While contemplating the passing of 2003, we thought it might be worth taking a look at what we were thinking at the end of 2002. This DR classique was orginally broadcast a year ago yesterday.
"God does not play dice."
Einstein upset the world with his Relativity Theory. All of a sudden, there were no fixed positions; everything seemed unhinged…loose.
"It’s all relative," people said. Nothing was absolutely this or that, right or wrong, here or there.
And then Heisenberg’s Indeterminacy Principle came along and even Einstein had had enough. Not only are there no absolutes, said Heisenberg, but you couldn’t know it even if there were. Everything was in motion, he pointed out; you could figure out where an object was…or its speed…but not both. And the process of trying to figure it out can’t help but change the readings!
After Einstein and Heisenberg the world had begun to look like a giant crap game. You throw the dice and hope for the best; what else can you do?
The idea of an uncertain, unknowable universe did not please Einstein; he spent the rest of his life trying to prove it was not so.
Heisenberg Uncertainty Principle: What Are the Odds?
But today, we hear the rattle of dice everywhere. It is the end of one year and the beginning of another. People are regretting what they did last year…and warming up the dice in their right hands for another throw. What are the odds of this…or that…they wonder, as if they could know.
To give you a preview of our conclusions; we guess that this is a bad time to buy stocks. [Depending on how you look at it… we didn’t exactly get this one right.]
The odds of a huge meteorite destroying lower Manhattan, we assume, are fairly low – as remote as the odds that Congress will pass a sensible law or that Jack Grubman will win a Nobel Prize for his investment research. Anything could happen, but some things are more likely than others. But, as Heisenberg warns us, as soon as we try to figure these things out, we distort the odds.
That is the strange perversity of the marketplace. As people come to believe that something will happen, the odds of it coming to pass go down. Likely as not, it has already happened. As people come to believe they can get rich by buying stocks, for example, they disturb the universe – they buy stocks and run up prices. Then, the higher stock prices go, the more people believe in them…and prices go still higher. At some point, because this cannot go on forever, stocks reach their peaks – at almost precisely the point when people are most sure they can get rich by buying them.
This point was reached in the U.S. somewhere between the fall of ’99 and March of 2000 – about 3 years ago. Since then, the Dow has fallen 37%. The Wilshire Index, a broader measure, has lost 43%. It is has been the worst bear market since ’29, with the leading mutual funds down an average of 27% in 2002 alone. In terms of money lost, it has been the worst bear market ever. The total loss so far has equaled 90% of GDP, compared to only 60% of GDP for the two years following the ’29 crash. [Despite the Great Reflation of 2003, these figures are still true.]
Almost all market forecasters were wrong during this period; they overwhelmingly thought stocks would go up, not down – especially in 2002, because stocks "almost never go down 3 years in a row." Abby Cohen, Ed Yardeni, Louis Rukeyser, James Glassman, Jeremy Seigel – all the big names from the ’90s – still believe that stocks will go up, if not last year…certainly the next. They seem completely unaware that their own bullishness has tilted the odds – against them. Talking up the bull market year after year, they helped convinced Mom & Pop that stocks for the long run were an almost foolproof investment. Now, the fools are having their way – proving that nothing fails like success.
Heisenberg Uncertainty Principle: Tides Ebb and Flow
In the last quarter of the 20th century, nothing seemed to succeed better than American capitalism. Stocks began rising in 1975…and continued, more or less, until March of 2000. By then, all doubt had been removed. Americans had become believers in the stock market.
"To believe that stocks will be rotten again…," wrote James Glassman early last year, "is to believe that they will buck a strong tide that has been running in the same direction for more than 60 years."
Glassman doesn’t criticize our metaphors, but we can’t resist criticizing his. Tides do not run in a single direction forever. They ebb and flow in equal amounts and opposite directions.
Glassman seems to believe in tides and weather, but never looks out the window. "It rains, but the sun comes out again. Stocks fall, but they always recover to a higher ground," he wrote. And then, he failed to mention, it rains again! And when the sun shines long enough, people stop noticing clouds on the horizon.
Who noticed, on those perfect days of early 2000, that odds had changed; the stock market had become very different from the stock market of ’75…and that the few investors who bought shares in ’75 were very different from the many Moms & Pops who put their money into stocks in 2000? Who noticed, as Buffett put it, that these people may have bought for the right reason in ’75…but they bought for the wrongs ones 2000? Warren Buffett has another helpful dictum: if you’re in a card game and you can’t figure out who the patsy is, you’re it. Millions of patsies had entered the stock market in the last 25 years…lured by Buffett’s example, Rukeyser’s spiel, and the appeal of getting something for nothing. Hardly a single one of them carried an umbrella.
