The 17 Year Itch

“Thus is the universe alive. All things are moral. That soul, which within us is a sentiment, outside of us is a law.”
Ralph Waldo Emerson

Oi chusoi Dios aei enpiptuousi

(I’m sure you know what that means. But I had to look it up. “The Dice of God are always loaded.”)

Yesterday’s news brought new evidence, not necessarily of a moral universe, but of a symmetrical one. Nature gives…but it takes away too.

Far from Wall Street, the law of regression to the mean…of “return to trend”…has been invoked. A sentence has been handed down and carried out. “Japanese Stocks Plunge to New Low,” the BBC reported.

Ten years ago, the Dow in Tokyo and the one in New York were 35,000 points apart. Fewer than 1,000 points separate them today.

Yet, there is still a big difference between Tokyo and Manhattan. Wall Street is still on top of the world, the way most people view it. Tokyo is on the other end.

Daily Reckoning masochists will recall the Japan story. It has been recited often in this space, once as a cautionary tale, then as moral lesson, and most recently as a preview of things to come in America.

In 1989, it was hard to find something negative to say about the Japanese economy. Every word was flattery as the Nikkei Dow rose towards 40,000. The triumph of “Japan, Inc.,” as it was called, was thought to be inevitable. Japanese labor was more disciplined and harder working than labor elsewhere. Japanese management was willing to look farther ahead and take bigger risks than its competitors. The Japanese government was thought to be capable of guiding the economy more artfully than Western counterparts.

Japanese terms – such as “kaizen” – sprang from the mouths of investors in January of 1990, as they rolled the dice again, expecting to win as they had in every year since the “Japanese Miracle” began. Little did they know that the dice were loaded.

The head follows the heart, reasons dress up reality, and markets make opinions. In January of 1990, the Nikkei began its descent. Eleven years later, it is hard to find a good word to say about Japan.

Columnists – so recently busily trying to explain why the Japanese would dominate the world economy for a very long time – now explain why Japan will not recover anytime soon. With an alarming lack of imagination, they turn to the familiar reasons, merely giving them a spin in the opposite direction. Japanese government is out-of-date, managers are incompetent, and Japanese laborers will never learn the secret of a healthy economy; that is, borrowing and spending!

Rarely, (perhaps not since the peak of the Nasdaq) has the financial press been so unanimous. Every headline about Japan makes the country sound hopeless. Yesterday, not only did we learn that stocks “Plunge to a New Low” in Japan, we also discovered that “Japan’s Jobless Rate Surges” to its highest level since WWII (USA Today) and “Japan’s Industrial Production Falls for 5th Month” (Financial Times).

The Nikkei dropped to 10,9779…below 11,000 for the first time since 1984. It has taken more than a decade, but Japan has erased 17 years of stock market gains. Over a period of 11 years, investors have lost 75% of their money as the Nikkei Dow has come from a high of nearly 40,000 to within 900 points of Wall Street’s most popular index.

Tokyo’s unemployment rate – once almost a non-existent number – has risen to 5%…almost exactly the same as America’s current level.

Even Japan’s GDP growth and that of the U.S. have converged – both presently at about 0.2%…an 8-year low for the U.S…and very nearly an 8-year average for Japan.

My, my…might not other things converge too? How long will it be before American reputations are flattened by a bear market just as those in Japan have been? Will people come to see that U.S. stocks, U.S. central bankers, U.S. corporate managers, and U.S. politicians are big losers…just like their Japanese counterparts?

“There is a crack in every thing God has made,” explains Emerson. “It would seem there is always this vindictive circumstance stealing in at unawares, even into the wild poesy in which the human fancy attempted to make bold holiday, and to shake itself free of the old laws – this back-stroke, this kick of the gun, certifying that the law is fatal; that in nature nothing can be given, all things are sold.”

“Great bear markets take their time,” says Jeremy Grantham. “In 1929, we started a 17-year bear market, succeeded by a 20-year bull market, followed in 1965 by a 17-year bear market, then an 18-year bull. Now we are going to have a one-year bear market? It doesn’t sound very symmetrical. It is going to take years.”

“Every one [bubble market]” adds Grantham, “went back to trend, no exceptions, no new eras, not a single one that we can find in history.”

Japanese stocks have returned to their 1984 trend line – 17 years later. The U.S. bubble market began in 1995. If the U.S. repeats the Japanese experience, stocks may be expected to return to their 1995 trend line…with the Dow below 4,000 in the year 2012… almost the very moment at which America’s baby boomers will most need the money.

