Tech stocks' pain proves they're vulnerable, too

By Bill Fleckenstein

Last Tuesday, based on the increasingly bizarre action of the market, I wrote in my daily "Market Rap" column: "I don't see how the four horseflies -- aka the four horsemen: Apple (AAPL, news, msgs), Amazon.com (AMZN, news, msgs), Google (GOOG, news, msgs) and Research In Motion (RIMM, news, msgs) -- and the other handful of momentum stocks can carry the market higher by themselves. . . . It will be interesting to learn the identity of the event that finally hits tech stocks over the head with a 2-by-4, making folks understand that they, too, will be vulnerable in a recession."

Was that message definitively delivered Wednesday, when tech stocks were roughed up? Given the sector's hardy resistance to reality, it's too soon to say. (And ambivalence was thrown into the mix when stocks rallied late in the session.) But one thing is for sure. Wall Street has been buying tech stocks on the belief that they are the place to be.

And, for a long enough time, folks have been able to keep the stocks up. They've performed well -- unlike the earnings reports from many companies behind the stocks -- so the dead fish, the fools who listen to them and the computers that wind up buying the back-tested version of what other folks do, all have feasted on tech.

A new leaf of grief

As to where we stand in the truth timeline, I do think Tuesday's action in semiconductor-oriented stocks may be meaningful. To wit, amid the buying frenzy that day, not only was Texas Instruments (TXN, news, msgs) down 10% (on the back of disappointing results), but it started to weigh on the other chip companies as well. For once, bulls did not pronounce the news to be company-specific.

• Video: A look at Texas Instuments' earnings

More importantly, the semiconductor-equipment stocks, which have ignored bad news for about a year now, also were weak. That was the first time in at least a year that semiconductor-oriented stocks were under pressure in a tape that was otherwise strong. In fact, they've hardly been weak in a weak tape. Thus, I view that day's market action as an important juncture in the process whereby folks come to understand that technology does not soar unscathed above the recession at hand. Which I think may be an indication that the entire stock market is finally vulnerable.

Bulls suck the venom out of 'recession'

Another market observer on the lookout is Justin Mamis, who penned a spot-on, tongue-in-cheek description of that common misconception: Bulls "are willing, graciously, to concede that housing is already in a recession. A 'recession' has quickly lost its Victorian unspeakable-word status -- if Lenny Bruce were still around, he could readily use it without being accused of talking dirty. Ah, but such a recession will not be in technology (that's the youngsters at play)."

Of course, there is no sin of denial on the part of the Lord of the Dark Matter, whose postings on the mortgage-paper unwind will be familiar to my regular readers. The problems continue to worsen, he notes. But people keep giving him the same silly line, that it's all been discounted, which is a variation of "it's contained." He says that there are more dark-matter downgrades to come and that some of the insurers of credit may find themselves in serious trouble as credits go bad. He points out that if the insurers get into trouble, then all of the credits they insure obviously will worsen.

For those who don't know, there is an absolute mountain of paper that trades where it does only because it has insurance. Sort of like the paper that traded where it did because it was supposedly AAA, and that rating turned out to be worthless. Any AAA, AA, A or whatever rating that's based on insurance may not be worth the paper it's written on.

Barf went the Merrill bull

It's a lesson that hit Merrill Lynch (MER, news, msgs) hard. Witness the subprime fallout behind the company's sobering third-quarter earnings report. Merrill wrote down about $5.8 billion of $14.2 billion in what's known as super-senior subprime assets -- the stuff that's supposedly above AAA and bulletproof.

When asked on the conference call if everything was marked where it could be sold, there was no answer, leaving folks with the idea that there was plenty of stuff still marked to model. And you can be sure that if Merrill Lynch has this problem of potentially mismarked paper, so do all of the brokers and probably some of the big banks. This is a huge deal. (Memo to nonbelievers: The problem is spreading, it has not been discounted and it has not been contained.)

• Video: The inside scoop on Merril Lynch

To end on a more positive theme: If you think of the return to sanity as a positive development, there's reason to be encouraged by Investors Intelligence's report, which recorded the most lopsided sentiment reading in many years. Last week, bulls stood at 62% and bears at about 19%. For anyone who's been around the stock market for any length of time, that is a clear warning sign.

At the time of publication, Bill Fleckenstein was short Amazon.com.