Dark Glasses

"For now we see through a glass, darkly; but then face to face… "

Paul of Tarsus

The subject of light came up at church on Sunday too. The sun had come out after several months’ bed rest… and seemed to draw attention to itself like a fair queen in a veterans’ parade.

It is the Lenten season – in which the faithful of Christendom prepare for the most important day of the year.

"Jesus saw man who had been blind from birth," Pere Marchand recalled the celebrated story. "He gathered some dirt from the ground, spat on it, and made mud. Then, he daubed the mud onto the man’s eyes. And when he washed the mud off, he could see for the first time in his life."

"Christ offers this same gift to all of us," continued the old priest, "even if we haven’t been afflicted with blindness. He came as a ‘light unto the world’ and gives us a way to see things we could never see before."

"But it’s not easy. Heh, heh. No, it’s not easy. You have to look much harder… much deeper, beyond the surface of things, beyond appearances… and look with your heart as well as your eyes."

Again, today… we look at the remarkable US economy and its stock market with every organ we have.

Is a new boom beginning? Or is the recent run up of stock prices merely a mistake – a bear market rally that helps more of the patsies lose more of their money?

God knows.

But God does not discuss such matters with us directly. So, once more, we stagger into the warm light of a March day in the hope of seeing something new… as we try to discover not necessarily what will happen, but what should.

And what we notice first is what hasn’t happened. "By this stage of the recession," writes Rob Parenteau, "this close to an economic recovery, the corporate sector has [normally] cleaned up its deficit spending and is well into net saving territory… It is this net saving in the mid to late innings of an economic recession that allows corporations to close their financing gaps, pay down their debt and generally clean up their balance sheets enough so they can convince lenders to spoil them again in the next economic expansion. We have no such cessation of corporate deficit spending this time around – yes investment and inventory spending collapsed, but so too did profits at a pace unseen since the last Great Depression (and probably equal to the 1930’s collapses once we strip away corrupt self-dealing accounting practices from earnings measurement)."

Nor do we see the consumer sector preparing for a boom. "We achieved no net pay down of private sector debt during the recession," notes Parenteau. The consumer ‘financing gap’ – roughly the difference between what the consumer makes and what he spends – "is near a new wide for the past half century," he says. "The last time we hit this wide a financing gap was in the early ’50s. That one was closed by a breathtaking collapse in household expenditures as a share of GDP – from 74% to 67%. A similar decline from 77% to 70% of GDP today would, given the higher private debt loads, be an invitation to a full scale debt deflation in the US.

"Nearly all of the business cycle recoveries of the past half-century have been led by consumer cyclical spending (that is, consumer durables and residential investment spending). It is widely unrecognized that we are already back near the peak rates of change (10-12%) of consumer cyclical spending that we have seen in the ’90s recoveries. We never got negative y/y comparisons in the growth rate of consumer cyclical spending, as we always have in the past half-century of recessions."

Another thing conspicuously absent is business profits. The patsies have been spending as though we were at the crest of a boom, not in the gully of a recession.

Yet, profits have collapsed. What gives?

Businesses make profits by selling products and services for more than they cost to produce. An individual business can increase profits by cutting costs. But one business’ costs are another’s revenue. So, cutting costs does nothing for the economy as a whole.

The way an economy increases its profits is by selling more… or by raising productivity. With consumers already spending as though we were at the top of a boom, and more deeply in debt than every before, we can hardly expect them to do more.

But productivity? That is the great hope of Alan Greenspan and bullish economists. "The synergies of key technologies markedly elevated prospective rates of return on high-tech investment, led to a surge in business capital spending and significantly increased the growth rate of structural productivity," said the Fed chairman in July of 2001, explaining why stock prices were so high.

Consumers did their duty. They came with their credit cards. They saw new cars, TVs, houses… And they conquered their fear of insolvency by spending more than they should have on things they didn’t really need. With Greenspan’s remarkable new productivity, one might have expected business profits to soar. Greenspan said they would. Everybody thought they would. And stocks were priced as if they would.

Instead, corporate profits collapsed. Toss the operating statements on the table in full daylight… and you still will not find much in the way of profits. "Profit margins are at their lowest since the Depression in the 1930s," writes Dr. Kurt Richebacher, the Jeremiah of the economic profession.

Profits were supposed to increase, thanks to the enlightened new management practices of US corporations and the new, productivity-enhancing information technology. But, says Richebacher, "we have been emphasizing the exact opposite conclusion, that the influence of these two major changes in the U.S. economy were grossly misjudged. Instead of improving profits, they would implicitly demolish them. And that is just what has happened."

"When the economy sharply slowed in the course of 2001," Richebacher continues, "the poor profit performance turned into an outright profit disaster."

How can it be, dear reader? Are stocks really priced for profits that do not exist? Well, yes. That is why P/E ratios have gotten so high. The latest Decision Point figures put the S&P at 43.79 times sales. At the height of the bubble, stocks were not so high. And now… even if profits come roaring back – for reasons only God knows – equities will still be priced at absurd multiples of earnings.

Still the patsies, wearing dark glasses, don’t seem to notice.

What went wrong with profits? What should it mean for the ‘recovery’… and the stock market rally? Tune in on Thursday…

Your patsy in Paris…

Bill Bonner
March 12, 2002

P.S. Healing blind patsies on the street got Jesus into trouble. The Pharisees didn’t seem to mind that he had restored a man’s sight, but rather that he did it on the Sabbath. You were not supposed to do that sort of heavy-lifting on the holy day.

Finally, Jesus so provoked the authorities that they decided to crucify him. But that is a story best left to another day…

Poor Warren.

