*** Value is back! Investors are still very bullish...
*** Money rushing into equity funds...but not tech funds...
*** Three predictions...credit quality slipping...euro
holding...Edward turns 7 on this, the anniversary of the
most devastating single event in 20th century history...
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*** There was a "return to the tried and true," yesterday.
In with the Old - out with the New. "Value investing" is
back in style, said the International Herald Tribune.
*** The Dow rose 159 points. It is now only down 4.5% for
the year.
*** The Nasdaq fell 35 point. It is off 16% for the year.
*** But investors have short memories. They seem unable to
recall the world in which George W. Bush got arrested for
drunk driving, when the Dow was below 1,000 - and sinking.
The 'old' - in investors' collective memory - goes back no
farther than 1982, when the Dow began the longest and most
impressive bull market in history.
*** Despite disappointments in dot.coms and now Big Techs,
people are still very bullish. Richard Russell reports that
last week $11.4 billion of new money went into equity
mutual funds. Through August, the year-to-date total was
$255 billion - twice the level of a year ago.
*** The public now owns $4.4 trillion of mutual funds - a
figure that was only $1.3 trillion in 1995.
*** But while the public still believes in stocks, it seems
to have lost faith in Technology. Cisco fell 1 5/8 ahead of
announcing its results. Then, after the market closed,
Cisco said it beat estimates by the usual penny. Still, in
after-market trading, Cisco shares fell.
*** Cisco announced that sales and profits were up 67%
above last year. But the "actual net income" was only 11
cents a share - about the same as last year. The stock,
once $82, now trades at $55 - still about 70 times
earnings.
*** "When Cisco Systems tells Solectron Corp. to jump,"
writes Grant's Investor Eric Fry, "the contract
manufacturer says, 'How high?'" After all, some 12% of
Solectron's revenues come from making widgets for Cisco.
But when it comes to creative accounting, Solectron can
hold its own. "[Selectron] will report what it wants, how
it wants. And if the company feels like revising its fiscal
2001 earnings forecast both higher and lower on the same
day, it will do that, too..." (See: Earnings Went Thataway)
*** Linux fell 42% to $17 and change. It was $320 a year
ago. What were investors thinking?
*** "The evidence is in," writes Uncle Harry Schultz, who
economizes on verbs and articles, "Tech funds are
shrinking; value funds increasing (in number & price).
Nasdaq in major downtrend; DJIA hanging in here. My longer
view: Nasdaq bear market will continue til decimated. But DJIA
will stagger sideways in wide trading range, shorterm,
benefiting from money flowing out of tech. 'Tech' will be
the new dirty 4-letter word."
*** Richard Russell: "My own belief is that the public will
remain bullish unless or until the Dow breaks below its
bear market low of 9796.03, the low that was recorded last
March 7."
*** Since I am surveying sooth-sayers, I will say some
sooth myself: I don't think there are many Dow Theorists
among the lumpeninvestoriat. The 9796 mark will come and go
with hardly a soul noticing. Investors will not abandon
stocks willingly. They will have to be destroyed by them
first.
*** William Fleckenstein quotes Justin Manis on how the
bottom will be reached: "Changing valuations from crazy to
merely excessive is not the way a bottom forms... 'fair-
value' if such a thing exists at all, is never a market
bottom, because historically important bottoms are made at
extreme undervaluations.
"If/whenever that 3,000 [Nasdaq] neckline is decisively
broken," Mamis continued, "the floodgates of selling will
open. Any declines that follow such break will terrify the
public... Excuses that 'It's only a paper loss' will no
longer ring true - the losses will look very real because
the much higher prices they paid will no longer look
achievable! Once someone knows he won't ever get his money
back, his mind switches to the other extreme: 'Then the
hell with it.'... the public sells down, not up."
(see: Bubble Splat: The Week Gets Off To A Sloppy Start)
*** The WSJ includes a warning from Bruce Bent, who helped
develop the money market mutual fund industry. Bent notes
that the risk of holding money funds has quietly increased:
"People are going into money funds," he says, "and they are
not getting what they think they are getting." Fund
managers have been increasing yields by buying more
marginal paper - such as commercial notes, asset-based
securities and short-term funding agreements. As Ray DeVoe
put it, "More money has been lost reaching for yield than
at the point of a gun."
