Just Absolutely Freakin' Terrible
Things are happening as we feared they would.
The new Afghan democracy – meeting in a beer tent from Germany – "deteriorated into shouting, finger pointing and threats," said the International Herald Tribune. No Western nation has ever gone to war in Afghanistan without regretting it later.
Meanwhile, the dollar and the stock market have been going down. Gold has been going up.
Of course, if we could tell you what would happen next we wouldn’t be sitting at our desk this morning writing the Daily Reckoning. At the very least, we might be tempted to charge something for it.
We don’t know what will happen, but peeking over our shoulder at history and tradition…we can at least take a guess.
Fish gotta swim…birds gotta fly. And here at the Daily Reckoning we gotta reckon. What we think we’re reckoning with today is the beginning of the second major phase of a bear market. Stocks have gone down in 11 of the past 13 weeks. Despite occasional rallies, investors’ portfolios are being ground down, day after day.
The Dow is down 13% so far this year…and seems to be heading for its 3rd straight year of losses. Not in 60 years has such a thing happened. Few investors can imagine that it might happen again.
Double-digit gains are a hard habit to break. Once they’ve had them, investors want them to come back, real soon. And so the patsies believe that the last couple of years are just a lull before another storm of rising share prices. Stocks are down, they think, but only because a few bad apples spoiled the barrel…or Greenspan didn’t cut rates enough…or whatever.
The insiders, meanwhile, have a clearer picture of what it going on. They see few profits coming…and a lot of disappointments hidden in the small print. They’ve been selling more than 4 shares for every one that they buy. But the lumpeninvestoriat holds on. Thanks to these stock market bumpkins, the Dow gave up ground so gently investors have hardly noticed. There has been no panic selling, no fear, no revulsion. Two and a half years after the market turned down, investors still pay $40 for every dollar of earnings.
In the first stage of a bear market, investors are shocked. They thought stocks never went down. They thought the bull market was eternal. When they find out otherwise, they take the news with the equanimity of the brain-dead. "Of course," they say to themselves with new-found sagacity, "stocks don’t go up every year. The trick is to have patience. For in the long-run, stocks always go up."
The second stage of the bear market tests their conviction. Stocks get ground down lower and lower. Investors begin to wonder…then doubt. Then look for someone to blame. Why am I losing money, they ask themselves? Typically, there are hearings in Washington and a few show trials in New York. Companies go bankrupt and corporate chieftains are tortured.
But most people still believe the promise of long-run riches. The trouble is, they have bills to pay. They have retirements to finance. So, they begin to shift a little of their money out of stocks, just in case.
Worst case, think most investors, they will be down another 10-15% this year. That is the risk they face in sticking with stocks. "The whole secret is to stay the course…" they believe, "through bear and bull markets. The worst thing you can do is bail out when the going gets rough."
But the going has not even begun to get rough; stage two has barely started. Somehow, stocks have to get down to levels where people are no longer interested in the Daily Reckoning’s stock commentary.
At 40 times earnings, stocks can lose 80% of their values before they finally find the bottom. How many investors will want to watch CNBC when the Dow is at 3,000? How many ads will be placed in Barron’s? Imagine how investors might feel if stocks suddenly crashed to half current levels? Or the Dow dropped 100 points each week for the next 12 months? How long would it be before they gave up?
A bear market does what a bull market does – only in the opposite direction. No logic, nor argument deters it; it keeps going until it is exhausted – fully correcting whatever came before. In this case, America enjoyed 20 years of near-perfect circumstances. Its competitors collapsed. Foreigners competed to lend Americans money. Interest rates fell, government budgets went into surplus. The stock market boomed and new technology promised a Brave New World with constantly improving productivity and riches for all.
It was "just absolutely freaking wonderful," says the Mogambo Guru. What might America need to correct such a great thing? What might be absolutely freaking terrible enough to break the patsies and destroy the confidence of the last two decades? We will see…as Stage Two of the Great Bear Market of ’00 – ? continues…tomorrow!
Your editor, sweating…
June 17, 2002 — Paris, France
Everywhere you look, dear reader, the conditions that made the U.S. economy such a marvel seem to be turning against it.
In the latest reported week, foreigners unloaded $2.6 billion of U.S. assets. During the same week a year ago they bought $62.5 billion.
What’s with these ungrateful foreigners? Are they forgetting that U.S. consumers are what make the world go ’round? Who else would be willing to buy all this stuff that the foreigners make? But how can Americans keep spending without foreign money?
"The United States, by far the largest indebted nation in the world," writes Siow Li Sen in Singapore, "is being bankrolled by thrifty Asian savers like Japan, China and Singapore. But this is unsustainable…"
The world makes…Trenton takes. So does Newark…and Dallas…and Tuscaloosa…and even Hays. America owes $2.2 trillion to the rest of the world – nearly $7,500 for every man, woman and child in the country. The world’s developing countries, meanwhile, have only about $500 of external debt per capita.
As nations develop, people begin wanting more automobiles, more carpeting and air-conditioning themselves. Instead of financing others’ consumption, they begin to spend more of their own money. This leaves less money to save…and less available for others to borrow.
Besides, foreigners are getting nervous. The dollar has been falling. So have U.S. markets. Foreign investors are beginning to think they can do better elsewhere. And they’re probably right.
