The Scariest Scenario Imaginable

Newsletter writers, as a group, are now as bullish as they’ve been since 1987. When optimism reaches extremes as it has right now, warns Steve Sjuggerud, there is nobody left to buy…which can pose a problem.


I never thought we’d see the day…the day when wild speculation actually exceeded the excesses of the late 1990s. And I really didn’t think it would just take four years to get there. But here we are…

Investors are actually borrowing money to buy Nasdaq stocks. In fact, more people are borrowing more money to buy stocks today than at any time in history, including the “Great Bubble” of early 2000.

The result? Just like in the days of the Great Bubble, the ‘garbage’ stocks have soared, while sounder stocks have struggled. A $10,000 investment a year ago in (do you know anyone on the planet that actually uses would be worth $220,000 today. Or how about $10,000 invested a year ago would be worth even more than AskJeeves… is valued in the stock market for over $2 billion (with a “b”) dollars. Yet sales…yes, sales…over the last 12 months were only $27 million (with an “m”) dollars. Who’s buying this garbage at these prices? It appears to be individual investors at online brokers…

Corporate Speculation: Rampant Speculation at Its Finest

Trading activity at online brokers in the most recent quarter is up 40% from the same quarter last year. And this is clearly ‘hot’ money…speculative money… At online broker E-Trade, the level of margin debt in the latest quarter (ended June 30, 2003) among E-Trade customers rose by 31% over the previous quarter (ended March 31, 2003).

It’s rampant speculation at its finest.

By contrast, look what corporate insiders – the ‘smart money’ – are up to. Obviously corporate insiders know more about their businesses than anyone else. Insiders are generally right, but a little early in their selling. Recently, they’ve been selling at a rate not seen since 1986. They were early back then…but they got out ahead of the Crash of 1987, when stocks fell 22.6% in one day.

Looking at the latest data, corporate insiders set a dollar record for the last decade…insiders sold $44.53 dollars of stock for every dollar of stock they bought. That is unbelievable.

“Insiders, of course, know much more than the general public about their own stocks,” Professor Henry Hu of the University of Texas said in a news story on the subject. “Ordinary investors are terribly naive – all they pick up is what they hear from the their friends the financial media. And, unfortunately, investors today still have this pathological fear of being left behind if the market goes up.” (Some folks wrongly dismiss this figure, saying that “Bill Gates regularly sells a ton of shares.” What these folks don’t know is that these figures actually EXCLUDE insider trades over $50 million – so the Bill Gateses of the world are NOT included in this figure.)

Corporate Insiders: Smart Money vs. Dumb Money

It gets even worse when you look at tech stocks alone. Kevin Schwenger, the insider data research analyst at Thomson Financial, who puts out these numbers, told the story in the Wall Street Journal… In August, $644 dollars of stock were sold for every dollar of stock bought by insiders at semiconductor companies. As a frame of reference, $20 sold for every dollar bought is considered bearish…


While the ‘smart money’ sells tech stocks in record amounts…the ‘dumb money’ is taking on debt to buy these stocks on margin. By my studies, the ‘dumb money’ is at an extreme of optimism not seen since, well, right before the 1987 crash… In the last few months, individual investors have become more bullish than at any time in history (as measured by the American Association of Individual Investors sentiment poll), except in 1987.

And the same is true of newsletter writers. The folks who write investment advisory letters (like me), as a group, are now as bullish as they’ve been since 1987 (as measured by Investor’s Intelligence, who has been monitoring these things since the 1960s).

When optimism reaches extremes, as it has right now, quite frankly, there is nobody left to buy… Individual investors have been buying…newsletter writers and analysts have been buying…and the pros have been buying. There is no ‘greater fool’ left to buy and hope for a higher price. There is nobody left to buy.

We’re extremely close to the scariest scenario imaginable, at least from my perspective.

Corporate Insiders: A Gruesome Spectacle

There are three major ways to size up the markets to get some clues on where it might be headed: fundamental analysis, technical analysis, and analyzing the market sentiment. All three reveal a gruesome spectacle.

We’ve already made the case about market sentiment – the dumb money is at a record level of optimism, while the smart money is at a record of pessimism. Which crowd do you want to be with?

In the case of fundamentals, stocks are still more expensive than they’ve been at any time in history. We are still at 30 times earnings and three times book value in the case of the S&P 500 Index of the big, boring stocks. And of the tech stocks, oh my…by my calculation, the companies of the Nasdaq 100 are trading at a price-to- earnings ratio of 49. To explain this in plain English, if you were buying a stock with a P/E ratio of 49 as a business, it would take you 49 years to break even on your investment. Why would anybody in their right mind borrow money to invest in that?

