*** Earnings reports - treacherous times. Fed is fighting
the credit cycle....
*** Dow up, Nasdaq down...gold goes nowhere - is it out of
fashion forever?
*** Major defaults...GE...GM...and more!
*** The big boy - GE - was supposed to come forward
yesterday and make its announcement. Did it 'beat the
numbers' yet again? Or was this last quarter of the 2nd
millennium a killer, even for the house that Jack Welch
built?
*** Here at the Daily Reckoning, we were all sitting on the
edge of our chaises...for we, apparently alone in the
universe, are on record saying that GE is overpriced.
Sooner or later the news will get out, we think.
*** But not yesterday, GE delayed its announcement until
Thursday. And investors used the occasion to boost the
stock 4% - a move, I predict, they will some day regret.
*** The Dow rose 127 yesterday. The Nasdaq fell 8. The
dollar was up a bit - the euro at 94 cents.
*** Gold rose 20 cents, to $272. "A common feature of
manias," according to Marc Faber, "is that the asset class
that was the epicenter of the whirlwind of speculation goes
out of fashion for a very long time - in fact, usually
forever."
*** Gold was the epicenter of a bubble in the late '70s.
Has it gone out of fashion forever?
*** Earnings are falling. Earnings almost have to fall. The
economy is slowing down, as everyone knows. But beyond
that, earnings always fall at the end of an asset boom.
That's how they work. People pour money into capital
investments - because capital assets are rising in price.
"In the recent U.S. capital spending boom," wrote Marc
Faber a few weeks ago, "capital spending as a percentage of
the economy reached a 40-year high." This created a glut of
capacity - which could only end in falling prices and
falling profits.
*** But there's something else at work: accounting. Faber
explains that profits surged in the first stage of the boom
because "the sales of business equipment were immediately
recognized as revenues by the vendors, whereas the expenses
of the purchased equipment will only gradually be
recognized by the buying company." Capital assets are
expensed over time.
*** "When the boom stops accelerating," continues Faber,
"profits slow dramatically as the back-end expenses rise
faster than the front-end revenues." We are plainly at this
stage now.
*** As of the 11th of this month, a record 624 companies had
issued earnings shortfall announcements - almost twice as
many as the year before. The previous high was 554 whose
earnings fell short in the 4th quarter of '98. Nokia, Yahoo,
Gateway, Int'l Paper, Ameritrade, Martin Marietta have all
disappointed investors. And, as one analyst put it, "it's
still early in the game."
*** The Fed is fighting the credit cycle. It hopes to pull
off the same 'reliquification' that it managed in 1998 -
when it was faced with LTCM, Russian debt, and Asian
currency crises. One of the effects of that reliquification
was that good money was poured into glutted industries,
following the bad money that had already been lost.
*** "Over the past 11 quarters (first quarter 1998 to
third-quarter 2000), in what has been a key aspect of an
almost continuous reliquefication, home mortgage lending
expanded by more than $1.1 trillion, or 30%," writes
Prudent Bear, Doug Noland. "Predictably, the results of
this reckless credit expansion have been spectacular home
price inflation, and resulting overspending (and massive
trade deficits) by the household sector. ... The question
now becomes, when does the marketplace discount this
scenario, and what are the ramifications for interest rates
and the dollar."
*** The International Harry Schultz, a man who has been
logged in Guinness Book of World Records as the "highest
paid investment consultant" on Earth for over 20 years,
sees only weakness in the dollar. Schultz: "Why is the US$
'weak' when it's not far down from its multi-yr high? For
some of the same reasons the Nasdaq was weak when it was
making one new high after another. It was pricing itself
out of existence. The US$ has priced many US products out
of world mkts, & US current account/trade deficits are the
biggest in world history, for any nation or any 5 nations
combined."
*** "The US$ is also vulnerable because of bad US bank
loans," continues Schultz "derivatives, certain commodity
shortages, looming recession, the tech stock catastrophe,
the productivity myth, oil denomination, overvaluation of
most US stocks, corporate over-merging, endless spin on a
strong $ which can lead to overnight disenchantment..."
(see: Complacency Has No Reward)
*** In fact, the news is full of evidence of financial
distress. Both Globalstar - a giant telecom - and
California Edison said they could no longer pay their
bills. The Financial Times reports that the Bank of America
would write off between $1.1 and $1.2 billion in bad debts
this week.
*** The average 401 k fell 4% last year. Owners cut back
their exposure to stock from 80% two years ago to 70% at
the end of last year.
*** "There is no evidence," concludes the Financial Times,
after reviewing a report from Ernst & Young, "that the
large increases in information technology investment over
the past 5 years has raised the rate of UK productivity
growth."
*** While GE rose 4% yesterday, GM rose even more - 5.4% to
$55.75.
*** And here's a little item on the indomitable human
spirit from the Independent Institute. Despite billions
spent to wage war on drugs...and a prison population that
is the envy of incarcerators the world over...federal judge
John L. Kane noted that "about 1.3% of the population is
addicted to cocaine - the same percentage as in 1979, a few
years before the Drug War, and the same percentage as in
1914, when cocaine was sold legally in grocery stores."
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"Half the American population no longer reads newspapers:
plainly, they are the clever half."
Gore Vidal
There are "minor investment manias" and there are major
ones.
"Minor manias," Marc Faber reminds us, "took place in the
US in bowling stocks and SBICs in 1961, in gaming stocks in
1978, in the first PC companies such as Commodore, Atari,
and Coleco (whose original business was above-ground
swimming pools) in 1983, and in such 'dubious' companies as
Presstek, Diana and Iomega in 1995."
