Sage-Flavored Food for Thought

Index Close Change
Dow 8980.00 -82.79
S&P 500 975.93 -11.83
Nasdaq Composite 1603.97 -21.45
Nasdaq 100 1195.55 -17.56
Russell 2000 445.15 -8.79
Semiconductor Index (SOX) 378.84 -9.35
Bank Index 855.74 -15.72
Amex Gold Bugs Index 145.88 -0.64
Dow Transports 2447.48 -34.06
Dow Utilities 245.61 -0.66
NYSE advance-decline -1,172 -1,160
Nikkei 225 8822.73 +36.86
10-year Treasury Bond 3.28% -0.073

Editor's note: This column, which reflects market activity from the day before, originally appeared June 9 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.

Europe was weaker overnight, as were our stock index futures. Preopening, a couple of announcements affected the tape to the downside. Motorola ( MOT) cut its second-quarter and full-year forecasts, blaming lower sales in Asia. The bigger bomb, however, came from Freddie Mac ( FRE), which said its three top people had resigned, it was the target of a federal investigation into employee misconduct, and that it was going to restate earnings. Freddie did allow that going forward, earnings would be more volatile, meaning that perhaps in the past, they were less volatile than they should have been (more about Freddie below).

Government-Sponsored Agita: Folks will of course be staying tuned to learn exactly what precipitated this. If it turns out to be derivatives-related, as some expect, things could get very messy. Interestingly, Fannie Mae has been considered by many to be a much riskier stock, a view which I share. In any case, Freddie's announcement saw the stock open down about 20%, while Fannie opened down only about 4%.

Stunningly, despite a double helping of bad news and the weaker opening after Friday's reversal in technology, the tape was bought pretty aggressively for about 20 minutes. To me, that made the day look rather binary. Either they were going to turn it, or it was going to get smacked. A rescue seemed unlikely today, so down appeared to be the most probable direction, and down it was, such that a couple hours into the day, the big averages were down about 1%, and the Nasdaq was down about 1.5%. The upside leaders of yore -- tech, finance, biotech, and housing -- today led the charge to the downside.

In essence, the first couple hours captured almost all the action, as the markets basically spent the rest of the day going sideways, near the low end of the range, which was where they closed. Some of the speculative darlings actually held up pretty well, even though the SOX was hit for 3% and biotechs for a similar amount. Big-cap tech hung in there, though the same cannot be said for housing stocks, which were roughed up from 3% to 5%, plus or minus.

Hushed-Toned Harbinger : Problems at Freddie Mac could potentially spell trouble for housing, and maybe that's what accounted for the weakness in housing stocks. Mortgage paper widened across the board today, including Ginnie Maes, which actually are backed by the government. If problems are going to occur at Freddie Mac, such that they will be unable to provide quite as much liquidity as in the past, that might also apply to Fannie Mae. If so, there will be less availability of credit, perhaps pushing up either underwriting standards or mortgage rates -- potentially the nail in the coffin of the housing boom.

That's just conjecture on my part. In the past, however, I have seen folks at first ignore a piece of very damaging news when it comes from out of the blue (can anyone say "Enron"?). Given how denial of problems has been one of the hallmarks of the market in the last five or six years, I wouldn't be surprised at all to witness a continuation of that reaction, which is why I thought it was worth pointing out.

Away from stocks, gold was both positive and negative, before closing down 0.5%, and ditto for silver. Fixed income was strong, with the 10-year closing up half a dollar. The dollar was weak against the yen and the euro.

