Contributed by Bill
Publisher of: The
Fleet Street Letter
WEDNESDAY, 9 MAY 2001
Dreams of Avarice
*** Stocks mixed...and Greenspan betwixt a rock and
a hard place...
*** Surprise, surprise...the Cisco kids beat
*** Stagflation...lower productivity...higher labor
costs...the Internet peaks out...and Sherman does
|*** Stock moved up and down yesterday, with the Nasdaq|
gaining 25 points as the Dow dropped 51 points. Press
reports said investors were merely marking time until
Cisco Systems reported its earnings after the close.
The excitement built up - like waiting for a count of
the Florida ballots. The company had made 14 cents a
share in the first quarter of last year. This year,
it was expected to earn only 2 cents.
*** Surprise, surprise! The Cisco kids managed to
beat expectations by a penny. But the number and
magnitude of "one-time" charge-offs rendered the
reported number utterly meaningless. Business is
downright awful at Cisco. Including all charges,
Cisco lost $2.69 billion, or 37 cents a share, on
the quarter. And don't look to Cisco for upbeat
comments about the future. "It is also now clear to
us that the peaks in this new economy will be much
higher and the valleys will be much lower and the
movement between these peaks and valleys will be
much faster. We are now in a valley much deeper than
any of us anticipated..." Chambers belly-ached.
*** Cisco rose 6% yesterday, anticipating the
evening's earnings announcement. Dell fell 4% -
after the company said it was laying off 10% of its
*** But yesterday's big news came from the federal
government's statisticians. Actually, there were two
important pieces of news. You will recall that the
big promise of information technology is that it is
supposed to increase productivity. With the hot air
of all the world's information at their backs, people
are thought to be able to work more efficiently and
produce more. Alan Greenspan is so excited about it
that he speaks of it often. Rising levels of
productivity will not only make us all richer, they
will also eliminate the threat of inflation.
Greenspan may be flooding the world with purchasing
power... but so what? People are producing goods and
services even faster!
*** What a disappointment yesterday's news from the
Labor Dept. must have been. Instead of increasing,
productivity actually went down by 0.1% in the first
quarter. And to make matters worse, labor costs/unit
increased - at a 5.2% annual rate. Economists had
expected an increase of only 4.4%.
*** Oh la la... Greenspan is caught between the
Charydis of inflation... and the Scylla of a
recession. My associate, classical scholar Addison
Wiggin, explains, "Charybdis and Scylla refer to the
two mythical threats to Odysseus and his crew as
they made the passage between the the Straits
of Messina, between Sicily and Italy's boot end.
Charybdis and Scylla were the ancient world's
equivalent of a 'rock and a hard place.'"
*** Dissecting last Friday's unemployment report,
Northern Trust chief economist Paul Kasriel
observes, "Factory employment fell 104,000,
construction jobs declined 64,000, in-service
producing jobs dropped 59,000. The message is clear
- there is a rapid deceleration in the demand for
*** But at the same time he notes, "Hourly earnings
increased 0.4% in April. During the three months
ended April, hourly earnings have risen at an annual
rate of 5.8% - the highest since November 1983." He
concludes, "The central bank is essentially trapped
- rapid gains in price and wage inflation combined
with a rising unemployment rate." Kasriel expects
Greenspan to cut rates anyway when the FOMC meets on
*** Here at the Daily Reckoning, we put little faith
in our ability to predict the future. "Justifiably
so" readers may be tempted to remark, unkindly.
But our modesty results as much from theory as from
experience. The markets are, we believe, inherently
unpredictable - except in the grossest way (that is,
we know that they will go up after they go
down...and vice versa). In fact, we do not even want
to be able to predict the market's future. We fear
we would be breaking some sort of natural law. And
the day we do that, all other natural laws may cease
to work too...the earth's gravity could be turned
off and we would all fly into space.
*** But yesterday my fears were allayed as I joined
old friend and investment guru Harry Schultz for
lunch. We ate at the Cafe de la Paix, which seemed
appropriate for VE Day. "Actually, I am quite good
at predicting the future," said Harry. In fact, he
allowed as to how more than 80% of his January
forecasts had proven correct...and his annual
predictions for the Dow often come "within a few
points" of where the index ends up.
*** What is Harry predicting now? "I'm getting the
first whiffs of a major change. I can see it on the
charts - just little burps so far...but important
ones. Everything is pointing in the same
direction...commodities, currencies, gold shares,
interest rates, energy prices, unemployment,
consumer spending - economic stagnation and rising
prices...especially prices of commodities.
Stagflation, in other words." Harry needs no other
words to describe stagflation - he invented the term
more than 20 years ago.
*** The price of gold fell $1 yesterday. But
something is going on in the gold market. Gold
shares - as measured by the HUI - continued to rise.
They're up 60% since last November.
*** A Barron's poll of investor attitudes towards
the next 12 months found 35% of respondents
"bullish"...33% "neutral"...and only 19% "bearish."
