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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

PARIS, FRANCE 
THURSDAY, 18 JANUARY 2001 

 

Today:  Imagine That

*** Hmmm...Intel's profits...GE's profits... They're not 
great...but Intel is promising to spend even more money in 
the year ahead...

*** Why are Internets and Big Techs rising? Because they 
appeal to the most naive investors...

*** Is Mr. Bear in retreat? Don't count on it...O'Neill and 
the dollar...dynamic silicon...and the failure of the New 
Paradigm...

*** Hmmmm...

*** Yes, hmmmm...Intel's sales and earnings weren't great, 
but they weren't terrible. Revenues are falling. Costs are 
rising. And a third of Intel's earnings came from 
investments and interest. 

*** That is one of the features of an asset bubble. 
Companies pad profits by investing in the inflated assets. 
They buy each others' stock - or real estate, as companies 
did in Tokyo in the 1980s. "During every investment boom," 
as Marc Faber puts it, "companies make extraordinary 
profits by participating in the boom through the purchase 
of the object of speculation."

*** Intel said that it would increase capital spending next 
year, from $6.5 billion to $7.5 billion. Intel seems not to 
have noticed, or cannot imagine, that the industry may be 
at the tail end of a capital spending boom, burdened with 
too much capacity already. Investors' trimmed Intel stock 
by 3%.

*** Jack Welch was on TV too - with a similar message. 
Things were not great at GE, because the economy was slow, 
but the economy would surely pick up later in the year. GE 
had no plans to cut IT spending next year.

*** GE did not beat analysts' estimates. But it did not 
fail to meet them either. Instead, it came in right on the 
money, not a penny more. Investors took 1% off the stock's 
value.

*** Juniper reported strong earnings...3M reported weak 
ones. Investors heard what they wanted to hear, and did the 
inappropriate thing.

*** The Dow sank 68 points. But the most speculative 
sectors - the Big Techs and the Internets - rose. 
TheStreet.com's Internet index rose as much as 6% intra-
day, and ended up 2%. It has gained an impressive 25% so 
far this year. The Nasdaq 100 is up 9% for the year.

*** The Nasdaq itself rose 64 points yesterday - as the 
nation's most naive investors bought up Wall Street's most 
overpriced stocks. 

*** "The bear is starting to retreat," said one optimistic 
trader at Kaufman Brothers. Maybe. Maybe not. In the 13th 
century, Subadai took a small army of Mongol horsemen all 
the way across Asia and into the heart of Europe. Often 
outnumbered, his favorite tactic was to pretend to retreat. 
His pursuers left their bases...stretched themselves 
out...wore out their mounts...and exposed their flanks - as 
Subadai wheeled around for the kill. Could Mr. Bear be that 
clever? 

*** A chart of mortgage refinancing has a line going nearly 
straight up beginning the last 2 weeks of December. In the 
last two weeks, the index has doubled. Could all these 
people really be attracted by a half-percent cut in the Fed 
Funds rate - especially when more cuts are as certain as a 
gambler's second bet? Or, are they desperate?(see: "We are 
now living
financial and economic history on a daily 
basis.")

*** Merrill Lynch is now forecasting flat earnings - zero 
growth - for the S&P 500 this year. 

*** Power blackouts in California? Emblematic of the 
failure of the New Paradigm, California will begin 
rationing power rather than allow prices rise and clear the 
market. All the billions of IT spending...and all the 
genius of Silicon Valley...were not enough to overcome the 
titanic imbecility of California lawmakers. 

*** The Boston Globe, meanwhile, reports that nuclear power 
is making a comeback. The plant on Maryland's Calvert 
Cliffs had its license extended for another 20 years - 
thus, doubling its expected life cycle. Suddenly, there's a 
bidding war for nuclear power.

*** The Financial Times reports that losses are growing for 
U.S. banks. Wells Fargo's loan losses are up 20% over '99. 
Citicorp's problem loans rose 5.8% in the 4th quarter of 
last year. And Bank of American says it will lose $3 
billion to bad loans next year - that is, if there is a 
soft landing. 

