TFTF

Buying Time

June 22, 2001

Today, I want to welcome several thousand new readers. Many of you came from Bill Bonner's Daily Reckoning or from the Fleet Street letter, and others from the Association for Investor Awareness. I appreciate Executive Director Mike Casson's enthusiastic endorsement. Plus, a number of other web site's have been following my ruminations on Faith and History and have posted links. And, as always, we continue to grow mainly from referrals of loyal readers. I am thankful for the support.

For Readers unfamiliar with my recent thoughts on why the markets have appeared so erratic, at the end of this letter I am re-printing a recent summary I did for the Daily Reckoning this week on Faith and History. For brand new readers it might help to go to the end of this letter now and then come back as it will give you some background on today's letter. It is just 1,200 words instead of the 15,000 or so I have written on the topic in the past month. If you want friends to read this shorter version, simply copy it and send it to them. (For long time readers it contains nothing new.)

Very quickly, Kevin Klombies, chartist par excellence, directed me to the best web site I have seen for index prices, futures, stocks, etc. AFTER you read my stimulating prose, go here and see if you agree. If you know of a better site, please send it to me.

Letters, We Get Letters ....

(What old TV show was that jingle from? Who did this before Letterman repeated it? Was it Perry Como? Andy Williams? I was VERY young back then.)

The last few weeks' articles have triggered a large number of very good questions and comments. I am going to take the first part of this letter to try and answer some of them.

1.Won't the Fed rate cuts help? What about the historical fact that the markets are up an average 20% one year after the first rate cut? Is it different this time since the Fed is cutting so aggressively?

First, let me unequivocally state that the rate cuts will help. Just because I think we are headed for a recession does not mean that I think that rate cuts won't make a difference. Long time readers know I was screaming for rate cuts last fall as the Yield Curve inverted. In my mind, that was when rate cuts should have begun. If Greenspan had started to cut then, we would be three months closer to a recovery.

For fundamental reasons I have written extensively about, I have been a stock market bear and a bond market bull since the beginning of last year. I was bearish on stocks last year, simply because on a value basis, the tech world and most of the major stocks were simply too high. I have been a bear since last fall because I believe there is a high probability we are headed for recession, and once investors realize we are in a real recession, History teaches us the markets should drop substantially.

I have been predicting a third quarter recession since last fall. In the next few months we will see if the recession unfolds, or if the combination of rate cuts and massive money supply growth has kept us out of recession. The data I will cite below doesn't give one confidence that we will avoid a recession.

But in a few months it will get interesting. IF we enter recession and IF investors act as they normally do, we could see a large drop in the markets this fall.

And that is when we have to start considering whether to become bulls.

But will the market rise 20% from the beginning of this year? I seriously doubt it. Previously, the rate cuts began when the stock market was at very low or reasonable valuations. These rate cuts started at the highest valuations of any beginning rate cut period I could find. That does not leave much room for growth.

As stated above, I do think the rate cuts will help the economy. Typically, they take about 9-12 months to kick in. That would be in the first part of next year. It is not unreasonable to think we could have another recession like 1990-91. Two quarters of mildly slower numbers, and then the economy begins to grow again.

If that happens, we will want to start getting back into the stock market, maybe as early as this fall or in the 4th quarter of this year. There will probably be blood in the streets and you will wonder if I have lost my head getting excited about stocks. It is precisely when no one wants to buy stocks that we should be boldly lining up at the buy window, assuming there is no major deterioration still lurking in the broad economy.

What will be our keys? My investor sentiment numbers (see below), junk bonds and commodity prices to name a few.

I will be suggesting you move back into stocks in a very balanced manner, with heavy emphasis upon value. At the bottom of a recession, we should be able to find plenty of opportunity to buy value. I expect by the end of this summer, we will start getting tempted by a few issues.

For new readers, we generate our own proprietary investor sentiment numbers. They are based upon dollar flow in the NYSE and AMEX exchanges. We also then look at where the dollar flow is coming from (large investors or small investors) and what the trends are.

It appears that we may finally be seeing the end of a an extremely long period of high sentiment. The drop-off is still not causing any sizeable earthquakes, but we can see some tremors.

