The Bear Market Explained 22 March 2001

This short article is designed to answer questions I am receiving as to why the US stock market is acting the way it is and what must happen in order for things to get better.

The reason the several cuts in the interest rate by the federal reserve bank have NOT caused the stock market to recover is that the problem in the economy is deeper than that which can be repaired by an interest rate cut. Besides, interest rate cuts take about 6-9 months to affect an economy. Tax cuts as will be passed by the Congress take 18-24 months to affect an economy.

The reason the economy is in a recession (which it is) is as follows:

Until this fall you had all this venture capital pumping up companies that went out and spent it on things such as PC’s and servers. This pumped up Dell, Sun Microsystems, consultants such as Hewlett Packard and IBM and all kinds of companies that made peripheral items such as Sandisk, Applied Materials, JDS Uniphase and Corning. In the telecom sector, companies spent a ton developing the capacity to handle all this business AND they spent a ton of money bidding on wireless frequency spectrum and developing wireless technology which it thought people would run out and buy. 

When all those dotcoms turned out to be losers, venture capital dried up. But because these companies had ordered so much equipment, all those companies had manufactured so much equipment to meet the demand that they were all of a sudden stuck with cancelled orders, no more future orders and people who bought and didn’t pay up. So there is lots of inventory left over. There are fewer consumers of consulting services because as we all know consultants are people you often hire with other people’s money.

Wireless technology turned out not to be that good and the customers didn’t run out and buy it. The only exception was DoCoMo in Japan.  Telecom companies found out they had overpaid for the spectrum they bought at auction and didn’t have the customers for all the fiber optic capacity and products they created. Imagine what that did to the producers of the fiber optic cable itself.

Several things have to happen:

1. Companies have to start buying stuff again. The excess inventory will eventually get sold although it will also be written off as technology becomes obsolete so fast, and when people do buy they will buy newer stuff. But share prices assumed future sales which are not going to happen now that all those dot-com customers have disappeared out of existence. Almost everyone who wants a PC has one and they’re not going to replace them immediately especially since they’re so good now and people are not running to embrace the latest technological upgrades. So somewhere somebody has to go out and start buying Dell computers because so many customers make things that go into or that get used as a result of what Dell sells. We don’t know right now who will and that’s why it doesn’t matter how low stock prices go – there is no hope and therefore no bottom to stock prices (ie: no magic numbers on any index that represent bottom values except Zero, scary huh?). When someone starts buying key products such as PC’s and servers from Dell, the market can begin to go up.

2. Companies have to start hiring again. People without consumer confidence won’t buy things and companies that sell things such as cars and build houses therefore won’t make any money. To get to #2, #1 has to happen first.

In May 2000, I noted that there will be a real estate recession 6 months after the market dropped. Now it is beginning to become evident. Layoffs mean people can’t pay ridiculous rents. I expect prices to go down 20-30% in New York City. Stay tuned and there will be good buying opportunities.

One other point: The US interest rate cuts are having the effect of bringing the Japanese economy to the point of collapse. The reasons are complicated. Fact is that Japan is in bad shape and its inefficient political and social system built over the past 50 years is no longer sustainable. Big change is more possible in Japan now than since 1945. This is good because until Japan reforms, Asia and America will always be at the mercy of a set of a major economy that really doesn’t work. However, as much as Greenspan is aware that the US needs interest rate cuts and the Japanese need to reform, he doesn’t want to drive the Japanese, the world’s 2nd largest economy, to total collapse because the effects will only prolong the US recession. It’s not easy being Green(span).

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