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March 12, 2008
Alan M. Newman's Stock Market CROSSCURRENTS
Alan M. Newman, Editor
These brief excerpts from the March 10th issue have been posted
to coincide with receipt by snail-mail subscribers.
Financial Weapons of Mass Destruction
The first line of James Mackintosh’s Financial Times story was rather blunt; “Peloton Partners plans to apologise to investors on Wednesday after the London hedge fund manager’s $2bn (£1bn) flagship fund imploded and lost all their money.” ALL their money?! Back in January, the fund was long high-quality residential mortgage-backed securities and short low-rated mezzanine and subordinated subprime securities, which they believed would be “the trade” of 2008. However, as it turned out, the fund had $6 billion of bets on top-rated tranches of the ABX index, a contrived “product” (see http://tinyurl.com/yt9s6u) administered by Markit. We have been critical of the ABX several times in recent months and believe that it is one of the principal sources of the current credit crisis. We can’t count how many times we have forecast enormous problems would come home to roost with derivatives and it is all finally occurring. Read the Economist’s take on the matter (see http://tinyurl.com/3do7fp) for an eye opener. Even Markit now sees the problem! “Two years ago we had to tout [the ABX's] virtues. Now people consider it to be more relevant than it should be. They are panicking, over-reacting,” says Ben Logan, Markit's head of structured finance. More than four years ago, Warren Buffett warned of “Financial weapons of mass destruction” (see http://tinyurl.com/2p2j4o). We are literally killing ourselves with structured finance.
The Argument Against Any Expansion In GDP
Our colleague Ian McAvity recently showed in chart form that it now takes $5.33 in debt expansion to fuel every dollar increase in nominal GDP (Ian’s research is available from Deliberations/Iris Ltd., PO Box 182 Adelaide Stat., Toronto, ONT M5C 2J1). Given the problems now facing the banking industry, this would clearly imply there is no room at all for GDP to rise. Recession, here we come.
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Fleeing For Their Lives
We last looked at insider activity for the top ten QQQQ issues quite awhile ago, specifically the August 20, 2007 issue. Nasdaq was still two-and-a-half months from peaking but we believed the stats indicated a vote of no confidence. For the six month period we measured, sellers exceeded buyers by a huge 57 to 1 ratio and for each share purchased, 453 were unceremoniously dumped, continuing a pattern put into place ever since the stock option game became the favored route to riches for highly placed corporate execs. The game offers no downside for management and one can easily see why every effort is made to show the largest possible increase in earnings, since growth in earnings tends to drive the stock price. Given that each option exercised increases the supply of treasury stock, corporations tend to be more aggressive as time passes in order to keep prices robust. Dividends? Why should they issue dividends? Dividends tend to reduce the price of shares, which makes option grants less valuable. The game is definitely not designed to favor the little guy from Tulsa who owns 500 shares. However, the downturn in the stock market had us wondering. Perhaps insiders were finally beginning to bite at their own shares. After all, Nasdaq had fallen over 20% from last October’s high and although the economy was rapidly deteriorating, maybe insiders had a better grasp on matters and expected a turnaround in the prospects for their companies. No such luck.
As of our last check, on March 4th, we found 413 sales versus only one buy for the most atrocious sell/buy ratio we have ever witnessed. Worse, the one buy totaled a mere 2777 shares (Intel) while 155.6 MILLION shares were jettisoned by insiders. In the interests of fairness, we took the same poll on February 22nd and found disgustingly similar results; 2 buys totaling 5777 shares and 427 sales totaling 151.9 million shares. Note: no data was available for Research in Motion (RIMM), which comprises the sixth largest issue in the QQQQs. We considered adding another issue to round out the top ten but the 11th ranked issue, Teva Pharmaceutical (TEVA), is also outside the U.S. like RIMM and insider activity was not reported.
Nevertheless, the top nine issues are quite representative and as one might expect, valuations are rich. Although P/E multiples have clearly contracted and now stand at an average of 23.3, the average price to sales ratio is still extraordinary at 5.2. We can remember the good old decades when a P/S ratio in excess of two or three indicated a "popular" stock. While some might argue that the top nine are still rapidly growing companies, we would forcefully argue the point that some are no longer in rapid growth mode. This is an enormous segment of the market, valued at over $1 trillion. The more the big nine are hyped, the higher their share price and the more insiders will fetch when they feed at the trough. Only seven of the same companies in today’s group were tallied in our August analysis and our rough estimate of how much stock was sold by insiders at those few companies is a startling $7 billion. This is not chump change, friends, and it is not just Bill, Sergei and Larry* who are lapping up these tasty morsels.
*Bill Gates (MSFT); Sergei Brin and Larry Page (GOOG)
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ABOUT ALAN M. NEWMAN
Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.
The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.
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