Pearl Harbor

“We play with fire. We play with war. And then, fire and war blow up on us. America, until now, enjoyed the luxury of watching things from a distance. It offered its advice, lavishly…its homilies…its encouragement to the ‘little people’ of the world. Now, America is ‘in the bath’ along with the rest of the world. Now we will see. We will see if America is really the military, industrial, and social power that it claims to be. We’re going to see if ‘America’ really exists. Because it is no longer a matter of preaching, while taking orders and grabbing market share. It’s no longer a matter of exhorting others to acts of heroism. Now, America must fight. And send Americans to risk their skins. Things have changed. We’re going to see…”

-Marcel Deat, writing in the collaborationist French newspaper “L’Oeuvre”, 9 December 1941

Mr. Deat sounded skeptical.

My father wondered too. The morning of December 7th, 60 years ago today, was a rude awakening for him. After a late Saturday night on the town…his head must have throbbed early Sunday morning. It was as if there were bombs going off, he must have thought…then, his eyes must have opened with a start; bombs really were exploding!

“All I remember is confusion,” he once told me. “We didn’t know what was going on. All I knew we knew was that we were under attack. We thought the Japs were going to land troops, so we got our rifles and got ready to fight back. Thank God, they didn’t try to take Pearl Harbor. We were so disorganized, it was pathetic.”

Disorganized, unprepared…America put aside its confusion and was soon fighting back. By dumb luck, perhaps, none of America’s 3 Pearl-based aircraft carriers were in the harbor that morning. The Japanese hoped to put the U.S. Pacific fleet out of service for 18 months. But within just 60 days, U.S. forces were back in action. My father and thousands of other Americans had the pleasure of an extended tour of the South Pacific, courtesy of the U.S. Army. Maybe they were not the battle-hardened fighters of the Third Reich – with strong military traditions, iron discipline, and years of painful experience. But when the chips were down in 1941, they did their duty…sometimes well, sometimes not-so-well…

When Pearl Harbor was bombed, Americans knew the “luxury of watching things from a distance” would no longer be possible. Unlike the patriots of 2001, they prepared for sacrifice, not self-indulgence. They braced themselves for hardships and losses. Rather than buy a new Packard, they were likely to put the old one in the garage and walk to work. Gasoline was rationed. So was almost everything else. Stocks fell to a level never seen before – and changed hands for just 6 times earnings. Things had changed; America was “in the bath” with everyone else.

Men do stupid things regularly and mad things occasionally. And sometimes, the impulse to self- destruction is so overwhelming it overtakes an entire nation.

It is almost always madness to buy stocks at the peak of a bull market…or to buy a stock at 50 times earnings. (Note: currently, tech stocks in the U.S. are selling at an average P/E of 50 based on next year’s earnings!) Ruin may not come quickly – as stocks may rise further. But it comes eventually.

The best a person can hope for when he goes mad is that he runs into a brick wall quickly…before he has a chance to build up speed. That is why success, in war and investing, is often a greater menace than failure.

My father did not realize it at the time, but he was witness to one of the stupidest, maddest acts in all of history. The Japanese had embarked on a campaign of conquest. Rampaging through China and Indochina, they found success easy. Encouraged, they sought to extend Japanese hegemony, by force of arms, throughout Southeast Asia.

“What was the point of the military expansion?,” you may ask.

“To secure vital resources – oil, rubber, metals,” comes the answer.

“Why did Japan need so many raw materials?”

“To supply its military expansion!”

The Japanese have little in the way of raw materials. They could buy them on the open market. But in the politicized world of the 20th century, markets seemed unreliable. What if producers decided not to sell?

The idea was absurd. Why would producers not sell, when it was in their interest to do so? In fact, the only reason they did not sell was to try to cripple Japanese military expansion! Thus did the Roosevelt Administration, in early 1941, cut off vital supplies – especially oil – to the Japanese war machine.

What were the Japanese to do? For nearly 10 years, they had been “on a roll” of military success. Were they not entitled to believe that their stock would always rise?

“The grandiose mood of the fascist powers in which no conquest seemed impossible, must be taken into account,” writes Barbara Tuchman in her “March of Folly.” “Japan had mobilized a military will of terrible force which was in fact to accomplish extraordinary triumphs…”

But attacking Pearl Harbor was a big risk. The Japanese knew what they were up against – a country far larger and with far more resources than their own. Admiral Yamamoto had attended Harvard and spent years in Washington as a naval attachundefined. Even so, he was no fool…he knew that Japan could not endure a long contest with the U.S. “I have utterly no confidence for the second or the year,” he told Premier Konoye.

