July 27, 2001

Ugly. That's how the 3rd week of earnings began. And why shouldn't it have? Earnings tell us what the LAST quarter produced in terms of sales and profits -- and we know those have stunk.

Hey, no surprise here: A weak world wide economy continues to plague corporate earnings. Companies complain there are no clear catalysts in the pipeline, and that they "lack visibility" going forward.

Market observers have, more clearly than any time in recent memory, have become divided into two camps: The first claims that the economy is going to hell in a hand basket, that valuations are still too high, debt levels are terrible and growing ever larger. There is still too much bullishness, based on sentiment surveys. Despite 6 Fed cuts, we still have not kick started the economy.

The Bears point to the danger that the Argentine debt crises could spread through out Latin American, eventually hurting large US and European lenders. And, they point out that Europe's economy, a large exporter to America, is now feeling the US slowdown. The implication is that we are on the verge of a deep, worldwide recession, or worse.

The second camp notes that the weakness in the economy has already done its damage. A combination of the deflation of the dot com bubble, and a tremendous slowdown in IT (information technology) spending constitutes a majority of the market's problems. They note consumers continue to spend unabated, that home sales are still at high levels,

Add to this the continued aggressive Fed, and a "trough" in market earnings.

I love the fact that there is no consensus in the market place; When there's widespread agreement, it's usually prudent to take the other side. At Nasdaq 5100, so many market participants were sure we were destined to go much higher; At 1600, we surely going much lower.

Though I may agree with some of the key elements of the Bear camp (debt in particularm, and some aspects of valuation) others are fatally flawed: In particular, excessive bullishness, and lack of the Federal Reserve efficacy.

This is especially true in the immediate near term.

The claim that there is still too much bullishness -- based on sentiment surveys -- is belied by actual market activity. It's a case of "watch what they do, not what they say." The statistic that keeps getting cited is the "American Association of Individual Investors' Bullish Sentiment Readings" showing that there are too many Bulls. I referred to this sentiment reading in my discussion on Contrary Indicators ( "Contrary Indicators Tip Off Discerning Investors in Year 2000" )

I think many, many people are misusing this data. This sentiment survey is important when people are expressing excessive Bullishness, AND throwing money at all manners of stock.

This is not what is actually occurring. Numerous other sentiment readings are equally negative. UBS Warburg recently noted that its Index of Investor Optimism hit an all-time low as investors expressed concerns about reaching their personal investing goals, as well as skepticism that tax rebates will stimulate the economy. The Financial Times of London also revealed its survey showing investor confidence at a secular low.

What does it mean when (mis)using Contrary Indicators becomes fashionable?Watch what they do, not what they say: When investors are saying conflicting things, look to what they are actually doing. Its clear that they are NOT buying all that many stocks. Volume has been light in all markets -- even less so than the typical summer doldrums. The Put Call ratio has been moderately high -- suggesting that there is still a decent Bearish bias out there in people who are betting real cash, as opposed to an opinion poll. Bullish readings may be high, but is anyone out buying equities with both fists?

And lastly, the Arms Index -- a good proxy for genuine Fear in the market place. (You can always substitute the words "Greed" and "Fear" anytime you see the words "Bull" or "Bear."). The Arms index flashed its third highest signal recently, suggesting a short term turn in the market is due.

The action in the marketplace -- sending us back to the nice 3 month base levels of 1941 on the Nasdaq, and continuing the range bound, sideways action of the Dow -- has not been caused by a huge sell off. Rather, its been the ABSENCE OF BUYERS. As long as there are more sellers than buyers, stocks will go down. Who wants to own stocks through an earnings season, widely and correctly expected to be miserable?

Does fear of owning stocks sound excessively Bullish to you?

Finally, as to the Fed: We have the claim that despite 6 cuts, we still have not kick started the economy. That's a false data point for two reasons:

1st, its accepted economic wisdom (is there such a thing?) that it takes about 6 months for the effects of Fed Cuts to be felt in the economy. The first 2 cuts were in January of this year. Today is Friday, July 27, 2001 -- 6 months later.

Whoops, didja feel that? That was the 1st cut impacting the economy. Whoa -- RIGHT NOW -- there is the impact of the 2nd cut, starting to be felt. AND, We still have 4 (and maybe 5 or 6) cuts to work there way in.

My point is that its way too early to write off the Fed. I would certainly revisit these thoughts if by the end of the 3rd Q we did not see significant progress.

Second, consider this astute observation from Al Goldman (strategist at AG Edwards). "While the Dow is off 0.4% and the Nasdaq Composite 9.8% in that time, 66% of all NYSE stocks have advanced, and 68% of all Nasdaq stocks have moved higher (universe of stocks greater than $5). In fact, 52% of Nasdaq stocks are up by 15% or more. The majority of stocks have responded positively to the aggressive Fed rate cuts."

The bulk of the decline in popular averages can be tied to market cap weighting of the large tech stocks (Lucent, WorldCom, Sun, Cisco, JDSU, EMC, Intel, Nortel, Oracle, etc) . Just as the average stock started the bear market in March of 98 -- while the averages went ballistic over the next 2 years -- the average stock has made its lows and are moving higher -- despite the indexes treading water.

So what do we do, now that we are but one week away (thank goodness!) from the end of earnings?

Our continued course of action: Maintain a bullish posture in diversified stocks, emphasizing a mix of mid cap, non tech companies, with stocks sensitive to the yeild curve (declinign interest rates). Financials, healthcare, manufacturing. Add to positions in Media and Regional Banks. Lastly, for those of you with patience and a longer time horizon, selectively add tech positions of leading companies with little or no debt, good management, profitibility and a defendable franchise.

Have a nice weekend.

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