It is now three years since it began raining on Wall Street. On paper, more money has been lost than ever before. And yet, the little guys still believe. They believe the ‘reasons’ why stocks are likely to rise …because they hardly ever go down 4 years in a row! On the little evidence available (since it so rarely happens) after stocks have fallen 3 years in a row, the odds are about 50/50 that they will fall again in the 4th year.
This year, the odds may be distorted – but not in the way investors hope. Stocks rarely go down 4 years in a row because – usually – after 36 months, they have almost always hit bottom. But this year is different. The patsies are so confident that they have not been willing to sell their stocks and take their losses. At the beginning of 2003, stocks were still selling at prices more typical of a top than a bottom. Based on ‘core earnings,’ S&P stocks were priced at 40 times earnings. Or, as Barron’s calculates it, based on last year’s reported earnings, they sell at a P/E of 28. Either way they are expensive. [And even more so now!]
While earnings are subject to interpretation, dividend yields are not; stocks yielded only 1.82% in dividends at the end of 2002.
Heisenberg Uncertainty Principle: Rolling the Dice
But maybe the patsies will get lucky in 2003. Maybe the U.S. army will catch Osama bin Laden…and maybe stocks will go up. Maybe it is just luck, after all. [Luck… and a whole lot of government stimulus!]
Imagine the roar of laughter when Einstein arrived in heaven and God explained, "I don’t have any plan…I just roll the damned dice!"
God can do what he wants, of course. But made in His image, we will do the same. We don’t presume to know God’s plan or his method. We know that history is full of myths and lies, that the present is impossible to fully understand and that the future is unknowable.
But so what? As the existentialists tell us, we still have to get up in the morning and make decisions. Recognizing that we can’t know whether stocks will go up or down in the year ahead, what do we do?
We take a guess…we make a wish…and we say a prayer. We guess that stocks are a bad investment, for very simple reasons:
"The place to find a safe and remunerative investment is unusually where others aren’t looking for it," writes James Grant. Everybody is looking on Wall Street. So we will look elsewhere.
"Buy low, sell high;" the old chestnut practically pops out of the pan towards us. For the last 100 years or so, the average stock has sold for less than 15 times earnings (which used to be calculated more honestly). Almost any measure you take puts them about twice as expensive today.
"A bear market continues until it comes to its end – with real values," says long-time observer Richard Russell. Stocks are real values when they sell for 8-10 times earnings, not 28-40 times. If stocks are destined to sell for 10 times earnings some time in the future, why would we want to buy them today?
Of course, stocks could go up. And maybe they will. But it is a bad bet. Not that we know the odds any better than anyone else. What we know that many others don’t is only that we don’t know them….
The Daily Reckoning
January 5, 2004
P.S. Einstein and Heisenberg proved the latter’s point. Trying to describe the world – they changed it. "A kind of madness gained hold…" wrote Stefan Zweig of Germany in the ’20s. The whole nation seemed to come unhinged by the realization that nothing was quite what they thought it was…
Start the New Year Off Right…
Why not give your kids or grandkids something to help them grow wealthier and wiser every year of their lives?
Alan Greenspan and Ben Bernanke are in the news today. The two Fed governors gave speeches over the weekend.
The big financial story of ’03 was the drop in the dollar — which dwarfed all other trends put together. All U.S. assets are priced in dollars. If, all together, they are worth about $50 trillion — Warren Buffett’s estimate — last year, Americans lost $10 trillion (measured in gold or euros). This followed a similar loss the year before. But neither Greenspan nor Bernanke bothered to notice…or stooped to wonder what it might mean.
"There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful," said Greenspan to the annual meeting of the American Economic Association.
Success, in the Fed Chairman’s view, is demonstrated by the "exceptionally" mild correction will be followed by the most extravagant bubble the world has ever seen. Despite terrorist attacks, stock market scandals and war consumers just keep trucking their way to the poorhouse. Mr. Greenspan did not mention it, but since he has been head of the Fed the average American has spent a higher percentage of income — from 75% to about 85% — trying to keep up appearances while not falling behind in his debt service payments.
Greenspan acknowledged that he might have raised rates to prick the bubble. But that would have meant a real correction rather than a phony one. A falling stock market would "bring the whole economy down with it," warned Greenspan.
The Fed chief declined to explain why avoiding a correction by increasing consumer debt was a good thing…nor did he explain how debt might someday be eased without a correction…or what would happen when his debt bubble, now at higher altitudes, eventually blew up. Nor did he bother to reflect on what would happen when foreigners lose confidence in the debt-puffed dollar.
But leave it to Ben Bernanke to rush in where even Greenspan feared to tread. The newest Fed governor said he saw "little risk" of a dollar crisis. Instead, the risk Bernanke sees is the menace of not enough inflation. Inflation is "at the bottom of the acceptable range," he said, and explained that the Fed would make sure it moved higher, not lower.
