*** Big drops in the Dow and Nasdaq...earnings warnings from
MSFT...
*** Debt problems...defaults...The Winter of Woe - only a
week away
*** The dollar looks weak and vulnerable...
*** I have been expecting Mr. Bear to take a little end-of-
the-year holiday break. So far, he seems reluctant to leave
his work on Wall Street.
*** The Dow dropped 119 points yesterday. J.P. Morgan and
Chase Manhattan Bank announced that fourth quarter earnings
would be well below expectations. Chase's venture capital
arm, Chase Capital Partners, reported losses of $300
million. The Street didn't like the news.
*** Yesterday, 1,183 stocks advanced; 1,695 retreated; 105
hit new high; 77 hit new lows.
*** GE - a stock with a long way to go (down) - fell 3%.
*** The Nasdaq did even worse - losing 3.3% of its value, or
94 points. This brings the Nasdaq to a loss of 32% for the
year...compared to a 7% loss for the Dow. TheStreet's
Internet index fell 4.5% yesterday - leaving the dot-coms
with a loss of 66.5% for the year.
*** I will resist the temptation to say, "I told you so."
Oops, I said it.
*** The Wall Street Journal's latest stockpicking contest
illustrates what kind of success investors are having this
year. The professionals' picks lost 32% over the last six
months. So did the public's choices. Random selections -
'the dartboard' approach - did better. They only lost 19%.
*** The WSJ also provides a clue as to why holiday shopping
seems subdued. Half of the families polled said they
expected a recession next year.
*** The dreaded Winter of Woe begins next week. People are
losing their confidence. They know something is wrong.
They're hoping that Alan Greenspan will make things right
again. But they're not sure. Abby Cohen and other
cheerleaders are still shaking their pompoms...but, somehow,
the thrill seems to be gone. Cohen says stocks are 15%
undervalued, by the way.
*** We are entering a period of major readjustment and re-
evaluation. It won't be easy...but at least it might be
amusing. The bad ideas, bad loans and bad investments of the
late '90s have to be cleared away before new growth can take
root. Before it is over, people are not going to want to
hear about stocks. And few people...sniff, sniff...will
want to read the Daily Reckoning.
*** The Bank of England joined in warning about the risk of
major defaults by telecom lenders. And Bloomberg reports a
Moody's estimate that corporate bond defaults in the next 12
months will be 3 times as great as those in the last 12
months.
*** "Credit risks have increased across the ratings
spectrum," said a Moody's official. "Every day commercial
paper costs creep higher," says another Bloomberg headline.
Commercial paper outstanding - short-term lending to
business - is at its highest level ever...$1.624 trillion.
*** The PPI came out yesterday. The annual rate of price
increases at the wholesale level were unchanged - at 3.6%.
*** Could it be that inflation has topped out? Gold and
gold shares seem unable to advance. And bond investors are
paying less and less of a premium to buy inflation-adjusted
bonds. The difference between the 10-year TIPS (inflation
adjusted) and the regular 10-year treasuries is just 1.45%.
*** The dollar seems to be at the beginnings of its own bear
market. The euro rose again yesterday...with March futures
at 89 cents. A guess: The Winter of Woe (and the next
phase of the Great Bear Market of 1999-?) will get off to a
rousing start with a sharp decline in the dollar.
*** Yesterday, the European Central Bank announced that it
would not change rates...and the U.S. disclosed another
record current account deficit - $113.77 billion for the
third quarter.
*** But maybe the news today will be better. Not likely;
Wall Street starts business this morning with 3 strikes
against it. Oracle announced last night that it missed its
revenue targets. A key executive from Cisco resigned. And
MSFT, mighty Microsoft, for the first time ever, warned that
its numbers may not measure up to expectations.
*** So today should be interesting.
*** And the latest news from home: Maria, 14, wants to be
an actress. Her career got a major boost yesterday, she
believes, when she tried out for a part on a French TV show.
Also, she reports that a man came up to her on the Champs-
Elysee and asked her if she would like to work for his
modeling agency.
*** "Maria," I warned, "I hope you didn't fall for that
line."
