Contributed by Bill
Publisher of: The
Fleet Street Letter
MONDAY, 24 SEPTEMBER 2001
Is War Bullish?
*** Is war bullish? It looks as though we will find
*** Dow down 14% last week. Investors lost $2.31
trillion in last 16 trading days...
*** Housing begins to soften...Microsoft below $50...and
|The market will rise at the sound of gunfire. |
That is the bulls' great hope. And maybe it will.
Prices have fallen on 13 of the last 16 trading days.
The Dow is down 2,200 points. Addison calculates that
this represents a loss of $46,200 per stock-owning
"We are now in the grips of a full fledged global
financial crisis," writes Doug Noland. The Paris market
is down almost 40%. Brazil is down 30%. Japan is down
nearly 30%. And Germany is down more than 40%.
"The business world is simply covered in a blanket
of hesitation," remarked a spokesman for data storage
company EMC, explaining why it will lose money in the 3rd
quarter. "Dazed companies sit on their wallets," adds
the NY Times.
A few weeks ago, investors were rushing to the big
cap companies for safety. Now they are fleeing them,
again, for safety reasons. Microsoft, once at $119, is
now on sale below $50. Cisco, once $81, can be yours now
at prices below $12.
Housing starts fell 6.9% from July to August -
suggesting that even the real estate bubble is beginning
But when the shooting starts, many believe, stocks
will rally 'round the flag. And maybe they will. It is
rare for stocks to go down this much without either 1) a
panic to the downside, or 2) a big rally. Anything could
happen, as they say, and anything will. More below...
Eric, what's going on in Manhattan?
Eric Fry in New York:
- To judge from yesterday's sparse attendance at my
church, faith is a little less fashionable now than it
was last week, when a standing room only crowd packed
into the sanctuary for the 10:00 AM service.
- Meanwhile, a friend of mine who owns a number of very
trendy bars in Manhattan, Los Angeles and elsewhere
reports that his business is rapidly returning to
normal. "Immediately after the WTC attack my bar
business in Manhattan dropped about 60%," he says. "Last
week, it was off about 25%. But it looks like this
weekend we might be getting back to the pre-attack
levels." His business elsewhere in the country has not
dropped off one iota since the attack.
- Empty churches and full bars suggest to me that
Americans are getting back to the business of self-
indulgence. Can an economic recovery be far behind? Just
as foreign nations should never underestimate America's
will to fight, economists should never underestimate
America's "will to consume."
- My prediction: GDP will fall in the third and fourth
quarters. In fact, the fourth quarter might be
especially dismal. But some kind of sharp but fleeting
recovery will likely materialize in the first quarter of
2002. All the recent stimulus from the Fed ought to get
us at least one decent quarter before things turn sour
- The Dow tumbled 14.3% last week - the steepest one-
week decline since July 21, 1933 when the average
slumped 15.5%. Furthermore, the market's eight-day
string of consecutive losses is the longest such slide
- "Some folks would say this has been a horrendous week
for the market," writes C.A. Green, investment director
of the Oxford Short Alert. "I call it a 'short-sellers'
rally." Indeed it has been. But the selling looks like
it may be starting to exhaust itself. The Dow's bounce
last Friday morning from down more than 300 points to up
about 60 points could have been a preview of the week to
come. (For more see: Oxford Short Alert)
- The extreme VIX Index readings at present indicate
that some kind of rally is imminent. This index, which
measures option volatility on the S&P 500 index, is
currently registering high levels of fear. Often, such
readings precede rallies. I repeat, "often" - as in, not
- Perhaps the news that we have commenced some kind of
military action in Afghanistan will spark the rally.
Americans, for whatever reason, seem to get into a
stock-buying mood whenever our military lashes out at
- "Giving Terror Inc. its own Ground Zero won't bring
back the dead or secure a quick and painless victory,"
writes Smartmoney.com's Igor Greenwald. "But it would
certainly cheer up the millions of investors wondering
how that patriotic market rally [they had been
expecting] turned into the Battle of the Little
- Historical precedent might also shed some light on the
market's likely direction over the next few weeks. Then
again, it might not, says Grant's Investor's Andy
Kashdan: "Financial markets are no strangers to
catastrophic shocks to investor confidence. To bring the
historical record into view, Ned Davis Research has
looked at 28 different crisis events dating to the fall
of France to the German army in 1940. Although the Dow
Jones industrial average dropped immediately after most
of the events, the Dow on average had gained 12.1% after
- But as Kashdan points out, "Crises naturally come at
different points in the business cycle, and that
variable adds to the difficulty of predicting future
outcomes based on the past...Even before the recent
tragedy, consumer sentiment had plunged, the
unemployment rate was higher than expected, and profit
warnings were plentiful."
