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Longboat Global Advisors CrossCurrents 4/28/4


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#1 TTHQ Staff

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Posted 28 April 2004 - 09:02 AM

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HOME OF "PICTURES OF A STOCK MARKET MANIA"

April 28, 2004
Longboat Global Advisors CROSSCURRENTS
Alan M. Newman, Editor



Charles Allmon is 82 and has been investing longer than many of our readers have been alive. Along with Richard Russell, Sir John Templeton and Seth Glickenhaus, Allmon has been through decades of bull and bear markets and knows value when it appears and knows when the public is being taken for a wild ride by hype. In the April 15th issue of Growth Stock Outlook (4405 East-West Highway, Bethesda, MD 20814), Allmon says, "The bigger the cock-and-bull story, the happier the investors. We've seen that again in 2004, witness the plethora of 90%-100% invested bears and overwhelming evidence that a vast majority of investors truly believe a bull market forever is a national birthright. Forget value. Whether you look at P/E ratios, book value, cash dividends, or quality of earnings, on February 1, 2004 the broad market indexes stood at levels of excess seen only in March 2000, just before the roof caved in." Allmon goes on to point on the incongruity and lack of discrimination by investors, gobbling up lower rated issues in preference to those higher rated, such as Value Line's #1s rated up 40% in the year ending January 12, 2004 against a 90% (!!!) gain in those stocks Value Line gave their #5 bottom rating. If that isn’t a tip-off to a phase in which speculation is running rampant, what is? Although our experience is limited to “only” 40 years, we also note the proclivity towards hype and the preference for issues such as Yahoo, one of those Allmon mentions as suffering from "delirious demand, " citing the still extant problem that Yahoo would again have no earnings at all had stock options been properly expensed. When 2005 rolls around, there will be no further denials possible for corporations that utilize stock option programs to reward execs in a big way. Although S&P estimates that earnings may fall only 3% for the group of 500 next year as a result of the new accounting rule, it will clearly hit some companies harder than others and in case those cited earlier in the newsletter were not sufficient, you can add Boise Cascade, Monster Worldwide, Phelps Dodge and Robert Half to the list of those where earnings would have disappeared entirely last year had options been expensed. No wonder insiders are selling as fast as they can and selling every share they possibly can, like the zero buyers and 35 sellers at Yahoo over the last six months!

The Arizona Republic recently carried an article by Russ Wiles about investment regulator concern that some folks are using home-equity loans or refinancing cash to invest in stocks, "imperiling their homes in the process." Given that some of these players may be also utilizing the temptation of margin loans as well, we'd say "imperiling" is a very apt description of the risks at hand. An NASD spokesperson claimed that although home mortgages were not "within our purview," they were concerned about the use of home-equity loans to invest in securities, and about (investment) brokers who suggest that." Meanwhile, the investment industry appears to be pooh-poohing the possibility that investors are going out on a limb, instead quoting margin debt stats that fell heavily from the March 2000 highs and are still substantially below those levels - but then again, so are prices. From 1958, as far back as our margin database goes, through 1994, margin debt on the NYSE averaged less than 0.6% of Gross Domestic Product. Although the highest year end stat we have is 2.4% for 1999, if we combine NYSE and NASD margin against the March 2000 top, total margin debt was likely almost as high as 3% of GDP, second only to the madness in 1929. Total margin debt dropped from nearly $300 billion in March 2000 to $136 billion in September 2002. But margin has since expanded 40% to more than $190 billion and represents roughly 1-2/3% of GDP, clearly a dangerous level if there is any presumption that home-equity lines and mortgage refinancing are also being used to buy stocks. Just one peek at the chart in the center of this page affords a rather shocking perspective of how tapped out the consumer may be. If ANY of the proceeds from refinancing mortgages has been directed towards stocks, risk is far higher than anyone can imagine. And if you think about even more, the numbers can get pretty scary. Just between Fannie Mae and Freddie Mac, total mortgage portfolio holdings are now $1.5 trillion. We’re not including any banks whatsoever. This could be quite a stretch since we have no way of determining this, but if only 5% of Fannie & Freddie’s borrowed money has gone into the stock market, that's the equivalent of another $75 billion in margin and that would bring total stock market leverage back up to 2.3% of GDP. And that's only using the portfolios of the two largest players. Add in a few of the major banks and who knows how leveraged stocks are?! Conceivably, the market is as leveraged now as it was in March 2000.

Our measure of 10-day new highs and new lows for the combined markets has finally begun to show signs of deterioration. Note the arrow is nowhere near where one might expect a correction to take us after a solid year on the upside. Even in the midst of the mania, this indicator showed a lot more daily new lows and we suppose that much more in depth and time will be required before the expected correction can end.

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