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Second-Half Rebound -- in Recklessness

Bill Fleckenstein

Editor's note: This column, which reflects market activity from the day before, originally appeared July 14 on RealMoney.com. To sign up for RealMoney, where you can read Bill Fleckenstein's commentary every day, please click here for a free trial.

Last night's party in world equity markets continued this morning when our casino exploded higher right out of the blocks. The first few hours were as speculative as any I have witnessed, vs. the fundamentals, with no discernible catalyst other than motion begetting more buying. In the first few hours, the big averages were up 1.5%, the Nasdaq was up 2%, and the more speculative stuff was up a multiple of those numbers.

Upgrading Intel: The Sequel: Swept along by current sentiment, the morning papers carried several arm-waving stories that proclaimed an imminent turnaround in technology. Similarly, Intel(INTC) was again upgraded by a dead fish, for the fourth or fifth time in the last week or so, and again based on nothing more than hype. It's very reminiscent of the mania, when dead fish would unilaterally raise their price targets -- just because. So, you can file "analyst" behavior, particularly in technology, under: a perfect example of how little has changed since the bubble.

The early-morning glow/euphoria and the blast that it precipitated lasted until lunchtime. Then we traded sideways for a few hours, before seeing the rally fizzle to some degree in the last hour or so. There was a rumor about an error in the futures market, which saw a decent-sized selloff in a short space of time, with about 45 minutes to go. Whether it was an error or not, I do not know. But I do know that on the rare occasion lately when we've had a sharp break in the futures, this seems to be followed by a rumor about somebody having hit the wrong button. It's as though the market's never supposed to go down.

Of course, I notice that whenever the futures go straight up, you never hear this story. In any case, today was a fine day for speculation across the spectrum, as can be seen from the box scores or a look at individual stocks, even if some of the fluff came off the rally late in the day.

A Closed Golden Gate: Away from stocks, the long bond was down 1 1/4 points. In currency land, the action was kind of interesting. After having been quite strong overnight, the dollar weakened across the board as the New York session wore on. The metals were mixed, with gold higher by 1% and silver unchanged. As I stated on Friday, anybody who wants to hold a position in gold should already have established some portion of it. It is quite possible that we have seen the lows for this move.

Turning to the speculative mood of the day, I really am thunderstruck by the pervasive insanity of people's attitudes and actions. The loony behavior runs a close second to what we saw in the mania, which makes this particular disconnect bigger. During the mania, nothing had gone wrong, yet right now there is plenty wrong and very few signs that things are going to get better. Folks are banking on a turnaround simply because of the move in the market (once again).

Evergreen Glows Bullish Sentiment: During some office cleaning last Friday (the monotony of the tape drove me to this), I stumbled across a Rap written on March 11, 2002, which, upon checking, turned out to be the day the Nasdaq peaked during that rally. In rereading the column, what struck me was its timely description of the current mood. Animal spirits were pretty revved up back then, though not as revved up as now, as everyone was convinced (as they are now) that the economy would come racing back. Folks had a decent argument then, because a lot of the economic data looked pretty good. However, the data had been distorted by hedonics and seasonal adjustments, and that was one of the main points I made at the time. Anyway, here is what I said, with new emphasis added in italics:

Turning to today's news, the lead-off in 'How Real Was This Recession?', a page-one story in The Wall Street Journal, has prompted me to reprise my assessment of the state of the economy, because it shows the extent to which a generalized euphoria regarding recent macroeconomic statistics has largely displaced common sense: 'With evidence now overwhelming that the recession has ended, some economists argue the decline in output was so mild it didn't qualify as a recession at all.'

Now, I am not saying that the data don't show what they purport to show. They do. But there are a handful of us who remain somewhat skeptical about what it all means. My point is that given all the qualifying circumstances surrounding the macroeconomic data, I question the sustainability of the trend, and whether it can morph into the full-blown economic recovery that Wall Street and other pundits anticipate.