- Furthermore, as Paul Kasriel, director of economic
research at Northern Trust Co., recently reminded us,
the S&P 500's decline from its 2000 peak still leaves it
more overvalued than in any other postwar recovery
- "The lesson that we take from economics and from
market history," Kashdan concludes, "is that, for better
or worse, the path on which the United States economy
was traveling before last week's attack will not be so
quickly changed." (see: Crises and Keynesians)
- "The event is on. And it could be the most important
gathering we've ever held in our 20-year history,"
writes Kathleen Peddicord, editor of International
Living. The event? The Agora Las Vegas Wealth Symposium,
from October 31-November 3, 2001. The gathering is
little more than one month away and it ought to be very
interesting. "We've all been through a lot these last
couple of weeks...[but] it's time to make some hard
decisions and to take action to protect our financial
future." (Call Agora Travel for details: 1-800-926-6575
Back in Paris...
- Seven people were arrested over the weekend for
planning to blow up the American Embassy here in Paris.
- Meanwhile..."I don't know if this is true or not,"
ventured our friend Yves at tea yesterday, "but the
French press says that George Bush is not very smart. He
thought the Taliban was a rock and roll band...and he
didn't know who the president of Pakistan was. Of
course, I don't know who it is either."
- "Look," I replied, defending our president, "most
people couldn't tell the difference between the Grand
Mosque and an Exxon station. But so what...that's why we
have GPS on our bombers."
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IS WAR BULLISH?
by Bill Bonner
"It is easy to criticize," said Elizabeth, letting me
know that my views are as irritating at home as they are
to many Daily Reckoning readers.
"What we've learned is that it is a dangerous world,"
she continued. "And if we can make it any less dangerous
by going after a gang of murderous barbarians in
Afghanistan, we should do so."
Polls show that 91% of the people of America agree with
her and with President Bush. Recent surveys in Europe
show sentiment here not too much different - with 79% of
the British ready to back the U.S. and 72% of the
French. Curiously, Germans are more reluctant. Only 52%
of them want to get involved.
Perhaps enthusiasm for military campaigns is as cyclical
as it is for junk bonds and bubble stocks. The Germans
took such heavy losses in WWII that they have had little
interest in beating the war drums since.
The Russians, meanwhile, have vivid recollections of war
in Afghanistan. Their advice is clear: fighting a ground
war in Afghanistan is a form of suicide.
But war has been proclaimed...and now it must be
pursued. Will it make the world safer? Or less safe? We
may never know. For whatever happens, we will never know
what might have happened otherwise. That is why it is so
hard to learn from politics...we can know what happens,
but not why.
We merely note, for the record...and just to annoy
readers...that war fever, like market fever, has a way
of generating its own reward. The Austro-Hungarian
Empire felt not only justified, but duty-bound, to
demand satisfaction after its archduke had been
assassinated by terrorists in 1914. And what self-
respecting nation could ignore its treaty obligations?
If Serbia went to war, Russia must too. And if Austro-
Hungary found itself in bellicose circumstances...France
and Britain must be drawn in too. And then, though no
one wanted it or asked for it, the whole world was at
By September 24, 1914, trench warfare had already begun
on the Aisnes. And a single battle of this new war -
Verdun - would cost the lives of 700,000 soldiers.
But here at the Daily Reckoning, we will confine
ourselves for the present to following the money. It is
often said that war is bullish...and it is widely
predicted that, when the shooting actually begins, the
U.S. will get the shot-in-the-arm...that glorious,
heaven-sent wound...that sends us home and puts us back
on the road to prosperity.
Could it be, dear reader? Could the world be such a
paradoxical mess that you can get richer by destroying
lives and property? If that is true, the terrorists'
attack must rank as one of the greatest risk/reward
investments of all time. At trivial cost - maybe
$200,000 - they did $60 billion worth of damage. Will
nature, in her inscrutable majesty, allow us to build a
boom on these ruins?
We are not so immodest as to set out to answer that
question. But, in the rest of this letter we will at
least toy with it...
"The stock market is more than 17% undervalued," says
this week's Barrons. "It's time to Buy Stocks," screams
the headline, illustrated with a comic drawing of an
enraged bull with a U.S. flag tattooed on his arm.
