What is the difference between Las Vegas and Wall Street? Las Vegas has crap tables, roulette wheels, slot machines and black jack. Wall Street offers currency swaps, puts and calls, pork bellies and other commodities, mutual funds, straddles, indexing, junk bonds and stocks. Las Vegas posts the odds, and Wall Street has to convince “investors” that the odds are in their favor. But truthfully, at both places, the odds are stacked in favor of “the house”. Also, Wall Street is not mandated by law to let “investors” know that the odds have turned against them even though Wall Street themselves know the odds of success are deteriorating.
While the stockbrokers who work for Wall Street firms may be only marginally better informed than your better than average investor, the top executives of the Wall Street firms clearly know what is going on. At their cocktail parties and clubs you will find such heavy’s as Alan Greenspan, Treasury Secretaries and Under Secretaries, and the line up of the governors of the New York Federal Reserve Bank (which is the bank in the system that sets the interest rates that affect short term money market instruments). These executives who control firms through their stock ownership know darn good and well when the signs of a deteriorating market are evident.
Wall Street has one function: acting as a medium between principals who are buying securities and selling securities. The “Big Money” on Wall Street is derived from raising large amounts of capital for corporations and governments. The favored instruments are stocks and bonds. The risk is so enormous that the top partners in the firms are charged with making the decision (and held accountable by their partners) as to the timing of the market, the price and the syndication (sale) of the securities. Wall Street “under prices” a new security in order to insure that the market does not turn against them. If the market turns against Wall Street after they have purchased the securities from a corporation like AT & T, the Wall Street firms involved stand to lose large amounts of money. So, therefore, bet your bottom dollar that your top partners of the major Wall Street firms that engage in these transactions know which direction the market is heading at most times.
With that in mind, why are we seeing the following in the news at this time?
Morgan Stanley is projecting that the Standard & Poor’s Index of 500 Stocks will show an increase in earnings in the year 2002 of 14%. Sure!
Continued “buy”, or “hold” recommendations, and almost no sell recommendations on common stocks. As an example, for the latest statistics available, according to Fortune Magazine, “in February, the top ten brokerage houses had approximately 6,300 buy recommendations and only 57 sell recommendations!!!” What do you think has happened to those people who bought all those stocks during that time? These recommendations come in spite of the fact that today’s bear market has already inflicted more economic damage than the worst market of the past sixty years, and it’s done it in half the time. In twelve months the US stock market has lost $5 trillion dollars worth of investor’s wealth, which is seven times the 1990 bear market losses, and five times the loss experienced in the 1987 crash. Furthermore, while the market’s decline in 1987 represented only 23% of our GDP, the last twelve month’s loss represents almost 50% of our current GDP.
The answer to “why are we seeing the above in the news” is that Wall Street makes money when the public is in stocks, and Wall Street losses money when the public is in cash or bonds. The commissions on stocks far exceed commissions for handling any type of cash, or cash instrument, like a CD or bond. When investor’s get scared or worried they tend to move out of stocks and into bonds and/or cash. Furthermore, the top Wall Street partners hob nob with the top officers and directors of the major corporations in this country for whom they raise money. Part of the “deal” in establishing a relationship with companies, who need large amounts of money to sustain their growth, is that the research departments of the Wall Street firms that raise money will “tout” the stocks. The chief executive officers of major US corporations expect and demand that the research be good, positive and “on the buy side”. Remember, a significant percentage of the pay of top officers of major corporations in this country is stock options. Stock options are worthless if the market is going down and extremely valuable when the market is going up. So, it’s money again.
Now let’s look at some other things that bear upon
this issue which Wall Street is fully aware of:
1. Most “margin” (credit) buyers of stock are speculators. Remember the day trader? Lately, you hear as much about day traders as you do about the “new economy stocks”. Nothing. But margin buying is a result of borrowing large amounts of capital from brokerage firms themselves, who make a lot of money on interest they charge on those borrowings, and the trend of the borrowing will tell you every time the direction in which the market is headed. For example, margin borrowing to purchase stocks in March of 2000 was $278 billion dollars. Margin borrowing at the beginning of July 2001 was $166 billion dollars, a huge percentage drop in the last twelve months. Why? Because the day traders and the speculators have been wiped out of this market. Furthermore, Wall Street knows that in bear markets, margin accounts can end up at 10% of their high during the preceding bull market, which could mean as little as $30 billion dollars of margin borrowing before this bear market is finished.
2. When the primary trend of the market is down there is nothing that the Wall Street firms or the Federal Reserve can do to stop the deterioration of values. The two hundred day moving average of the Dow Jones Industrials is about 10,600 points, so the market is below that level. All the yapping by the Fed, all the flooding of the economy with cash by the Fed, all the buy recommendations of the big stock houses so we can “get in on this new bull market” are not going to turn around this bear market.
3. Phase one of the bear market started in March of 1999. The fed has tried desperately in that period of time to manipulate the law of supply and demand in favor of demand with no success. The first phase of a bear market is a slow deterioration of values. The second phase of the bear market, which we are now in, reflects deteriorating business conditions. It is usually the longest phase of the bear market, at the end of which the stock houses “finally admit” that we are in a bear market. By that time, most investors have lost their shirts, are fed up, and will sell for cash at any price. We then enter the third and final phase of the bear market when values are great and smart investors, who have been in cash, can then stand to make huge gains on their investments. Bear markets usually last twenty-five to thirty-five percent of the length of the bull market, so this seventeen-year bull market would suggest a four to six year bear market, and we are in the third year right now. Presumably, in the third phase of this bear market, Dow Jones Industrial stocks will sell at ten to twelve times earnings (they are almost double that now), and the dividend yield will be 4 to 5% (it is less than 1.5% now). Those who accumulated stocks when they were selling at bargain prices have generally made the great fortunes in the stock market. When price earnings ratios have been under ten, the median return for stocks over the next ten years has been about 17% compounded annually.
How have so many smart people gotten it so wrong? The dividends on the Standard & Poor Index of 500 Stocks dropped 2.5% last year, the most since 1951 when they dropped 4.1%. That alone is indication of deteriorating business conditions. Yet right now, of 8,000 recommendations made by analysts covering the Standard & Poor 500 Stocks, not even 2% are “sell” recommendations.
When everybody is thinking the same way, nobody is thinking very much at all. Intelligent analysis dictates that if the market is continuing to deteriorate in light of all these positive moves by the Federal Reserve System, and positive recommendations by the Wall Street firms, it is time to liquidate stocks, sit on the sidelines and be thankful that “going against the grain” can save one so much money and heartache.
Remember, most investors have not been down this road before. All roads lead to an end. And the end of this road is the end of the third phase of this bear market. The Dow Jones Industrial Average could very well be between 4,000 and 6,000, one half of today’s values!
George W. Rauch III
August 21, 2001
