In Today's Daily Reckoning:
*** Consumer spending still outstripping earnings
*** Dow 12,000...21,500...or where?
*** Yeat's grave...Lisadell House...and a beautiful,
*** "WOW DOW 21,500 TO 43,000 BY 2008." So reads the
headline of a letter I received from a stockbroker. "Hi
again," begins the letter from a man I've never heard of.
"I trust you remember me." The letter goes on to suggest
that I follow the advice of Harry Dent's book, "The
Roaring 2,000's" and prepare "for the greatest boom in
history, from 1998 to 2008."
*** The source of the "WOW DOW" boom is identified as
baby boomer spending. No mention is made of where the
baby boomers get all the money they're supposed to spend.
*** The public's confidence in stocks is extraordinary.
Over the last 12 months the gain from stock investing has
only been about 1%. Still, in the last quarter a record
$73.4 billion was invested in mutual funds.
*** Occasional rallies give cause for hope. The Dow rose
another 84 points yesterday, for example. More stocks
rose on the NYSE exchange than fell - 1675 to 1179. And
more hit new highs than hit new lows - 98 to 40.
*** But the Nasdaq continued its decline, giving up 81
points. The Big Techs are slipping. Intel lost 2 1/8
yesterday. Cisco lost 2 1/4. These big techs will be the
source of much of investors' losses as the bear market
develops, simply because there is so much of the public's
money in them.
*** While the public continues to put its money in the
stock market, the pros are taking their money out.
Yesterday, Goldman's partners announced that they were
getting out while the getting was still good - selling
10% of their holdings to the public.
*** And bonds and utilities - favored by professional and
more serious private investors - both rose yesterday.
Even a 6% coupon from a bond is better than a 1% return
*** The euro fell to a 2-month low against the dollar --
at 91 cents. The dollar is still below it's May peak,
however. Two very important things happened in May that,
I believe, signaled the end of the 'New Era" illusion.
The dollar topped out. And first quarter productivity
numbers returned to more normal levels - following rather
spectacular numbers from the final quarter of '99.
*** If I'm right - admittedly a low-probability event -
it is just a matter of time until confidence yields to
anxiety and high prices yield to low ones. Foreign
investors will lose confidence in the dollar as domestic
investors lose confidence in stocks.
*** The big news yesterday was that baby boomers and
other consumers are still spending more than they make.
Consumer spending rose 0.5% in June, 25% more than
expected...and 25% more than personal income. How much
longer can spending exceed earnings? Until 2008? We don't
know - but we're going to find out.
*** As I've been saying, today's high stock prices do not
rest on higher earnings, greater productivity, new
metrics nor a New Era. They repose upon a bed of debt.
(See "How a Bull Turned Into A Bubble" below...Addison)
*** The public, believing that it can get something for
nothing in the stock market, has been willing to shed its
savings in order to participate. But debt costs
something. At an 8% interest rate, investors (who only
earned 1% in stocks over the last year) paid 7% to own
stocks. Unless stocks rise substantially, and soon, the
public will begin to follow the professionals out of
*** An increase in stock prices is just what many people
are predicting. I got an email from InvestorPlace - a
service of my friendly competitor, Tom Phillips. On it, I
found a prediction - from Richard Band, I believe -- that
the Dow would end the year above 12,000. And, of course,
there's Harry Dent...and the 21,500 Dow.
*** "Cast a cold eye on life...on death...Horseman ride
on" - these are the puzzling words W.B. Yeats wanted on
his grave. And there they were. We paid homage to the
great poet by visiting his grave in Drumcliff, near
Sligo. Then, we went on a tour of Lisadell House nearby.
*** The house was built in the 18th century. It is an
unusual place - perhaps the ugliest important country
house I have ever seen. It sits at the end of an untended
drive, on a hill...in dark gray cement unbroken by
anything save the large windows. It looks as though it
would make a good reform school.
*** But for pure unattractiveness nothing about the house
could match the tour guide. A hefty German woman, she
wore a pair of dirty, striped pants made of some
unnatural fabric that had been long since stretched
beyond its limits. She had a full red face and glasses
that looked as though they had been taken from Leon
Trotsky after the axe fell upon his head.
But even less attractive than her appearance was her
attitude. She welcomed us to the house as though we
intended to spit on the floor and steal the silver. And
she might have been giving a tour of a concentration camp
- so little sympathy did she seem to have for the people
who built the place and lived there.
Indeed there had been some illustrious occupants. One
owner was an Arctic explorer - who, according to our
guide, must have exterminated several species single-
handedly. She made it clear that she did not approve of
the heads of caribou and moose on the walls.
