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Contributed by Bill
Bonner
Publisher of: The
Fleet Street Letter |
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PARIS, FRANCE
FRIDAY, 5 OCTOBER 2001 |
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Today:
Inflation or
Deflation?
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*** Value picks...become greater values...
*** Fed funds rate now lower than inflation...banks get
free money...
*** Inflation? What inflation? Government
payrolls...defense spending...gold...and more!
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Barron's "value picks" became slightly better
values yesterday. GE, for example, fell 2%. Fannie Mae
dropped 1%.
But who cares?
Stocks are priced - according to the Wall Street
Journal's reconstituted numbers - at 36 times earnings.
Whether they are going up or down doesn't matter. They
are far too expensive for a sensible investor. The rule
in investing is to buy low and sell high. If you buy
high, instead...it won't work (unless you are lucky
enough to sell to an even greater fool.)
But what if you are holding stocks? People don't
seem to mind holding stocks at prices they would never
buy them. But it is the same thing...you are either long
a stock or you are short. The middle ground is an
illusion...
If a $100 stock goes to $50...it doesn't matter
whether you bought it yesterday or 10 years ago...the
loss is the same.
Of course, many people believe that the huge
losses in the stock market have not really hurt
investors...yet. Because the stocks were bought years
earlier at even lower prices. The losses, they argue,
have been mostly "paper losses." But this market is now
at levels not seen since the end of '98. Anyone who
invested money after that date is facing a real loss,
not just a paper one.
Those who invested prior to the end of '98 have made
no money, collectively, in stocks for the last 3 years.
Eric...over to you...
****
Mr. Eric Fry, in the land of milk n' honey:
- The stock market was open for business yesterday, but
there was no real good reason to show up. Stocks
thrashed around all day and by the time trading ended,
the Dow was down a little and the Nasdaq was up a
little.
- Without Alan Greenspan cutting interest rates or
President Bush stopping by, what chance did the stock
market have of putting on a big rally?
- But just because the Fed Chairman took the day off
doesn't mean he won't be cutting rates again soon.
"What is clear is that in monetary matters, there will
be no erring on the side of stringency," writes Caroline
Baum of Bloomberg News. "The inflation-adjusted federal
funds rate is now -0.2 percent. In other words, banks
can get free money from the Fed and, thanks to the steep
yield curve, lend it out or buy Treasury securities for
a nice profit."
- Yet, despite Greenspan's monetary largesse, inflation
is on the minds of almost no one these days. "CPI
inflation has slowed around the world, and based on the
significant global slowdown in economic activity, it's
likely to slow even more," predicts International
Strategies & Investments.
- Maybe so. But if one feature of the investment
landscape has changed since September 11th, it is that
inflation is no longer an impossibility. The Bush
Administration will be waging just as fierce a war
against a slowing economy as it will be against the dark
forces of terrorism. The early battles in the economic
campaign feature deep interest rate cuts (so far, nine
cuts in little more than nine months) and an exploding
money supply.
- What's more, defense spending is on the rise, and not
just temporary. "Arguably the U.S. may have under-
invested in national security during the 1990s," writes
Moody's John Lonski. "As a percent of real GDP, defense
spending had dropped sharply from 1987's latest peak of
7.4% to 2000's 3.8%, which was the lowest such share
since 1941, at least. Stepped-up spending on national
security might curb productivity growth, where the
latter would eventually add to inflation risks."
- "Wartime is associated with...inflation," observes Jim
Grant in Grant's Interest Observer. "Belligerent powers
spend as necessary, borrowing to finance the inevitable
shortfall in tax receipts...No Unites States war known
to the research department of this publication has been
waged in a deflationary setting." (www.grantspub.com)
- The trend makes Jim both bearish on the U.S. dollar
and bullish on the inflation-indexed/protected Treasury
Notes known as TIPS. "[Wartime spending] has, in the
past, been inflationary, even in the gold-dollar era,
which ended in 1971. Now, the dollar is [only] a unit of
paper, convertible into nothing except small change. Yet
so persistent is the deflationary undertow that the TIPS
market, on the brink of war, is cheap."
- Increased government spending in the form of rising
defense payrolls, while somewhat helpful to the overall
economy, is a poor substitute for private enterprise.
