Contributed by Bill
Publisher of: The
Fleet Street Letter
WEDNESDAY, 22 AUGUST 2001
of a Bust
*** Poor James Glassman...if only he had half a brain!
*** Greenspan cuts rates for the 7th time...has he
finally appeased the gods?
*** Oh la la...it doesn't look good for investors:
stocks at their highest levels ever, as the world sinks
|*** Poor James Glassman. If only he had half a brain! |
*** He should have panicked when the fear first came
creeping up his back.
*** Instead, he let his left brain talk his right brain
out of doing what it wanted to do - sell out. He's
holding "for the long run" - when, he's darned certain,
stock prices will be higher. They're always higher in
the long run, aren't they? Life always gets better,
*** Well, yes...except when it gets worse.
*** Yesterday, things got worse for investors worldwide.
With no virgin and no volcano anywhere in sight, Alan
Greenspan cut the fed fund rate by another quarter of a
point. It was hoped that this 7th cut would do that which
the previous six had been unable to do - touch off the
"rocket fuel" of cash that is said to be lying around.
But instead of shooting up...the stock market blew up.
*** Eric, can you give us the details?
Eric Fry in New York:
- The Dow Jones Industrial Average dropped 146 points
yesterday to 10,174, while the Nasdaq Composite Index
tumbled 50 points, or 2.7%, to 1,831.
- Greenspan seems like a nice enough guy and it's clear
he means well, but can somebody please tell him that his
interest rate cuts don't really do anything?
- Stocks, in particular, are putting the lie to the myth
of Greenspan's magic interest rate. They've been
declining all year. No doubt about it, the stock market
is a rough place these days. How rough? Even James
Cramer, theStreet.com founder/columnist and self-
anointed investment guru, is losing money.
- Cramer's personal portfolio, updated daily in the
"RealMoney" section of theStreet.com, has lost 8% since
April Fool's Day, 2001. The starting date is, I'm sure,
- The genetically bullish Abby Joseph Cohen reduced her
earnings estimates for the S&P 500 and trimmed her year-
end price target - again - for the index from 1,550 to
1,500. Considering that the S&P 500 currently trades at
1,157, she has left herself plenty of room for future
price target reductions.
- Neither Cramer nor Cohen's brand of investment genius
operates "24/7," but only in bull markets. In bear
markets, it's a pretty safe bet that Mr. Market doesn't
care what either one of them predicts.
- Down in the dark, dank caves far removed from proper
society, where gold bugs, class-action securities
lawyers and other social outcasts congregate, the
question on every investor's lips has been, "Is this the
- Is it? Could it be? Is this the beginning of the epic
new millennial gold rally?
- The bullion price has advanced about 4 � % over the
last three weeks. What's more, the XAU Gold Stock Index
has gained almost 14% since Greenspan kicked off his
rate-cutting adventure on January 3rd. By contrast, the
Dow has dropped more than 4% since then and the Nasdaq a
perfect bear market 20%.
- It's enough to make a guy bullish on gold.
Back to Bill in France...
*** Oh la la...as we say here in La Belle France...God
does not share His plans with us here at the Daily
Reckoning. But He occasionally drops a hint.
*** The Wall Street Journal reports that P/E ratios are
typically understated, because companies tend to inflate
the divisor, that is...earnings. If earnings were
brought down to GAAP standards, the P/E ratio of today's
S&P 500 would be 36.7 - the highest it has ever been.
*** So, let me pose a rhetorical question; Does it make
sense to own stocks at the highest prices in history
-rate cuts have just been cut for the 7th time -
after which, investors dump stocks!
-consumers are tapped out - savings are at their
lowest level ever, consumer debt at its highest
-durable goods orders are falling - they fell 2%
in June, after a rise of 2.7% in May...car sales
dropped 5% in June
-unemployment is rising - AOL announced another
1700 layoffs yesterday. Ford says it is cutting
5,000 jobs. And Futjitsu is eliminating nearly
-world trade growth is off 60% since last year...
while world GDP growth is falling below the IMF's
2.5% recession threshold
-business profits are falling...down 17% in the 2nd
quarter with no sign of improvement...
