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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

BALTIMORE, MARYLAND 
THURSDAY, 14 DECEMBER 2000 

 

Today:  Ship of Fools

*** What happened to the post-election rally?

*** More evidence of deflation...PPI comes out today...

*** Telecoms set to lose more than dot-coms...why the 
natural gas shortages...and more.

*** Not much of a rally. In fact, hardly a rally at all.

*** You may recall, when we left off yesterday, investors 
were ready for the long-awaited post-election rally. Well, 
the post-election finally arrived...and GWB, as fine a post 
as any, won.

*** Gore was more wooden, but Bush had more friends in high 
places, notably the U.S. Supreme Court. And so we have a 
new Commander in Chief.

*** Stocks didn't seem to care. The Dow barely moved - up 
just 26 points. And the Nasdaq resumed its losing ways - 
giving up 109 points.

*** The nation's favorite big techs were mostly down - with 
Intel off a buck. Microsoft fell more than $1. Oracle 
dropped $2.25. IBM lost $2.50. Cisco went down $3.25. And 
Juniper plummeted more than $6.

*** Since election day, the S&P 500 has fallen 5%. The Dow 
is only off 1.5%. But the Nasdaq has slumped 17%, with the 
Internet sector sinking 37%.

*** So what's new? Well, bonds rose. The dollar moved 
little...and the price of oil fell 94 cents. 

*** The Producer Price Index comes out today. It is not 
expected to reveal much of an inflation risk.

*** That's because the risk is on the other side. People 
are hoping that Mr. Greenspan will lower rates next year -
and that the economy will come to rest at a more moderate 
rate of growth. This is the "soft landing" that - like the 
Big Bottom - the financial press thinks it sees all the 
time.

*** But the problem in the U.S. economy is not that credit 
is too tight - it is that it has been far too loose. As a 
result, too many people owe far too much money - and have 
too little to show for it. Consumers frittered away money 
they had never earned...and businesses invested trillions 
in projects with a much lower rate of return than the cost 
of capital.

*** You don't solve these problems with lower interest 
rates. You solve them with bankruptcy, defaults, work-outs, 
cutbacks and real savings.

*** "Of the 300 CLECs operating in the United States, only 
two are profitable," said John Windhausen, President of the 
Association of Local Telecommunications Services. An 
estimated $150 billion has been lost in dot.coms. An 
article at prudentbear.com by Marshall Auerback explains 
that "in today's turbo-charged world of new economy 
finance, this sum is but a pinprick of the scale of the 
credit problems likely to result from faltering telecoms 
and Internet infrastructure companies. Here, the quantities 
of debt held by several leading household names (AT&T, 
British Telecom, KPN, Cisco, Lucent, Germany's MobilCom, 
and France Telecom to name but a few prominent examples), 
and the concomitant deteriorating backdrop for their 
respective businesses, imply future debt write-offs and 
possible bankruptcies that will dwarf those of the 
dot.coms."

*** Alan Greenspan recently discussed the problem as 
follows: "In many respects, the situation may be analogous 
to a phenomenon of which I am sure many of you are all too 
painfully familiar - the tendency to overbuild in 
commercial real estate when low vacancy rates prompt 
commercial building starts well beyond the point that, on 
completion, could be supported by the ongoing growth in 
demand. Problems have even arisen among a number of well-
established companies whose forays into uncertain newer 
technologies have come up short."

*** "But ultimately," Auerback continues, "the biggest 
losers are the millions of investors who have bought into 
this nonsensical rhetoric about the new economy, whose 
euphoric expectations were stoked by people who ought to 
have known better than anyone how to recognise and prevent 
a financial mania." 

*** The telecoms have hundreds of billions in debt already. 
But even that will not be enough. They have bought 
expensive licenses and made commitments for hundreds of 
billions more in capital investment.

*** Where will they get the money? People who expect Fed 
rate cuts to automatically make cash available to these 
high-risk borrowers are going to be disappointed. Lenders 
need to be compensated for the risks that they have, 
suddenly, noticed. The result will be higher effective 
rates for the people who actually need the money.

*** This is not a set of conditions likely to end up in a 
soft landing. The Financial Times reports that the chief 
economist for HSBC, Stephen King, "believes that even 
aggressive rate cuts may not be sufficient to prevent a 
hard landing. This is because of the irrational exuberance 
that prevailed in the late 1990s - companies have over-
invested, consumers have over-borrowed, and banks have 
over-lent. All three will decide to cut back whatever the 
level of interest rates."

