*** The rally sputters...can it hold?
*** The bear market in the dollar may have begun
*** And gold! Glorious gold! Up again...
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*** Richard Russell tells us that the halfway point
between the Dow's most recent high and its most recent
low is a critical level. He calls it the "50%
Principle." If after making a low, the Dow can recover
50% of its losses - and hold above that level - there is
a good chance it will continue to rise.
(http://www.dowtheoryletters.com)
*** Yesterday, the Dow rose 20 points - bringing it
decisively above the halfway point of 10,759. Can it
hold? We'll see. Does it matter? Who knows...but it
adds a little drama to our daily review of the numbers.
*** Last week's great bull explosion sputtered on Monday.
The Dow and Nasdaq still had enough momentum to end the
day in positive territory. But the advance/decline line
fell back into loss - with 1329 stocks advancing on the
NYSE and 1625 declining.
*** The price of gold continued to rise yesterday - up
$4. Gold, as explained in a research report by Paul van
Eeden, varies inversely with the foreign exchange value
of the dollar. The dollar goes down... gold goes up.
*** So, the dollar fell yesterday...a very ominous trend,
in my view. Every major sector and indicator of the bull
market has topped out - including most recently, the
Nasdaq. Et tu, greenback?
*** The euro rose against the dollar to a value of nearly
95 cents. A few days ago, financial journalists
pronounced the euro dead. They may have been a bit
premature. In fact, it may be the dollar that is ailing.
If so - the US economy and its stock market will soon be
infected.
*** The end of the bull market could be the biggest
financial story never reported (except here). It would
make imports more expensive and, thereby, begin the work
of reducing the current account deficit.
*** Working on Wall Street was not always the high-
earning, high prestige career it is today. After the
bear market of `73-'74, the Charles Schwab Corp. was in
trouble. It had only 13 employees, many of whom were
looking for other jobs. But the 80s and 90s were good to
Schwab. It grew to 356 domestic offices, 7 million
accounts, $823 billion in customer assets and a market
cap of nearly $40 billion. But now, volume is falling
and at least one company is offering to do stock trades
for free. Schwab and the other discount brokers are
being squeezed. Schwab's share price fell to 32 �
yesterday.
*** Optimism dies hard. Bill King reports that Jose
Conseco, baseball and stock market player, was on CNBC
talking about his investments. He is 90% in tech stocks
and expects the Nasdaq to hit 5,000 within 8 months.
King opines that perhaps Conseco's judgement was impaired
by the homer that "caroomed off his coconut."
*** Speaking of infections, there's a strange infection
afflicting heroin users in Glasgow. Women drug addicts
seem to develop abcesses and then about half of them die.
Health authorities believe the infection may be a type of
anthrax poisoning.
*** "A prolongation of the resistance would make for a
useless loss of blood," wrote General Erwin Rommel to the
besieged Free French forces at Bir Hakeim, North Africa,
58 years ago. "You will suffer the same fate as the 2
English brigades that were annihilated at Got Saleb the
day before yesterday." The French refused to surrender.
The Italian and German armies attacked, but the French
held out, miraculously, until they were relieved.
*** Today is, of course, also the anniversary of the
Normandy landings in WWII.
"Why should we invest our money in our own business?"
asked a business partner recently, "We could make more
money in the stock market."
The publishing business has not been a high-growth, high
profit industry in recent years. We have the opportunity
to extend our product lines, or buy new ones, but the
return on investment may be as low as 5%.
"It doesn't make sense," was the obvious conclusion, one
that must have been reached by thousands of business
people over the last few years.
I am grappling with a subtle, but important, point. The
market discounts future earnings. The discount rate is
the equivalent of society's `hurdle rate' - the minumum
return you need from an investment to make it worth
doing. The hurdle rate is usually roughly the same as
the riskless rate of return that you can get from, say,
T-bonds. If an investment won't do at least that well -
why bother?
But stocks return 10% to 15% per year. Those numbers are
taken as a minimum by investors and a benchmark by
analysts. It is presumed that there will be periods -
from a few months to a few years - in which stocks
underperform the longterm averages. But, "over the long
run," the mantra goes, "nothing beats a well-balanced
portfolio of equities."
There is short term volatility, we are told, but no real
risk if you are willing to wait out the down periods.
Thus, the return from stocks has come to be regarded as
`riskless' - and establishes a new a `hurdle rate' for
comparative investment.
But at that rate of return, relatively few capital
investments measure up. If you can build an office
building and get only an 8% return - what would be the
point? You could earn more by doing nothing.
