Confirming the Thesis

Barry L. Ritholtz
Market Commentary

Home

Writings

Published Articles

Market Commentaries

Favorite Links

Professional

Curriculum Vitae

Resume

Contact

Ritholtz Remarks

"Confirming the Thesis"
Microsoft? Who cares about Microsoft . . .

Several people have asked what to make of what has transpired with Microsoft earnings and the fundamental analysts' flip flop.

To be blunt, I don't care about the shenanigans surrounding Microsoft's fundamentals. The perceived "miss" and the analytical reversal is irrelevant to the bigger picture. Its tough to say that about a firm as huge as Mister Softee (or other large companies nonsense, such as WorldCom's Friday night "stealth" pre-announcement), but there it is.

The Microsoft earnings story is now all spin. I prefer to look at the bigger picture -- yes, bigger than MSFT or GE or Enron, yet incorporating them.

I always work from a thesis. Inherent in that thesis is that it will be proven right or wrong -- and the sooner the better. So I look for verification of the thesis -- what proves or disproves its ideas?

My most recent thesis (7 months and counting) has been this: After a relentless 2 year bear market, the week of 9/17 - 9/21 was the final capitulation; (Post 9/11 Market Reaction ). We started to rally off that blowoff bottom. Eventually, that rally went too far (How Sustainable is the Recent Rate of Advance?), and needed to retrace some of the gains, (Retest or Retracement?)which is what it has been doing.

This has been taking place within an environment of economic recovery, and decreasing investor confidence in key market structures, namely accounting, SEC enforcement, and corporate management credibility.

The economic improvement and low interest rates are bullish; The other issues raise questions that are short term bearish, but -- potentially -- longer term bullish. It depends upon how they are ultimately resolved.

Campaign finance reform -- unthinkable under this administration a year ago (pre-Enron) -- is a bullish development. The Anderson/GE/IBM/Tyco nonsense could potentially lead to the greatest set of Security reforms since the Securities Exchange Act of 1934.

This would also be a long term bullish development.

But back to the here and now: The present combination of events are unusual, to say the least: I cannot fathom a comparable nexus of events that include a post-terrorist attacks/accounting questions/economic recovery. Its just weird.

Under these circumstances, a general public disinterest in equities has developed, while at the same time there is an enormous stockpile of cash on the sidelines.

The disinterest is reflected in the low volatility. While a lot of folk seem to think low vol is a sign of complacency, I must disagree: The general public is not complacent, they are disgusted. I think you will agree that there is a big difference. Note that we had low reading on the VIX from December 1988 to September 1989, and again from February 1991 to November 1995; Each of these periods corresponded with a healthy advance in the indices.

The Pu/Call ratio should be confirming the low volatility topping sentiment -- instead, its indicating high levels of fear and bearishness. I take that as a bullish indicator.

So to get to the big Microsoft reversal day, we have the following:
1. Terrorist attacks;
2. Capitulation sell off;
3. Big rally;
4. Rally becomes overextended;
5. Retracement (30 - 50%, depending upon the index); This sell off led to:
6. Arms Index signal, suggesting the selling was overdone.

Now we get to the proving/disproving the thesis portion of our show:

Lets use the Arms Index signal a week ago Friday. That suggested a bottoming of the retrace from the late December/early January peak.