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Friday, 17 September 2010

Correlation Corral

by Michael Santoli

Too much herd behavior among traders is making us feel anxious about the real state of the markets. The un-wisdom of crowds.

MARKET METAPHORS ARE LIKE license-plate numbers: everyone has one, but eventually they all get recirculated.

The thought struck last week that the market lately has seemed like a game of roulette, with a binary outcome of up or down, with almost every risk-asset class moving in tandem on whatever macro data item or currency relationship or policy utterance traders collectively deemed to be the key.

Doug Kass, of the hedge fund SeaBreeze Partners, had already gotten to this one, having written recently that "the equity market ... has morphed into a roulette-like casino setting in which risk is taken off and put on like the ball that falls into either black or red slots. And, as the U.S. stock market has been totally correlated -- you either win or lose depending on the color you bet on."

On May 17, this column got lucky in suggesting, "With 2004's market offering a rough guide for how 2010 has progressed, an emotional, wide trading range would seem the most plausible upcoming scenario, as macro/systemic fears vie with positive domestic economic trends for investors' attention." Within such a range, the market oscillates quickly from overbought to oversold, and investor sentiment flops irresolutely from upbeat to downcast.

The "interminable trading range" idea has become so ingrained in investor consciousness that it's time to muse about what might dislodge it. One common line is that the Nov. 2 elections and the related debate on tax policy will somehow usher in a new trend.

Maybe. It's true that midterm elections that tack against a first-term president's party have been known to please the market (see 1982 and 1994).

Yet, here's suggesting that not only is the interplay of politics and markets rather inscrutable, but the firm beliefs of the entrenched political cognoscenti on Wall Street often aren't borne out.

Consider quotations such as this: "Now, we can understand why [the president] would seek comfort in his old campaign theme of blame-the-[past decade]. No wonder [the president] is getting testy, while [the] labor secretary tells reporters he's searching for stimulus.

"Our own view is that [recent] tax increases have hurt both business incentives and consumer confidence, while [the] incredible looming health-care mandate suppresses job creation. Only a brave employer hires new workers when he has no idea how much they will cost. We do give the [president's] team high marks for giving the Federal Reserve a pass, a fact that has helped produce the marked plunge in long-term interest rates. Yet it's hardly reassuring that even lower rates don't seem to be lifting the real economy ... ."

This is from a Wall Street Journal editorial on Sept. 9, 1993.

THE QUITE COMMON VIEW THAT Big Tech is "radical cheap" would be easier to accept if the sell side weren't so lopsidedly aboard this trade. Microsoft (Nasdaq: MSFT - News) has 34 analyst Buy ratings, seven Holds and no Sells. Apple (Nasdaq: AAPL - News), almost absurdly, has 47 Buys and three Holds, no Sells.

The consensus price targets for Microsoft, Apple, Intel (Nasdaq: INTC - News), Hewlett-Packard (NYSE: HPQ - News) and Google (Nasdaq: GOOG - News) are all 30% or more above current prices. It would be nice if more analysts -- who mostly came of age in a world when these stocks were chronically overpriced -- threw in the towel. Last week saw one downgrade, of HP to Neutral from Buy, by Maynard Um of UBS, in a report titled, "When valuation isn't enough," so now "only" 28 of 39 analysts recommend it.

The market, broadly, is sending the message that modest valuations, which most of the classic Big Tech stocks have going for them, is not enough for it given underleveraged and inefficient balance sheets, skimpy organic growth and miserly dividend policies. They are now treated as flush but mature companies -- and that's just how they're acting, by paying up to acquire smaller, rapidly growing upstarts.

Watching HP and Dell (Nasdaq: DELL - News) scrap for the right to buy data-storage firm 3Par (NYSE: PAR - News) -- a contest that sent 3Par's market value from $600 million to $3.1 billion in 10 days -- was like seeing a couple of wealthy men of leisure vie, with gifts and promises of material comfort, for the affections of a starlet.

With this as context, it is noteworthy that Big Media stocks, beneficiaries of many of the same digital-information mega-trends that excite tech investors, are less avidly promoted by Wall Street. Media executives are figuring out how to get paid for their globally portable brands and content, have strengthened balance sheets and have gotten religion on capital allocation and shareholder friendliness.

1 comment:

snoring solutions said...

I had expected something with a tinge of bullishness. Recent market action camouflaged within this range bound trading the beginning of a new bull market. Most of the time when I change my point of view I read about similar thinking in your column but not today.

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