With the exception of Wednesday and Thursday, what I term the Big Boys (the largest institutions) have turned negative. Remember, I have talked about how they had turned negative and then went AWOL. Their market share dropped from a normal 21% to less than 15%. What remained was positive, but it is not a good sign when their volume drops that much.

This trend has been broken the last few days. However, I think that much of the positive buying is coming from large institutions and mutual funds re-positioning their portfolios at the end of a quarter and also because the numerous S&P indexes are changing the stocks inside them. This nearly always creates odd market conditions. This extra buying should dry up soon and the markets will resume their downward march

The Big Boys have now come back. But for the last 10 days, they have been net sellers. The rest of the market has been buying, especially mutual funds and small investors. It will be interesting to see what happens next week after the Fed cuts interest rates.

I expect another 50 basis point cut. Contrary to many analysts, I also do NOT think this will be the last cut. There will be enormous pressure for the Fed to cut again in August and September if we are in a recession, as I think we will be.

Could Faith in the Fed keep the market from dropping much next week, especially early in the week? Yes. But I think the summer doldrums are going to grind on the nerves of investors. It will be hard to maintain Faith as we get more and more bad news, especially from the tech sector.

I have gotten scores of letters from small businessmen as of late. 80% of you are telling me your business, or that of your friends, is starting to really slow down. This, coupled with very little good news and more announcements of lay-offs, will have an effect on consumer confidence. This is still a very dangerous time to be long the stock market, except in special situations.

Junk Bonds

A number of you have asked about high yield bond funds. You are looking for current income but want to avoid loss of principal if junk bonds get worse. I really do sympathize, but I cannot get excited about junk bonds as yet. Junk Bonds are still well below their mid-term moving averages. Typically, junk bonds will start to rise just before the economy begins to recover. We are getting no such signal today from the low end of the bond markets. Our High Yield Bond Timing Program (which we do for clients) is still in money market funds, and I expect that to be the case for the next few months. When the economy begins to show signs of turning around, high yield bonds are going to do very well. They rebounded 79% in just a few years at the end of the recession in 1991.

2. What about my Nortel (or Verizon or Lucent or JDS or Broadcom or AT&T...)

Telecom stocks, as I have been writing, are on the wrong side of some really bad trends. That trend is a HUGE oversupply of fiber optic capacity. We now have enough fiber to handle 5 times or 10 times or 25 times (depending upon whose report you believe) more data than we need.

Plus, rates for all services are dropping. Long distance rates are falling every quarter. Wireless rates are falling. Data line rates are falling. Competition is increasing. The market is not infinite. This is not the description of an industry with unlimited potential.

Plans for further expansion are on hold at most major companies. Bankruptcy attorneys are in full swing. Why build when you can buy at 25 cents on the dollar in the near future? Suppliers of these services are reporting huge drops in revenues. It is not going to get better.

These stocks are reminiscent of railroads or automobile or airline stocks in earlier times. They showed HUGE promise, everyone was starting a new company and most of them failed. It is not clear who are going to be the winners. Those left standing will be the companies like Verizon with sufficient cash flows, but they will not be the earnings growth stocks analysts talked about a few years ago.

Large telecom companies should be viewed strictly as dividend plays. And you should watch the strength of the company. When the "ultimate" widows and orphan stock like AT&T cuts its dividend and has no earnings, things are not good in the sector. Nortel has laid off 1/3 of its 90,000 employees this year. Other companies are following suit.

There are lots of choices for your money. I don't see the upside in telecom stocks unless you have some inside knowledge about some smallish firms. There will be some new companies that will do well as they start up without the burden of an entrenched overhead, but it is not clear to me who they are as yet.

The World is Still Slowing Down

Merck gave the stock market heartburn today as its earnings are well below expectations. They listed a number of problems, but the one that caught my attention was the currency problem. The dollar remains stubbornly strong. The Euro is down 9% since the beginning of the year. Merck sells 45% of its products in Europe, so my math tells me sales in dollar terms are off by 5% just from currency problems. Frankly, given the magnitude of the dollar's strength, I think they should be complimented on their hedging abilities to hold the currency losses to what they were.

Merck was not alone. They have a lot of company. The US trade data showed we were exporting less and importing less. A consistent theme in this letter has been the decline of world trade and the HUGE impact it will have on our US economy.