"When government payrolls expand faster than private-
sector employment," Lonski writes, "some combination of
slower productivity growth and more rapid wage gains
have tended to emerge...When government employees rose
from the 16.5% of non-farm payrolls of the 1960s to the
18.2% of the 1970s, the average annual rate of growth of
unit labor costs shot up from the 2.1% of the 1960s to
the 6.3% of the 1970s."
- In support of Mr. Lonski's argument I submit exhibit
A: the post office and exhibit B: the DMV.
- From the glass half-full dept ISI predicts that the
U.S. economy will recover in 2002. Among the reasons
cited: G7 short rates, which tend to lead economic
activity by 12 months, peaked in November 2000 and since
then have declined a record 38% - from 4.75% to 2.95%.
This has been a much sharper decline than the -6% over
10 months in 1990 or the -17% over 10 months in
1981/1982. And more easings around the world are in
store (we expect a 2% Fed funds rate).
- Oil prices, which also tend to lead economic activity
by 12 months, also peaked in November 2000 and have
declined roughly -30% since then. Fiscal policy is
already stimulative and is likely to become more
so...federal spending, particularly defense related, is
set to accelerate.
*****
Back in Paris...
*** "Global Slump Could Last Until 2003" says an OECD
report.
*** The outlook for Japan? "Dismal." And in America? Job
losses in September were up 77% over August...and 4
times those of the level a year ago. Recession is a
"done deal." And Warren Buffett predicts that it will be
like a winter nap...longer and deeper than most people
can imagine.
*** What's more, the World Bank notes that the downturn
in growth is likely to push thousands of very poor
people over the brink. As many as 40,000 children under
the age of 5 will die, it estimates.
*** But what is tragedy abroad is comedy at home. The
forces of bullish illusions are infiltrating
everywhere...apparently even in my own business.
*** An informer in Baltimore passed along this report:
"Earlier today a Legg Mason rep. met with Agora
employees to go over 401(k) investing strategies...his
goal was to make us feel GOOD about investing...
especially for the long term (as he defined as the next
3, 5, or 10 years). Here are some of his comments
concerning today's market:
"'Today's market is UNDERVALUED'...he said...'we are at
historic lows...The market is drastically mispricing
companies.'
"I didn't want to be rude," says my source. "But, I
couldn't let him lie like this...so I asked 1 simple
question:
"I asked him how he could sit there and say our market
is at a historic low, when the average P/E ratio on the
S&P 500 is around 25 or 26...and the historic average is
11 or 12!
"His response: 'That is a good question, and I have an
answer. You see, today's companies aren't valued the
same way as they were 50 years ago. Companies today are
valued on cash flows...not simple price to earnings. (I
don't really know what that means...but I let him
continue). You see, there weren't growth companies
back in the 40's or 50's like there are today. So, to
say that a company with a P/E of 35 is overvalued
compared to a company with a P/E of 8 (in the 1950's) is
absolutely untrue. He says using yesterday's ratios in
today's market is not only impossible...but dead wrong!
"Here is his investing strategy NOW:
- OVERWEIGHT EQUITIES,
- UNDERWEIGHT BONDS
- UNLOAD CASH
"One of the WORST things to do in today's market, he
said, is hold cash. Now is the time to fully invest in
stocks...especially since they are at their 'historic
lows'!
"Here is a quote that I liked: 'Today's businesses
aren't going out of business. What we need to see is
consumer confidence...we've reached the bottom!
There's no where left to go but up!"
"I had to laugh."
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* While investors thought they were going to get rich -
they lost $5 trillion in wealth in an 18-month period.
* While consumers heeded the Fed's call to "buy...
buy...buy" - financial security was going bye-bye under
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* * * * * * * * * * * * * * * * * * * * * * * * *
INFLATION OR DEFLATION?
by Bill Bonner
Japan has seen it all. Stocks crashing for a decade.
Unemployment rising. Billions in stimulus with no
effect. Rates cut to zero.
What the Japanese have not seen is the very thing you
might expect when you give away money: inflation.
Instead, prices have fallen. Consumer prices have been
falling at annual rate of 2%, and asset prices - both
real estate and stocks - have collapsed to a third to a
fifth of their previous levels.
