Isn't This Market Ironic ... Don't You Think?

Alanis Morissette Market

NEW YORK -- Oh the irony, Exhibit A:

On the day revelations emerged that Janus has scaled back its tech holdings, big-cap bellwethers such as Cisco (CSCO), Sun Microsystems (SUNW), Oracle (ORCL), and Siebel Systems (SEBL) rallied sharply, sending the Nasdaq Composite up 4.9% and the Nasdaq 100 by 6.5%.

Elsewhere, the Dow Jones Industrial Average rose a modest 0.3% while, the S&P 500 climbed 1.6%.

Oh the irony, Exhibit B:

On the eve of expected passage of a tax cut the Bush administration has said is crucial to reviving the economy, Treasury Secretary Paul O'Neill said the U.S. has dodged a recession. (I know ... just the idea of the tax cut has helped.)

Oh the irony, Exhibit C:

Shares of PurchasePro.com (PPRO) rallied 16.7% on news of the resignation of the company's colorful and controversial chairman, Charles "Junior" Johnson.

This column long ago detailed concerns about the B2B company -- and did so when the stock was trading around its all-time high. More recently, my colleague Joe Bousquin has provided stellar coverage. PurchasePro.com always embodied the best and worst of the "New Era" trading phenomena, and remains so today.

Oh the irony, Exhibit D:

Don Hays of Hays Advisory Group in Nashville, Tenn., today provided upside targets for the major averages, as follows: 12,600 for the Dow, 1430 for the S&P 500, 2820 for the Comp, and 13,500 for the Wilshire 5000 Index, which rose 1.8% to 12,142.14 today.

Hays is hosting a conference call tomorrow -- about which I'll likely report -- entitled: "The Last Part of the Bull Market Rally."

Oh the irony, Exhibit E:

Gold's recent upward momentum was snapped on the day Goldman Sachs upgraded several mining stocks and The Wall Street Journal gave its imprimatur to the inflation story (although the venerable daily did not make the gold-inflation connection). Today's stall was probably inevitable because the rally in gold and related shares -- ongoing since late November -- has recently lost its stealth status.

After trading at a 10-month high of over $298 an ounce, gold settled down $2 to $285.80 in New York's Comex trading. In tandem with the underlying commodity, gold stocks couldn't sustain early gains; after trading as high as 66.30 early on, the Philadelphia Stock Exchange Gold & Silver Index closed up 0.8% to 65.27.

After the Gold Rush

Certainly, today's setback doesn't mean the gold "story" is over and many participants believe this rally is for real. But it shouldn't be surprising that momentum traders returned to more familiar territory (i.e. technology) today. Investors have been burned repeatedly in recent years by false "breakouts" in gold, and the inflation story remains hotly contested.

"It amazes us that anyone can worry about inflation next year," Bruce Steinberg, chief economist at Merrill Lynch declared in a report today. "The Fed is easing rapidly, but not excessively [and] inflation is a lagging economic indicator -- it peaks after the business cycle peaks and almost always falls during the early stages of an expansion."

The economist expects the fed funds rate to be at 3.5% by the FOMC's Aug. 21 meeting, but concluded "inflation won't be a problem next year," and that the recent steepening of the yield curve is a harbinger of economic growth, not inflation.

Steinberg also argued that if the economy revives -- and he is predicting a "V-shaped rather than a U-shaped recovery," beginning in the fourth quarter -- much of the renewed capital spending will be on technology equipment and services. Since "there is strong evidence tech spending leads to stronger productivity growth and lower costs," inflation will remain under wraps, he surmised.

I'm paraphrasing, but the economist seemed to base his "no inflation" call partially on a continued belief in the panacea of tech-led productivity. If it's good enough for Alan Greenspan, it's apparently good enough for Steinberg, who was not available for additional comment.

Gerald Cohen, a senior economist at Merrill, confirmed I wasn't misreading the productivity argument but stressed the notion of inflation being a lagging indicator is paramount.

On the other side of the debate -- at least for today -- is Thomas McManus, equity portfolio strategist at Banc of America Securities. Picking up the theme mentioned Friday, McManus today cited inflation as one reason he's keeping equities at 60% in his recommended allocation -- where they were lowered to on April 23.

"We view Alan Greenspan's fifth easing move -- coming especially as it did with the market's inflationary guard on alert -- as confirmation that the near-term economic trend continues to get worse and not better," McManus wrote. "The Fed continues to downplay inflationary risks while fretting about the wealth effect on consumption even as the 'average stock' climbs to new highs."

Therefore, the strategist deduced the Fed is worried something more wicked is coming this way on the economic front.

The April Consumer Price Index reported last week was restrained by a big drop in apparel prices, he noted.

Conversely, Steinberg dismissed the 0.2% jump in April's core CPI as due almost entirely to big increases in prices of tobacco and baseball tickets.

McManus cited the median CPI published by the Cleveland Fed, which seeks to eliminate such nitpicking by removing one-month anomalies in any category, not just food and energy. The median CPI is rising 3.5% on an annual basis, its fastest pace since January 1996, "and shows little tendency towards reversing lower in the near future," McManus observed.

Finally, he noted 30-year bond yields were only 25 to 30 basis points higher in January 1996 than they are today, while the S&P's price-to-earnings ratio was around 14.5, compared with more than 25 today.

Thus, the strategist maintains the "slightly underweight" 60% equity allocation and "slightly overweight" 35% weighting in bonds, which resumed their recent bounce today.

McManus conceded there is some irony to recommending bonds while simultaneously being concerned about inflation. But he believes Alan Greenspan is starting to think about retiring and doesn't want to be remembered as the Bill Buckner of Fed chairmen; that is, he'll soon strive to rein in inflation, perhaps by tightening sooner than most investors now contemplate. (Buckner's otherwise stellar baseball career was marred by a memorable gaffe playing for the Boston Red Sox in the 1986 World Series against the New York Mets.)

Mainly though, McManus is overweight bonds because he believes stocks are now overvalued, based both on current bond yields and future corporate earnings, which he says will not prove nearly as rosy in the second half as Wall Street currently anticipates.

"The market seems very willing to jump to conclusions," he said. "I think this [stock] market needs to have some support from bonds in order to perform much better."

Imbedded in that outlook is the notion that bonds could benefit if stocks falter -- the old "flight to safety/quality" trade, that is.

McManus didn't explicitly say that, but he did say (or write, actually): "We are not convinced we have seen the ultimate lows for the Nasdaq, where sharp percentage gains from the recent bottom have tempted many players to risk additional capital at still-elevated valuations."

Oh the irony, indeed.

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