These minor bubbles are like border wars or revolutions in
small countries. They attract little attention and are over
before most people become aware of them. For example,
Laurent Kabila was shot and killed in the Congo yesterday.
But who cares? I never met the man.
Major manias - like world wars - are another matter. "When
these major bubbles (1873 and 1929 in the US, 1989 in
Japan, 1997 in the emerging economies) are pricked," writes
Faber, "the impact on the economy is usually felt around
the world and leads to vicious recessions or depressions."
The world has had some experience with major financial
manias. But Americans' personal experience is frail. An
investor would have be to at least 90 years old to recall
the '29 crash and Great Depression as an adult. There are
some active nonagenarian investors - but not many.
So what do we have? Books? Histories? Theories? And our
imaginations.
That is the problem with humans, dear reader. We lack the
imagination to see things as they really are. How much
happier a woman would be if she could see her husband as
the man he really is. And how much more successful her
husband would be, too, if he could only open his eyes and
see the world around him as it really is...rather than as
it is supposed to be.
The boom...and subsequent bubble on Wall Street, '95 to
'99, looks for all the world like a classic, major asset
price bubble. Such events are hardly unknown to financial
historians...nor are their symptoms difficult to spot: They
usually begin in a low-inflation environment, for example -
allowing the expanding credit to feed directly into asset
prices rather than consumer prices. Consumer price
inflation was low in the 1920s...and very low again in the
1980s in Japan.
Likewise, a major boom is almost always accompanied by some
technological or business excitement. In the '20s, people
were able to believe that the new machines and appliances
were the source of the apparent boom. In '80s Japan, they
believed in the quality of Japanese management, and the
whole Japanese enterprise system.
The boom actually plays an important economic role -
focusing resources on an up-and-coming sector and speeding
its development. Investors are not crazy to put money into
the boom...the problem only arises after prices surpass
reasonable expectations.
In the early stages of a capital asset boom, as explained
above, the feedback loop works to amplify the boom and
confirm people's wishful thinking. Profits do rise. Asset
prices do go up. People do seem to be getting richer.
Since these effects are visible, there must be a reason for
it. The new technology...smarter management...or, as in the
case of the South Sea Bubble, the opening of a new
continent.
The media reinforces whatever delusion is popular at the
time - providing investors with plenty of information with
which to support their favorite fantasy. Thanks to the
media and the mob, people do not have to open their eyes or
flex their imaginations.
Information, as I have said many times, is cheap. But
wisdom is dear. And unfortunately, there are many things
that have to be learned the hard way.
You can read about sex in books. You can study ice-skating
in manuals. You can find detailed studies on bear markets
and depressions on the worldwide web. But to really
appreciate them, dear reader, you have to experience them
for yourselves. Our imaginations cannot do justice to real
life.
In real life, it is not central bankers' rate hikes that
kill asset bubbles - they die from natural causes. As asset
prices rise, the expectations of profit rise with them.
Finally, they become so wildly optimistic that there is no
chance they can ever be realized.
"Just think for a minute about the last great investment
boom in the oil and gas industry in the late '70s," Faber
suggests. "It came to an end in Houston and Dallas once the
oil price failed to rise after 1980."
Why did the price fail to rise? Because oil-producing
assets had been marked up to such levels that they drew in
billions of investment capital, which increased supplies to
the point that prices had to fall.
"When oil prices collapsed in '86," Faber continues, "the
drilling industry experienced a terrific slump. This would
have happened even if interest rates had been at close to
0%, because when an asset declines in value, interest rates
even close to zero can be high in real terms."
"It isn't rising interest rates that prick an investment
bubble," Faber observes, "but widespread losses by
investors."
Rising rates do not bring an end to asset bubbles, nor do
falling rates protect them. This is the lesson of
experience and logic. But it might as well be Aristotle's
Poetics in the original Greek - so remote and foreign is it
to most investors.
At this stage, most investors still cannot imagine that
they have been caught up in a massive bubble...and most
cannot imagine how it will end. In their minds, Alan
Greenspan raised rates last year because he thought the
economy was "overheating." Now, having seen it cool off,
he's lowering rates...which will put things back on course
for double-digit stock market gains, year after year.
Yet, Bill King recently described how America's last major
asset bubble actually deflated:
The S&P 500, like today's Nasdaq, was down 44.5% when the
Fed decided it was time to cut the discount rate 50 basis
points to 4.5%. Two days later, stocks rallied. The Fed cut
rates in February and March, 1930.
Then, as now, investors were pretty sure that the worst was
over. There were plenty of bulls back then too...and
newspapers...and brokers...and Fed chairmen. None of them
could imagine what lay ahead. Stocks rallied until April
10, "then," says Bill King, "they started their death
march." The Fed continued cutting rates - in May, June, and
December of 1930...and then again in May of '31 and
February of '32. Stocks just kept going down until, finally
exhausted, the S&P hit bottom on June 1, 1932 after 8 rate
cuts.
Your reporter...flexing his imagination...
Bill Bonner
About
The Daily Reckoning:
Daily Reckoning
author Bill Bonner
Bill Bonner is,
in spite of himself, a natural born contrarian. Early each morning, Bill
writes The Daily
Reckoning—his take on the financial markets and what’s going
on in the world—and 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 up—not 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 ’90s—opening offices in Florida, London, Paris, Ireland, and
Germany.
Agora's publication
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.
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Last modified: April 01, 2001
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