Here again, without hardly trying, the Japanese may have
become trendsetters.
American investors, yesterday, looked as far into the
future as they could. What they could see, we don't
know. But we know what they didn't see: inflation.
Bonds hate inflation. At the sight of inflation on the
far horizon, bonds fall in price...and yields (the
return per unit of capital invested)...jump. Yesterday,
the yield on a 10-year T-note didn't jump. It sank...to
4.46%. Meanwhile TIPS, bonds with inflation protection
built in, were paying 3.08%...a mere 0.37 % above the
current inflation rate...and only 1.38% less than you
can get from the non-protected note. This differential
is a rough measure of what investors expect from
inflation. It has reached a new, very curious low level.
It is new because never before have investors estimated
the rate of inflation over the next ten years at such a
low level - 1.38%. It is curious because never at any
time in the last 3 decades has the inflation rate been
anywhere near that low. Instead, it has averaged 1.9%
for the last 30 years and now stands at 2.7%.
Investors are betting that inflation will decline to
half the current rate...and stay at a level it hasn't
seen since the Nixon administration.
Investors - perhaps the same investors who saw no risk
of a bear market - now see no risk of inflation.
Indeed, inflation seems as remote a risk today as an
attack on the WTC was in August, a risk - at the time -
so slight that owners thought it unnecessary to fully
insure themselves.
This is doubly curious, because never - since perhaps
the Vietnam War - have governments shown themselves so
eager to do what they do best...destroy their own
currencies. And never, ever...as far as we know...has a
war failed to produce a substantial increase in domestic
prices.
"War is Keynesian," writes Gary North. It is always
financed by deficit spending and monetary inflation.
Conservatives yell and scream that they want more
freedom, but when war clouds or recession clouds roll
in, conservatives join the Establishment's Amen chorus
for more government, more restrictions on liberty, and
more inflation."
The same people who once believed a peace dividend was
good for the economy now believe a war will be even
better. Those who urged Japan to build bridges to
stimulate its economy seem to believe that destroying
bridges will be just as good.
And where once they looked with pride on a budget
surplus and a social security lock-box, they now cast
their eyes appreciatively upon deficits and an open
Congressional checkbook. If the taxpayers won't spend
their own money, they reason, government will spend it
for them...
And those who never saw an economic downturn or bear
market approaching...now see them going away, thanks to
all this stimulus provided by the Fed and Congress.
Even in this post-irony age, we feel a great paradox
coming on. Like the onset of the flu...it is but a
chill...a mere, expectant frisson now. But soon, it may
have us shaking feverishly and begging for relief.
Wars may be lost or may be won...either way, if enough
stimulating firepower is used, a nation's currency
always seems to be among the casualties.
Here at the Daily Reckoning we are agnostic on
inflation. We have little doubt that eventually the
dollar will go the way of the austral, the confederate
dollar, the sou, the livre, the reichsmark, the wara,
stamp scrip, the Old Franc, the continental, the ostmark
and every other paper currency ever created.
All things, paper currencies included, eventually
regress to their intrinsic value. The dollar will be no
exception. It has lost 95% of its value since the
Federal Reserve was set up to protect it. Sooner or
later, the Fed will succeed in eliminating the last
5%...
But, we also note that Japan has been unable to kindle
inflation - despite all its efforts. And we suspect that
Mr. Market will have some surprises for us first.
In America, people are on the hook for more debt than at
any time in history. We suspect they will twist and turn
a little...like the Japanese...before they are let off
by inflation.
Bill Bonner
P.S. But I promised that today's letter would be about
gold. And so it is.
"Gold thrives on uncertainty," observes an article from
the BBC. "And the world has shifted into a new climate
of insecurity. Risks have increased markedly. The
attacks on the United States were the start of the
drama, not the climax."
Andy Smith, precious metals analyst at Mitsui Securities
in London, and no gold bug, believes the yellow metal
"could go to $340 an ounce within the next three
months...and continue to soar after that."
Maybe. Maybe not.
But in a world of full of risk, a little bit of
insurance seems a healthy precaution. Gold, at $289,
seems cheap protection.
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| About
The Daily Reckoning: |
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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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