Advice Squad Raids the Rap: Turning to the news, there is quite a lot to discuss. First of all, folks who'd like to see a good discussion about gold, Wall Street, and debt should read Richard Russell's piece posted last Saturday at www.dowtheoryletters.com. I have been recommending Richard's service over the years, and this posting was especially good. Next, Barron's carried probably the best article I've seen there in quite some time: an interview with Seth Glickenhaus, the extremely successful Wall Street money manager still at work at age 89. He has the experience and net worth to back up his views, and of course I liked hearing them articulated, as they align closely to mine. Folks should get a hold of the interview, but for now I would just like to share a couple of his points, beginning with this one:

"A boom is not bad; it is only bad in the excesses it creates. ... This particular recession has been obscured and diminished sharply by extensions of credit and by historically unheard-of low interest rates. That, in turn, has cannibalized future growth in the auto industry and home building, and will continue to do so. ... Another evil that exists today, and one that is going to prolong our recession and one we could do something about, is the situation of the municipalities and the states, which in the boom period built up tremendous costs and activities and now don't have enough revenues and are, as a group, facing a shortfall of $70 billion a year."

Glickenhaus on Greenspan: From there, he lays out problems for our currency and the economy: "The dollar is depreciating, and it is just beginning its descent because of our perpetual trade deficits and federal budget deficits. Foreigners will not only not invest in our bond and stock markets but will be pulling money out." He talks about the fact that our unemployment rate will go "much higher," adding, "We talk to companies every day. All of them are trying to reduce their capital expenditures, not increase them. . . . Greenspan has created a demand with these low interest rates that is abnormally high. The economy today is much stronger than it is going to be in the future because we are borrowing from the future." He believes the economy could languish until 2012 or longer. "Second-half" bulls, take note.

Then, when asked specifically about Greenspan's monetary stimulus, he opined, "That cannibalizes the future" and said that it's not particularly useful, because "we would have had a real recession sooner but it might have been over already if Greenspan hadn't lowered interest rates my emphasis. The best thing that can happen is a good fat recession because that produces the changes that we are hoping for but that are not yet happening." This is my view exactly.

Fine-Tooth Company-Combing: Those sobering words aside, Glickenhaus offers his own prescription for success: "People will have to study companies, find those that can do abnormally well and distinguish them from those that will have average performance and those that will have sub-average performance." (He actually mentions a couple of ideas that he likes, which seem pretty sensible to me.) That is precisely what I believe. Folks who want to own stocks will have to practice extreme due diligence in their stock selection, because the risk is so great. He himself thinks the stock market will be in a trading range for a decade.

Continuing in the same vein, yesterday's New York Times carried an interview with Richard Bernstein that touched on similar points and is also must-reading. As a preview, here is Bernstein's take on Greenspan et al.: "The Fed, in their extraordinary fashion, is keeping excess capacity alive by lowering the cost of capital. The marginal players are still able to raise capital. ... The more they ease, the more the threat of deflation stays alive. One of the amazing things is that capacity utilization continues to fall even though the Fed continues to ease aggressively."

In-the-Know on Flow of Funds: He goes on to debunk the myth that corporate balance sheets have strengthened, by noting that while cash flow has seen an improvement, absolute debt levels remain high. This bolsters his view of the second half: "We think the economy and profits will be weaker in the second half." He also underscores the point that speculation continues to dominate the environment by noting that despite folks' chirping about the dividend tax cut, they've been chasing after stocks that don't pay dividends. That is precisely what's been happening.

Successful money managers who've been around a long time and seen it all have a view that is reasonably similar. In addition to Seth Glickenhaus, think of John Templeton, the late Leon Levy, who articulated his thoughts in The Mind of Wall Street, and Warren Buffett (though I think Buffett is more sanguine about the economy, at least based on what I've heard him say). Consider that these fellows fall on one side of the argument, and that opposing them are Wall Street/Bubblevision talking heads, out espousing a bullish view. Just ask yourself, which side of that bet do you want to be on? I have made no secret of where my allegiance lies, and likewise, my often-stated view that the second half will be a major disappointment, both in the stock market and the economy.

William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. Outside contributing columnists for TheStreet.com and RealMoney, including Mr. Fleckenstein, may, from time to time, write about securities in which they have a position. In such cases, appropriate disclosure is made. At time of publication, Fleckenstein Capital was long Fannie Mae puts, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Mr. Fleckenstein's columns are his own and not necessarily those of TheStreet.com. While Mr. Fleckenstein cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to bfleckenstein@thestreet.com.

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