Sunday, October 15, 2006

Manic market ignores the bad news / fleckenstein

einmal mehr ne "dose of reality".

During the last stock mania, the biggest problems we faced were caused by the mania itself. Today we face a world of woes, but the bulls don't mind.

As I viewed the landscape last week, it struck me that what we're seeing is one of the crazier moments in modern financial history. Obviously, the late 1999/early 2000 blowoff to the mania was, by definition, complete madness, as essentially worthless businesses commanded bigger valuations than worthwhile businesses do today. Questionable businesses were also far more expensive than their counterparts now -- i.e., the price of ideas and concepts, etc., was far higher

However, we basically didn't have many problems then, other than those created by the mania itself, which would surface only after it unwound. Indeed, the euphoria that greets nearly every piece of news lately, good or bad, would lead one to believe that all our problems have been adequately discounted, and the upside of a bright future is all that's left to deal with.

Bulls: The Dickens with Bleak House!
If one makes a list of the problems versus the potential good news, it doesn't seem to be an even trade. First, we must deal with all the debt created in the housing mania (as prices have stalled and are headed down), as well as near-record home inventories.

Of course, if you're what I call a dead fish, or cheerleader, why confront reality? Just do what one of them did last week: upgrade a couple of homebuilders D.R. Horton (DHI, news, msgs) and KB Home (KBH, news, msgs) -- on the back of poor results. In the case of KB Home, that included its acknowledgement of potential loan defaults due to an options-backdating problem, plus its inability to file financials.
Apparently, dead fish (and the bullish audience they play to) think there will be no further ramifications other than what has occurred thus far. Even though lending standards are in the process of being tightened, that crowd anticipates a rush of new buyers -- wherever they're supposed to come from -- who will qualify for the financing to purchase the homes that others need to sell.

Up to the eyeballs in LBOs
Similarly, leveraged buyouts (LBOs) are cheered, though little thought is given to who will buy the mountainous debt of all these deals and those still being dreamed up. Of the LBOs that I'm aware of, and I haven't been paying close attention, I can come up with an easy $100 billion worth of junk debt that will need to be swallowed.

Then, of course, we have a litany of macro problems, whether it be North Korea and Iran with their nukes, the Iraqi civil war we're in the middle of, or, on our soil, the many investigations that Republicans will face if the Senate or House swings to the Democrats

A cautionary view of the current milieu
In times like this, when it seems as though madness abounds and one feels out of sync for noting problems that seem so serious and tangible, it's interesting to see comments from other people who agree with you yet travel in completely different circles.

In this case, it's a Sept. 7 interview with Clinton-era Treasury Secretary Bob Rubin that was just released by Citigroup's (C, news, msgs) Global Economic & Market Analysis group. While he doesn't specifically talk about a dislocation, Rubin's comments do echo what I have been saying:

"Most people seem to think that the problem is somewhere down the road. I think the markets are remarkably complacent. It's curious to me that economists, with an exception here or there, are as sanguine as they seem to be. They talk about a cooling off or a soft landing or whatever it may be, but generally seem to attach very low probabilities to really serious, adverse developments. Most of the people I know in the national security world, and there are many, seem deeply troubled about a variety of matters: nuclear proliferation, Islamic radicalism, the endgame in Iraq, instability in countries that mean a great deal to us in the Middle East, what's going to happen in Pakistan and many other issues as well. And the markets do not reflect this."

I'm sorry for being a broken record, but at some point, all of this lunacy -- exacerbated by the combination of wanton premium-selling in options and "financial dark matter" derivatives, as well as 10,000 hedge funds -- will end in a dislocation, and no other way. Just because it hasn't happened thus far does not mean that the odds have diminished. In fact, as the reckless behavior continues, the risks have only increased.

When 'Bubbleonians' roamed the Earth
I suspect that when the history books are written on this particular moment in time -- and, for what it's worth, right now "feels" to me like a cross between September 1987/early 2000 -- people will look back and shake their heads in wonderment at how the market could have done what it did. Just as anyone would think, looking back to the autumn of 1973 or any other inflection point: Wow, how could market operators have been so blind?

Well, that's what the madness of crowds is all about: always wrong at the inflection points but driving you nuts as you try to exploit the opportunity.


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