The Daily Reckoning - Dynamic Market Theory (Christoph Amberger)

verfasst von Firmian, 16.10.2003, 20:28

-->Dynamic Market Theory

The Daily Reckoning

Paris, France

Thursday, October 16, 2003

---------------------

*** America on the Third World 'Watch List'... ruble rises
against dollar...

*** America's peso policy... Dow ends down after bullish
trading day... earnings surprises...

*** Dumb money in the driver's seat... insiders getting
out... insulting whoredom... and more!

---------------------

"It feels strange to be quoting [NY Times economist] Paul
Krugman," said colleague Dan Denning last night."But his
analysis is pretty good, even if his solutions are
foolish."

"There one thing I can't help noticing," wrote the foolish
economist earlier this week."A Third World country with
America's recent numbers - its huge budget and trade
deficits, its growing reliance on short-term borrowing from
the rest of the world - would definitely be on the watch
list."

Normally on the 'watch list' are Third World countries with
big financial troubles. Argentina, Brazil, Indonesia,
Malaysia - all have made the watch list. All have
subsequently suffered banking and currency crises, or
hyperinflation, or depression or some hellish combination
of economic fire and brimstone.

But now,"the U.S. budget deficit is bigger relative to the
economy than Argentina's in 2000," says Krugman,"and the
U.S. trade deficit is bigger relative to the economy than
Indonesia's in 1996.

He continues:"The brokerage firm Lehman Brothers has a
mathematical model known as Damocles that it calls 'an
early warning system to identify the likelihood of
countries entering into financial crises.' Developing
nations are looking pretty safe these days. But applying
the same model to some advanced countries 'would set
Damocles' alarm bells ringing... most conspicuous of these
threats is the United States.'"

Welcome to the pampas, dear reader.

George W. Bush may not feel like the president of a
backward, Third World nation when he visits Asia this
weekend. Americans do not go around barefoot, nor do they
live in horrible scrap-cardboard shanties. Instead, they
live in $200,000 suburban shebangs and borrow against them
in order to buy $100 Nikes imported from Asia.

But selling Nikes to Americans has left the Orientals with
$1.7 trillion in U.S. dollar-denominated Treasury bonds. It
also leaves them with a strong desire to keep their
currencies low compared to the dollar in order to keep the
cash flowing their way. To this end, the Chinese are
unlikely to revalue their yuan upwards in the near
term... and the Japanese, with no further rates to cut, have
taken to printing money (the money supply in Japan is now
growing at a 21% annual rate).

The U.S. Treasury has not admitted it, but the strong
dollar policy of the Clinton Administration has been
replaced by a third-worldish peso policy. And Fed governors
have announced their intention to drop dollar bills from
helicopters if that is what it takes to weaken it.

The sluggish chocolate-making countries, too, are eager to
keep their currency from rising. Close to recession, Europe
can ill afford a rising currency.

And yesterday's news brought word that Russia's ruble had
risen to a 22-month high against the dollar after Moody's
upgraded Russian bonds to investment status. The
authorities were not happy, blaming the rise of the ruble
on 'speculators.'

How all this will end up, we don't know.

Consumer prices may rise... or they may not. China can
produce new widgets and gee-gaws almost as fast as the rest
of the world can print and circulate paper currency.
Besides, demand for widgets and gee-gaws could decline
sharply when times get tough.

But while America, the Far East and Russia can print all
the paper currency they want, the supply of gold is limited
to what miners can pull out of the ground. It takes years
to bring a new mine into operation; during the 20-year bear
market in gold, few new ones were put into service. And
even now, after the price of gold has risen from a low of
$253 a few years ago to $373 today, miners are still
reluctant to invest in new production.

And while there may be only 370 dollars ready and willing
to purchase an ounce of gold today....there will almost
certainly be more next year.

Our old friend Chris Wood guesses that the price of an
ounce of gold will reach $3,400 before this bull market is
over. That price would equal the peak at the last bull
market, adjusted for nominal increases in personal income.

While we are waiting for gold to reach $3,400 an ounce,
here's Eric with more news:

-------------

Eric Fry, our man-on-the-scene in Manhattan...

- The stock market's formulaic rally continued yesterday
morning, as if following the same tired script it has been
following almost every morning lately...