A six-month outlook found 45% bullish and only 11%
bearish. Remarkably, over 90% expected further rate
cuts from the Fed. What a surprise it would be if
the Fed didn't cut rates!
*** Kevin Duffy, who tracks various investor
sentiment indicators on behalf of Grant's Investor,
states, "Total bull fund assets dropped to 73.7% of
total assets (weighted for average) on April 4, but
have since rebounded to 86.6%. The greatest
speculative juices are flowing in Nasdaq 100-based
funds, with 90.8% of fund assets in the bull camp."
(see: Bull Sighting)
*** The Sequoia Fund has made a name for itself over
its 31-year existence by unabashedly copying Warren
Buffett. Whether by prescience or sloth, the fund's
founders, William Ruane and Richard Cunniff, managed
to grow Sequoia into a $4 billion fund that has
returned an average of 17.2% per year since its
inception in 1970 - easily besting the 13.4% return
of the S&P 500 over the same time frame.
*** What do Ruane and Cunniff think of today's
market? Investors seem too "complacent," Mr. Ruane
told the Wall Street Journal last Monday. Stocks may
be lower than they were last year, he acknowledges,
but "we still don't see many things out there that
*** Move over Mickey Mouse. Make way for Dr. Aki
Ross. Aki is the stunningly beautiful actress
appearing in the new film, "Final Fantasy." There's
just one thing: She's not human. The uncannily life-
like Aki is a true technological marvel. How life-
like you ask? The International Herald Tribune
reports, "Aki edged out dozens of real-life models
and starlets to become the cover girl on Maxim's
'Hot 100,' a supplement [although not required
reading] to the babes-and-brews magazine. Forget
routers and semiconductors, Aki may be just the
ticket to jump-start the tech sector."
*** "Benjamin Graham and David Dodd would be
horrified," the Wall Street Journal writes. No, not
about Aki Ross nor about the Nasdaq 100's PE ratio.
Rather, about the $30,000 asking price for the first
edition of their classic investment guide, "Security
Analysis." First published in 1934, the "Bible" of
value-investing has helped to shape the investment
skills of a generation of investors, including the
legendary Mr. Buffett. Will James Glassman's "Dow
36,000" also fetch $30,000 per copy 67 years from
now? Will a McDonald's cheeseburger cost $31,000 in
*** As anticipated numerous times in this column,
the bear is finally starting to take a bite out of
consumers' wallets. Consumer credit increased by a
seasonally adjusted $6.2 billion in March, or a 4.7%
annual rate, according to the Federal Reserve. "That
was a smaller increase than the $9.8 million rise in
credit that many analysts had forecast."
*** To gauge from Moody's latest data, American
corporate borrowers are not in any better shape. The
rating agency reports that corporate defaults in the
first quarter totaled a record $31.8 billion, equal
to 65% of last year's total new issuance volume of
*** John Myers, editor of Outstanding Investments,
took a brief time-out in the May issue to
congratulate himself, and well he should. "Our picks
have been amassing profits the way Imelda Marco
collected shoes," John writes. "Over the past year
Toronto's Oil & Gas Index (TOG) - home to several of
our picks - is up 43% while the NASDAQ is down 46%!"
*** Has the Internet already peaked out? USA Today
reports that fewer U.S. households had Internet
access at the end of the first quarter than at its
beginning. This was the first time in Internet
history that access levels declined.
*** A modest prediction: The Internet is a useful
tool. But like an egg beater or a toilet plunger,
people will only get it out when they need to use
*** Choltitz spared Paris. But Sherman burned
Atlanta. "You might as well appeal against the
thunder-storms as against these terrible hardships
of war," wrote the general to Atlanta mayor James
Calhoun, explaining why he was going to lay waste to
the city. "If the citizens of Atlanta want an end to
the war," he continued, "the only way they will get it
is by 'admitting that it began in error.'"
"We will have a just obedience to the laws of the
United States. That we will have, and if it involves
the destruction of your improvements, we cannot help
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The Daily Reckoning Presents: Raymond F. Devoe, Jr.
DREAMS OF AVARICE
By Ray Devoe
"We are not here to sell a parcel of boilers and
vats, but the potentiality of growing rich beyond
the dreams of avarice."
Dr, Samuel Johnson, 1781
Prior to the opening the bid of an auction over
which he presided
I am a professional skeptic, based on my career as a
security analyst, from a time when analysts really
analyzed securities. My "fundamental rule of life"
which includes stocks, women, sports and virtually
all events is, "Reality very rarely exceeds the
square root of expectations."
Looking at two stocks I've panned over the last
year, MicroStrategy - down 99% from its high of $333
- and Akamai Technologies - down 97% from a $345 per
share - the square root of the square root of those
high stock valuations would more closely represent
reality in today's world. Mathematically, the higher
the expectations, the greater the potential damage.
Optimism has been referred to as "suspicion asleep,"
but the bubble mania referred to would be more like
"suspicion OD'd on controlled substances and in a
coma." I should point out that I have been a raging
bull (Barron's term) on the stock market since 1980,
with the exception of mid-1987 to early 1988-with
some periods of caution (1984, and mid-1990 and
1995-97) up until three years ago. How bearish am I
now? I am truly scared about what could happen to
the stock market.
