“Happy ever after in the marketplace, Molly lets the children lend a hand.” – Lennon-McCartney, Ob-la-di, Ob-la-da
Right on schedule every spring, we find ourselves confronted with the same phenomenon: hopes floating on spring breezes, especially the type brought on by hot air. It seems like it always come between the end of March and April, when equities take it into their head – possibly under the influence of warming temperatures in the lower canyons of Manhattan – that somehow, all will be well.
In reviewing our past columns, we find that we are irresistibly drawn to certain April themes. One is the idea of how hope floats in the spring (along with stock prices). Another is April Fools, a title we used last week and in 2008 as well, which seems like a poor omen for this year. The columns have been followed by May tales of woe and corrections, except in 2007, when it took until July for the jig to be up (and even then, the markets managed to put on one more senseless-but-let’s-have-fun-anyway rally in October).
The market can be divided into a few groups, and only of them is moving the markets. Not institutional money – they were the big dogs during the ‘80s and ‘90s, but that was back when inflows gave them clout in the marketplace. Nowadays their impact on the daily equity market is limited to interviews in the media – they have less marginal impact over than TV impresario Jim Cramer (does that strike you as healthy?).
Classic hedge funds aren’t having any impact either, because they make the mistake of analyzing companies and trying to understand economic currents. Along with the big institutional funds, they like to own really cheap, great franchises that produce tons of cash – names like Microsoft (MSFT), Hewlett-Packard (HPQ), Intel (INTC) (we are guilty of all three), some big energy, some drug and a few consumer staples names. They’re so cheap and when will the market catch up to them?
The biggest impact is coming from the black-box group. They’re responsible for two-thirds of the daily trading volume, and so far as they’re concerned, stocks go up in April so you buy until the calendar says you don’t buy. It leads to astonishing little moves like the last two weeks of March (nearly six percent higher on below-average volume), and big air pockets like the first two weeks of March. They are slicing and dicing the tape all day long with no opinion whatsoever on the direction of earnings or the economy.
The business press (most of whom understand the market much less than you may think) desperately trawls managers and strategists for explanations on why the market is rising in the face of bad news, but they are talking to the wrong people. They aren’t the ones moving the market. They may be fully invested, they may want the market to go up, but they aren’t driving the tape. The boxes are. As a friend of ours put it, daily market action is now largely a group of video-gamers playing against each other. We would add the qualification that most of the gamers are programs and programmers.
The game programs aren’t going to buy stocks like Microsoft or Intel, because their market caps are too large to push around and they lack the volatility for profitable short-term positions. They’d rather own the jazzy stuff that trades a few million shares a day and produces lots of three- and four-dollar moves (when was the last time you saw Microsoft move three bucks in one day?).
Perfectly willing to pile into wildly overvalued names, they’re not investing in anything but their own trading program. So far as the stock goes, it’s in and out, buying and selling from day traders and others, going long until they’ve made a buck or three and their program or chart point says x happened and exit.
That’s not to say fundamentals don’t matter, because they do. They just take longer to matter now that the market is so momentum-driven. When the jig is clearly up, everybody sells, be they black-box, day trader or mutual fund manager. Similarly, when it’s clear that the economy and earnings are in a healthy environment, everyone wants to be long. The hard part comes when the economy clearly isn’t so healthy, as any moron walking down the street can tell you these days, and the stock market is trying to convince you otherwise.
Last week we heard a strategist (and a technical guy here and there) essentially say that momentum will take us to 1400 or so, and then look out below. It could happen. Even in two weeks, it could happen – why wait to go to 1400? Just go there and sell. That’s not as cynical as it sounds – one by-product of black-box steering is the effort to be first with the edge. If your pattern analysis is telling you, “rebound at the 200-day moving average,” then it must be best to get there first and buy at the 180-day average. If the pattern is, “1400 top by June 1st” then buy now and don’t wait for June 1st, when everyone else will be trying to get out the same door at the same time.
Last week we narrowly dodged a government shutdown, but in the process it became clear that the larger battle (the debt ceiling) is yet to come. We’re not optimistic. The tone afterwards was one of seeking confrontation.
But what, me worry (another favorite springtime title of ours)? Nothing bad can happen until the end of April, right? The trend is your friend – until the end.
The Economic Beat
It certainly was a quiet week, at least on our own shores. The main report of the week was the ISM non-manufacturing index. Although the rate slowed from 59.7 to 57.3, with business activity falling from 66.9 to 59.7, it was still a good report. 16 of the 17 industries reported growth, and pricing pressure remained high. Some industries talked about potential supply problems coming from Japan.
The FOMC minutes came out the same day, and caused little reaction. The most notable part, it seemed, was that the Committee really isn’t thinking about ending QE-2 (the Fed’s bond-buying program, scheduled to end in June) early at all.
It’s a funny thing, QE-2. Not so much the program itself, which is a fairly straightforward part of the central bank’s toolkit. It’s the wide spectrum of opinion about it. One can read columns the same day on the same investment site avowing without hesitation that QE-2 is responsible for the imminent demise of the American economy, the rally in the stock market, the destruction of the U.S. dollar, the rally in commodity prices, and halitosis.
Depending on what camp you’re in, the end of QE-2 is either built into market expectations, or the bridge to QE-3, or an impending deflationary event that the market just doesn’t want to think about. We’ll let you choose, but one thing we say is that the market prefers to dream about better things during spring.