Nature in her wisdom…and God in his grace…always make sure people get what they’ve got coming, not what they expect.

Your correspondent,

Bill Bonner
August 30, 2001

*** Eric is traveling to visit me in France, so I am going to check on what is happening on Wall Street myself. Let’s see…

*** Well, the GDP number came out. It was not negative. It was positive, but barely…0.2%. So, no recession yet, officially.

*** Whether the GDP numbers prove it or not, it feels like a recession to many people. “What is that BS,” writes a Daily Reckoning reader, “THE RECESSION IS HERE!…This is the mother of all recessions, a global financial meltdown is imminent!”

*** Kathleen Peddicord, who lives in south-east Ireland and has reported on the real estate boom going on there, now reports that real estate has dropped dramatically – in some cases by as much as 20%.

*** The IMF revised its growth targets downward. Corporate profits fell for the 3rd quarter. And the Dow fell another 128 points. If it does that again today, the index will once again be below 10,000…

*** The bear doesn’t like to advertise his intentions. And, as I explain below, he has a lot of time to do his work. He will want to keep what Gary North refers to as the “illusion of a generation: capital gains” alive for as long as possible.

*** A drop below 10,000 today would be very discouraging. Coming just before the September/October period – which is typically dangerous for stocks – it could even set off a panic.

*** Who knows. But one way or another, Mr. Bear will have his way. Stocks will eventually return “to trend.” You, dear reader, will want to be sure that you are not in the bear’s way. Sell pricey stocks now, if you haven’t already done so. That way…you can sit back and enjoy the spectacle.

*** Bonds are hitting new highs; gold rose $1.40. The euro hasn’t moved much – it’s still at 91 cents.

*** Amazon is still below $10. GE fell 2% to just above $40. (Investors are almost certain to lose a lot of money in GE in the months ahead.)

*** Housing prices, meanwhile, are rising at 8% per year. The 30-year fixed rate has finally dropped back down to the levels of late last year – about 6.83% currently. People, eager to spend the “savings” they think they’ve found in their houses, are refinancing faster than ever. The refi rate rose 15.7% last week.

*** Speculating on housing seems to have taken the place of day trading stocks. The rule used to be that a family should spend no more than 20% of its income on housing. But a recent study found that one in five households where both husband and wife work spends more than half its income on housing.

*** “All bubbles meet their makers,” writes Caroline Baum. It wouldn’t take much of a setback to cause serious problems in the housing bubble. What if one of the wage-earners loses his job? He defaults. Fannie Mae takes a loss. The house goes on the market with thousands of others. Housing prices fall. And the “equity,” against which so many homeowners have borrowed, disappears.

*** I should talk – I probably spend an inordinate amount of my own income on housing. But in a pinch I could easily move to a cheaper apartment – or even give it up. That’s one of the unappreciated benefits of renting – there’s no capital risk.

*** Another DR reader follows up on our note about planting trees with a suggestion: “A good timber stock to buy is Evergreen Forests of New Zealand. It trades in the U.S. as an ADR under EVFSY. It is a pure play forestry company with some savvy investors including Jean-Marie Eveillard of SoGen and Hambrecht and Quist. Dan Case, CEO of H&Q, owns some personally and has put his children into it. Jim Grant has recommended it in his newsletter. It is trading very low right now due to the strength of the U.S. dollar.” (I will look into Evergreen Forests and give more details in an upcoming letter.)

*** Improvement on the tax front? Perhaps…”The distinction between what is ‘offshore’ and what is ‘onshore’ is rapidly disappearing,” says the Sovereign Society’s Mark Nestmann. “Propelled by the realization that more than 50% of the world’s wealth now resides offshore, high-tax countries are rapidly lowering taxes, decreasing regulatory barriers and rolling out the red carpet for outside investment.”

*** “I’m going to be a veterinarian,” said Henry, announcing his latest career objective (after studying “The Dog Book” for the last two weeks). “But I’m not going to be a regular veterinarian. I’m going to do genetic engineering on the dogs. You know, fix the collies so they don’t shed hair all over the place. And you know how Dalmatians are always biting people? I’m going to fix that too. And then I’ll sell my new, improved breeds for a lot of money. Or maybe I’ll just write a newsletter about them…”