Newsletter

December 11, 2003

Volume VI, Issue 124

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Coming Attraction

Successful microcap investing can be as much about understanding yourself as picking the right stocks. Microcap investing is an emotional process. Very few people invest in microcap stocks for any clinical reason- the stocks don't lend themselves to Wall Street coverage or institutional participation.

Understanding your own psychological profile when making a microcap investment can be one of the most critical components in successful microcap investing.

This weekend I am going to publish a special article from our contributing editor, Dr. Richard Geist. Dick is a Harvard Ph.D. in psychology, and is considered by many to be the foremost expert on the psychology of investing. Stay tuned.

It's The Economy Stupid, Part II

There is enormous debate about the market and the economy. Corporate profits are climbing rapidly, gold continues making new highs, and the dollar continues falling. The talking heads on CNBC are now trumpeting the likely hood inflation will return. Weren't we hearing about deflation just a few months ago?

I believe the only real risk for stocks right now is increasing interest rates, barring any major geopolitical catastrophic event. It's a simple concept most people fail to grasp- When interest rates are higher, earning are worth less in the eyes of the market. This simple fact explains why the morons who believe the market needs to drop to a PE of 8 before the Bull can come back are simply wrong. The Bull is back, and the PE did not drop to 8. Past bears dropped this low, but in high interest rate environments with less complex accounting methods.

Interest rates have already started going up, driven by market forces, not FED action. However, this implies growth has returned, which is good for stocks. I believe stocks will continue to appreciate for some time even as interest rates increase moderately. The rate of appreciation for stocks could slow.

How do you think this chart of the NASDAQ might have looked if we hadn't had 911, Enronitis, an war with Iraq? I believe the NASDAQ has a shot for a return to the 3200 level over the next 18 months.

I have been reading a number of predictions stating our market will mirror the Nikei in 1993/1994, which I believe is wrong. One of the many newsletters I read is The Agile Trader (www.theagiletrader.com), by Adam Olensis. This guy is brilliant, and highly technical. He is one of the few technicians that is not married to his beliefs, then finds the data to support them. He clinically dissects what is happening.

Last weekend he published a beautiful overview of the debate on the economy. Here is an except from that newsletter which I believe puts in all in perspective.

Excerpt From December 7 Edition of the Closing Bell, By Adam Olensis

Given that the US economy is growing at about 4½ times the rate of the Japanese economy over the past 9 years, it would be difficult to imagine that the apparent correlations in the Nikkei and Nasdaq are anything but episodic and anecdotal.

Now, one other interesting point may be made about the difference between the way the US economy is responding in its post-bubble era and the way the Japanese economy has responded. Basically the US government has begged, borrowed, and bought this 3.4% growth, leveraging its capacity to stimulate the economy by lowering taxes, by massively lowering interest rates, by electronically "printing" money, by borrowing money from bond buyers, and by spending oodles more than it collects in tax revenue (growing the deficit). It's a little a little bit like the way Cisco (CSCO) used to buy its growth by acquiring small companies and writing off the acquisitions in that the government has assumed debt, pumped the proceeds into the economy and called it growth, extracting the money from the "debt pocket" and putting into the "GDP pocket."

Of course the big question is whether this leveraging of debt is a zero-sum game, a less-than zero-sum game, or an effective counter-cyclical strategy that will smooth the amplitude and widen the frequency of the business cycle, and ultimately make the US economy a more valuable going concern (less cyclicality in any "asset" makes it more valuable).

Whatever the correct answer is to the tripartite question above, it will look different than do the Japanese economy and the Nikkei. Either the counter-cyclical stimuli will work or they won't. But the results will almost certainly be patently different from what happened in Japan, and consequently the relative progressions of the stock markets are most likely to look quite different. In fact, I would suggest, the LEAST likely scenario would be for the US markets to trace out paths similar to the one traced out by the Japanese market. Our demographics are different (US population is growing where the Japanese population stagnated), we have vastly more immigration, our country's racial makeup is quickly transforming itself, and the two countries' histories just prior to their bubbles were markedly different (Japan was a newly minted, post-WWII juggernaut overlaid onto a culture that still bore the earmarks of a feudal society, forced onto the launching pad by foreign (US) stimulus after the war.) Furthermore, and perhaps most importantly, the current aggressive countercyclical stimuli proffered by Greenspan et al are explicitly designed to AVOID just the fate that befell Japan.

So, what should we provisionally conclude? The Greenspan Gambit is working in the short run. We do not yet know whether it will work in the long run. If it is going to work, then the US economy will grow itself out from under the giant debt load assumed to counteract the post-bubble stagnation. If it is not going to work, we probably won't know that for some time. Which is to say that the stimuli in the system still have some more room/time to play themselves through. And (in the "failure" scenario) the current strong growth path in the economy will then turn down...but down with an even larger debt load on its back, which will accelerate its decline to an even lower low. (Just like stocks, larger return implies higher beta.)

Bottom Line: In my opinion this market will tend to work itself higher as earnings and the economic statistics continue to reflect the effects of stimuli in the system. And it will probably be mid-to-late '04 before we start getting clear on whether the economy has been on a stimulus-induced high from which it will crash like a crack addict, or whether it has ingested a healthier kind of "nutritional support" that has helped it to heal itself.

President Bush's re-election hopes are very likely to hinge on just this issue. So we can bet that the pedal will be to the stimulus metal into at least 3Q04..

In my opinion, this piece of work is brilliant, and I had to share it with you.

The market is now grinding sideways. It is estimated $3 to $5 billion in stock sales are hitting the market everyday to meet mutual fund redemptions as investors flee from their corrupt mutual funds. This spells opportunity for those on the long side.

Charts Provided Courtesy Of TradePortal.com

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