Crosscurrents April 27/05

April 27/05
by Alan M. Newman

The great supposed housing mania controversy continues unabated, a most unusual dichotomy from the dearth of similar commentary while the mania that came before was very much in progress. We are pointing to stocks and in particular, Nasdaq 5000 in 2000, of course. We counted less than a handful of observers, ourselves included, that went clear out on a limb condemning the environment and labeling the stock market as a mania, whereas the theory of a housing mania in progress has rapidly attracted a consensus. The "bubble now" consensus argues against the existence of a mania and so does the evidence, some of which we presented in our February 28th issue, showing half of the nation's local housing markets undervalued and only one-sixth overvalued by 20% or more. Additionally, it is entirely apparent that the appearance of manic conditions are confined mostly to expensive or vacation homes and not in homes bought, sold and lived in by the "average" consumer. In the vast majority of neighborhoods around the country, houses are occupied by full time residents and not sold and resold like Nasdaq tech stocks. There is a huge difference. And there's more. According to our friend and colleague Howard Hill, the median house cost $76,000 in January 1988 and rose to $173,000 in Mach 2005, an annualized gain of only 4.88%. In the same span of time, the broad money supply grew 5.41%, West Texas Crude rose 6.91% and GDP through the fourth quarter of last year grew by 5.63%. Coming closely on the heels of the veritable mania in stocks, it became much easier to misidentify a robust trend in another asset class as a mania. Yes, prices are extremely high in certain areas and will most assuredly correct significantly, perhaps even soon. But a mania? Hardly. Bear in mind that Nasdaq was still down more than 60% from its peak by the end of March, but in the span from January 1988 to March 2005, still managed to gain 10.7% per year. The entire U.S. stock market grew at an annual rate of 11.1% and total market capitalization grew by more than $12.5 trillion. With wealth growth of that magnitude, one should logically expect that other asset classes would finally benefit. And if we are correct that the secular bear market in stocks will endure, there is every reason to believe that money will continue to gravitate to other asset classes, including housing. Incidentally, one of the supposed manic hot beds is the Bay area of San Francisco. In the same 17 year period cited above, gains are 7.64% per year, still a lot less than Nasdaq (source: http://tinyurl.com/c5dld). The housing market should find ample support for prices.

Many eyebrows have been raised over our focus on Regulation SHO over the last six months, but that's our job - to open eyes. Naked shorting is a fact of life and although there are legitimate failures-to-deliver of shorted stock, our concerns are with those that are either not legitimate or those that are abusive. Unfortunately, it is not just the odd share that falls through the crack in the system's floor. Given the infallibility of the mathematics of normal data distributions, there must be cases wherein we can fairly assume that fails are extraordinarily huge and as such, represent a real threat to stockholders - in effect, counterfeit shares that dilute real holdings. But there is more to the controversy than naked shorting, much more....

On May 2, the SEC's "Pilot program" [Ed. note: pursuant to Rule 202T of Regulation SHO] goes into effect, which will remove the "uptick" price test for shorting 1000 selected stocks in the Russell 3000. According to the SEC, "....the Commission has selected a subset of stocks from the Russell 3000 index for inclusion in the Pilot, after giving due consideration to the liquidity, volatility, market depth and trading market of these securities." However and most unfortunately, this blanket explanation covers the group of 1000 and not the individual securities, which have been randomly selected to participate. In certain cases, especially those listed as Threshold securities, we would suspect that "liquidity" and "market depth" may be very much in question.

The SEC further states that, "The Pilot will allow the Commission to obtain data on the impact of short selling in the absence of a price test." On one hand, we can understand the academic or clinical interest the Commission may have in such a study but on the other hand, this situation is being forced upon shareholders who - if they had the choice - might be far more resistant to experiments upon their hard earned assets. We have already shown repeatedly how easily the system can be gamed. We have also shown that since there may be zero tax consequences for dedicated short sellers, the impetus to game the system is enormous and is quite probably irresistible.

A list of the 1000 securities in the Russell 3000 subset that will be included in the Pilot program can be found at http://www.sec.gov/rules/other/34-50104.htm. If you own shares in any of these companies, be aware that the uptick test will no longer be a factor as of May 2nd. We strongly believe that at least a handful of these companies will experience relentless pressure from short manipulations designed to produce a profit, without regard to fundamentals and no matter the cost to shareholders. With so many hedge funds in view of investors, the name of the game is Performance, and we expect that Performance can easily take the place of ethics for some unscrupulous money managers. The mania was patent proof that ethics could be clearly compromised by a few analysts and brokers, fund managers, corporate CEOs and their minions, as prices roared upwards. There is no reason for us to doubt our thesis that unethical practices may be unfolding during a lengthy secular bear market as well.

As the "Pilot program" unfolds, we will expect to see a concerted effort to collapse the prices of a few unfortunate companies that already suffer from ongoing and possibly huge fail-to-deliver problems. Cal-Maine Foods (CALM) has been on the Threshold list since day one and is also one of the 1000 issues included in the "Pilot program." CALM's float is only 64% of shares outstanding, which means the actual threshold is much higher than the 0.5% guidelines. Given that trading typically averages more than 2% of the float each day, one can only wonder why the company's shares remain on the Threshold list. Clearly, there is sufficient trading for settlements to take place! However, come May 2nd, if CALM has been targeted for destruction, the floodgates will be open for shorts to take the company down. It's unfathomable that a company that has been on the Threshold list since its inception should also be a part of the "Pilot program." This is a travesty.

Short term positive: the 21-day indicator of Emotional Intensity is now on a buy signal. Shorter term incarnations are not as enthusiastic about prospects but still point to the upside as a more likely case for the here and now. Typically, readings as low as suffered recently are within about 2%-3% of a bottom. Thus far, the actual low is about 2.5% below the Emotional Intensity lows.

PLEASE NOTE: OUR BREAKING COVERAGE OF A POTENTIAL SHORT SQUEEZE OF NOVASTAR FINANCIAL STOCK HAS FORCED US TO TEMPORARILY DISCONTINUE FREE TRIALS. IF YOU REQUEST A FREE TRIAL, YOU WILL BE GIVEN SEVERAL ALTERNATIVES. THE FREE TRIAL PROGRAM SHOULD BE REINSTATED WHEN THE ARTICLE SERIES IS COMPLETED, PROBABLY IN FEBRUARY 2005.

ABOUT ALAN M. NEWMAN

Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.

The newsletter is published 22 times per year and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation. Broad samples of our work can be viewed at http://www.cross-currents.net/.

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