The S&P 500 is lagging? No problem.
Point to the small caps. Small caps lagging? Point to the hot
sector. There's always a bull market somewhere and in fact, folks,
that's been Wall Street's trick - to connive and coerce while fleecing
the sheep into the belief that a bull market is always ongoing. Even
the venerable New York Stock Exchange got tired of seeing the NY Index
linger and lag, so they changed it to suit the times. It's all so
easy. And now, as our subscriber noted, "You get these big, mid and
small caps acting like the tight float stocks," yes indeed, they now are!
Look at all the ETFs that are divvying up the pie. According to Thomson
Financial, there are now 1400 institutional investors holding U.S. listed
ETFs! Screw analyzing individual companies - too much time, too much
effort, too much risk - so buy an index or buy the market, what difference
does it make? How else can valuations become as hugely bloated as
in the U.S.? Let's repeat it for the umpteenth time; valuations are
higher now than anytime in history except 2000. They were even lower
at the manic peak in September 1929, just before the greatest stock market
crash of all time. How bad has the craze become? See for yourself
in our featured chart. There are now 166 separate ETFs comprising
more than $207 billion in assets, trading at the rate of $13.3 billion
per day! If our math is correct, one of every seven dollars traded
in the U.S. stock market has nothing to do with the underlying securities,
but is traded via the ETFs. Demand for ETFs also comes from overseas,
such as Norway’s $140 Petroleum Fund. Knut Kjaer, head of the fund,
said ETFs "have become liquid and an alternative to futures contracts."
And of course, we have not yet begun to even factor in the effect of futures
or options. How can anyone believe that stocks represent value in
an environment when the individual corporate shares that comprise the backbone
of capitalism are relegated to the status of also-rans against the mighty
and powerful derivative market?! We'll scream it from the mountain
tops if we need to; stock prices are compromised by the growth of derivatives,
especially ETFs, which have grown at a 42% clip annually for the last five
years. If you're wondering what 42% annualized growth over five years
means, it's the equivalent of the NYSE trading 5.4 billion shares per day
or the Dow over 66,000. This is not just rapid growth - we are witnessing
a historic and full fledged phenomenon that threatens to overtake every
vestige of investment sanity that remains. As Chairman of the Presidential
Task Force on Market Mechanisms, Nicholas Brady reminded us in 1987, "We
are looking down the barrel and the gun is still loaded."
At the top of this report, we mentioned our task
in compiling the data, which includes estimating DTV on the Amex.
On January 24, 2005 for example, the Amex most active list included 11
ETFs in the top 20 most actively traded issues. The top five issues
were all ETFs. The total dollar volume traded for just the 11 most
active ETFs came to $9.35 billion that day, and at that pace, just the
top five traded on the Amex would trade $2.18 trillion for 2005, nearly
one in every ten dollars traded every day in the U.S. Bear in mind,
we have not included the QQQQs, which by themselves will quite possibly
trade more than $1 trillion in 2005. Clearly, if we include the other
161 ETFs and those that will come on stream in 2005, more than one in every
ten dollars traded will NOT be individual stocks.
Investing? Not any more.
If you buy all the eggs in
the basket, you must get some rotten eggs.
That's not investing.
- IT'S NOT ABOUT INVESTMENT
The following article was first
seen in the January 10th issue of Crosscurrents.
The charts have been updated
and reflect activity for the entire calendar year of 2004.
Our colleague and fellow technician Ralph Acampora
recently penned a report entitled, "Fearless Forecast for 2005: The
Cyclical Bull Accelerates Higher." The highlights of the report target
an all time record high for the Dow Jones Industrials to as high as 13,300,
a further 22% gain in the S&P 500 and another 30% inflation of the
Nasdaq Composite. Wow. We're impressed. Forget
the fact that modest earnings gains on the order of 10% accompanied by
the same increase in dividends paid out would take the S&P up to a
23.2 P/E multiple in a rising rate environment and lower the dividend yield
to 1.54%. None of this makes any sense to us, but what do we know?
