A Bull Market in Hubris
The End of History… The Pax Americana… Triumph of the West…endless peace and prosperity for all. These were good ideas, weren’t they?…so what happened?
[The crowd] is not prepared to admit that anything can come between its desire and the realization of its desire…while the notion of impossibility disappears for the individual.
Gustave Le Bon, The Crowd
"In the late 1990s," writes Strategic Investment contributor, Dr. Marc Faber, "companies were able to book huge profits gains simply because few people cared how companies achieved these profits."
"The investment community – caught in a whirlwind of speculation and blinded by the bullish comments of business leaders, analysts, and Mr. Greenspan – was prepared to ignore all kinds of accounting gimmicks, stock buybacks financed with debt, dangerously speculative investment positions, and even blatant fraud in order to boost profits."
As long as stocks were rising, nobody really cared.
In San Francisco a few weeks back about 180 Agorans – readers, writers, analysts and editors alike – convened for our annual Wealth Symposium. For my part, I expressed these thoughts, or ones similar to them, early Saturday morning between sips of coffee. I reprint them here mostly for your amusement, but also to express a degree of disbelief at the level of hubris still running amok in the investment markets, in the world of politics, and throughout American society.
Since Enron – the ‘beginning of the end’ in the eyes of the mainstream financial media – Congress, the president, analysts, newsletter editors, soccer moms, even dipsomaniacal soothsayers on the streets of Paris, have been largely focusing on – and blaming – CEOs and accounting fraud for market woes. But "the true commanding problem of the US economy and the stock market," suggests Dr. Kurt Richebacher, "is not the accounting fraud but an effectively miserable profit performance that aroused the fraud [in the first place]."
An incredulous DR reader wrote to us recently to ask: "Given the fact that the markets have plummeted…now that [even USAToday] is bearish…shouldn’t the Daily Reckoning turn ‘bullish’?" The question suggests that bullishness would now be the truly ‘contrarian’ position to take.
But the fact is, even after two years…we here at the Daily Reckoning HQ are inclined to believe that we haven’t even begun to see the bearishness that is yet to come. All things get corrected, we’re wont to say. Nature has a way of seeing to it.
Even as recently as two years ago the "peace dividend", the "Triumph of the West" and Dow 36,000 were on everyone’s lips. Nobody was willing to admit that the success of the "new era" was anything but real. Only a handful of cranks suggested otherwise.
If you "didn’t get it", they said, then you just "didn’t get it."
And it wasn’t just Americans…foreigners bought into Pax Americana like tourists on the first day of annual summer sales here in Paris – that is, in a passionate rush with arms flailing, hoping to score the deal of a lifetime. Foreign direct investments in the US markets at the end of 2001 totaled more than $3 trillion. "But looking at their miserable return," says Dr. Richebacher, "it was a gigantic malinvestment."
In 1997, earnings from foreign direct investments amounted to $43 billion dollars. These peaked in 2000 at $69 billion, collapsing in 2001 to $37 billion. Rather than the 20% year over year growth they were looking for…the rate of return was a little over 2%…
"Considering the miserable corporate profits, a weakening dollar, the uncertainties about a US economic recovery and the accounting scandals, it is implausible that foreigners will add more dollar denominated to their portfolios. Nobody can be so stupid," says Dr. Richebacher.
"Yet the record suggests [and recent rallies prove] that at almost every point some people will be prepared to bet that the stock market or the dollar has bottomed out."
But what’s really going on? Rather than Pax Americana… or endless prosperity…we have the War on Terror…an impending invasion of Iraq…and a potential multi-year bear market. Where did the New Era go?
"Internationally," writes Bill Buckler of the Privateer, "the Bush Administration has managed to place the U.S.A. in a next to entirely isolated position. Nobody, except Great Britain and Australia, is siding with the U.S…If a war with Iraq now does take place, the U.S. will have to wage it on its own, with some British military help.
"Such a self-made global political isolation is exceptional. It is now vastly beyond anything the former communist bloc could have ever dreamt about imposing. The Bush regime has managed to accomplish it in six months."
"If President Bush goes to war in the Middle East, it is for the purpose of internal U.S. distraction. Iraq is a small country bled white by a tyrant, and it is far, far away."
A distraction? What could we possibly need a distraction from?
