Plenty of Froth

Thursday, the last trading day before the Easter break, saw the Nasdaq close at a three month high. As a value investor, the Nasdaq intrigues me. It’s a working laboratory. As with people, so it is with stocks: class tells, and the lack of it will out sooner or later.

That Nasdaq plunged from 5,000 in March 2000 to 1100 last October was no surprise to conservative investors. Throwing money into a pool of no value, enticing others to follow you, and selling out your ticket as new suckers come in is only legal in the stock market. Elsewhere it is called a Ponzi scheme, and you have to go to jail if you’re found to run one. The Nasdaq rot confirmed everything value investors say about overpriced stocks.

Such things are supposed to clear the marketplace for the stronger and better. It is true. And now I find dozens of Nasdaq companies, including some techs, that fall into ranges I could live with…

This is a pleasant change. But there’s still plenty of trouble on Nasdaq. The cleanup proceeds. So far this year, six Nasdaq companies have gone to heaven and moved to the NYSE. One went to Amex. Fifty-four are rumbling around purgatory, having been acquired by other companies. In most cases, not a minute before they had to see a judge about a bankruptcy. And 115 former Nasdaq stocks have gone to hell. Almost all of them are now OTC bulletin board stocks. Some just disappeared altogether.

NASDAQ Losses: On the Way Down and Out

So much for the notion penny traders have of BB glamour. The pink sheets are not filled with little companies on the way up. They’re a repository for once-greater companies on the way down and out.

Nasdaq’s losses are not offset by new companies coming in. In the first quarter this year, only five IPOs graced the Nasdaq club. The membership is decidedly on the shrink.

So if fewer companies are getting richer, something must be going on here.

This month as I was writing Fleet Street Letter, I noted a lot of cash floating around the investment world. Usually, we worry about the lack of ready cash and beware companies that have too little… especially if they also have too much debt. And so we should. But I am suspicious of too much cash as well.

While we investors have seen the market numbers shrink and have personally lost money, the world is not running out of money. Nor are many companies. Here in the United States, we just keep making the stuff. M3, the broad measure of money has increased 6% in the past year. In 1999, the Fed was supposedly flooding the market with liquidity to ease us over any problems with Y2K crashes and hoarding. The flood never abated. The money just keeps coming, and some of it has landed on Nasdaq.

This is creating some odd things, and the insiders are on it. They are throwing money at their Nasdaq companies. Insider buying is usually taken as a good sign. Who better than those closest to the company should know a good thing when they meet it?

NASDAQ Losses: Rogue Market

But Nasdaq has always been a rogue market.

Some of this buying may be pretty savvy. Consider USA Interactive. It used to be known as USA Networks. It hasn’t earned any money until lately. The last time it saw net profits was 1998. But as its industry has bombed, USA has been using its cash to buy assets, recently entering a joint venture with Vivendi.

Now this company has cash galore, $3 billion on the books. It could pay off its entire long-term debt and have $2 billion left over. So it hasn’t made any money for years until last quarter… it may be doing a smart thing. Insiders sure think so. They’ve bought over 11 million shares of the company lately. I’d have to dig into the industry farther to trust this one, but, yeah, it’s worth the time.

I can’t say as much for the wisdom of insiders who are buying Advent Software, maker of portfolio accounting software. Yawn. Barra has been doing the same thing profitably. That’s its specialty. So has giant Intuit (excepting 2001), almost 10 times as big, and portfolio softward is one of its major sub-specialties.

Then there’s ImageX, a commercial printer, with $12 million in cash. OK, that’s not a bundle, but the company’s market cap is only $16 million. Wow. Three-quarters of the business is a pile of money. Lazy money, too. There is no return on equity, no return on assets. Insiders bought 45 million shares. The company has never made a profit. Isn’t close to one. In fact, its sales are falling.

NASDAQ Losses: Not a Gimme

Is it possible that these insiders know something? Is ImageX going to be acquired at a fat premium over its existing price? I wouldn’t bet on it.

