Beware markets with no reason to rally

By Bill Fleckenstein

For readers who have been scratching their heads over the recent action in the stock and metals markets, this week I'll try to make some sense of the recent motion we've seen. My hope is to put it into some kind of perspective in an attempt to get a handle on what may be coming next.

Baked-in-the-cake cacophony

To begin with, let's remember that these are markets -- meaning that they're wild, emotional and, oftentimes, weird. That is the animal we're dealing with. (While it may sound obvious, the obvious needs to be stated from time to time, because it often gets overlooked.)

Turning first to stocks, the market often gives off false signals -- which, by definition, it does at inflection points. In any case, to show how tricky trying to divine the tea leaves can be, step back with me to my Aug. 7 column, "Even if the Fed pauses, the trend is down," in which I laid out two opposing views.

First, I was certain that there would be a Fed-is-done/no-news-period rally, mostly because I felt that people were terrified of the Fed (which I knew to be toothless). I also knew that when people realized their tough-Fed views were incorrect, they would party. This is a view I held as recently as July 19, and it led me to reduce my short exposure.

Bobbing, weaving, walloped

However, as the earnings news drifted in, the market action was so abysmal that I abandoned that view. Shifting gears, I started getting short on July 21, which turned out to be the low of this rally. So, here is an instance where someone (namely, me) who'd understood the case for a strong rally got snookered by the market action.

I stayed with my positions because the data from a bottoms-up standpoint have been on the weak side, as have the top-down macro data, though that has been ignored. And of course, all bad news has been ignored in spades recently, as the stocks with really uninspiring results have recently gone wild.

Apparently, there exists the belief generically that all of our problems will be sorted out positively and that we're headed for a soft landing, followed by a new rebound. The market appears to strike folks as bulletproof at this moment in time.

However, that doesn't necessarily mean anything. In fact, I anticipate disappointment on the corporate (as well as macro) front, in the form of preannouncements. In addition, I believe that third-quarter earnings may miss expectations and that fourth-quarter guidance could be weak. It's hard for me to see how stocks can just power their way through all of that.

Having said that, my experience has taught me that, once a market gets as frothy as this one has become, in the very short term, it can do anything. But remember, the market always looks the best at the end of a rally, just as it always looks the worst at the bottom of a decline. (Witness my being head-faked on the low in July.) My view -- and recognize that it's just a guess -- is that at some point in the next week or so, this rally will have ended in exhaustion (with the recent $10 break in crude oil offering no bailout).

Tech is served a Freescale cocktail

An example of the current mindset: Freescale Semiconductor (FSL, news, msgs), which rocketed recently on the news of a potential buyout. A leveraged buyout of a fab (semiconductor fabricator) strikes me as the height of lunacy. LBO candidates used to be thought of as companies with steady cash flow and low capital expenditures. Freescale, spun off by Motorola (MOT, news, msgs) in 2003, is the antithesis -- and not a particularly appetizing candidate in the first place. I guess the fact that a "private equity" firm took over Philips, one of the perennial dogs of the industry, should have been a heads-up that this was possible.

To take a step back, the initial craze of the 1980s finally ended when takeover artists tried to LBO United Airlines -- a deal that collapsed, signaling the end of the party for some time. I remember being apoplectic that anyone could consider taking over as absurd an entity as an airline. I view airlines as essentially flying fabs, so levering up a company whose business is capital-intensive and "obsolescence-intensive" may be even more insane. This should illuminate how late in the day we are in the buyout craze if second-rate chip companies are being LBO'd -- though it does seem like this private-equity craze is just getting rolling.

Metal 'logic' on the lam

Shifting to the metals market, we see a variation of the same one-way action in stocks -- only in the other direction. Apparently, the metals have "assumed" that none of the macro problems, which would bolster the case for owning them, will occur -- when, to me, the probability of things going wrong is as high as it's ever been.

Just a look at a recent chart makes it obvious that the metals have had no friends. But look at a chart from early May, when gold was exploding every day. It seemed as though gold would never stop going up -- just as gold, of late, seems unable to stop going down. This doesn't tell you anything about what the ensuing rally in the metals will look like. But as I said earlier, it's useful to keep in mind that markets often mislead at turning points.

At the time of publication, Bill Fleckenstein did not own or control shares of companies mentioned in this column.