As the Austrian economists – people like Dr.Richebacher and Sean Corrigan, our man-on-the-scene in London – are so fond of reminding us…following the ’29 crash there was a 17-year bear market, followed by a 20-year bull market, followed by a 17-year bear market, followed by our most recent 18-year bull market. Dave Skarica, editor of a newsletter called Addicted to Profits, recently traced the cycles all the way back to 1815. With the exception of a few shorter cycles of 8 and 5 years for both bull and bear markets, the cycles generally last in the 17-20 year range.
Of course, we have no idea what the future holds. But we’re not afraid to take a guess. We’ve had a bear market for 2 years…is it likely that it will end by next year? The year after? Or will we need a major distraction to cut the cycle short?
Certainly not out of the realm of the possible, is it?
After the excesses of this last boom we expect we’ve got a few years yet of negative returns. And the greatest excess of the bubble yet to get corrected is that of the bull market in hubris that grew so large in the 90s… but correct, we suspect, it will.
The Daily Reckoning
August 29, 2002
P.S. The Agora Wealth Symposium, was in my humble opinion, a success…fine company, a wide array of ideas and even a rather sumptuous wine tasting to top it off. In all it was the perfect precursor to the New Orleans event which we are, in part, playing host to in November. There are still early bird discounts available.
How does it work, we asked ourselves yesterday?
The market, that is. Does it really reward patient, careful, long-term investors? Or does it ruin them?
The popular view is that the market is benign: Yes, people made mistakes in the late ’90s…and unscrupulous CEO’s and analysts took advantage of them. But buying sensibly-priced stocks still pays off…even if you have to wait awhile for other investors to recover their confidence.
Markets make opinions, as they say on Wall Street. But what makes markets?
We wish we knew. We’ve noticed, though, that markets – like politics – seem to reflect some kind of collective mood…a zeitgeist…which has a logic of its own. Encouraged by success and low interest rates, people come to believe that ‘the market’ is there to make them rich. For a while, it seems to be true. And for years, even after it has turned against them, they still believe it; the market is benign…stick with it and you will be rewarded.
Then, after years of disappointment, the collective mood gradually changes to the point where many people see the market in entirely different terms…as a malignant and destructive enterprise, probably immoral and certainly unprofitable, that only a fool would get involved with.
Where are we now? What is the zeitgeist of our time… and what is to come?
When the public’s exuberance for stocks is at its most irrational, people are willing to trade a dollar for a stock that might earn only a penny or two. Later, you have to pry their fingers apart to get them to buy one that earns 10 times that much.
Currently, an S&P stock earns less than 3 cents per dollar of share price. Yet, 3 times since WWII, stocks have traded so low that the average dollar brought you more than 13 cents in earnings.
"In a nutshell," writes Steve Puetz, "the conditions for a major stock-market bottom aren’t anywhere close to developing. As a general rule, the size of the financial bubble determines the magnitude of the subsequent decline and under-valuation. Based on that premise, a bottom won’t form until the market plunges to depths below the extremes witnessed in both 1932 and 1974. When fear is widespread and unemployment high, then a major bear market will be possible…that is a long way off."
But getting closer, according to Eric’s report:
Eric Fry, back on the job in the Big Apple:
– One week ago, when I left New York to vacation on a lake in New Hampshire, my mind was racing with thoughts about the stock market, the dollar, America’s current account deficit and many other weighty financial subjects. I now return to New York from New Hampshire with my mind idling in neutral – filled with thoughts like: "Why does the ‘Basic Ingredients’ pie shop in Bridgewater, NH close at noon on Sunday?" Or: "Why does the ‘Big Catch’ restaurant serve fried whole clams, but not clam strips?" Or: "Why does moss grow near the lake shore, when none was growing there 10 years ago?"
– But even while I was out of town, I kept half an eye on the state of American capitalism. What I saw wasn’t very pretty. The Dow dropped about 300 points during my absence from the scene of the crime, including the 130 points it yielded yesterday. The blue-chip index now stands at 8,694. The Nasdaq Composite slid 2.5% to 1,314.
– The beleaguered Canadian telecom company, Nortel Networks, provided a handy excuse for investors to sell stocks, especially tech stocks. The company warned of yet one more revenue shortfall and yet one more massive job cut. 7,000 more jobs are on the chopping block; that’s on top of the 53,000 the company already axed in the past 18 months. After the latest cuts, Nortel’s work force will have contracted by two-thirds from its boom- time peak.