Over the last few years, companies discovered that they
could earn more money buying the stock of other companies
than they can by developing their own business. And what
better stock to buy than your own? Not only do you earn
money from the general rise in stock prices, your buying
helps to drive up the price, which coincidentally helps
to put your own executive bonus options in the money.
Occasionally, corporations earned more from the increase
in share prices than they earned from operations. IBM, to
use one example, has been a massive purchaser of its own
shares - spending more money buying IBM shares than the
company earned.
However, a company does not become a better company -
with new and better products - by buying stock. It
becomes a better company by developing its product line.
So while IBM used its cash to bid up its own share price,
the actual value of the company (at least, theoretically)
must have declined.
If a company really could earn more from share buying
than it could from operating, it would not only buy a few
shares from time to time, it would fire its workers, lock
the doors - and put all the money to work in the stock
market.
As Mark Hulbert puts it in his piece in the NY TIMES, "If
the market's expected return is greater than a company's
return on equity, the rational thing for the company to
do is to close up shop and invest its assets in the stock
market."
Over the long run, stock market price increases cannot
exceed corporate earnings. Otherwise, the companies
would disappear - their capital values liquidated so
owners could participate more fully in the stock market.
Disappear might be the right word. Because a company
that can't produce a return on equity equal to risk free
rate of return is not an asset - it's a liability.
You find the value of a company by discounting (using the
prevailing discount rate) the stream of income it is
expected to produce. If the discount rate is greater
than the return on equity, the capital value is negative.
It has no value...or actually, negative value...since an
investor could make more money in a risk-free, discount-
rate placement.
Any company that has not made at least as much return on
equity as the average return from stocks should have been
sold off. Yet, one of the strange trends of the last few
years has been for stock in companies with negative
capital value (that is, companies that are not likely to
produce enough income to exceed the hurdle rate of
return) to rise in price. This, of course, cannot
persist.
Two professors - Eugene Fama at the University of Chicago
and Ken French of MIT - have been researching the long-
term returns from stocks. They discovered that, for the
last 50 years, corporations have been earning 11.9% on
equity. But the stock market average has been increasing
at 14.8%. How could that be? How come businesses knock
themselves out for a 11.9% return, when the owners could
have gotten 3% more without any real effort? How could
America's corporations have been unprofitable, on a
discounted basis, for half a century? Or, how is it
possible that all the publicly-traded businesses in
America would have, again discounted by the `risk free'
returns of the stock market to net present value, a
negative value?
The professors answer the question by saying that stock
market investors erred. They overestimated the gains the
stock market should produce. The expected rate of return
from stocks, say the academic duo, should be more than 5
points lower than most people think.
Looking further back, Fama and French discovered that the
stock market returned an average of 8.8% for the 70 years
from 1872 to 1949. They believe that period was more
representative of the market's true capacity to reward
investors. Their work has not yet been published, says
Hulbert, but "word of it is beginning to spread."
More on the mysteries of the discount rate...soon.
Your correspondent,
Bill Bonner
P.S. I am the victim of a new syndrome...yet to be
picked up by TIME or by the talk show circuit: road rage
on the information highway.
Mark Hulbert wrote a piece in the NY TIMES on Sunday,
which I had clipped. But between the time I read it and
this morning, when I needed to refer to it for this
article, the article was lost.
So, I asked my assistant, Addison, to go to the NY TIMES
website to retrieve the article.
Easier said than done. The website asked for our zip
code which, once given, was refused as "incorrect." We
were sure it was the right zip code, but we tried a few
others too. No zip codes were accepted. So we were
unable to pay $2.50 for the article.
So, we tried the International Herald Tribune website.
IHT had run the article too. And IHT doesn't charge to
view articles, so we would thus avoid the zip code trap.
This, too, proved unavailing. The article which appeared
in Monday's paper, for whatever reason, was not included
among the articles that supposedly appeared in Monday's
paper.
Finally, Addison picked up the phone and called the
librarian at the IHT office across town. "No problem,"
said she, "just email me with what you want and I'll
email it to you." After another phone to chase it
up...the article finally arrived.
Things don't always happen the way they're s'posed to.
And time is precious. That is why a dollar in the future
is worth less than a dollar today. How much less?
That's what the discount rate tells us.
And "in the long run," said the economist John Maynard
Keynes, whose birthday we celebrated yesterday, "we are
all dead." So, if you're going to do something
important, or something you want to do, you'd better do
it now rather than in the future. Who knows what the
future will bring?
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