There are so many things that are different about
the slowdown/ recession/whatever it is-that it could
be quite different from the traditional "garden
variety" economic contraction. For example:
The reaction of the Federal Reserve to every
perceived crises since 1994 (Mexico, Asian Crisis,
Russian default/Long Term Capital Management, Y2K
and now, "The Recession That Isn't Here Yet") has
been to cut interest rates and flood the system with
liquidity. This has been true of other central
banks. As Jim Grant's Interest Rate Observer points
out, this produced very low, occasionally zero or
negative, real interest rates. This brought about a
boom in business fixed investment, particularly in
technology, telecommunications, and information
The latter was also propelled by concerns about
survival in The Internet Age. A second beneficiary
has been the stock market, which became a mania and
then a bubble. Because of the boom in business fixed
investment there is widespread excessive capacity
virtually everywhere. It would take years before
they outgrow their IT equipment.
Excess capacity and rising inventories exist at many
areas of technology - not only at the manufacturer's
level. These include the contract producers, the
distribution channels, and as mentioned, the
customer's in-place equipment. In addition, hundreds
of dot-com buyers of technology products have gone
out of business, and that almost-new equipment is
coming back into the market, interfering with new-
CEOs and CFOs have been intimidated by Chief
Information Officers (CIOs) into buying equipment
with the goal of "productivity enhancement." As
mentioned, it may take some time for this upgraded
equipment to reach its full capacity utilization.
With margins under pressure, and a slowdown/recession
underway, CEOs and CFOs are now demanding a "bottom
line benefits realization" before replacing IT
equipment. This depends on the economy of course,
and the technology cycle - which is a function of
If this is a technology and falling business fixed
investment led recession, as I believe it is, it
will be much less likely to respond to Fed monetary
stimulation through lower interest rates. With
excess capacity virtually everywhere, revenues
falling and margins under pressure, there is very
little incentive to expand because of lower interest
Economists differ about the impact of the "wealth
effect" due to rising stock prices - and some question
if it exists at all. But, in my opinion, investors
have been using rising stock prices and home values
as proxies for savings. The savings rate near zero
and in negative area illustrates this. An estimated
$4.1 trillion, equivalent to 40% of GDP, has been
lost in NASDAQ and NYSE stocks between September
2000 and the end of February this year. At some
point, one would expect the "negative wealth
effect" caused by a decline in the stock market to
start to kick in.
But a 399 point surge in the Dow following the last
Fed surprise and the 34% recovery of the Nasdaq from
its low early last month has added a lot of wealth.
Will it stabilize the stock market? Probably not.
Will it be enough to avert a recession? As I've
pointed out, the Fed's response to every perceived
crisis since Mexico's problems in 1994 have been
Pavlovian-cut interest rates and flood the system
with liquidity. This has led to a worldwide
investment boom in business fixed investment,
particularly technology and information technology.
There is excess capacity virtually everywhere and it
will take time to unwind this overhang. Technology
is not responsive to interest rate cuts. Whether
consumer spending holds up because of the
stabilization of the stock market and possible
neutralization of the "negative wealth effect" is
Weather, summer blackouts across the country,
inflation, soaring energy costs are other problems,
but those are perennials and may be only marginally
significant "This Time." In my opinion Fed policy
will have no meaningful impact on technology
companies. The PC, Internet, IT and telecommunications
booms have pretty much run their courses, and some of
the products are being commoditized. No amount of
monetary ease will cause greater technology growth
until there are new products to replace the saturated
markets in place now.
The "V" shaped recovery model is becoming less and
less likely. The profit picture is not particularly
favorable - and I would expect continued wild
emotional swings characteristic of bear markets. If
the recovery pattern is a broad "U" - or "L" - I
think there will be a great buying opportunity next
year. That is, unless Congress, the Administration,
or the Fed make some serious policy blunder(s) -
which has happened before.
I never like to forecast where the Dow Industrials
or S&P 500 might go - since they always go further
than my worst-case scenario. But the Nasdaq holds
many companies where the P/E is already high, which
will only rise further as the "E" begins to shrink.
Once you factor in the tremendous amount of debt,
particularly by telecommunications companies, it's
easy to see that there could be further casualties...
consequently the downside potential for Nasdaq is
still more than that of the Dow or the S&P 500.
I have a habit developed after many bad experiences
in younger days, of leaving parties when I would
like to have just one more drink. Friends will tell
me that I miss a lot of the fun. My response is that
I would miss some of the fun - but I would also miss
all of the unpleasantness at party's end - and all of
the hangover. I left the party three years ago as
far as the stock market is concerned and have been
almost entirely in cash since then. I missed some of
the fun and all of the hangover. At some point next
year I will consider getting back into the party.
Your guest editorialist,
Raymond F. Devoe, Jr., editor of the Devoe Report
distributed by Legg Mason and a frequent contributor
to the Fleet Street Letter.
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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.