The Nasdaq 100 Index is trading at 8 times sales. If you were buying this business, that means if you paid yourself every penny of sales for the next eight years, you’d break even. Of course, you can’t pay yourself every penny of sales. Rent needs to be paid, salaries need to be paid, and of course it will cost you money to make your product. In other words, getting your money back in eight years is a total pipe dream. The basic point is, fundamentals in tech stocks are horrific.

All that’s left is the technical analysis – the major trend. The trend has not broken down yet…but in the face of horrific fundamentals in the tech-heavy Nasdaq 100, and the truly scary insider selling in the tech stocks, it is time for us to place our chips on the table that the Nasdaq 100 will be lower a year from now than it is today.

When the market breaks down, you can’t say you weren’t warned…


Steve Sjuggerud
for the Daily Reckoning

October 07, 2003

Dr. Steve Sjuggerud has worked in the investment world as a stockbroker, the vice president of a $50 million global mutual fund, an international hedge fund manager, and the director of several research departments. An international currency expert, he is also a member of the Oxford Club advisory panel.

Well, it’s 4 A.M., time to get to work. Living in Europe has its advantages; the early bird doesn’t have to get up so early.

But here we are in sunny Nicaragua…trying to keep up with the news. And what’s this…? Why, it must be tomorrow’s news. From the Seattle Times comes a headline that is bound to be popular in the years ahead:

“More homeowners selling houses for less than they owe.”

What went wrong? We don’t know, but we have a feeling that the headline will soon make its way down the coast. For, elsewhere, we read that the California Association of Realtors is projecting a 13% increase in house prices this year in the Base Metal State. That will bring the median house to $414,000, compared with $168,000 in saner parts of the nation.

There you have it, dear reader: a business opportunity. Buy up houses in Missouri and ship them to California. If you can put them down on a lot for less than $246,000, you will make a profit.

It is madness, of course. But it is madness with plenty of reasons behind it. The California economy is almost the same size as France…and run on the more or less on the same principles.

“California governor faces a big mess,” CNBC tells us. (Advice to Arnie: if you win the popular vote…demand a recount.)

One part of the mess, however, is not of the governor’s making…and not within his power to fix. It is the mess we keep mentioning. California operates on dollars. France does business and keeps its money in euros. The euro went up again yesterday, after the head of the European Central Bank noted that dollar was doomed. “The U.S. has a huge current account deficit,” explained the silver-maned banker, “so sooner or later there will have to be an adjustment of its currency.”

The day will not be a happy one for homeowners on the West Coast. The median owner checked his ‘home equity’ account last year and saw that his ‘wealth’ had gone up by $40,000 or so. Many were they who could not help themselves; they took the money out. And many will regret it, we predict, when a falling dollar forces up interest rates and brings down house prices. They’ll find themselves with less equity than they thought…while their mortgages are still every bit as big as they remembered.

But that is all in the future. Like the Seattle headline.

Over to you, Eric:


Eric Fry, checking in from lower Manhattan:

– Move over Reggie Jackson! Meet the new Mr. October!…The stock market chalked up its fourth straight winning session of the new month – a perfect 4 for 4. The Dow added 23 points to 9,595 and the Nasdaq gained 0.7% to 1,893.

– The gold market also attracted a few buyers, as the price of the yellow metal rebounded slightly from Friday’s $13.70 drubbing – recouping $3.30 to $373.30 an ounce. But the U.S. dollar tumbled again, falling 1.1% against the euro to $1.17.

– How is it possible that stocks continue their winning ways, even while the dollar continues its losing ways? These two inimical trends are strange bedfellows indeed. Imagine Rush Limbaugh as Halle Berry’s new love interest and you will begin to understand the freakish and unlikely pairing of a rising stock market and a falling dollar.

– What makes this pairing particularly bizarre is the fact that our nation relies so heavily upon the enthusiasm of foreign investors for U.S. assets. In some way, shape or form, foreigners lend our consumption-crazed nation almost $1 trillion every year. We Americans, in turn, use the money they send our way to buy SUVs, plasma TVs and costly military campaigns in distant lands. However, we do not forget to repay our creditors with ever-cheaper dollars. Some day – timing uncertain – foreigners may lose interest in subsidizing our consumption. They would have lost interest already, except for the fact that we are consuming the goods that they are producing.

– Exactly how unrewarding is it to exchange foreign currencies for U.S. assets? Consider that the Nasdaq Composite has jumped almost 5% since the end of August…in U.S. dollar terms. But euro-based buyers of the Nasdaq Composite have lost 2% over the same time frame.