These remarks seemed to push the world’s lenders closer towards the risk Bernanke couldn’t see. "Dollar drops to record low against euro after Bernanke’s comments," Bloomberg reported. An American who earned $20 per hour in 2001… earned the equivalent of only $12 last year.
In terms of real money, Americans are losing income faster than at any time since the Great Depression. Pity no one mentions it.
*** Addison and company haven’t quite assembled back in the Paris HQ of the Daily Reckoning following the holidays. In lieu of any insightful financial news for the day, Hugh Hendry, London-based fund manager, gives his stock picks:
"I’m buying stocks with inelastic supply curves. That means as a producer, you can’t produce more of the product in the short term. If demand rises, the only way you can ration demand is by raising prices. I see monetary inflation and I’m betting this money will bid up prices in the wider economy. So it takes me into mining companies. We have Anglo American. It’s raised diamond prices three times this year. It also has gold. And you see what’s going on with gold. Others I own are Lonmin, BHP Billiton, Rio Tinto, Phelps Dodge and Xstrata. Yet put them all together and the market cap is less than Vodafone’s. There is an enormous reluctance on the part of institutional investors to buy these stocks. They’ve looked at the past 20 years, and they say ‘You know what? They stink.’
"Yet, these stocks are already performing. The valuations don’t look remarkably cheap, but the analysts are pricing expectations by the absolutely awful 20-year prior history.
"There’s a better chance of these stocks doubling than any other stocks doubling in the marketplace. I own a zinc mine in Ireland called Arcon International, a tiny company. Zinc is at a 70-year price low versus the real economy when you’ve got China growing and you’ve got every other metal higher. If we are wrong, Arcon is [already] priced as if it has no future. If we are right…Arcon’s on two times earnings…I’m going to make 10 times our money."
*** And how about Japanese stocks? Is it time to buy — after a 13-year bear market? Maybe. In Japan you can get an 8% dividend yield, says Hendry. And a P/E of 6. This is like buying equities in the U.S. in 1976.
*** Tech stocks rose 66% last year. But gold stocks rose 68%%. Which are likely to rise again this year? We will put our money on the gold stocks.
*** "History records many turning points leading to human tradegy, but few ‘turning-back’ points," writes our friend Byron King. "From the pointy-headed wise men at the FED, to the stampeding shoppers at Great-Wal-of-China-Mart, this nation’s economy is too far gone to reverse the unfortunate trends. We are all in this together, unless maybe you have been foresighted enough to open up an overseas bank account, or two, and squirrel away some gold. The conventional thinking is that the problem of a ‘jobless recovery’ is a strange and new economic disease. I think that the ‘jobless recovery’ is actually part of the cure, and we are now only suffering the sniffles that precede full-fledged pneumonia. This is nature’s way of imposing a hard-edged economic phenomenon, a painful social phenomenon, and a dislocating cultural phenomenon on the world of the ‘dollar standard’, the purpose of which is to deflect the political and economic forces that impel the nation to its own disaster. We shall have to wait and see how the body politic takes to this particular homeopathic cure."
"When John Steinbeck published ‘The Grapes of Wrath’ in 1939, he told a tale of the Joad family, driven off their land, in the midst of the Great Depression, when the crops failed due to a drought. What nature commenced, according to Steinbeck (and what FDR prolonged, I must add), the Joad family’s fellow American citizens made into a tragedy along the sad route West in a beat-up old truck. But ‘Grapes of Wrath’ was also a tale of hope, because at least there was the possibility of a better life in California, pre-Gray Davis.
"What is the modern version of ‘The Grapes of Wrath?’ I think it can be updated to commence with a ‘jobless recovery’ because the U.S. Federal Reserve created too many dollars, to fund the long-term deficit spending of an unrestrained federal government of Pharaonic scope. These excess dollars then went overseas via the conduit of unchecked consumerism, an American version of what Pope John Paul II has called ‘the cult of radical individualism,’ pushing the nation to the point of irremediable indebtedness and national insolvency. And then, in the updated version of the Steinbeck novel, people lose their land and homes not to drought, but to debt-collection and unpayable taxes. And when people pack up in their beat-up old SUV’s and head out onto the National System of Interstate and Defense Highways, they go… hmmm… where do they go?
"The Joad family went West and picked peaches in California, but is that really a job for today’s unemployed investment bankers, mortgage brokers, graphic designers and software programmers? Is the prospect of picking peaches for a bare living why countless Americans went to college, and even took Economics 101 while enrolled? Hardly. No, I wonder if the Joad families of the future will wait for the next election cycle, and then vote for a Man (maybe a Woman?) on a White Horse, who promises ‘good jobs at good wages,’ and who will stand up to those perfidious foreigners, with their ‘sweat-shop wages.’ Perhaps I am overstepping my bounds in all of this. It is difficult to predict the future, but when I find out what happens I will be sure to let you know."