We have already seen the greatest stock market mania of all time unfold
before our very eyes, why not a huge echo of the very same madness that
drove valuations well beyond anything ever seen in all of stock market
history? Thus, by using mirrored "measured moves" from an earlier
cyclical bull market that occurred within a secular bear market circa 1970-1973,
Mr. Acampora posits the targets offered above are within reach. Our
problem with the report is any comparison of this cyclical bull market
as part of a secular bear with any cyclical bull that occurred before -
since the present cyclical bull market still sits solidly on the back of
participants who have lost all comprehension of value and simply do not
INVEST either their own money nor clients' money. This is not
your father's stock market anymore. Turnover is so robust that the
investment process has been completely replaced by the ultimate metric
- performance via trading.
Valuations have been so far out of whack for so
long that professionals no longer believe that they are out of whack.
What was inconceivable just a decade ago is now routine. Even with
five interest rate hikes and more on the horizon, stocks can trade at literally
any multiple and yield almost nothing in comparison to bonds. Worse
yet, because valuations have lost their meaning, sentiments about the future
have been enabled beyond all reason and optimism has risen to extremes
as crazy as any ever seen.
Perhaps the echo of the mania is seen best in the
activity generated on the OTC Bulletin Board. Monthly data was finally
updated after a recess dating from August, but the data seem incorrect,
showing a drastic contraction in share volume for September & October
while evidencing an increase in dollar trading volume and total transactions
for the same period. Nevertheless, we’re reporting what we found.
At the rates generated through the first 11 months of the year, total shares
traded have exceeded the manic peak of 2000 by a factor of 3.8 and have
increased rapidly since the brief fallout experienced in 2001. Apparently,
the folks who buy penny stocks were no more discouraged by their experience
than those professionals who are still eager to "invest" in stocks at valuations
that cannot possibly hold up over time.
Perhaps most striking is that those who play the
garbage penny stock market have increased their action dramatically versus
trading on the NYSE and Nasdaq. Even in the mania’s most insane moments
in 1999 and 2000, bulletin board volume was only a small fraction of the
combined trading on NYSE & Nasdaq. Now it is 56.4% of the big
two, up from 35.5% in 2003, and apparently headed for equality. Remember,
for Bulletin Board issues, “There are no minimum quantitative standards
which must be met by an issuer….” Forget earnings. Even sales
are not necessary.
If these two charts are not
graphic evidence of an echo of the mania,
we are prepared to eat them....
- DERIVATIVE MANIA IN FULL
We try to cover the derivative environment twice
a year in the hope that our continued exposure will lead to greater comprehension
of the systemic risks the markets incur. Although derivatives supposedly
reduce risk for individual parties, these risks are then laid off again
and again down a daisy chain of counter parties. No one knows how
long the daisy chain is nor precisely who is involved, not the banks, not
the regulators and not the government. The chain is so convoluted
and complex that there is no way of computing all the interactions.
As well, there is no readily available method to measure the "hedgedness"
of all contracts accurately on a daily basis. It is entirely possible
that we only find out after the stuff hits the fan. The perfect example
was the fall out from the Long Term Capital Management fiasco in 1998.
And if the Federal Reserve had not quickly stepped in to broker a deal
between the counter parties, there is no telling what might have occurred.
Meanwhile, derivative growth continues unfettered
by any attempts to regulate or to define which risks are tolerable and
which are not. At the end of 2000, the total notional value of derivative
contracts for insured commercial banks in the U.S. was $40.1 trillion,
two-and-a-half times the total market capitalization of the stock market
and four times the total generated by our Gross domestic Product.
As of the Third Quarter of 2005, the total notional value of derivative
contracts for insured commercial banks in the U.S. was $82.3 trillion,
six times the total market capitalization of the stock market and seven
times the total generated by our Gross domestic Product.
To place the numbers in another perspective, let's
compare them to the Dow. From the beginning of 1995, when we pinpoint
the birth of the mania until now, the Dow would have to be trading near
21,000 to grow at the same rate as derivatives have in the last decade.
