PERFORMANCE ANNOUNCEMENT
As Of: January 16, 2002
The Emperor's New Clothes
What will earnings reports reveal?
Judging by the dramatic stock price increases since the lows set after September 11th, the investing public believes that stocks will be wrapped in a raiment of finery as they are paraded in future public earnings reports. Of course we all know not to expect much from the fourth quarter earnings reports just now starting to be released; but hand in hand with those dismal reports is the expectation that the worst is behind us, and 2002 will confirm a V-shaped recovery from the recession. This implies steadily improving earnings for each quarter of 2002.
As in the well known tale of the Emperor who ordered a new suit, we have been led to believe that wonderful things lie ahead. With great anticipation, stock prices have been bid up to a level consistent with these expectations, but not necessarily consistent with reality. Will the truth reveal a fraud? Will stock valuations be exposed in all their nakedness to a scrutiny that cannot be tolerated? Or will the fundamentals prove out with improving earnings, and place badly needed support under the current market prices?
The risk is clearly skewed toward the possibility that the recovery doesn't occur as expected, and stock prices decline. If there is an adequately quick recovery as is generally expected, it is not clear how much more stock prices can go up without the further display of even more accelerated economic growth. Thus, the potential loss of profit by not being in the market if it goes up does not seem as onerous as the certain loss of assets from being in the market if it goes down. This is a time when the conservation of money in hand seems better than the mere possibility of more money in the future.
The axiom "Don't fight the FED" has proven to be a disservice this time. Instead of the normal debt liquidation that should occur with a recession, eleven interest rate cuts have spurred additional borrowing. Stock prices have moved up in a belief that the Federal Reserve has administered the cure. What the FED has actually done is simply stretch out the slide into recession. The end is still nowhere in sight. There is a gnawing feeling that auto sales and real estate have yet to tumble, and that bankruptcies and unemployment have yet to grow. If this happens, the recent bounce in stock prices will be viewed as only a bounce. There is a very real risk that there is more downside ahead.
I am short technology, and short or avoiding financials that have credit risk exposure, as well as short the home builders. I am long select utilities and select foreign bonds. I am short the U.S. dollar, and I am scalping option premiums that have been driven up by high volatility. It is far too early and stock prices are too high to whole heartedly buy into the market on the belief that recovery is just around the corner. I am still waiting to see the emperor's new clothes.