– Foreign bondholders are faring no better…Foreign central-bank holdings of Treasury and agency securities total nearly $1 trillion. So, roughly speaking, the dollar’s drop over the last five weeks has impoverished our foreign creditors by about $85 billion. That’s real money.

– And yet, the brain trusts at the Federal Reserve and Treasury and White House all want the dollar to fall even more. It’s good for our exporting industries, the politicians say. That’s true, but it’s very bad for U.S. consumers and savers and almost everyone else living in a U.S. zip code. A feeble dollar gums up the consumption engine that powers most of the U.S. economy…and a large portion of the global economy.

– “Other countries share in the deep commitment to keep U.S. consumers laying out their cash,” observes CNN/Money’s Justin Lahart. “Big exporters – Japan and China in particular – have strived to keep their currencies low against the dollar, allowing Americans, in effect, to buy more of their stuff. U.S. consumer spending accounts for around 20 percent of world gross domestic product.

– “So the world economy is leveraged to the U.S. consumer. And the U.S. consumer is leveraged to the hilt…At some point the U.S. consumer’s creditors – which is to say the rest of the world – may have second thoughts about how their money is being used.”

– This nightmare scenario features a buyer’s strike by foreign investors that causes the dollar to slide and U.S. interest rates to rise…What then would become of the American consumer?

– “We’re a what’s-my-monthly-payment nation,” says Northern Trust chief U.S. economist Paul Kasriel. “The idea is to have my monthly payments as high as I can take. If you cut interest rates, I’ll get a bigger car.”

– If the dollar keeps sliding, America’s what’s-my-monthly- payment consumers will be making much higher monthly payments. But very few stock market investors are worrying about such things. Stocks are rising and that’s all that really matters.

– Didn’t investors learn anything from the 1990’s?…$7 trillion of shareholder wealth disappeared between February 2000 and October 2002. Somebody somewhere must have lost some of that money. Nevertheless, greed is much more evident than fear.

– “You would think that seeing such a massive amount of wealth wiped off their books would have made investors cautious about the market – deeply mistrustful, even – but that hardly seems to have been the case,” notes CNN/Money. “Flows into the mutual funds are steady, online trading has picked up and casual conversation is turning back to what stock did what. Even more distressingly, the stocks that have been doing the best are the sorts of highfliers that got investors into so much trouble last time around.”

– The stock market bulls are back, their ranks are swelling, and they are fearless. Most sentiment indicators are showing levels of bullishness that exceed that of both 2000 and 1987.

– “There is a whiff of 1987,” says the New York Times’ Floyd Norris, “and not just in the buoyant sentiment indicators. Then, as now, there was international economic discord. The dollar was weak, and the Treasury secretary was criticizing policies of others for harming the world economy.”

– But that was then…History could not possibly repeat itself, could it?


Bill Bonner, back in Rancho Santana…

*** “Corporate profits will continue to go up,” opined a fellow on the TV the other day, “because companies are getting so good at cutting costs.”

Aha, we thought, what an imbecile…

A single corporation can improve profits by cutting costs. But one man’s cost cuts are another’s income. A business can fire an employee, for example. But then the employee will buy fewer products. Or, it can force suppliers to reduce prices; but then, the suppliers must cut costs too. Taken all together, an economy cannot get richer by cutting costs (though individuals may…).

*** “We have our own little bubble, right here,” observed a partner yesterday.

Five years ago, your editor invested in a daring venture. He and some friends bought a large parcel of land on the Pacific Coast of Latin America. It seemed almost mad at the time. Nicaragua had passed through the Sandinista period, but was still politically unsure. And the land itself was only reachable by a dirt road that washed out in the rainy season. But it was beautiful land. And very cheap. Even if it doesn’t work out as a business project, your editor was able to say to himself, it will be great to own and enjoy alone. He half wished the development would flop…for he could imagine himself in his own private Eden, free from the Internet.

Alas, it has sold so well there is almost nothing left. A lot that sold for only $17,000 is now on the market for nearly $70,000. And now there is an office with three computer terminals and a satellite dish. So, your editor shuts himself off from the morning songbirds, lowers the blinds against dawn…and at 4 A.M. sits down to his computer screen to enjoy the fruits of progress.

*** In other news…Financial Reckoning Day, the fruit of our labor, made it to the NYTimes Best-seller list yesterday – but only on-line. Apparently, they publish the top #15 spots on-line and only the top 5 in the actual printed newspaper. Guess where we are?

Who cares about the darn print edition anyway!

Several readers have written in to tell us they went to the bookstore to find a copy, but were greeted by puzzled clerks who’d never heard of a book called Financial Reckoning Day. Although this is clearly the response we might expect even after the book is released to bookstores, it might be worth noting, at this point, that you can generally only purchase the book on-line.