At some point, something has to give. Four times GDP in 2000.
Seven times GDP last year. Is there a limit?
Although we have not yet
suffered a irrevocable fallout from the few major derivative events that
have taken place like the crash of 1987 and LTCM, that time will come.
It must. All markets, no matter how sophisticated, no matter how
mature, no matter how reasonable, have eventually witnessed a worst case
scenario based upon unforeseen developments. In 1987, it was the
cascade effect of portfolio insurance. In 1998, it was the collapse
of Russian government paper. Tomorrow's event? We only know
that an event will eventually occur, a circumstance that is totally unexpected,
a situation that roils the markets. If that event forces the collapse
of an entity that is as exposed to credit risk as the banks you see represented
on our chart, what are we to believe?
IT'S NOT ABOUT DIVIDENDS EITHER -
For the first 67 years covered
by this chart, the price-to-dividend ratio ranged from roughly 15 to 35.
If stocks traded down below a 3% yield or thereabouts, watch out, a bear
market was probably on the way. If stocks traded to over a 6% yield,
pile it on, a bull market was surely around the corner.
Then in 1995, we are supposed
to believe that all the rules changed and a new paradigm was born.
Stocks need not pay dividends any more and the valuation measure that had
served investors so faithfully for more decades than we can show, was summarily
kicked out the door. Although strategists and analysts were more
than ready to rationalize the new paradigm, it is obvious in retrospect
that it was all about stock options. Executive compensation soared
in the mania and was driven principally by stock options. For stock
options to work best in favor of executives, companies had to pay out less
in cash for dividends. Whatever a company paid out was gone from
the corporate treasury. Whatever the company kept in the treasury
meant the shares had to be worth more. How else can you explain the
sudden and utter disappearance of benchmarks that had functioned perfectly
for so long?
In fact, the S&P's dividend
payout ratio topped in 1992 at just over 50% and was still 49% when the
"new paradigm" commenced. The ratio dropped like a stone to as low
as 26% on 2000 and was 30% as recently as last year (the ratio is currently
Although we would certainly
hesitate to bless the new paradigm's potential to endure, for the sake
of argument, let's assume it will. We'll further assume that the
boundary that used to mark overvaluation will in the future, mark UNDERvaluation.
The P/D ratio is currently 57.22. Let's presume a bullish scenario
where dividends rise 10% per year for five years and it takes the same
five years for stocks to return to the "under" valued boundary. S&P
500 Dividends, currently $20.85, would rise to $33.58. At a 35 P/D
ratio, the S&P 500 would then trade at 1175, lower than today!
Of course, it doesn't have
to work out that way. If the "under" valued benchmark is achieved
in three years, the S&P 500 would trade down to 971, almost 20% below
today. Of course, if we're wrong, it might be that the historic benchmarks
will once again be in play. If so, watch out! Given 10% increases
in dividends over the next decade, the historical undervaluation parameter
would be achieved in 2015 by the S&P 500 at 811, more than 35% down
Since 1928 and until
the mania commenced, dividends accounted for 47.5% of all gains for investors.
Even as the mania and stock options curtailed dividends and speculation
increased, dividends since 1928 have still accounted for 40.7% of all gains.
But in a rising interest
rate environment like now, it is becoming more and more difficult to justify
a new paradigm. Right now, dividends imply that it's not about investing
anymore - dividends still do not count for much.
that will all change in the next few years.
Targets for 2005 - these are now very low odds except for SPX):
Dow 10889 /// SPX
1218 /// Nasdaq Composite 2199
Targets for 2005 - these are now very low odds except for SPX):
Dow 8500 /// SPX 960
/// Nasdaq Composite 1600
Term Targets for ultimate bear market low - now most likely to occur in
Dow 6400 /// SPX 680
/// Nasdaq 1000-1100
OF THE ENTIRE WEBSITE ARE COPYRIGHT 2005 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, 2005
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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,
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or related options or other derivative securities mentioned in this report.
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