*** "The US is now showing severe symptoms of distress," 
writes King. "Banks are showing a degree of credit 
constraint last seen during the early 1990s' hard landing. 
The collapse in the Nasdaq carries enormous implications 
for the cost of capital. The deterioration in household net 
wealth this year is an event that, in the past, has been a 
precursor to recessions." 

*** Meanwhile, unionised bank workers in Seoul decided that 
they would not take a credit crunch sitting down. They took 
the chairman of Kookmin Bank hostage until he agreed to 
discuss future merger plans with the union.

*** And energy is in the news on this cold, rainy morning 
in Baltimore. Natural gas was about $2 per thousand cubic 
feet last year. Now it trades for between $9 and $20. U.S. 
Senator Frank Murkowski wanted to know why "the demand for 
natural gas in the future has been grossly underestimated." 

*** He's got a point. It's not exactly rocket science. 
Still, even in this Information Age, it is ignorance that 
moves markets - not information or knowledge. Apparently, 
nobody bothered to check the fuel gauge until the snow 
started to fly. Meanwhile, inventories of computers and 
manufactured goods rose - beyond what the market could take 
up.

*** People don't like the uncertainty that markets - and 
life - produce. They much prefer the false security of 
politics. Thus, a headline on today's newswire: "Energy 
crunch adds to deregulation doubts."

*** A modest prediction: millions of people will go broke 
in the coming downturn. More than a million bankruptcies 
are expected in the coming year alone - without forecasting 
a major bear market or recession. These people will not 
blame themselves for making bad investments. They will 
blame anyone and everyone they can. There will be 
lawsuits...criminal charges...and the demand for greater 
regulation.

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SHIP OF FOOLS


Some people take abstract ideas so seriously they are 
dangerous. An article in Monday's International Herald 
Tribune told of a cruise organized by The Nation magazine. 

"Caribbean Sea, 18 miles off the southwest point of Cuba" 
began the article, helpfully pinpointing the cruise ship 
for anyone with a handy missile and GPS. More than 300 
"silver haired pinkos," as the IHT called them, readers of 
The Nation magazine, "sipped coffee and ate breakfast 
pastries in a dimly lighted auditorium, where they had 
gathered to hear a lecture about the environment titled, 
'Are Humans an Endangered Species'." [many of the attendees 
no doubt hoping the answer would be positive].

They had each spent an average of $2,400 to join the cruise 
- on a Holland America ship which must contribute massively 
to the global warming these people fear...and operated with 
a non-unionized crew.

For the money, they got the dubious pleasure of listening 
to panellists such as Tom Hayden, Barbara Kingsolver and 
Molly Ivins discuss topics such as "chlorocarbons, 
atmospheric radiation, God and global warming" - topics 
that none of them actually knew anything about.

But that is the nature of Big Ideas - they allow people to 
divert their attention from the real problems of everyday 
life - with its uncertainty, complexity and baroque 
absurdity - to big problems that they can pretend to 
understand and do nothing about.

I have promised a fuller introduction to the Daily 
Reckoning. In today's letter I will let you in on our 
little secret...the insight that gives us, I believe, a 
competitive advantage.

The secret, dear reader, is that the Daily Reckoning 
harnesses the power of modern life's most underrated 
resource: ignorance. Or maybe you guessed as much?

At last night's dinner, a group of executives from our 
publishing company sat at a table in a local diner, trying 
to solve some of the business problems that confront us. We 
were not small progress, but what else could we do?

Meanwhile, the group at the next table was deeply engaged 
in another subject - politics. There were two young men - 
eager to comment on Gore's speech, which was on the TV at 
the time...arguing about how the Democrats might organize 
themselves for a comeback in 2004...and how Gore would 
likely take Hillary as the VP candidate...or would it be 
the other way around?

The older man walked with a limp and might have had severe 
arthritis - as if even his body as well as his soul had 
been corroded by too many years as a political hack. Like 
the silver-haired pinkos, this man seemed to have an answer 
for everything.

As I discussed yesterday, Darwin left the world in 
ignorance. He merely described the evolution of species as 
he saw it. Likewise, the Efficient Market Hypotheorizers 
described the movement of stock prices - as best they could 
make them out. But both ideas were taken up by the mob, 
vulgarized and hollowed-out...giving the "pretense of 
knowledge"...and ultimately producing grotesque results.