- Here's the basic storyline: 1) High-profile tech stock
reports"positive earnings surprise" after the close of
trading; 2) High-priced tech stock then soars in after-
hours trading, thereby establishing a"bullish tone" for
the following day; 3) All evening on CNBC, Maria Bartiromo
gushes breathlessly about high-profile tech stock's
positive earnings surprise; 4) The nation's investors lay
themselves down to sleep, comfortable in the knowledge that
the bull market in stocks will resume the following
morning; 5) When the following morning finally arrives, the
stock market opens for business to a flood of buy orders
for tech stocks... Voilà, another bullish trading day is
born.

- Alas, by day's end yesterday, the Dow was down. Intel
provided a tailor-made earnings surprise Tuesday evening,
by reporting a third quarter result of 25 cents a share - a
couple of pennies per share better than the consensus
earnings estimate. The company also offered an upbeat
forecast for the fourth quarter.

- On Wednesday morning, predictably, Intel shares spiked
more than 5% higher immediately after the opening bell. The
rest of the stock market tagged along. But the market's
early gains faded in the afternoon, as the Dow fell 10
points to 9,803 and the Nasdaq slipped 4 points to 1,939.

- The bulls needn't despair just yet. Last night, IBM
became the latest high-profile tech stock to provide an
"earnings surprise." Actually, the earnings themselves
weren't much of a surprise, but Big Blue's big plans for
2004 were quite surprising. The company announced that it
hopes to hire 10,000 new employees next year.

- Notwithstanding the company's optimism, IBM shares fell
in after-hours trading. Which brings up an all-important
question: Is a strong economic recovery already priced into
the stock market? It's true that the economy is showing
signs of life. But it's also true that stocks are not
cheap. Isn't it possible that the richly priced stock
market more than adequately reflects current economic
realities?

- Signs of economic recovery are almost as plentiful as
signs of investor exuberance. Here in New York, the Federal
Reserve's Empire State Index of conditions at regional
manufacturers jumped to 33.7 in October from September's
18.4 in September. On Wall Street, signs of recovery
include rising interest rates. Yesterday, the 10-year
Treasury yield jumped back up to its early-September high
of 4.38%.

- Signs of recovery are also trickling in from Main Street.
"Uniform rental industry statistics showed that employment
growth began picking up over the summer," the Wall Street
Journal reports. Citing a survey conducted by Michael A.
Schneider, an analyst at Robert W. Baird & Co., the Journal
notes,"In June, just 28% of the companies surveyed said
business was improving - they were adding more rentals in
their existing accounts than they were losing - while 12%
said business was getting worse. [By contrast], in the
September survey, 41% of the companies said they were
adding more rentals than losing, while just 6% said things
were getting worse."

- It's comforting to know that ketchup and deep-fryer
grease will be splattering a few thousand more fast-food
uniforms this year than last. But doesn't the stock
market's lofty valuation reflect this bullish fact already?
Doesn't a Nasdaq Composite selling for 50 times earnings
verily scream,"Recovery!"?

- Indeed, the Nasdaq not only screams recovery, but
"sustainable recovery." And that is where we beg to differ.
Consider, for example, that the boost to consumer spending
provided by the Bush tax rebate has already run its course.
Retail sales, which boomed in August, petered out
completely in September, according to the latest stats from
the Commerce Department.

- Consider as well that the nation's massive financial
sector is heading into its own private recession, thanks to
rising interest rates. The financial services industry was
one of the very few industries to add jobs since 2000, even
while the manufacturing sector was shedding 2.6 million
jobs. But now, financial services jobs are starting to
disappear, even as other industries begin adding a stray
job or two.

- Unfortunately, even if IBM promises to hire only
unemployed mortgage brokers, job losses in the financial
sector could offset employment gains elsewhere in the
economy. In other words, the jobless recovery may hang with
us for a while longer.

- Lastly, consider that finance companies are not the only
American corporations vulnerable to rising interest rates.
As we have noted frequently in this column,"closet"
finance companies like General Motors are also vulnerable.

- Yesterday, the giant automaker reported a profit of $425
million in the third quarter. But GM's global automotive
operations contributed only $34 million to the bottom line
- down dramatically from $368 million a year ago. GM's
finance operations - especially its mortgage finance
operations - carried the day, contributing essentially all
of the company's third-quarter profit.