In my opinion, the macro data have been constructed in such a way as to make things look as if they are OK, and getting better and better. But given the 'headwinds,' I believe that it will be rather difficult to support a sustainable recovery, one that would give people something to feel good about. But, as I was saying last week, even if my thought process is dead wrong, stock prices have certainly discounted the next economic upturn and then some. So, the risk/reward ratio continues to be totally out of whack.

Of course, none of this means that the rally in progress will end as you read these words [even though, amazingly enough, it did]. This 'economic euphoria' rally will simply need to exhaust itself before it ends. Who knows how long it will last? Will it last six weeks, six days, two hours? I have no idea. All we can do is be alert for clues. But it would be a mistake to necessarily believe that a strong stock market rally indicates that we have a new bull market under way, or that we are now in a recovery. As I pointed out last week, there have been many, many stupendous rallies since Nasdaq 5000, and we're still where we are.

Berge Serves Up Catch-22 of the Day: Fast-forward to today. Sentiment is more bullish now than it was then. Folks have less to base their optimism on. Analysts and individuals appear to be behaving just as crazily as they ever did (more about that in a second). The Catch-22 of the present-day environment was nicely illustrated this morning by Susan Berge, of Berge Consulting Group: "The consensus view of the present time is that the stock market has been rising for many months now; therefore, it is discounting an economic recovery, and because we are going to have an economic recovery, there is no reason for the stock market to go down."

Got it? To me, it's the stuff of an absolutely dramatic disconnect. Though I expected that we would have a rally in this time frame, as I stated last winter, I must admit that I am floored to see how wild it's gotten, on such flimsy ground.

A Broker's Beta-Loving Ingrate: Given how flagrant today's speculative fervor, I thought it particularly appropriate to share an email from a reader (who happens to be a money manager) that hearkens to the Mania Chronicles. For those of you who don't know, during the late stages of the mania, i.e., the first quarter of 2000, it was so impossible to describe the action that I would share readers' vignettes, titled thusly, about the wacko behavior they were witnessing. As folks got giddy in the first quarter of 2002, I briefly resurrected the Mania Chronicles, and today I offer Mania Chronicles Redux, Part 2:

Joe is a broker at a major house in NYC. He is a good friend. He is ethical and a conservative broker. In early- to mid-2000, one of his larger retail clients was very nervous, but despite Joe's repeated attempts to get him to sell, the client refused. He continued to call the client weekly all the way through early 2002, trying to get him to adjust his portfolio. After the client took a 50% hit on a $4 million portfolio, he decided to finally listen to him in March/April 2002. Joe reallocated his portfolio in investments that did very well from that point until March 2003. Then the market began to rally. Even though Joe's investment selections were doing pretty good, they weren't going up fast enough.

In mid-June, Joe received a notice that the client was transferring his account to a new house. When he called the client, the response he received was stunning: 'YOU FAILED ME. YOU NEVER GOT ME BACK INTO THE MARKET NEAR THE LOWS IN MARCH. YOU SHOULD HAVE KNOWN THAT IT WAS TIME TO GET BACK IN! I CAN'T ACCEPT 4%, 5%, OR 6% RETURNS EVEN IF THEY ARE SAFE! I NEED TO HAVE TOTAL EQUITY EXPOSURE! I NEED TO MAKE IT ALL BACK.'

Joe also notes that it feels like 1999/early 2000 again. He said, 'People don't call me to ask about conservative strategies. They call me for their buying power. What stocks are they allowed to margin? What's the hot play for the day? This is insanity!" (Certainly, recent margin statistics back up what Joe is seeing.)

Fiesta, Before a Fall: Thus far, this rally has not yet reached exhaustion, though at some point it will. Even if the economy does better than I expect, there is no way today's stock prices can be supported by whatever comes next. This behavior on the part of individuals and the OPM crowd (note the consistent increase in margin debt) is a recipe for a crash. The longer it persists, the greater the likelihood of a crash.