Insider buying and lots of cash with low debt are positives. Such signs might lead to good companies to own. But it’s not a gimme. Especially on Nasdaq. If you think the people who buy those wild stocks are dreamers, you should meet the folks who sell them. And that’s the nice ones. The others are crooks.

Truthfully, if you want to follow insider buying on Nasdaq, you need to know a lot about the industry. It’s pure speculation… guessing who’s going to break out, break through and finally make some money. Few of the stocks with the heaviest recent insider buys can boast of positive earnings. Hardly any can measure a return on equity (read… turning investors’ money into profits) and most of those are so low they still wouldn’t pass a value investor’s bottom bar.

And most of them have plenty of cash. For now. That’s a little like saying Imelda Marcos had plenty of shoes. She always needed more. Companies that don’t create earnings are burning cash. And you can never have too much cash if you’re using it for fuel.

On the other hand, some companies just have cash. They aren’t burning it rapidly, nor are they using it productively. Like certain trust-fund kids, they’re rich and pretty, but awfully stupid. And a disproportionate lot of them are listed on Nasdaq.

On all the U.S. exchanges, 1205 companies have cash equal to a third or more of their market cap. And 904 of them are on Nasdaq. Nearly half of these companies suffer substandard operating margins… and 94% of these cash-laden wonders fail to deliver even 12% return on equity. The plodding old Dow stocks, average 20%.

If lots of cash can’t buy profits or better margins, then it isn’t doing much good. That’s the way of Nasdaq. Too many companies there are run by entrepreneurs who expect to get rich by selling shares instead of products anyone will buy at a profit.

I don’t hold with those who say the whole market is still a bubble. But on Nasdaq… there’s still plenty of froth, and good reason to worry.


Lynn Carpenter,
for The Daily Reckoning
April 21, 2003


The whole world is appears to have slept in this morning.

At least, that is, from the looks of things on rue de la Verrerie in front of the office here in Paris… even the Paradis cafe has been slow to open it’s doors for business.

But what do you expect?

It’s Easter Monday (still a holiday for most of Europe)… the war in Iraq is all but over and fading quickly from the headlines… SARS is still only a serious threat to the Chinese somewhere on the other side of the planet; its effects yet to show on corporate balance sheets… The Dow, Nasdaq and S&P are all trading in positive territory for the year.

What’s not to like?

As is our wont here at the Daily Reckoning, we’re sure we could dig up some dirt… some filthy stone as yet unturned… some silver lining itching to have its lead underbelly revealed…

Instead, we simply plan to enjoy the sun, the Seine, the wine… the company of our families… and leave the dirty work to the New Yorkers.



Eric Fry in New York…

– Last week, for the umpteenth time, the lumpeninvestoriat demonstrated their abiding faith in stocks-for-the-long-run. Giddy over the US military successes in Iraq, they eagerly chased after pricey stocks, especially pricey tech stocks. Investors dumped more than $5 billion into stock mutual funds last week – the largest inflow in more than a year.

– Hope springs eternal…three straight losing years in the stock market needn’t beget four, or so the common thinking goes. Ironically, even though share prices are advancing, the New York Stock Exchange is under siege.

– Several specialist firms stand accused of nefarious deeds like “front-running” — that’s when a specialist firm trades for itself immediately in front of one of its customer’s orders. Even before it came to light the NYSE specialist firms may be front-running their clients on occasion – duh! – the price of exchange “seats” had been falling. The last sale of a seat occurred in March at a price of $1.5 million. That’s down from a peak of $2.65 million in late 1999 and $2 million as recently as November 2002.

– Apparently, buying and selling (and front-running) stocks just isn’t as lucrative as it used to be during the bubble years. In those halcyon days, investors didn’t mind getting clipped for a few extra cents from time to time…But times have changed. Most investors are pinching pennies, including those that do not belong to them, but that their plaintiff attorneys can help them find…

– Now that the S&P 500 has rallied more than 10% from its recent low, it is time once again to ask ourselves: “Bull market or bull trap?” We suspect the latter, of course, for all of the oft-cited reasons: stocks are pricey; earnings growth is dubious and of dubious quality; and most importantly, Abby Joseph Cohen recently raised her recommended allocation to stocks…That, alone, is reason for caution.