*** Expectations of a 'soft landing' are wide and deep. 
Investors, CEOs and bank analysts all agree: things are 
getting better. And upon this happy forecast, they build 
their plans for the future - investment, business and 
personal. Polls show consumer confidence falling - but 
still very positive. Investors, too, expect much less than 
they did a year ago...but much, much more than they did 20 
years ago. According to CNBC $15 billion went into equity 
funds since the Jan. 3 rate drop. 

*** The dollar rose after Paul O'Neill, the man the 
incoming Bush administration has fingered for the Secretary 
of the Treasury, said he favored a strong dollar policy. 
But Reuters reported that "O'Neill may tolerate weak 
dollar." Reporters, as well as investors, hear what they 
want to hear.

*** I was intrigued when Steve Sjuggerud recommended the 
Argentina Fund a few weeks ago. It was trading at a 32% 
discount while Argentina struggled to stay solvent. 
Yesterday, I asked Steve how it was doing:

"The Argentina Fund is already up about 20% this year," 
Steve replied, "and it's going much higher. But again, 
don't worry, you haven't missed a thing - the Argentina 
Fund is actually trading at the same price it was back in 
1992, when it was first established. There's plenty of 
upside left." According to my back-of-the-envelope 
calculations, the current discount - about 22% - gives you 
Argentine companies at the equivalent of about 8 times 
earnings. (see: The Greenspan Home Run)

*** "France's tax regime is among the most diabolical in 
the world," writes International Living's Kathy Peddicord. 
"As the French tax minister Jean-Baptiste Colbert (1619-
1683) explained to his King Louis XIV, 'The art of taxation 
is to pluck from the goose the most feathers with the least 
hissing.' Jean-Baptiste's present-day counterparts don't 
even seem to mind the hissing." Despite that fact, it seems 
Addison and I reside in one of two countries deemed to have 
the highest standard of living in the world... an honor 
France shares with the United States. (see: International 
Living's
2001 Quality of Life Index)

*** And this amusing report from the frontiers of the New 
Paradigm... George Gilder: "Dynamic Silicon, the missing-
link technology I have been predicting for 15 years is 
emerging now and will unite the Microcosm and the Telecosm, 
and consummate the transformation of the economy of matter 
into an economy of mind. This emerging revolution in the 
microchip industry will be as profound and transformative 
as the invention of the microprocessor itself." 

I don't have any idea what that means, but I thought you 
should know.

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IMAGINE THAT


Why do people vote? 

Why do they get married...and then get divorced?

Why do they go marching off to war...or get caught up in a 
tremendous and absurd investment bubble?

In every instance, dear reader, the problem - when you 
strip it of its oily peel - is a lack of romantic 
imagination.

How much human misery could be spared...simply by the 
application of a little imagination! A man might imagine 
what life would be like with his bride after, say, 10 years 
of marriage. Sharing his life with her ...his bathroom... 
his checkbook...his breakfasts and dinners...his 
heartbreaks and ambitions...and watching the cheek he so 
loved to embrace at 20 turn into quite another kind of 
cheek by 50...he might decide to skip the whole thing. 

Or he might not! But at least he would have some idea of 
what he was getting into.

Likewise, if the soldiers of 1914 had been able to imagine 
the pointless misery of the trenches...or the soldiers of 
the Wehrmacht had been able to capture - in their minds' 
eyes - the futile and ultimately calamitous denouement of 
their adventure...wouldn't they simply have stayed home?

Or, think of all the investors who poured their life 
savings into the South Sea Bubble, or Tulipmania, or the 
Nifty Fifty? Or, think of the many people who devoted their 
whole lives - and their fortunes - to trying to find a way 
to turn base metals into gold. They could not imagine 
it...but their investments would leave them completely 
penniless!

And yet, through the fog of wishful thinking, the light of 
imagination shines darkly at best. The soldier imagines the 
glory, but not the lice and missing limbs. The lover's 
internal screen shows photos like those in Playboy... 
airbrushed to flatter the curves, and hide the wrinkles. 
And the investor? Unless the experience of loss is fresh in 
his memory, he is no better able to understand how things 
work then a California lawmaker.