- The richly priced stock market may be ill prepared for
the trauma of rising interest rates... Watch this space.

-------------

Bill Bonner, back in Paris...

*** This is a dumb-money stock market rally. Investors are
buying the worst companies at the highest prices - and
making the most money!

Insiders, meanwhile, are using the opportunity to get out.
In the third quarter, insiders sold $8.7 billion of their
own stock, 36 times more than they bought.

*** An old friend describes the financial industry:

"It may sound harsh," begins Marc Faber,"but the entire
financial service industry is a like a huge brothel. The
brokers push stocks they know nothing about, but which move
and, therefore, can be turned over quickly, thus generating
commissions. The analysts recommend stocks not necessarily
based on sound fundamentals, but because they are showing
signs of rising momentum as other analysts are also
recommending them. And the fund managers are forced by the
brothel's owners to perform by buying sectors that they
don't really like but which will, as they soar, give full
satisfaction to the brothel's clients."

Ah, there's the difference... and the libel to all of
whoredom. The brothel's customers typically leave
satisfied. Real whores give value for money. But the
investment industry is just a pretender.

Another old friend, Martin Spring, explains:

"A new survey by the Vanguard Group, 'Sources of Portfolio
Performance,' shows that professional managers are often
not even able to deliver enough additional return to pay
for their fees and expenses.

"They analyzed the performance in the U.S. over 40 years of
420 actively managed balanced mutual funds - those
investing in both shares and bonds - finding that only 7
percent were able to add value on a consistent basis. And
only by accepting a higher level of risk.

"Financial advisers often speak and write about the various
kinds of risks that investors face - that markets may fall
or the issuer of a security may go bankrupt. But I have
never seen anyone refer to one of the biggest perils facing
the individual investor - fund manager risk."

*** On the other hand:"Dear editors and fellow readers,"
begins a letter from a reader."Am I alone with opinion
that the daily e-mail needs a thorough revamp?

"While subjects are usually topical, I think it just takes
too much time of your readers to pick good vs mediocre
stories. Hey, the Lessons of History are great for readers
to put current affairs in perspective.

"However, it's a real waste of time to read through Bonner
and mates indiscriminately bashing the stock market and
pumping gold. I don't disagree on the long-term view, but
didn't Keynes say: In the long run we're all dead! Fact is
that markets go up and down and you want to be long when up
and short when they go down. People want to be rich as
opposed to be right!! And we don't need to hear the same
off-message time and time again!"

Thorough revamp?! Waste of time?! Oh yeah?! We'll have you
know, we're a versatile lot... Bonner and mates can
indiscriminately pump up the stock market, too. See the
essay from our friend and colleague, Taipan's Christoph
Amberger, below...

---------------------

The Daily Reckoning PRESENTS: An entirely different
explanation for the rally on Wall Street...


DYNAMIC MARKET THEORY
by J. Christoph Amberger

Something has changed in the stock market. That
'something,' of course, is the dollar amount of Federal
Reserve repurchase agreements, which has dropped
considerably.

There is a strong correlation between repurchase activity
and the current rally in stocks: In the second week of
August, the Fed's repurchase activity totaled US$48
billion. A week later, the total is was 'only' US$35.25
billion. (Which means that for a mere US$83 billion, you,
too, can create a 100-point rally in the Nasdaq.)

The question is: How long will this go on? How long will
the Fed continue to feed the stock market's addiction to
liquidity? I think the answer is simple - 2,000 and
10,000... as in Nasdaq 2000 and Dow 10,000. Those are big,
round numbers that will scream,"the economy is OK!" to the
American people.

But is it OK? Or is this rally based on a false idea of
value?

The traditional measures of value for investors all have to
do with the actual or potential earnings of a company. What
is it producing? What are its costs of production? What is
its position in the marketplace? What is its competition?
What is its future potential for earnings?

Oddly enough, few investors these days seem to care about
value any more. They didn't back in 1999 (when all they
wanted was an Internet-related business plan scribbled on a
cocktail napkin). And unless they're seeing sales and
earnings increases in U.S. companies where we can't find
them, they still don't care now. But maybe you don't have
to care about value to make money. In fact, based on
Taipan's research into Dynamic Market Theory, the
traditional views on value are all wrong. I'll get to
Dynamic Market Theory in just a minute, but first, let me
explain our view of value.