Buffett’s fortune dropped almost $10 billion last year. But at least he took it like a man. No tears stained his letter to Berkshire shareholders. Instead, he merely let it drop that the war against terrorism would never be won and that insurance companies would no longer be willing to bear the risks.

The Great Sage of the Plains also attacked business leaders who sold shares even as they were urging others to buy and "view shareholders as patsies, not partners."

But Omaha is a long way from Wall Street. And $35 billion is a long way from the average patsy’s… I mean, shareholder’s… stock portfolio.

Business leaders do regard Buffett as a partner. But what about the punter who puts $10,000 into GE… or buys 10 shares of J.P. Morgan? And who but a patsy would buy Microsoft at 100 times real earnings, or the Dow at 10,611?

Thank God for the patsies. The whole idea is to transfer money from weak hands to strong ones… that is, from the patsies to the brokers, promoters, insiders, partners and more serious investors (such as Warren Buffett)… all the while pretending that stocks are the route to wealth for the common man!

Right, Eric?


Eric Fry in New York…

– The calendar may say it’s only March 12th, but summertime has arrived already on Wall Street. The days are long and the living is easy. We should not be surprised to find Mr. Market running through the sprinklers… or slathering Hawaiian Tropic tanning lotion on himself as he sunbathes next to the pool.

– The fact that the 10-year Treasury bond yield has spiked more than one half a percent – from 4.80% to 5.32% – in less than a month does not seem to trouble him one bit. And he can’t be bothered by the fact that the price of crude oil keeps climbing higher.

– No worries, mate… Gone is the Enron-inspired accounting storm that plunged stocks into a deep-freeze. The debilitating chill of investor anxiety has thawed, thanks to the balmy hot air blowing in from Wall Street brokerage firms and various financial journalists.

– And stocks are basking in the warmth. The Dow gained another 39 points yesterday to 10,611, while the NASDAQ just seemed to lounge around and finish the day about where it started, at 1,929.

– The sprightly shares of J.P. Morgan accounted for a large slug of the blue chips’ gains. Shares of the former Dow pariah jumped $1.56 yesterday to $36.30, or about 4 1/2 percent.

– The bank’s struggling operations appear to be no healthier now than they were one month ago. But its share price is in tip-top shape. The story behind the stock’s stunning turnaround is as interesting as it is instructive. It is yet one more picture of the new Wall Street that – like Patty Duke – looks remarkably like its twin "cousin," the old Wall Street.

– Yesterday, you may recall, the Daily Reckoning brought you the story of Interpublic Group’s creative cash flow accounting. Today we present yet another vignette from the new and improved Wall Street.

– It is the story of how J.P. Morgan’s management borrowed a page from German philosopher Friedrich Nietzsche to will the company’s share price higher.

– How exactly did the gang at Morgan revitalize the company’s struggling stock? Not by improving the bank’s operating performance (that would have been very difficult); but rather, by altering public opinion – a task that proved remarkably easy.

– "Twenty-five centuries after Thucydides advanced the theory that ‘might makes right,’ J.P. Morgan Chase proved it to be true once again," observed Apogee Research (You may also recall that I work for Apogee, too). "The banking giant made right its foundering share price with one of the mightiest PR campaigns we have ever observed – a campaign that culminated with this weekend’s effusive cover story in Barron’s…

– "About two weeks ago," Apogee continues, "we became aware that Morgan had launched a very aggressive public relations effort, beginning with the easily converted choir of Wall Street analysts and extending through the ranks of heretical naysayers, whomever they might be.

– "For example, Morgan summoned to its offices one skeptical voice particularly well-known to Apogee Research for a one-on-one meeting with the CFO and other high-placed executives.

– "Even knowing that this campaign was ongoing," said Apogee, "we considered it unlikely to succeed. We were wrong… [C]ountless Wall Street analysts have issued fresh buy recommendations over the last several days. Additionally, many of the previously skeptical voices in the financial press have either reversed themselves or merely grown silent."

– Apogee points out a series of factual inaccuracies in the Barron’s story that, all together, "flatter the bank’s financial condition by more than $6 billion. That’s a meaningful margin of error for a bank whose current tangible equity is probably less than $25 billion."

– Nevertheless, Apogee winds up, "By virtue of the banking giant’s power to influence the kinds of opinions susceptible to influence, it has engineered a higher share price."

– The stock has soared an astounding 36% since late February, adding more than $19 billion to its market capitalization. As Warren Buffett observed in his most recent annual report, "There is no shortage of egregious conduct in corporate America."


Back in Paris…

*** Ten-year TIPS, U.S. Treasury bonds whose rate of return is adjusted for inflation, yield 3.29%. Regular 10-year treasury bonds yield 5.32%. Thus, the gap – which is a rough measure of what bond investors expect as an inflation rate over the next 10 years – has widened to 1.93%.

*** But gold? At $291 an ounce the yellow metal is hardly sounding an inflation alarm. What to make of it?

*** CFO magazine reports that the politicians – currently ‘investigating’ financial shenanigans at Enron and elsewhere – are supposed to be overseeing 13 federal programs responsible for $20.7 billion in erroneous benefit and assistance payments.

*** Recently, my friend Mark Skousen accepted the title of president at the Foundation for Economic Education (FEE), the oldest ‘free market think tank’ in the US. I, in turn, have accepted an offer to speak at FEE’s 30th anniversary gala celebration to be held May 3-5 in Las Vegas… more details to come. If you’re interested in joining in the fun, there’s still time to take advantage of an ‘early bird’ special they’ve set up for early registrants.

*** Parisians have been enjoying spring-like weather for the last few days. The sidewalk cafes are expanding. Winter coats are coming off. Jonquils, cherry trees and other things I don’t recognize, are in bloom.