GeMerck was not alone. They have a lot of company. The US trade data showed we were exporting less and importing less. A consistent theme in this letter rmany again posted poor numbers this week. As I have chronicled the woes in Japan at length in previous letters, I will refrain for this week except to say that there are still no signs of intelligent life within their government circles.

The rest of the world is slowly following our nation into recession. It is primarily this world problem that makes me believe that we are not near the "bottom".

Bank Credit Analyst

From time to time, I read Bank Credit Analyst's excellent monthly letter ($600 per year). They are widely followed and very influential in institutional circles. A few points from the latest letter.

First, they agree with Greenspan that inflation is not a problem. While they do not seem to be worried about deflationary pressures as I am, their Leading Inflation Index which predicts the FUTURE rate of inflation is at its lowest level in 7 years. They feel that the Fed is likely to overshoot, whatever that means, in cutting rates.

They had a few statistics I have not seen elsewhere. "In the 12 months ended April, new orders for high-tech equipment dropped by 17% while inventories increased by 8%. New orders for communications equipment have fallen by almost 40% in the past year."

They echo my long-term concerns about the world economy: "On a final gloomy note, the US will continue to be held back by weak demand in most overseas economies. For years, the US was the world's growth locomotive and it was reasonable to hope that other regions would rake up the slack when the US slowed. Unfortunately, that has not been the case and US exports have suffered as a consequence. In real terms, merchandise export declined 10% in the 4th quarter of 2000 and 4.5% in the first quarter of this year. The leading economic indicators for Japan, Europe and the emerging countries have not yet hit bottom."

Overall, they feel the economy will begin to recover early next year, but they expect a slow recovery. Where we diverge is that they are not overly bullish on bonds, as I am. But part of that may be because they are writing to institutional investors.

I contend that if we see a recession and subsequently lower inflation and a few more rate cuts that long term bonds should continue their decades long growth trend. The market finally seems to be agreeing. My favorite bond fund, American Century Target 2025 is up 5% so far this month. Since we have seen a lot of sideways or slightly downward movement for the past few months, it is nice to see this breakout.

While I do not expect this move to be smooth, I do think it will continue for the remainder of the summer, if not for the year. You should continue to be building your bond positions. If you would like professional help, our firm represents Don Peters, one of the top 1% of bond managers in the country.

Summary

The stock market is still VERY risky, and I expect to see it drift lower for almost the entire summer, albeit in fits and spurts, as the Greenspan Faithful continue to buy the dips. I am still bullish on bonds. Patience and caution remains the name of the game.

A Final Thought

My wife, in a new career direction, has been the minister of a small church for almost a year now. This last week she taught on the subject of true wealth. The catalyst for her thoughts came from seeing a familiar bumper sticker on the back of many a Porsche, "He who dies with the most toys wins." Towards the end of the lesson (she is still uncomfortable with the word "sermon"), she proposed a new bumper sticker: "He who lives with the least toys is free."

That has been on my mind all this week, as I have reflected upon what truly gives me pleasure and happiness. Not that I am against toys, as I have been known to indulge in a few. (I have this incredible new cordless drill. I am sure I will need it some day. Just knowing it is powered up in the garage gives me great peace of mind.)

All of us have experienced the hassles of owning "stuff." Last year, I sold my home and moved into a lease home. I did so as I expect mortgage rates and home values to fall during the next year or so, and anticipate buying a new home some time in the future. My old home was somewhat large on an acre of landscaped grounds. It took a lot of time to maintain the property.

I thought I would miss it when I moved to a smaller home, as finding a home for lease that size was not possible. I found out that not only do I not miss it, I seriously doubt I will now go back to anything that requires as much of my time and effort. It is nice to have my weekends and evenings free. I am getting into the spirit of this "he who needs the least toys is free" concept more than I ever thought I could.

Toys (things) are not necessarily the problem unless they take your time or undue attention. In addition to buying bonds, maybe we should be thinking about buying Time as well, which means we buy less of the things that tale our Time. In fact, in the long run buying Time may even pay more dividends than bonds.

Just something extra to think about.

Your freer than ever analyst,

John Mauldin

 

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