We believe most market theories all deal with the
'intrinsic' value of stocks or other commodities. In other
words, the notion that the value comes from within the
thing. That it has value by and in itself, regardless of
any associations with other things.

But we believe that, for investors, the only value of any
importance is the value that someone else places on a stock
or investment at any given point in time. Following this
idea, there is really no such thing as a 'bubble.' If the
price of a commodity like real estate, tulip bulbs or
Internet stocks rises to hyper-value based on demand... then
that is its true value at that moment in time.

You see, a 'bubble' is an argument about value - mostly
made in retrospect, after a particular investment fad has
gone bust. Investment fads that don't go bust, conversely,
are called 'strokes of genius,' even if the underlying
speculative analysis and risks are the same for both.

For example, at the market peak in early 2000, it was said
that the stock market had a valuation of US$17 trillion
dollars. That amount had dipped to US$8.5 trillion by
October 2000. Right now, the valuation of the stock market
is about US$10 trillion. But all these figures are
assignments of value based only on what a small percentage
of shares is trading for.

Only a tiny fraction of a given company's shares are in
trade at a given time. Take Microsoft, for example. There
are almost 11 billion shares of Microsoft outstanding, but
on any one day, only 25 or 30 million might change hands.
If you dumped all 11 billion shares on the market at one
time, the price would plummet because of the monstrous
excess in supply - no matter what was going on at the
company or in the stock market. So the 'valuation' commonly
given to any or all stocks is arbitrary, not real, even if
it is based on the latest sale of a few shares of the
stock.

Those subscribing to a bearish view of the market like to
say that around US$8.5 trillion dollars of equity valuation
was 'destroyed' in the bear market from early 2000 to
October of that year. But since valuations are assigned
arbitrarily anyway, they can't be destroyed. They change
up, they change down. But they never go away. And that
US$8.5 trillion wasn't 'created,' but was generated by the
reallocation of savings and spending money put into stocks,
which pushed share prices up overall, causing the higher
'valuation.'

And here's another interesting little fact: In 1982, at the
beginning of the last 'bull market,' there were only about
1,500 companies listed on the New York Stock Exchange, with
roughly 40 billion shares. The market valuation was around
US$1.3 trillion.

But by the year 2000 and the end of the bull market, there
were over 3,000 companies listed on the New York Stock
Exchange... with over 349 billion shares available. Granted,
some of these were start-ups, but it's obvious that a lot
of the 'wealth' that was 'created' actually came from
existing private companies going public, taking advantage
of a rising market and putting shares of their company up
for sale to the general public.

These companies were already in existence, with dynamic
value. It's just that their value was now counted as part
of the stock market. So in these cases, wealth wasn't
created - it merely changed hands, from a few private
owners to millions of stock investors. Realistically, since
stock market valuations came down, the amount of money
invested in stocks also came down. Much of that money was
simply reallocated to other assets... like real estate,
bonds, gold, and other commodities.

Stocks are valuable to investors because their prices
change, both up and down. If they didn't change, why would
investors want them? It would be easier to hold cash - it's
more liquid, and there are no transaction fees.

Now, anyone with a computer can see - in an instant - that
a stock's price has moved from US$20 to US$25. And anyone
with any imagination can see that they could have made a
quarter for every dollar they put down. That's how it
begins. And that's usually about the time average investors
make their first mistake.

Because, as soon as you start looking for a particular
stock whose price could rise, you introduce the idea of
valuation - that a stock's price is somehow linked to the
prospects of the company. But this is true only in the most
general understanding of valuation.

If you watch stocks trade on options expiration days,
you'll realize that 'valuation' takes a back seat to the
infinitely more powerful forces of money flow. The only
question is, who's going to be left holding the bag? Watch
a stodgy old NYSE stock as options expiration day (the
third Friday of every month) approaches. Pay particular
attention to the open interest on puts and calls in the
vicinity of the current stock price. Like clockwork, the
greatest number of people who can be squeezed out of their
money at expiration, will be. Whether that means selling
down a 'good' stock or pumping up a 'bad' one!