*** "Oh no," she replied cheerfully, "I told him to get
lost...but he gave me his card. It's Madison Agency on
Avenue Hoche...the one that Laetitia Casta works for!"
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When we left off yesterday, the "gray-haired pinkos" were
still adrift in the Caribbean...and I had revealed my secret
weapon to you:
Ignorance.
Most of the big mistakes made in this world are made by
people who refuse to give ignorance its due.
It is not necessarily what they don't know that hurts
them...but what they think they know that ain't so, as
someone artfully put it.
Thus, The Nation subscribers at the floating blab-fest have
convinced themselves that they know the planet is warming
up...and they know why...and they know what to do about it.
The scientific evidence is inconclusive. The supposed
remedy is even less sure. Nevertheless, on the basis of
this "wissen" - the pretense of knowledge they get from big,
abstract ideas - these people are willing to force the
entire world population to do as they command. They not
only organize their own lives (assuming it is not too
inconvenient or uncomfortable), but those of billions of
other people, according to the latest fad in collective
thinking.
Meanwhile, investors over the last 10 years found another
big idea they liked: the Efficient Market Hypothesis. It
told them that all they had to do was buy and hold
stocks...regardless of how expensive they became.
Today, I return to the q ratio (the price of stocks divided
by their book value or replacement costs) - and what it can
tell us.
"There is no such thing as a free lunch," says Milton
Friedman. And yet investors might have thought they were
getting breakfast, lunch and dinner - all at no expense -
over the past 18 years. Stocks went up. They went up so
much that no other investment class came close. What's
more, the EMH told investors that the returns were virtually
without risk.
Since it was thought that stock price movements could not be
predicted, there was no reason to try. Buy and hold. That
was all you needed to know.
What a wonderful world it was for investors! They knew that
stocks always go up...and that no other asset class can do
as well...and that there is no long-term risk, only short-
term volatility.
And yet...it ain't so.
Usually, there is no way to know whether stocks will rise or
fall. Prices move around - like genetic variations -
apparently at random. But that is not the whole story.
When investors feel like they have a ticket for a free
lunch, they take advantage of it. They buy stocks. Why
not? They always go up. And there is supposedly no risk.
But how is this possible? How could the stock market
provide higher rates of return than other investments,
forever, with no further risk of loss?
The answer: it couldn't. Risk varies inversely with the
perception of it. The less risk investors saw in owning
stocks, the more stocks they bought, the higher prices went,
and the greater the actual risk of loss became.
The higher rates of return in the stock market are only
possible because, periodically, the stock market corrects -
bringing the longer-term rates of return down to levels that
are competitive with other asset classes. Over the very
long run - since the beginning of the 20th century - the
real return on stocks has only been about 5% per year. But
it has been nearly 17% for the last two decades of the
century.
"The quality that makes the stock market such a good place
to invest, most of the time," write Smithers and Wright in
"Valuing Wall Street," "means that it has to be a lousy
place to invest occasionally. One of those times is now."
You may recall that a careful study of stock price movements
found them almost random. I hope you recall...because I
have forgotten the details. But it seems to me that I
reported this to you last year - when describing Peter
Bernstein's book, "Against the Gods."
Academic researchers had discovered a wrinkle in the random
price fluctuation hypothesis. When prices were extremely
high or extremely low, the odds increased that they would
revert to the mean.
Hmmm...this is exactly the common sense observation
confirmed by Smithers & Wright in their examination of the q
ratio.
"Most of the time," they write, "when markets are neither
extremely over or undervalued, q is not very important,
since it cannot be used to make strong predictions about
future returns. It is only in times of extremes that it
provides vital information. The end of the 20th century is
such a time. Q tells you that you are running huge risks if
you remain in stocks."
Stocks provide handsome returns for long periods of time.
This is only possible because, for other also fairly long
periods of time, stock market investors give back their
extraordinary gains.
"The key point to remember..." observe the Smithers team,
"is that for over one-third of the 20th century, we have
been living in bear markets and that each bear market
followed a peak in q...investors who lived through these
periods would have found that these bear markets had a large
negative impact on their living standards."
So brace yourself, dear reader.
Bill Bonner
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Last modified: April 01, 2001
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