The article, written by Michael Santoli, claims that
stocks are undervalued based on the Fed Model, which
compares the earnings of the S&P 500 to the yield on 10-
year Treasury bonds. "For the next 12 months, the
collective earnings of the S&P 500 are expected to be
$55 a share," writes Santoli. He then does the math to
show that the earnings yield on the S&P would be higher
than the 4.68% yield on Treasuries.
Where does this $55 come from? It was Ed Yardeni's guess
for earnings in 2002...current earnings are below $40.
Thus, Yardeni expects S&P companies to increase their
earnings by more than 30% from this year to the next.
This seemed like a preposterous dream a couple of weeks
ago. Now, it seems merely unlikely. The economy is
slowing down, not speeding up. Earnings would probably
have been lower next year than they are this. But, with
the winds of war at the economy's back, anything is
Last week, Barron's looked at 9 international crises
since the end of WWII. In only one case - the Berlin
Blockade - were stocks still down one year later, and
then only by 3.3%. In every other case, stocks went up -
from a minimum of 7.2%...to a maximum of 42.2% in the 12
months following the Oil Shock of 1973. Two years after
the event stocks were higher in all cases...from a
minimum of 3.1% following the Gulf of Tonkin crisis in
'64 to 66.5%, again following the Oil Shock of '73.
Looking more carefully at the details, we observe that
most of these events had the good fortune to coincide
with what was otherwise a modest point in stock market
history. We see no instance of an external shock coming
at a point when the market sat precariously on a
pinnacle of prices, following an 18-year boom. Instead,
each instance seemed to come along at a favorable
moment...when the force of an impact might just as well
drive prices up as down.
In the entire post-WW II period, the U.S. economy and
stock prices climbed a mountain of rising valuations
(interrupted by major valleys and countertrends from
time to time). After the Great Depression and WWII,
stocks were cheap...the economy boomed...and people
became more and more confident that the future would be
brighter than the past. Gradually, their habits changed
as they became more and more confident - they spent more
and saved less, and bought more and more U.S. stocks,
which they had come to see as the greatest moneymaking
investment they could make.
As time went by, the Federal Reserve became better and
better at aiding and abetting the process of confidence-
building. Our central bankers learned - thanks to Keynes
and Friedman - that times of crisis needed more active
management...and that each shock should be an occasion
for introducing more money to the system.
On Wall Street, as perhaps in the rest of life, nothing
succeeds like excess. If a few dollars could help stave
off a crisis...a few more could trigger a real boom.
Thus did the Greenspan Fed go about its work in the
aftermath of every crisis to come its way - flooding the
world with cash and credit.
As long as the big boom was in place, the extra money
was taken up and used to expand demand, boost
production, and puff up asset prices. Each time -
especially, following the LTCM, Asian currency, and Y2K
threats - the economy boomed and the stock market
Most recently, central banks injected $208 billion into
the world banking system immediately following the
terrorists' attack. The Fed and the ECB each cut another
half of a percentage point from key lending rates.
Will the magic work again? Is it the same world it was
in 1948 and 1998? Or has something really changed? Have
we crossed some sort of watershed, such as people did in
Japan in 1989...or in Europe in 1914...so that the
habits of the last generation no longer produce the same
level of prosperity...or the same peace?
We will see, dear reader, we will see.
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The Daily Reckoning:|
author Bill Bonner
Bill Bonner is,
in spite of himself, a natural born contrarian. Early each morning, Bill
writes The Daily
Reckoninghis take on the financial markets and whats going
on in the worldand sends it off by e-mail before most Americans
alarm clocks have buzzed. Many readers say it's the first thing they want
to read when they get upnot only because it's informative and thought
provoking, but also it's inspiring, in its own quirky and provocative way.
Of course, there's
much more to Bill than his daily market commentary. He's also the founder
and president of Agora Publishing, one of the world's most successful
consumer newsletter publishing companies. Bill's passion for international
travel and big ideas are reflected in the company he's successfully built.
In 1979, he began publishing International Living and Hulbert's
Financial Digest . Since then, the company has grown to include
dozens of newsletters focusing on health, travel, and finance. Bill has
vigorously expanded from Agora's home base in Baltimore, Maryland since
the early 90sopening offices in Florida, London, Paris, Ireland, and
subsidiaries include Pickering
& Chatto, a prestigious academic press in London and Les
Belles Lettres in Paris, best known as a publisher of classical
literature in bilingual editions.