Want to know where the S&P 500 and Nasdaq are headed? You
could listen to bulls or bears or stock analysts. You could
track unemployment, follow earnings trends, and pay close
attention to market gurus and the financial media. But if
you really want to know, you should check the"Commitment
of Traders" report released every Friday by the Commodity
Futures Trading Commission. This report is more valuable
than all the economic or technical analysis known to man.

Because this report will tell you what the big money, the
money that literally moves the market, is doing. And this
is where you'll get your first clue about what's really
behind value... and why we prefer to use the realities of
Dynamic Market Theory.

You see, 99 times out of 100, you'll find that the big
money is doing the exact opposite of what 'the herd' is
doing. The investors looking for steady growth, low P/E
stocks in which to park their US$100,000 IRA have no idea
what they're up against. The big money, the guys with
billions upon billions in buying and selling power, WILL
have their way. And if that means dropping a low P/E stock
even lower, then so be it.

For example: eBay currently trades at 22 times sales, has a
P/E above 100 and a 50% premium to its growth rate. It is
richly valued, to say the least. Eight million shares are
sold short. And the open interest on options is about 2-to-
1 in favor of the puts (investors betting the stock will go
down). A lot of people are betting the stock is
overvalued... and expecting it to fall.

It's not that they're wrong. It's that they're asking the
wrong question.

The single-most important question you need to ask is not
whether it's overvalued, but... who's going to make money?
When you know the answer to that question, you can make a
fortune. That's how the richest people in the world make
their money.

Here's what I mean: The top three institutional owners of
eBay have about US$3.5 billion in the stock. Add in the
next three institutional owners, and you're talking about
US$6 billion. So, will the investors who have approximately
US$800 million in shorted stock ever turn a profit?

Not likely. The big boys, that is, the top institutional
owners, will keep the price up until the shorts call it
quits. Or they'll run the price up and 'squeeze' the shorts
- handing them bigger and bigger losses - until they give
in. And the situation is even worse for the vast number of
put options holders.

So, sometimes it pays to poke your head up out of quarterly
reports and valuation models and see what's around you. If
you find yourself surrounded by a bunch of people who, like
you, think they're about to make money... well, you're
probably wrong.

The stock market is a game, pure and simple. And there's
only one rule: money always wins.

In other words, a lot of that money that 'disappeared' from
stocks (equity funds) simply moved into bond and money
market funds. The money didn't 'disappear' - it moved. Add
to that the moves into gold and real estate, and you begin
to see that - allowing for fluctuations in the 'value' that
we love to give to the market - money tends to move around
more than it 'appears' and 'disappears.'

Point is, all that money didn't just 'vaporize,' as the
perennial bears like to claim. A lot of it simply moved.
Now money is flowing back into stocks again. But beware -
the market is set to fool investors and separate them from
their money yet again.

But if you follow Dynamic Market Theory, you're much better
positioned to profit... no matter what happens in the stock
market. It's a new and different way of investing that
takes into account volatile market conditions and the many
factors stacked against the individual investor.

Many stocks exhibit certain predictable behaviors before
they make a large move... that is, before the money moves
into or out of them. Over time, this behavior - shown by
any number of indicators - gets recognized, and everyone
begins to look for those indicators and act on them. Then
the significant factors evolve into something else.

To turn this action into profits, you need a set of
individual ways of looking at the dynamic market action of
stocks (in other words, price action) to arrive at
decisions about how to invest. With these individual
systems of looking at dynamic action, you can predict
developments in stocks... in any market... by looking at the
different indicators.

What's become obvious is that static theories or
traditional views of the markets can't and won't work in
the long run. Because there is no one set of principles -
like value investing - that will always work. Since the
market is dynamic and ever-changing, following one
investing principle dooms you to failure.

It may work for a short period of time, but once the market
factors change, then so must your investing philosophy.


Regards,

Christoph Amberger,
for The Daily Reckoning

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gesamter Thread:

• The Daily Reckoning - Dynamic Market Theory (Christoph Amberger) - Firmian, 16.10.2003, 20:28
  • Re: The Daily Reckoning - Dynamic Market Theory (Christoph Amberger) - trixh0, 17.10.2003, 02:28