Nor did she approve of the way so many people were
required to run the place. There were upstairs maids,
downstairs maids, cooks, cleaners, gamekeepers, gardeners
- all shamelessly exploited for the benefit of the rich.
(Where did they get this guide, I wondered?)
But there was one former resident she seemed to like -
Eva Gore-Booth, daughter of the explorer. She fought
alongside the American, Eamon de Valera, in the Easter
uprising against the English in 1916. The rebellion was
put down and the ring leaders hung - except for Eva,
because of her sex, and de Valera, because of his
American passport and Britain's wish to keep the U.S. on
good terms so as to bring American troops into W.W.I.
Later, Eva went on to espouse women's rights issues.
Eva looked very attractive in her portrait. But hearing
our guide speak of her so admiringly made me wish they
had hung her, too.
*** We drove out to Horn Head in the far North of Donegal
yesterday. Looking for a beach where we could have a
picnic, we drove to the end of the road and asked. A
blond woman at a farmhouse good-naturedly let us park in
her yard and showed us a path down to the water. It took
about a half hour of hiking through sheep pasture, but it
was worth it. The sand beach was about 100 yards wide,
between rock cliffs jutting out into the Atlantic. The
water was too cold for swimming but the kids had fun
playing on the rocks. It was a beautiful spot -
*** Kathie Pediccord, publisher of International Living,
moved to Ireland more than a year ago. She's fallen in
love with the island. If you're interested she's leading
a small group on a tour of the western counties of
Galway, Kerry, and Clare, in mid-September. They'll be
investigating retirement options... and other pleasures
on the Emerald Isle. E-mail: firstname.lastname@example.org
for more information.
*** I'll be back on the boat tomorrow - and unable to
write until Friday. Until then, your faithful
correspondent in the land of Joyce and Yeats.
Inflation is out of control, despite what the numbers
say. In our latest addition to the Investor Library,
renowned economist Dr. Kurt Richebacher tells you
everything you need to know about this misunderstood
economic force and how it affects you and your
investments. To read this free report, visit: http://www.dailyreckoning.com/specialreports/
* * * * * * * * * * * * * * * * * * * * * * * * * * * * *
I recall the summer of 1985. Europe was cheap. The
British pound was scarcely worth more than a dollar. And
this was thanks to Paul Volcker.
Volcker squeezed inflation out of the U.S. economy by
raising interest rates. Higher U.S. rates led to a higher
U.S. dollar...which made things overseas seem cheap in
But in September, at the very same hotel that Janet Reno
alleges served as a meeting place for conspiracy-minded
tobacco executives 30 years earlier, things began to
change. Central bankers from the G-5 nations, no doubt
pausing occasionally for a smoke, set the world monetary
system on a course that would ultimately lead to the
creation and destruction of the world's two biggest
Readers will already be familiar with the blow-up of the
first bubble. It happened 10 years ago, about 12,000
miles and 11 times zones from the Plaza Hotel. Tokyo
stocks fell from 38,000 to 12,000. Real estate fell by a
similar margin. The economy stalled, then dived. It has
yet to recover.
But the second bubble? That is the bubble we explore and
gawk at every day in these pages...it is the bubble on
Wall Street...concentrated now on a few big Dow stocks
and a few more tech and Net stocks...but held aloft by a
whole economy that has adjusted itself to the promise of
20% annual gains on Wall Street...without the risk of a
major market collapse.
Indeed, the average American household has leveraged its
own balance sheet...doubling its debt level...in the
belief that the bull market on Wall Street that began in
1982 will continue indefinitely.
Let's go back to the Plaza Hotel in 1985. The most
noteworthy decision made by the august group of bankers
and officials present was to increase the value of the
yen versus the dollar. This was not a decision welcomed
by the Japanese. Because it made it harder for Japanese
exporters (and what else was there?) to sell their goods
at a profit. Japanese goods became more expensive. So,
Japanese manufacturers scrambled to retool to make better
quality goods with higher margins. Sensing the need for
more capital and liquidity, the Bank of Japan lowered
interest rates. From 5% in 1985...to 2.5% in 1987.
Cutting interest rates in half while U.S. consumers were
becoming ever more acquisitive had the inevitable
effect...a boom. Stocks rose.
Companies bought stock in other companies. They bought
office buildings and land too. Everything went up. The
"psychological cycle" that made Keynes rich functioned at
least as well in the Orient as it did in the Occident.