-And the dollar is, finally, going down?
*** People believe in stocks "for the long run" because
equities tend to go up more often than they go down. But
nature does not give something away without taking
something back. In order for stocks to go up most of the
time, they have to go down A LOT some of the time...
This may be one of those times.
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The Daily Reckoning Presents: A Guest Essay in which the
author takes a look at the "vicious cycle" currently
consuming the markets...
ANATOMY OF A BUST
by Eric J. Fry
The vicious cycle of falling corporate profits that
prompts cuts in capital spending and layoffs, that
fosters less consumer spending, that leads to even lower
corporate profits - it's just getting warmed up.
During the boom, $50 million, give or take, would buy a
standard suburban garage stocked with two PCs, two
recent college grads and a B2C business plan scrawled on
a napkin. We called this "investing" - or more
specifically, venture capital investing - and, from
coast to coast, folks lined up to give it a whirl.
Since then, we have learned that $50 million is a lot of
money, especially when it is gone. We have also learned
that much of what passed for investing was nothing more
than rank speculation. Like a bottle-blonde, it only
looked like the real thing. Enter the bust, phase one:
Billions of dollars of VC money went "poof," along with
another $5 trillion or so of stock market wealth. And
sooner or later, we're going to miss this money.
The astonishing thing is that hardly anybody acts like
it's gone...so far. The line of people at Starbucks
waiting for $5 cappuccinos is just as long as it's ever
been. (I know. I stand in it.) What kind of pathetic
excuse for a bust is this? Five trillion dollars
disappears and still people buy lots of expensive cars,
houses and espresso drinks.
"A few quarters of weak GDP growth? A collapse in
capital spending offset, in part, by the indomitable
leveraged consumer? Is that all there is?" colleague
James Grant muses. "No, it seems to us. The millennial
adjustment is far from over. Telecom and tech were not
the whole bubble, only the most visible portion."
Make no mistake, the bust isn't over - in fact, it's
just getting warmed up. All Greenspan's horses and all
Greenspan's men, not to mention all Greenspan's interest
rate cuts, won't be able to put this economy back
together again...at least not any time soon.
About the only way to get things back on track is to
clear away the debris of the boom years. "Busts are
indispensable," says Grant. "At least - behold Japan -
no proper boom can be built on the uncleared debris of a
preceding boom. What is this debris? Business and
financial error as reflected in misbegotten investment
projects, bad debts, impaired balance sheets, wild
expectations. The job of the bust is to redress these
mistakes - in effect, to mark them to market..."
"Bust" is just a four-letter word for vicious cycle. It
takes a little time to crank these babies up, but once
they start humming, there's no shutting 'em down. The
cycle goes something like this: Corporate profits fall;
businesses curtail capital spending; businesses lay off
workers; the newly unemployed and the now-paranoid
remaining workers, in their part-time role as consumers,
spend less money. And once everyone starts spending less
money, corporate profits fall even further. You get the
Come, let's take a closer look at the bust currently
underway. First off, corporate profits are falling. The
surge in productivity that Greenspan and all the ivory-
tower dwellers crow about did not prevent business sales
from dropping 1.1% in the second quarter - the first
such decline since the last recession in 1990.
Expressed another way, the quarter-to-quarter annualized
decline in business sales registered at a minus-2% rate
in the first quarter and worsened to minus-2.8% in the
second quarter. "Meanwhile, [corporate] profits stumbled
from a year-to-year growth rate of 19.8% in Q3 2000 to a
21% decline by Q1 of this year," reports Moody's.
"Without a real upturn in revenues and profits...it is
hard to imagine hiring activity gathering speed..."
Indeed, quite the opposite is occurring. Cutting
expenses is the hot topic in boardrooms across the land.