*** The decline of credit quality was a major theme at the
contrarian bear fest hosted by Jim Grant in New York last
week. Our man on the scene, Thom Hickling reports:
"The historic mortgage finance boom continues to drive a
national real estate boom," according to Charles Peabody of
Mitchell Securities. During the second quarter, 83% of
household mortgagers took out loans at least 5% larger than
the previous loan amount - or stated differently, they
pulled out at least 5% equity. For comparison, during last
year's second quarter only 58% pulled out at least 5%
equity.
"Last year, 7 banks failed. Estimates are that 12 - 22
banks will fail in 2000. And some think that the regulators
are going easy on the big banks because of the elections.
It could be setting the stage for many more bank failures
to come. During the '91 recession 127 banks failed and
nearly $6.2 billion was lost.
"Bankruptcies will be heading up in 2001. There's about a
18 - 24 month lag between big credit card marketing
campaigns and ensuing rises in bankruptcy filings. After a
slight downturn, filings are moving up again...well over
300,000 in the 2nd quarter of this year.
"Expansion of credit card lines reached $2.8 billion a new
record. Credit card companies are aggressively marketing to
higher risk clients."
*** Meanwhile, the euro held above 86 cents yesterday. The
low point for the euro occurred on Oct. 25th at 82.96 cents.
It is possible that the euro will collapse to lower lows.
But is also possible that Great Currency Battle has turned
against the dollar... Yes, more below...
*** "An investor will succeed by coupling good business
judgment with an ability to insulate his thoughts and
behavior from the super-contagious emotions that swirl
about the marketplace." - Warren Buffett.
*** My friend John Forde celebrates his birthday today,
along with Leon Trotsky, and my son Edward, who turns 7.
*** This is also the anniversary of the Bolshevik
coup d'etat in Russia. For the next 70 years, Russians were
trapped by the logic of communism and the terror of the
KGB... Americans are now trapped too, albeit much more
comfortably, by the logic of democracy and the terror of
the IRS.
Time to Buy the Euro? Buy it in an FDIC-insured Deposit
Account!
The dollar is at historical highs... the euro at its low.
Perhaps it's time to hedge your portfolio, earn interest
and seek capital gains. Buy euro CDs and deposit accounts
(also available in over 30 other major currencies) -
available from everbank.com World Markets. Just one of the
many valuable service offered by everbank.com, a division
of Wilmington Savings Fund Society, FSB!
To learn more, e-mail: currency@everbank.com, or call the
trading desk at 800.926.4922 ext 1. For more on on-line
banking and all everbank.com products, visit the everbank
website:
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* * * * * * * * * * * * * * * * * * * * * * * * * * * * *
""[W]hat the United States owes to foreign countries it
pays - at least in part - with dollars that it can simply
issue if it wants to."
Charles de Gaulle,
President of France
1965
"I agree that the dollar is probably over-rated," wrote a
Daily Reckoning reader, in response to my harping on the
subject, "but if not the dollar...what? Surely not the
euro..."
Longtime Daily Reckoning masochists know that we live in an
imperfect world. Justice is not meted out with the
regularity and fluidity of laxative elixirs; nor are fools
as quickly or dependably separated from their money as,
say, married men or IRS audit victims. Even the earth
itself tilts on its axis... and migratory birds, responding
to the seasonal impulses triggered by the listing globe,
sometimes get lost.
And yet, somehow, sometime, somewhere - the books are
balanced. People get what is coming to them. After 180
days, the sun is back in the sky as it used to be...and
life goes on.
With this rather poetic approach to the mishaps and cycles
of life, we take yet another peek to see if we can spot
that yeti of the currency markets - the bottom of the euro.
We will also suggest an alternative.
The trigger for this reflection, should you wish to blame
someone, was an article in Grant's Interest Rate Observer
(http://www.grantspub.com.) In this piece, Grant proposes
an answer to the question posed by our reader above. If not
the dollar, what?
Well, the New Zealand dollar...for example.
The fall of the dollar has never been a popular theme with
Americans. It does not resonate in the collective
imagination the way "the top 1% of taxpayers" or "saving
Social Security" does. Americans feel they have little
direct stake in the international value of the dollar. So
what if it falls? Doesn't that make U.S. goods more
competitive on global markets?
Yes, it does. And the fall of the dollar is not a bad
thing, in any case, just like the fall of the Big Techs is
not a bad thing. Both are merely the market's way of
restoring balance - and making sure people get what they
have coming to them.