– Nortel stock – what’s left of it – dropped 15% on the news to $1.04. The former must-own tech stock has tumbled more than 85% in 2002 alone. The crumbling Canadian company is a poster child of the telecom boom and bust. During the boom, when fiber optic networks were as fashionable as summer homes in the Hamptons, Nortel’s revenues soared – hitting a peak of $7.8 billion in the third quarter of 2000. Now, only two years later, the company will be lucky to pull in one third of that amount.
– Vying for understatement of the year, Nortel Chief Executive Frank Dunn explained, "The market environment continues to be challenging with lower spending levels than previously expected and a more prolonged industry transition."
– Unless its fortunes change quickly, Nortel could well be the next major telecom company to file for bankruptcy.
– Unfortunately for the stock market, Nortel is an extreme case of corporate distress, but NOT a unique case. A rapidly growing number of companies are ratcheting down their earnings estimates for the current quarter. Estimates for the fourth quarter are falling fast and furiously as well. According to Thomson First Call, 361 companies have reduced their third-quarter forecasts, while only 167 have raised them. In other words, more than twice as many companies have lowered their numbers. Last quarter, by comparison, the number of companies lowering estimates was about even with the number raising them.
– Falling earnings, combined with rich valuations, is not the classic recipe for a new bull market. "Everything we look at indicates that stocks are setting up for another big decline," Comstock Partners ominously observes. "The market remains highly overvalued at a time when the economy is softening and threatening to go into another recessionary period."
– Comstock also points out that investors have become very bullish very quickly – a phenomenon that is more likely to signal a market top than a market bottom.
– "The Investors’ Intelligence Survey reported that the percentage of bullish advisors jumped to 45% while bearish advisors dropped to 31%. Such a rapid turn towards optimism is a further indication that the rally rests on shaky ground," says Comstock. "Authentic new bull markets are always met by widespread skepticism. That appears lacking at this time.
"The post-bubble period is playing out," Comstock concludes, "and there is little anyone can do until the severe imbalances have been corrected…In addition the rally is petering out just as we are about to enter the September-October period that has witnessed some of the sharpest market declines in history. We sense that long- term investors were getting extremely worried in July, but for the most part, they held on to their stocks. Another downturn could well be the straw that breaks the camel’s back."
– As a professional trader I know likes to say about overvalued markets, "Stay for a good time, but not for a long time."
Back in France…
*** "Retail sales fell sharply in last 2 months," reports the Cleveland Plain Dealer. Chain stores say they are selling fewer chains, and other items, in the back-to-school shopping season. Disappointment runs high.
*** But pity the poor older folks. If they were smart, they took their money out of stocks a long time ago. But now they’re paying their bills with a couple of lousy percent interest from money market funds. No wonder Bloomberg reports that "Older Americans Keep Working."
*** And poor Ted Turner. As we told you yesterday, the man has lost nearly $5 billion in the AOL/Time Warner mark-down. And that’s not all. He’s also America’s largest landowner…with 1.8 million acres…and its largest buffalo rancher. But sometimes trouble comes all at once, as we’ve noted on more than one occasion, and the price of buffalo has fallen in line with the general deflationary temper of the times. Two years ago, Ted could count on $2,000 a head from his herd. Now, it’s only $300.
To make matters worse, in a lunatic moment Ted pledged $1 billion to the United Nations Foundation. Now, he’s committed to letting the global do-gooder bureaucrats fritter away a large part of his remaining fortune.
*** "I don’t understand capitalism at all," said our cook, Donovan. The remark took us all by surprise. Not that we were surprised that he didn’t understand it, but that he thought about it at all.
"It doesn’t seem right," he continued, "that people earn money just from their money…and don’t care what it really does to people." We recalled the puzzled comment of former socialist president of France, Francois Mitterand. It did not seem just to him either "that people earn money while they sleep."
But we did not know where to start to explain it all…
…why capitalists give up their own consumption in order to invest in projects that make other people’s lives better…
…why capitalist acts between consenting adults were not necessarily immoral…
…why economies need savings in order to make progress, and why savers are rewarded…
…why people either get to decide what to do with their money themselves…or someone else will decide for them…
…why ‘capitalism’ does not describe a system designed by man…but a spontaneous order designed by nature and driven by an ‘invisible hand’ which Adam Smith took to be the hand of God…
…why capitalists don’t necessarily make any money at all, but instead get what the gods think they deserve…
How to explain it all! How to make sense of something so gigantic and confusing…like trying to explain the colours of a rainbow to a blind man or the federal tax code to a poet…where to begin!
"Would you pass the soup?" your editor finally asked.