Claims fell slightly, mostly due to the fact that the previous week’s number was revised upward, erasing most of that week’s reported drop. Wholesale inventories rose 1.0% in February, but it wasn’t so great: sales fell 0.8%.
Same-store sales got a nice write-up in the press as being “unexpectedly strong” and “beating estimates.” Really? Well, Costco (CSCO) did beat estimates – thanks to currency and gas prices. Excluding those effects, it came up short of estimates, enough so to get downgraded the next day by Goldman. Gap Stores (GPS) sales came up short too, put down to problems in Japan. But its North American same-store sales were down 10%. We also like to comment that the sample is now only 25 companies, due to the fact that most companies that struggle simply drop out of the monthly reporting game.
Consumer credit data for February showed that revolving credit fell yet again. The increase in car sales is driving growth in the overall credit figure, because credit is available in the auto sector. It comes chiefly from the car manufacturers themselves, because the banks are not participating. In the credit card area, dominated by the major banks, panic is still the operative mode.
Excessive interest rates discourage credit use and reduce the probability of loan payback, while continual reductions in credit limits squeeze the customer base. Why do the banks do it, when it raises the level of defaults? One is because the defaults are tomorrow’s problem, while the vigorish collected this month goes into this quarter’s earnings.
The calendar is very busy next week. Alcoa (AA) kicks off the earnings season on Monday. The company was a measure of industrial strength, but now results are more a measure of how much money hedge and pension funds have been throwing at commodities.
Google (GOOG) reports Thursday (nearly always the day before options expiration, a practice that helps pay the private school tuition of many an options dealer’s child). On Friday, Bank of America (BAC) report and that may be the most significant report of the week. The bank was recently rebuffed by the feds in its attempt to pay a bigger dividend, and analysts will be keen to hear what the company has to say on the matter. The expectation is that the bank will have had time to craft an approach, and some will be looking forward to trying to pierce the veil.
The latest price index measures may stir up the most dust next week. Data for March import-export prices come out Tuesday, producer prices (PPI) Thursday, and consumer prices (CPI) Friday. Friday should be the day of the week, for that matter, what with B of A’s earnings mixing it up with the CPI number, possible follow-through from Google earnings, the New York Fed manufacturing survey, April Industrial Production, international capital flows (who’s buying Treasuries?), a new consumer sentiment number and to top it all off, it’s an options expirations day. That’s always an occasion for some remarkable price activity (much of it to be immediately undone on Monday).
Wednesday puts up the March retail sales number, which should get a big boost from the rise in gasoline prices, and the Beige Book in the afternoon. Business inventories come out at 10AM. The signs point to Friday, though – as do hopes.
We want to take you back to May of 2007. In that column, we advised being short the stock of Research in Motion (RIMM). The company had had an Analyst Day, helping the stock climb 26% in that month. It was trading at ten times sales, forty times cash flow, fifty times earnings, twelve-and-a-half times book.
We wrote a negative piece on the stock. It was nothing against the Blackberry, it was and still is a decent product, and RIMM had had first-mover advantage in tying up deals with corporate networks to qualify its “push” email program for its cell phones (new emails were immediately “pushed” out from the corporate server to the handset without needing the user to initiate an email check).
It was just a software program attached to a handset, we pointed out. Useful, yes; irreplaceable, no. Competitors would come up with handsets that could do emails too (we suggested Apple (AAPL)) and the company would be unable to sustain that kind of valuation.
It couldn’t, but we were early. The stock went nearly vertical into November 2007, at which point we wrote another skeptical piece. We were short the stock, then twelve times sales. It suffered a major correction shortly afterwards, yet it had one last bout of fever left and relaunched on the back of a short squeeze up to its all-time high of nearly $150 in July 2008. Now it trades at about a third of that. Unless RIMM can show that the Blackberry adds twenty years to your life, it’s never going back to ten times sales again.
Last August we suggested that Acme Packet (APKT) might be overvalued. We were too early again. Packet has doubled since then (they had an Analyst Day too), and if you look at its chart, it looks eerily like RIMM in November of 2007. The stock trades at about seventeen times sales, seventy times cash flow, over one hundred times earnings, and fourteen-and-a-half times book. Research in Motion was a value stock by comparison.
Acme Packet is a decent company making session border controllers (SBCs), a useful product for the Internet. But they aren’t the only game in town. Sonus (SONS), a small cap, and Cisco (CSCO) the big cap are in the hunt too. SBCs are nice products, but it’s not like they’re impossible to engineer.
Packet just won’t be able to grow into these valuations. It’s got a relatively small market cap ($4.6 billion) and float (50 million shares), making it easy for wise guys to push the stock around and squeeze the shorts for a couple bucks as needed. But that will work against it when it gets abandoned, too.
Like RIMM, the stock may have one crazy move left in it. But we wouldn’t be long this stock going into this quarter’s earnings report, or the next one (as a matter of fact, we are short). Granted, there may be money to be made in between. Yes, the stock could go up ten to fifteen bucks if it can gin up another boffo earnings-plus-guidance report this month (at these prices, it had better). But if it disappoints, it’s probably going down twenty to twenty-five. You can get better odds in Vegas, and the drinks are free.