Businesses are slashing both discretionary capital
expenditures and non-discretionary costs, otherwise
known as employees. After rising by a cumulative 287,000
in the first quarter, non-farm payrolls reversed course
in the second quarter, shedding 217,000 jobs. "The
annualized growth in state unemployment benefit
recipients soared from 37.5% to 90.1% over the same
span," Moody's relates. "July's 3.06 million state
unemployment benefit recipients was the highest [number]
since October 1992." Clearly, hiring activity is not
Furthermore, a decline in hours worked reflects the
weakening demand for labor. "After rising by a meager
0.2% year-to-year in the first quarter, hours worked in
the productivity series declined 0.5% annually in the
second quarter," observes Moody's. "Hours worked last
year entered into a year-to-year decline in 1990's third
quarter, or what was the first quarter of the last
recession. Since 1950, annual drops in hours worked were
recorded in nine instances," Moody's goes on. Eight of
the nine coincided with recessions.
Enter Greenspan, armed to the teeth with rate cuts and
money-supply growth. His six rate reductions in six
months were - like Evil Knievel trying to jump the Snake
River Canyon - an audacious feat never before attempted.
Throughout its 88-year history, the Federal Reserve had
never before cut the discount rate six times in less
than six months (thank you, James Stack).
Greenspan has "succeeded" in cutting rates, to be sure,
but the cuts seem to have done little more than reduce
the number of Denny's "Grand Slam" breakfasts that
retirees can afford to buy each week. Neither consumers
nor businesses are borrowing as much as hoped, or, for
that matter, as much as needed.
Throughout the Greenspan regime, the Fed has always
attempted a kind of recessionus interruptus whenever
trouble loomed, by fostering an environment in which it
is easy to borrow money and, therefore, to spend it. In
other words, the Fed lowers interest rates and expands
the money supply, thereby enabling banks to lend more
money at cheaper rates.
Businesses and consumers then avail themselves of the
"inexpensive" debt and start spending money they don't
have. Soon, the economy recovers, and paying back those
old debts becomes no worse than a manageable nuisance.
At least, that's the theory.
This go-round is no different, as far as the Fed is
concerned. Greenspan's game plan for reversing the
current slowdown relies on the hope that businesses and
consumers, even if they stop spending the money they
actually earn, will start spending whatever money they
can borrow. But it's not happening and that's why this
economy is in trouble.
Initially, when the Nasdaq bounced last April and a
handful of economic indicators followed suit, the Fed
seemed to be succeeding in its mission to revive the
economy. But that brief respite now looks like a fluke,
more the result of surging home-equity borrowing than
any Greenspan magic. But for the largesse of home loan
lenders and their relaxed lending practices, our economy
would be in the tank. Mortgage refinancings through July
surged 469% year-over-year.
"Aha!" you say, "the result of lower interest rates."
Not quite. Many homeowners refinanced not to lower their
payments, but to take equity out of their homes. Fully
half of this year's record $660 billion of refi
transactions put money in the borrower's pocket,
according to Mortgage Servicing News. In most of these
cases, the monthly mortgage payment actually increased.
Susan Sterne, of Economic Analysis Associates,
Greenwich, Conn., reports that home-equity mining has
become, for some, a kind of career. "There are people
[in hot areas] who live on refis of appreciated
housing," Sterne says. But not even a record $660
billion of refi cash can compensate for $5 trillion of
stock market losses and rising joblessness.
All the more so because home-equity mining looks to be a
one-off phenomenon. Putting aside the unthinkable
possibility that home values might decline, thereby
slamming shut the door to more home-equity borrowing,
the willingness and capacity to borrow, both practically
and psychically, may be pushing up against the limits.
"Private sector credit as a percentage of GDP has fallen
to 137% (from a peak of 143% in 3Q00)," Walker and
Fishwick observe. "Bank lending to commercial and
industrial categories is now running negative year-over-
year. Commercial paper outstanding to non-financial
companies has fallen to $234 billion from its peak of
$350 billion a year ago."
Which brings us back to the beginning of our vicious
cycle. If businesses and consumers don't spend,
corporate profits don't rise. In fact, they fall. If six
rate cuts have not managed to break the downward cycle,
why should the seventh?
Eric J. Fry, the Daily Reckoning's "man-on-the-scene" in
New York, is the former editor-in-chief of
grantsinvestor.com. Mr. Fry has been a specialist in
international equities since the early 1980s and was a
portfolio manager for more than 10 years.
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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.