Credit fallout is just beginning

By Bill Fleckenstein

The problems gripping the credit arena continue to occupy the headlines. Two weeks ago, I reprised the view of George Soros. This week, I would like to share like-minded comments from Ted Forstmann, IMG's chairman and CEO.

In a recent Wall Street Journal interview, Forstmann warned:

"We are in a credit crisis the likes of which I've never seen in my lifetime. . . . The credit problems in this country are considerably worse than people have said or know. . . . It's hard for me to believe that it gets fixed without upheaval in the financial system. Things are going to fail. Enterprises are going to fail. The economy is going to slow."

As to Forstmann's timeline: "I think we're in about the second inning of this."

(That guess is not so dissimilar to that of a friend I call the "Lord of the Dark Matter," who says he doesn't know what inning it is but is sure it's going to be a double-header.)

Ironically, even though Forstmann cites monetary policies and financial innovation as the root cause of our problems, he does not blame former Federal Reserve chief Alan Greenspan. Quite frankly, I don't see how one can understand the situation as Forstmann does and not peg Greenspan as the man at ground zero. (But as they say, that's what makes markets.)

Regular readers know my long-standing view: that Greenspan pursued reckless policies during his two-decade term as Fed chairman. In fact, it was a climate hospitable to risk taking generically and stock speculation specifically. And Greenspan's "lesson" survives: With "muscle memory" intact, stock bulls have proceeded to pile into risky technology stocks.

Consider the frenzy for tech stocks July 8 in the face of an important pre-announcement from VMware (VMW, news, msgs), which specializes in a really hot niche known as virtualization.

There's no point delving into what virtualization is. It's just important to understand that VMware has the market virtually to itself. So when the company pre-announced that revenue for the yearwould be less than expected, it was a significant data point.

But while the news mattered to VMware that day -- its stock declined nearly 30% -- companies similar to it were being purchased.

A spending slowdown weighs on Cisco

Meanwhile, another data point was delivered after the market's close July 8. Call it a stealth pre-announcement: Cisco Systems (CSCO, news, msgs) CEO John Chambers told an interviewer that his company's customers were now looking at next year for a rebound, instead of prior expectations of a second-half recovery in 2008.

Not surprisingly, Chambers noted that enterprise spending remains challenging and that there'd been a further slowing in the U.S. (especially on the West Coast), as well as in Europe.

Of course, that Cisco is seeing problems corroborates what common sense would suggest (and corroborates the data point underscored by VMware), as it demonstrates the slowdown that has occurred in enterprise spending. Of course, that should come as no shock because the biggest consumers of tech are the financial-services companies, and everyone knows what state they're in. Thus, after July 8's frolicking to the upside, I was particularly curious to see whether Chambers' comments would be ignored or would matter.

On Wednesday, the market cast its vote for the latter. Cisco was down about 4%, with many associated companies also taken to the woodshed, as dots were finally connected that maybe tech companies were sensitive to gross domestic product -- as though that shouldn't have been obvious all along. It must be dawning on some of the Goldilocks crowd that troubles are greater than they'd assumed up to this point.

Sharing some thoughts on Schering

On a constructive note, I think that Big Pharma (aka drug stocks) is an interesting area to investigate. It solves problems, has little GDP sensitivity -- unlike technology stocks -- and enjoys big barriers to entry (also unlike technology stocks). Schering-Plough (SGP, news, msgs) is especially intriguing, given the level of recent insider buying.

At the time of publication, Bill Fleckenstein was short Cisco and long Cisco puts.