I say it is 'romantic' imagination that is lacking because 
while it is easy to imagine the intended consequences of an 
act...it is almost impossible to imagine the unintended 
ones...even when they are obvious. And yet, to repeat a 
point I make with tedious regularity - in the investment 
markets, it is the unanticipated consequences that are 
important - for those are the only ones that are not 
already discounted in current prices.

No doubt, you have received the latest 'Darwin Awards' in 
your email box. They seem to come around each year at this 
time, applauding the efforts of exceptional people to 
remove their own genes from the reproductive chain. The 
stories are often entertaining - because we see people 
doing very dumb things...things whose unintended 
consequences are obvious, as well as, fatal.

In the current instance, for example, a man is given the 
award for attempting to smash out his girlfriend's 
windshield with the butt of a loaded shotgun. His efforts 
were cut short when the gun went off directly into his mid-
quarters.

Surely there must be some equivalent award for investors - 
those whose imaginations are so underdeveloped as to be 
unable to foresee even the most obvious - though unintended 
- consequences of their actions. Alas, it is left to us to 
do the work. And a lot of work it is: the field of 
candidates is so crowded...and the resumes are so similar. 
It is like trying to pick the dumbest boy in the 3rd grade.

As a bubble swells in foreseeable ways...so does it 
deflate. Investors imagine a world much simpler than it 
really is. They think Alan Greenspan controls the economy 
and the markets - increasing interest rates when he wants 
to calm economic activity...and decreasing them when he 
want to stimulate it. 

The problem, once again, is that this simple metaphor 
doesn't come close to describing the romantic perversity of 
markets, economies, or human action. 

Recalling a quotation from Marc Faber, "It isn't rising 
interest rates that prick an investment bubble, but 
widespread losses by investors."

Investors have lost $3 trillion since March 2000. Since the 
U.S. economy grows at the rate of about $500 billion per 
year - that loss represents about 6 years of growth!

Meanwhile, real, effective interest rates have gone from 
negative 15% or so per year...to positive 30% or so. That 
is what an investor might expect to get as a net return on 
borrowed money. 

Lower interest rates do not automatically reverse the 
deflationary symptoms of the end of a bubble. In fact, they 
may make them worse! 

"Repeated easing by central bankers," explains Faber, 
"which is designed to combat the threat of a recession or 
deflation, actually ...reinforce[s] the deflationary trend, 
because it allows the boom in the object of speculation to 
continue for far longer than would normally be the case."

This is exactly what Intel's announcement yesterday 
suggests. Buoyed by the Fed's gallant effort at 
'reliquification,' Intel intends to float an extra billion 
of capital spending. 

Nor can investors imagine that the Fed's efforts to reflate 
the economy may produce perverse results in other ways. I 
have already discussed the "adverse selection" problem. At 
the end of an asset bubble, new credit tends to go to 
desperate borrowers, rather than those with useful projects 
to finance. Sensible lenders get worried. After years of 
very loose credit policies, too many borrowers are in over 
their heads. Businesses and consumers go bankrupt. Lenders 
turn wary and demand higher rates of interest - even though 
money may be, theoretically, more readily available from 
central bankers.

This - combined with falling price levels - produces yet 
another paradox. "Even if interest rates are cut," says 
Faber, "the borrowing costs of companies go up in real 
terms... Corporate margins are therefore squeezed badly, 
which in turn leads to further selling pressure in the 
stock market. Worst of all, at this stage, falling stock 
prices don't bring about lower valuations, because earnings 
decline more rapidly than stock prices. Thus, stocks 
remain, even at lower levels, overpriced."

"On the upside," Faber concludes, "the dynamics work in a 
miraculous way; bubbles usually last longer than 
anticipated and bring valuations few could have expected at 
the beginning of the expansion."

But just as investors couldn't imagine how high prices 
eventually got, nor can they now imagine how low they may 
fall as bubble excesses fully correct themselves. "Every 
boom leads to a bust," says Faber, marked by "sharply 
declining equity prices, a weakening currency, and a 
downward spiral in the economy."

Imagine that.

Bill Bonner 

P.S. Tomorrow? The Daily Reckoning's Financial Darwin 
Awards.

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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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