That is probably the disturbing point to most Americans.
After a spending spree that has been going on for
years...and one that has driven savings rates down to
negative levels...there must be many people who ask
themselves, perhaps in a quiet moment, when CNBC is turned
off, how it could be that they are able to buy a new car or
a new house, without earning more money or saving any?
There must be a nagging suspicion that there must be a
catch somewhere.
The catch is the dollar itself - which has made this
spending spree possible.
Peter Bernstein, in his book The Power of Gold, observes
that even the discovery of huge new supplies of gold in 15th
century did not actually make the Spanish richer. The money
came in from the New World...it was spent...and it was
gone. The world's supply of gold increased. But Spaniards
got no lasting advantage. In fact, they were probably made
poorer by the whole episode, as the easy money actually
discouraged investment in productive enterprises.
The rising dollar has given Americans a similar increase in
purchasing power. Foreigners were happy to accept it in
payment for goods and services...and to lend dollars to
American businesses and institutional borrowers. The circle
seemed virtuous - Europeans saved, Americans borrowed.
Foreigners produced. Americans bought. U.S. corporations
(including mortgage lenders such as Fannie Mae & Freddie
Mac) borrow the excess dollars accumulating in Europe, for
example, allowing further consumption spending by
Americans.
Not only does the willingness of foreigners to lend money
fund the current account deficit, it actually increases the
value of the dollar. Grant explains: "To buy these
securities [bonds issued by Fannie Mae, for example], they
have obtained dollars by selling their own currencies,
euros not least. In this way, foreigners underwrite more
leveraged American balance sheets while contributing to the
rise of the dollar exchange rate."
But at some point, for no particular reason and at no
predictable time, the virtue of the circle is called into
question. Perhaps, a slip of the tongue by Alan Greenspan,
or Wim Duisenberg, or George Soros... maybe just a rumor...
or a moment of clarity, such as the one that struck then-
president of France, de Gaulle, in 1965, when he observed
that the Americans could not only pay for things with
dollars but also control their value.
"What lends value to a paper currency?" asks Grant. "Is it
approximately the same set of psycho-speculative factors
that caused the boom and bust in U.S. Internet stocks? If
the answer is 'yes,' as we believe it is, the currency
markets are driven by momentum, not value."
Momentum will carry a collective sensation a long way.
Whether it is a stock, an army, or (Edward's favorite)
Pokemania, it can go much further than you might think. But
fads eventually pass and financial assets are eventually
marked down to their real values.
So what's the dollar worth? "We see in the dollar," writes
Grant, "the world's least rare financial claim. Believing
in neither a New Economy, nor an Old Economy, but only in a
Cyclical, Evolving Economy, we refuse to accept that the
world's demand for dollars is infinite."
There must be times when the shelves that hold dollar-based
assets become temporarily over-stocked. It is impossible to
tell for certain if this is one of those times or not. But
since the world's press is so overwhelmingly favorable to
the greenback, we can't help but think that supplies must
be bountiful. A value investor with a contrarian streak
might well decide to lighten up on the greenback, just in
case.
Which brings us back to the question at the beginning of
this letter. If not dollars, what?
Grant's suggestion: Kiwi bonds. The New Zealand currency is
down 40% over the last 4 years - from about 70 cents U.S.
to around 40 cents. Readers of the world news will
instantly identify a culprit - New Zealand's government
took a left turn a year or so ago. And yet, bond yields,
growth rates, interest rates and balance of payments
considerations provide no corroborating evidence. On the
fundamentals, the Kiwi dollar is no worse than other
dollars.
And yet, thanks to the momentum recently, and perhaps even
still, favoring the U.S. currency, prices in New Zealand
are marked down by 40% since 1996. Houses, stocks,
businesses - all are available at a deep discount. Telecom
Corp. of New Zealand is priced to yield 8%. Several of my
friends report that beautiful farms and ocean-front acreage
can be bought at giveaway prices.
There are also Kiwi bonds. The 10-year note yields 6.75% -
about a full percent more than similar U.S. notes. There is
a risk, of course, that the Kiwi dollar could decline even
further. But probably the greater risk for the average
American is that it will not. We may have already seen the
top in the dollar on October 25th. If so, Kiwi bonds will
turn out to be very good places to sit out the bear market
in U.S. stocks.
Your humble scribe... seeing euro bottoms everywhere he
looks...
Bill Bonner
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