Why did they do it? Why did they take “a gamble that, in the long run…,” Tuchman asks, “was almost sure to be lost?”

“Fundamentally, the reason Japan took the risk,” Tuchman answers her own question, “was that she had either to go forward or content herself with the status quo, which no one was willing or could politically afford to suggest. Over a generation, pressure form the aggressive army in China and from its partisans at home had fused Japan to the goal of an impossible empire from which she could not now retreat. She had become a prisoner of her oversize ambitions.”

How much better off the Japanese would have been if they had been beaten in China! They could have gone back to their island, renounced the Tripartite Treaty with Germany and Italy…and they could have “taken the orders and grabbed market share” – selling tanks, planes and ships to other combatants. Instead, a long string of battlefield successes led to one of the biggest strategic plunders of all time…and ultimately to complete ruin for Japan and her economy.

Before the attack on Pearl Harbor, Americans were deeply divided on the war. Most wanted nothing to do with it. A one-year draft law passed Congress by a single vote just months before the attack. Japan could have conquered any Dutch, British or French colonial territory in the Far East…without risking war with America. Of all the things Japan might have done, it chose the worst possible course of action. It did the one thing – and probably the only thing – that would bring America into the war as an active, determined combatant.

Admiral Yamamoto recognized his error almost immediately. “I feel that we have awakened a sleeping giant and instilled in him a terrible resolve,” he said. Churchill was ecstatic: “To have the United States at our side was to me the greatest joy. Now at this very moment I knew the United States was in the war, up to the neck and in to the death. So we had won after all! Hitler’s fate was sealed. Mussolini’s fate was sealed. As for the Japanese, they would be ground to powder.”

Twelve days later – on December 17th – Germans proved that they were at least as mad as the Japanese: Hitler declared war on America. He could have left the Japanese to their folly. Instead, in less than two weeks, the Tripartite Powers had managed to turn the war against themselves, by provoking the wrath of the world’s largest economy. America, protected by two oceans, could turn out jeeps, tanks, planes and c-rations faster than anyone. It could put millions of troops in the field, fully equipped, and bring to bear more bombs against a target than any nation ever.

But in 1941, Axis military power had been in a bull market for nearly a decade. People don’t think clearly in a bull market. And their imaginations are dull. They can only see ahead of them what they’ve just experienced. It wasn’t until the battles of Midway and Stalingrad, both in 1942, that Axis power peaked out. Then, the thinking began and imaginations began to work again. But by then it was too late.

“When we realized what had happened,” said my father many years after the fact, “all I remember thinking… was that it would be a long time before I got home…if I got home at all.”

He did get home, of course, three years later…

Your correspondent,

Bill Bonner
December 7, 2001

“It is as if September 11 didn’t happen,” says junk bond investor Michael Lewitt, quoted in Grant’s Interest Rate Observer. “And March 2000 [during which the Nasdaq Composite stopped reaching for the sky] didn’t happen. The cycle of memory is shorter than ever.”

Investors seem to have forgotten who they are and what they are doing.

“In a breathless leap of faith, the stock market has made a remarkable bet on the coming economic recovery,” adds Stephen Roach. “The financial markets are screaming for an imminent ‘V.’ I’ll continue to take the other side of that call.”

We’re with Roach. The S&P 500 is up 21% since the Sept. 21 lows. And tech stocks are up 50%. “It’s a new bull market,” say investors. But stocks rose more than 20% on 5 occasions between ’29 and ’32. And in Japan, there were also 5 rallies that took stocks up 20% or more during the 1990s – as the market fell from 39,000 to below 10,000.

Yes, in the race to the bottom, Japan is ahead on points. For the first time since it was created in 1971, the Nikkei Dow is below its Wall Street cousin. But, patriotic Americans that we are, we think the U.S. Dow will soon be in the race again.

Fortune’s index of business confidence – assembled from a poll of the Fortune 1,000 companies – is at its lowest level ever.

And business profits in this quarter are expected to fall 21% year over year. More and more Americans get a big bonus at the end of the year, based on company performance…which leads to a spending boom in the first quarter of the new year. This year, the Christmas stockings will be slimmer than usual, we predict. And January spending will be a disappointment.

The profit news is particularly bad for tech stocks. It was a capital spending boom that sent their shares soaring in the late ’90s. But companies without profits are not likely to invest a lot of money in new routers and software. Especially, since the productivity promised from IT investment has so far failed to show up. New figures for the 3rd quarter show productivity up at a 1.5% rate – the worst in 10 years.