– “Rallies of more than 25% are common in secular bear markets,” observes author Peter Bernstein. “Japan has had 9 rallies greater than 25% since 1990, and 3 that were greater than 40%. The U.S. experienced 13 bull markets of greater than 30% during its secular bears of 1902-1921, 1929-1949; and 1966-82.”

– But the rallies were fleeting…the obvious lesson is that valuation matters.

– “The whole world got to thinking 15-20% a year in equities was a birthright,” says professional investors Chris Bloomstran. “But that was silly. From the 1982 lows through the end of 2002, you got a 20-year total return on the S&P of all of 12.6% annually…The returns over last 20 years reflected a one-off victory in the war against inflation and power of government — the disinflationary monetary policy and a shrinking of the power of government in the markets. But that era ended in bubbles and now we are in a brand new and different world. Therefore, the returns over last 20 years, by definition, cannot be replicated…Working off all of the bubble’s excesses is going to be a very lengthy, painful process on all fronts. Painful to corporate profits, painful to household pocketbooks. It simply grinds.”

– The popular press says the US military found no weapons of mass destruction (MWDs) in Iraq…Lies! Damned lies!

– Did the US military not find bank vaults full of euros? And did the military not topple a regime that threatened to use euros, even on their own people? What weapon could possibly inflict greater mass destruction than the euro? Iraq flaunted its contempt for dollars by insisting that it receive euros for its oil production. The evil regime subsequently stockpiled these monetary MWDs. Fortunately, we stepped in to put an end to this dangerous proliferation…and not a moment too soon. In the hands of the wrong people, euros could undermine the dollar’s influence and blow apart our nation’s financial underpinnings. Euro hegemony could inflict mass financial destruction here at home.

– Thank goodness for America’s new “gunboat monetary policy.” We have dollarized the Iraqi economy at gunpoint. With the nascent threat to dollar hegemony eliminated, we may continue to safely borrow from foreigners and repay them with the paper and ink of our choosing.A little bit of advice to Syria: Don’t bother expelling your chemical scientists, but get rid of your euro stockpiles at once!

– And what about you all, over there in the Paris office? Are you stockpiling banknotes of mass destruction?…In the process arousing the ire of Rumsfeld and Bush? You might want to lighten up on those things, before cruise missiles start showing up at the office, unannounced.


Addison Wiggin back in Paris…

*** Irony… no one seems to have time for it anymore. We’ve been waiting for someone to draw out the irony of the 2nd war on Iraq. For example, the US invaded Iraq in order to install a regime who’ll respect the rule of law… and in the process the Iraqi national museum gets sacked and tablets containing Hummarabi’s code – one of mankind’s earliest known bits of written law – wind up in the MIA column.


*** Well, at least they protected the Oil Ministry… and why not?

“The United States has accomplished something every major power has wanted to achieve over the past hundred years,” writes our oil man John Myers of Outstanding Investments. “It has successfully marched its army into the Persian Gulf and captured one of the richest oil producers on the globe.”

“Let’s put that into perspective. Consider Prudhoe Bay — one of the richest oil field elephants ever to be discovered on American soil — it held more than a billion barrels of oil and delayed America’s severe dependency on foreign oil for nearly two decades.

“But in less than a month America’s military has captured a country that has the second largest oil reserves in the world. Other than the oil sands deposits in Alberta, Canada, only Saudi Arabia has more oil than Iraq, with conservative estimates pinning the country’s oil reserves at 112 billion barrels – or more than 100 Prudhoe Bays.”

That’s a lot of black gooey stuff. What effect has the war had on its price? Nada. Nothing… zilch. Like the dollar and the major indexes… oil seems to have taken this war in stride and remains locked in at $30 or so.

It sure made for some stirring footage on CNN though, didn’t it?

Addison Wiggin

The Daily Reckoning