The higher stocks and properties were valued...the more
people thought they were worth. So they bought more. And
eventually, the boom turned into a bubble, as interest
rates remained at 2.5% and the yen rose. Americans were
buying more and more Japanese goods. The idea was to get
market share. Forget profits. Stocks rose to an average
p/e of 70. Golf club memberships reached into the
hundreds of thousands of dollars. A single piece of
property in Tokyo, the Imperial Palace, was worth more
than all of California.
By June `89, the markets were so hot, the Bank of Japan
got worried and decided to raise the Official Discount
Rate above 3%. Nothing happened. Then, on Christmas Day
they boosted it again...to over 4%. This had the same
sort of effect as interest rate hikes in the United
States in `29. The market crashed.
That is not the end of the story however. It wasn't long
before the Japanese realized their mistake. If lower
interest rates could produce a boom, surely they could
reverse the sense of doom in Japan's markets and economy.
The Bank of Japan began to lower rates again. And they
continued doing so until rates reached a point where the
Financial Times reported "short term rates are,
Wow. If 2.5% could touch off a spectacular boom and
bubble in the world's second largest economy...what would
Well...nothing. At least, not in Japan. Hmmm...Money is a
little like any liquid. It cannot be compressed. Push it
down somewhere...and it is bound to pop up somewhere
else. In this case, the Bank of Japan had the spigots
wide open...but little of it was showing up in Japan.
What was happening?
The trouble in Japan was that the psychological cycle had
turned. Investors, so recently eager to buy stocks at
1,000 yen...would not touch them at 400 or even 300. Golf
memberships that were worth $100,000 a year earlier could
not be sold for half that amount in 1990. No one wanted
to go into debt...even at zero interest.
What was true in the world's second largest economy,
however, was not in the first. The psychological cycle in
America remained fully bullish. And institutional
investors soon found a way to put Japan's free money to
use. They created the "carry trade." The idea was to
borrow yen...and buy U.S. Treasuries...and then use the
bonds as collateral in an equity account. This worked
like gangbusters. In effect, it funneled borrowed money
from Japan into U.S. stock markets. Stocks lifted off and
never really looked back. As stock prices rose, more and
more people saw the stock market as a money machine. You
just had to get in line. Get a ticket. Climb on board.
The machine would do the work. Heck, you don't even have
to think about it. Just buy a index fund. Almost everyone
in America wanted a piece of this action.
After the Asian currency crisis, the money spigots all
over the world were opened even wider. Again, most of the
money seemed to flow in the U.S. markets. But into fewer
stocks...the boom had become a bubble. American consumers
did their part too. They eagerly bought the world's
surplus production...and paid for it in dollars.
Now the world is awash in dollars. And America is awash
in wealth - on paper. The source of this wealth is not
savings...not additional productivity...not the
Internet...not the new era.
It is debt.
This can clearly be seen by looking at a chart of gross
debt relative to GDP. Debt as a percent of GDP has gone
from about 150% to 260% since the Plaza Accords. GDP is
about $9 trillion. This implies an increase of about $10
trillion in debt. Meanwhile, the paper value of the stock
market has gone from in the neighborhood of $5 trillion
to nearly $15 trillion...an increase, coincidentally, of
about $10 trillion. This is the juice...the expansive
energy that has ballooned stock prices in America, taking
them far above the ground of gold, oil and the economic
output to which they were formerly tethered. Many stocks
are now at prices equal to those in Japan at the peak of
its bubble. AOL, which advanced yesterday, trades not at
70 times earnings...but 200 times. (Note: Last Thursday's
Commerce Dept. release puts the current total GDP at $9.3
trillion... the NYSE estimates the total market cap of
the US stock market as of May, 2000 at just over $16
tillion... and today, AOL is down nearly 50% from it's
52-week high of 94 - but it's still trading at 109 times
The bubble in America must be near its end. Because, as
Bill King puts it, "Japan has gone Volcker." Oil is
priced in dollars. Japan imports all its oil. It can no
longer afford to export valuable goods and get U.S. paper
in return...pretending that each dollar is just as
valuable as the last. It has to use those dollars to pay
for oil...which has gone up more than 30% this year.
The carry trade is finished, too. It only worked as long
as the yen fell...or remained steady...against the
dollar. Those days are over. (Note: by August of 1998 the
yen had fallen to nearly 145 to the $US, today it's
trading at 109...Addison)
This is the drama that is unfolding now...and why "all
eyes are on Japan." If Japan really has "gone Volcker,"
the yen will rise further...the dollar will fall...and
the bubble will burst soon. Stay tuned.
Your correspondent staying tuned,
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Last modified: April 01, 2001
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