But let’s see what happened yesterday on Wall Street…Eric?

*****

Mr. Fry in New York…

– A massive Christmas tree towers above Broad Street, immediately in front of the stock exchange. It’s a beautiful tree, especially when illuminated at night, and it’s a very welcome adornment to the downtown area. Yet, because it was 70 degrees outside yesterday, it hardly seemed like Christmas-time.

– The warm weather is nice, I thought to myself, but shouldn’t it be snowing about now? Inside the exchange, the “weather” is equally pleasant.

– Winter will certainly arrive, both outside and inside the exchange. Try as he might, Alan Greenspan can’t prevent expensive stocks from falling any more than he can prevent the snow from falling.

– Stocks took a little breather yesterday. The Dow fell 15 points to 10,099, while the Nasdaq rose a subdued 7 points to 2,054. Not a bad performance after a couple of manic days in a row.

– I guess the Dow can’t go up 200 points every day…or maybe it can.

– Once again, the bond market tanked. The 10-year Treasury bond yield jumped back over 5%. Just two days ago, the 10-year was yielding only 4.63%. This very large and very rapid jump in long-term interest rates will snuff out the nationwide mortgage-refinancing binge.

– Without refinancings, the tapped out consumer has almost nowhere to turn for the fresh credit required to finance his consumption…It’s starting to get interesting…Rising rates could well choke off a recovery before it even gets a chance to begin.

– Meanwhile, Bloomberg reports, “The percentage of U.S. homeowners behind on mortgages in the third quarter rose to the highest level in 10 years as firings and a shrinking economy left more families strapped for cash.”

– But bullishness is back in fashion, no doubt about it. “Amid the fighting in Afghanistan and the Mideast, terror alerts and the global economic slump, the danger that increasingly worries investors is missing stocks’ next great leap,” jokes Igor Greenwald of Smartmoney.com.

– Yes indeed, just the thought of missing a rally, no matter how ill-founded it might be, terrifies investors. Just like old times, back in the go-go days of 2000, it’s fun to be a bull again, especially a bull who understands almost nothing about earnings growth, PE ratios, unemployment trends or any of the rest of that boring financial rigamarole. “Buy ’em at the market!” is the universal rallying cry.

– For all the shopping on Wall Street however, precious little shopping is occurring on Main Street.

– “U.S. retailers’ November sales at stores open at least a year rose 2% less than expected, as the industry heads for its bleakest holiday season in more than a decade,” Bloomberg reports. Says retail store analyst Henry Kaczmarek of American Express Financial Advisors, “I don’t think the recovery is coming as soon as people think it will.”

– If Mr. Consumer is back, he’s spending all his money on stocks. So it is that the shares of Gap Stores jumped 4 1/2 percent yesterday, even though the Gap reported an abysmal 25% decline in same store sales for November. That’s after reporting a 17% decline in both September and October.

– Customers are “staying away in droves” from Gap’s various retail outlets. The company announced yesterday that the fourth quarter would be “considerably worse” than the third quarter.

– “November sales results significantly missed our expectations, primarily at Gap and Old Navy,” said Chief Financial Officer, Heidi Kunz. “It is reasonable to expect that the current negative trends in comparable store sales and gross margins could continue.”

– Moving from clothes that don’t sell to shoes you can’t buy, “Top shoe designer Manolo Blahnik has pulled a pair of stiletto shoes from his latest collection for fear that their ‘killer heels’ could be dangerous,” Reuters reports. “Blahnik, renowned for his exotic and expensive creations, had designed a pair of shoes with razor-sharp 3.5 inch (8.75cm) titanium heels, as thin as the ink tube in a ballpoint…’If the wearer stood on someone’s foot, it would go straight through,’ [said] a spokesman for Blahnik.”

– Ouch! Sounds painful. Even so, I’m guessing that most short-sellers would prefer a Manolo Blahnik “killer heel” thrust between their third and fourth metatarsals than to endure another 600-point Nasdaq rally. But then, short-sellers are masochists anyway…until they’re proven right.

*****

Back in Paris…

*** Well, the Battle of the Bubble continues…

*** But what’s with the bond vigilantes? Bonds have been taking a beating as investors anticipate higher interest rates. What do they see that we don’t? Inflation?

*** The differential between inflation-adjusted bonds and regular 10-year notes is still only 1.46 points. And gold is still at $274 an ounce. No sign of inflation in other words. So, what’s bugging the bond buyers? We will see, eventually…