"A vicious cycle of foreign investors pulling the plug on Wall Street…" and a falling dollar, writes Addison Wiggin, "will in our view, drive the price of gold higher, as it is the safest investment for governments and individuals when markets are in turmoil."
By the way, as Addison mentioned over the weekend, our team has prepared a special report on the significant relationship between the dropping dollar and the rising price of gold. To read the report – followed by "The Investment Case For Gold," a groundbreaking analysis of the gold market by Tocqueville Funds’ John Hathaway.
In the meantime, Eric…more details from Wall Street, please…
Eric Fry from New York…
– Well folks, if you always wanted to know what a bear market looks like, now you know…Stocks slide for weeks on end, then bounce for a bit, and then slide even lower.
– Last week, the Dow lost 115 points, or 1.2%, while the Nasdaq and S&P 500 dropped 2% each. The week would have been much worse, but for the market’s gutsy rebound from the steep sell-off Friday morning. The NASDAQ clawed its way back from a 3% loss to finish the day with a 7-point gain at 1,504. The Dow, likewise, rebounded from an early 200-point decline to finish the day with a slim 28-point loss at 9,474.
– Friday’s dramatic recovery offers a glimpse into the sadistic side of Mr. Market’s personality. These sharp rallies serve little purpose but to foster false hopes that stocks will recover quickly. Emboldened by the market’s illusory show of strength, hopeful investors stay in the game and lose even more money.
– "The miracle [has] turned into a minefield," says Dr. Kurt Richebacher.
– The bear market could end at any time, of course. But is there any particular reason why it should?
– "With more than one in six stocks in the Standard & Poor’s 500 index at lows for the year, many people are worried that their investment portfolios might eventually move from the financial pages of newspapers to the comic pages," observes Reuters’ Pierre Belec. "Such is the story on Wall Street as the market appears headed to its third straight year of losses. The benchmark S&P 500 is down 13 percent so far this year, the Nasdaq composite has slumped 23 percent and the Dow Jones industrial average is off 5.5 percent. – "What’s scary," says Belec, "is that despite the market’s pullback, the price-to-earnings ratio of the S&P 500 remains very pricey at 40. A slump of about 80 percent in stock prices would be needed to bring the P/E ratio to its long-term average of 15." In other words, the bear market may have some unfinished business.
– "The Dow is half empty…and draining fast! The next wave could take us all the way back to October 1998," predicts Adam Lass, of the Q-Wave Trader. "Here’s my call," says Lass, "no frills, no hedging, no two ways about it. Expect the Dow to hit 8,800 in August."
– Lass, who bases his trading recommendations on a proprietary technical analysis of the markets, explains his bearish call: "Since May 31’s peak at 10,074, the Dow has peeled off almost 700 points…[The Dow’s] penetration below the falling trend’s 50% mark has greatly increased the probability that the Dow will drop another 800 points off current levels…and not in the next six months either, but rather the next 18-36 days."
– We have no idea if Lass is right or wrong. But even if he isn’t right, he probably deserves to be. Stocks are expensive and the risks are legion.
– All the sturm und drang in the US stock market is causing investors to cast a longing glance at foreign equity markets. According to a recent Merrill Lynch survey, many fund managers are lightening up on their US holdings, in order to invest in emerging markets like Asia and South America. "Globally, US equities are overvalued and with every week that goes by, with more negative earnings and visibility concerns, people are asking why they are paying these multiples for US equities," said David Bowers, chief investment strategist at Merrill Lynch.
– And what in the world has become of the patriotic, indefatigable consumer? Suddenly, he is shopping less, steering clear of stocks and – what’s this? – feeling LESS confident. The Michigan consumer sentiment index tumbled to 90.8 in early June from 96.9 in May. This is the lowest reading since February. More worrisome, the future expectations readings fell to 86.2 from 92.7.
– Is the consumer-spending engine running low on fuel? "At the heart of the New Economy was the miracle of new technology," observes Dr. Kurt Richebacher. "This, according to Federal Reserve Chairman Alan Greenspan and others, was the principal cause of soaring productivity, investment and economic growth…Today, new technology is the single greatest destroyer of wealth and profits in the economy. The plunging value of tech shares will inevitably affect the spending patterns of the seemingly invincible consumer."
Back in Paris…
*** Will the war in Afghanistan make the world a safer place – or less safe – we wondered, 6 months ago.
*** "Classified investigations of the Qaeda threat now under way at the FBI and CIA have concluded that the war in Afghanistan failed to diminish the threat to the United States…" says a headline article in today’s International Herald Tribune. "Instead, the war might have complicated counterterrorism efforts by dispersing potential attackers across a wider geographic area."
*** More and more…day by day…we seem to be leaving a world where everything went just right for the U.S.; we enter a world where nothing does.
*** Here in France, President Chirac’s right triumphed in yesterday’s runoff election. Familiar left-wing humbugs – including the Communist party chief, Robert Hue – were booted out of the Chamber of Deputies.
*** "Thank God they’re gone," said Mr. Goupil, our plasterer. "You can’t even earn a living in France anymore without cheating… These people don’t live in the real world. They’ve never had a real job… they’ve never left Paris and wouldn’t know a cow from a chipmunk…
*** "Well, I doubt [the new government] will eliminate the wealth tax," said my accountant this morning. "But they have five years to make changes….they’ll almost certainly ease up on labor restrictions and make some tax cuts. But not too much…"
*** Paris is sweating this morning. It was hot even at 7am. We dread the afternoon.