If random mutations and the `survival of the fittest' were 
the guiding principles of life, reasoned the Darwinists, 
then God really was dead, just as Nietszche said. 
Henceforth, there could be no sin. Even murder could be 
redefined as the process of natural selection...in which 
the more fit survived while the less fit perished..

With his "you can't make an omelette without breaking some 
eggs" rationale, Stalin did not have to ask the Kulaks if 
they wanted to be collectivised. He did not have to poll 
the Black Sea Greeks to see if they wanted to be relocated 
to Kazakhstan. Nor did he need to survey the bourgeoisie to 
find out if it wanted to be exterminated. The "pretense of 
knowledge" that Darwinism gave him was enough. If he were 
able to kill his enemies before they killed him, that must 
be the way nature intended it. No punishment - either in 
this life, or the next - was expected.

And yet, if the promise of heaven is anything more than a 
empty slogan, there must be a million Bolsheviks, Nazis and 
tort lawyers roasting at this very minute.

Believers in the random movement of stock prices, 
meanwhile, seem to have engineered their own destruction. 
If stocks move in a completely random way, the only 
reasonable thing to do is to "buy and hold". Price would 
not matter...since the odds that an expensive stock would 
rise should be the same as for a cheap one.

Thus, investors were encouraged to enter the market - 
anytime during the last four years - when prices were 
absurdly expensive. "Prices always go up over the long 
run," they were told.

And now we come to a paradox. I do not believe you can 
predict the future. Yet, I also believe that prices matter. 
If you buy a stock producing $1 of dividends at $10 - you 
get a 10% return. If the stock costs you $100 - you only 
get a 1% return.

Without pretending to know the future, common sense tells 
us that the stock is a better buy at $10 than $100 - you 
can get 10 times as much for your money!

Put another way, a buyer at $100 has 10 times the risk of 
loss per share. 

But bullish investors believe risk is no problem - they, 
relying on the Efficient Market Hypothesis, think all price 
levels carry the same amount of risk, because price 
movements are random.

And yet, Smithers and Wright show that stock prices do not 
just go upwards forever. Instead, they swing from expensive 
to cheap - around a ratio called q, which measures stock 
prices in terms of book value. Historically, whenever the q 
ratio is extremely high, stock prices tend to "revert to 
the mean." Smithers and Wright describe the pull of q as 
though it were a rubber band. The farther prices move away 
from the mean - the greater the tug on the rubber...and the 
more likely stocks are to move back to the mean.

Stock prices are now higher than they've ever been, as 
measured by the q ratio. That doesn't necessarily mean they 
will fall right away...but it does mean that they are 
extraordinarily risky. 

"We expect the stock market to fall," write the authors, 
"to a level that is less than half what they were at the 
end of 1998." This implies a Dow of about 4,000.

Your very ignorant correspondent,

Bill Bonner


 
 
 
 
About The Daily Reckoning:
The Daily Reckoning... "more sense in one e-mail than a month of CNBC."  That's what readers are saying about The Daily Reckoning.

Bill Bonner, recognized internationally as a brilliant writer, entrepreneur
and publisher of The Fleet Street Letter, offers you his daily market
commentary absolutely FREE. For the first time, outsiders are getting a peek into his powerful and profitable investment insights. Bill's practical contrarian advice empowers even average investors to protect their hard-earned wealth and achieve amazing gains.

Bonner writes his email letter from Paris, France, each morning --
describing the wacky, wonderful world of investment, politics and everything remotely related. Irreverent. Sharp. Honest. Thoroughly, unabashedly contrarian. It's also among the fastest growing e-letter on the Internet.  It's a brand new service... but it has a distinguished history..

For nearly 62 year, The Fleet Street Letter, the oldest investment
advisory letter in the English language has consistently delivered
invaluable economic and political foresights to savvy investors. Current readers regularly enjoy impressive investment gains even as the market falters. Here's more from his online readers...

"My small portfolio has followed true to my wife's description of my
investment philosophy, "buy high and sell low." However, that has changed since I started religiously reading DR... I credit this reversal of fortune directly to The Daily Reckoning"
(Timothy)

" Your Daily Reckoning is the best in business commentary... mixing
serious warnings and the state of the market with gentle humor"
(Makram)

"It is actually better than some of the newsletters that I pay to
get"
(Joe)

"Your statements and philosophy have kept me from storming into the market and in fact [I'm] making some money in put options" (Frank)

Open your mind with the most stimulating e-mail newsletter that you'll ever read, The Daily Reckoning. To receive this free daily email newsletter click here now.

 
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Last modified: April 01, 2001

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