The news media reports "consumer confidence" numbers as if they mattered. "Consumers remain confident," say the headlines. Two years ago, doubting that consumers could knock out any economic slouch who came along was a form of heresy.
Now, it is close to treason.
There are probably even those who believe that a person without faith in the fighting spirit of the American consumer…or confidence in the elastic band of credit that holds up his trunks…should be shot. And perhaps they’re right. But let us hope they keep their opinions to themselves.
The average consumer – like the average investor…the average Congressman…or the average financial kibitzer – is a knucklehead. Aggregate the opinions of any number of them, and what do you get? A bigger mass of nonsense. Still, if consumers are confident, say the economists, they will buy more…and their spending will give the economy a kick in the pants. The same could be said for investors. If they believe stocks will go up…well, by gosh, they do go up.
At least…until they go down.
You may recall, dear reader, that in the late ’90s consumers and investors reached such sizzling levels of confidence that the future appeared not merely bright, but blinding. It was as if the bartenders had gone mad and opened all the taps…and the lawyers had all gone on strike. In short, it looked like paradise.
Thus, in the early spring of the last year of the 2nd millennium, with smiling faces and eyes dulled by the flash of too many New Era bulbs, investors locked arms and staggered off the biggest cliff in a quarter century.
Not only did stocks fall, the U.S. economy defied almost all the analysts and dropped like a dipsomaniac down a stairwell.
"Let us briefly take stock of what has happened to the economy," Dr. Kurt Richebacher invites in his latest letter. "From 1998-2000, U.S. real GDP grew at an annual rate of 4.1%. In the third quarter of 2001, it was a negative 1.1% annual rate, as against 4.7% in the same quarter a year ago. This is the steepest decline in economic growth that has ever happened in the United States."
As reported above, manufacturing has just registered its 14th consecutive month of negative growth. Bankruptcies and late payments are at all-time highs. And the profit growth of the last 7 years has been wiped out. Profits are back where they were in 1995 – before the boom.
And yet, after the worse economic break of all time, where are the homeless, the destitute, the hungry? They are nowhere to be found. Remarkably, in the very year in which the U.S. economy produced its worst performance since Kevin Costner in The Postman, consumers bought a record number of new cars…house prices rose at double digit rates in many parts of the country…retail spending went up…and consumers borrowed more money than they ever did before.
"I think the American consumer is brain-damaged," said Marc Faber at Barron’s Roundtable Discussion. "He should be pulling back and increasing his savings rate dramatically. But, no. He’s pushed by CNBC and the authorities…into consuming more."
But, according to most economists, the fate of the entire world economy rests in the hands of these brain- damaged consumers.
"The American economy is a disaster waiting to happened," Faber continued. "Greenspan’s interest-rate cuts have supported consumption artificially and borrowed from the future. The so-called booms in car sales and housing will come to a very bitter end. Greenspan basically moved the bubble from Nasdaq into other sectors of the economy, and these bubbles also will burst. Whether they burst right away or in 2004 is immaterial."
"In every other recession," added Felix Zulauf, another Barron’s Roundtable discusser, "investments in fixed equipment and residential investments led the economy out. Now housing has been kept at a high level due to the Fed’s aggressive stance, so there’s no bounce coming there."
As everyone knows, there are three exits from a recession. Spending must increase. Either by business…a foreign economy…or domestic consumers.
This time, the business spending door is barred. "Spending by the corporate sector is the result of profits and the profit outlook," Mr. Zulauf continued, "but U.S. corporations have gone through the worst profit slump since the 1930s."
Is there any hope that Japan, the world’s #2 economy, might come to our aid? Or Europe? Not really.
So, that leaves the brain-damaged U.S. consumer. If he should suddenly have an attack of frugality or financial prudence, the entire global economy would be in even more serious trouble. So, the whole world sits on the edge of its chair and holds its breath. Does the U.S. consumer have the money to continue spending, people wonder? Can he keep borrowing and spending – even if the recession doesn’t end quickly? Is he fool enough to try?
But the American consumer may not be the fool he appears to be.
"Consumer spending was by no means immune to the downturn," writes Dr. Richebacher. "It has kept growing, but at a sharply diminished pace. Its contribution to real GDP growth in the 3rd quarter of 2001 was less than one-fourth of what it had been in the same quarter a year before…"
At the margin, consumers are cutting back.
Not necessarily because they want to do so. "The problem now is that American consumers and the corporate sector have piled up a mountain of debt."
For the last 12 years, added Art Samberg, offering corroborating evidence, both business and personal debt rose at 6% per year. Assets, however, grew at only half that rate. Falling interest rates made that debt load easier to carry. But an uptick in the economy would almost certainly lead to higher levels of inflation and higher interest rates.
The benefit of a real recession is that people return to their senses. They typically slow their spending and pay down their debts. Then, when the recession ends, they are in a better position to spend. Recessions also eliminate the weakest businesses, so the stronger ones have more room to grow when growth returns. But Greenspan’s quick, sharp rate cuts – so admired by economists – have stalled the process. American consumers have barely begun the cutbacks they need to make. And businesses that should have closed down their websites years ago are still sending out quarterly reports.
The bubble, to simplify things, was caused by too much money. Entrepreneurs could get capital for any silly project they could dream up. And consumers could spend money they didn’t have, because they were sure that there would be plenty more where that came from. In trying to fight the inevitable correction, the Fed has offered even more money at the lowest interest rates in 6 decades. This easy money has kept marginal enterprises in business…and allowed consumers to "unlock" even more of the equity trapped in their houses. Thus were consumers able to spend more…even as their earnings fell.
But the doors that might offer an escape from recession are closed. No foreign economies will heat up – not with the chill of the U.S. recession so near.
Businesses will not invest in new plant and equipment – not without stronger profits to encourage them. And consumers – brain-damaged or not – will not continue spending money they don’t have.
"It has now been 12 months since the Fed made the first move of its current monetary easy campaign," writes Dr. Richebacher. "Yet the data shows that downward forces keep worsening.
"What is the possibility of the U.S. economy’s V-shaped recovery that the consensus is better on?…The precedents allow no other conclusion than that such a recovery is completely out of the question…we doubt even the possibility of a sustained slow recovery."
January 17, 2002 — Paris, France
P.S. As you are probably aware, both Dr. Richebacher and Marc Faber contribute regularly to the insights (or lack thereof) you are subjected to as a reader of The Daily Reckoning.
The dollar is still holding up. Will it buck our Daily Reckoning forecast for a 3rd year in a row?
Maybe. But sooner or later, foreigners are likely to get worried about U.S. financial assets. They’ve seen how billions of dollars in capitalization can disappear overnight…and how even the biggest companies can cook the books until the pan burns.
"The Germans are on to us," says yesterday’s Prudent Bear’s Market Summary. A German press story reveals that S&P 500 companies are reporting earnings that are 70% higher than GAAP would permit. "America’s pro-forma disease," says the headline on FAZ.net.
The prices that Germans and other investors will pay for U.S. stocks depend on earnings. Not only are past earnings hugely overstated…estimated earnings for the future turn out to be complete fantasy.
The S&P 500 is expected to produce about $28 in average earnings for 2001. Estimates for 2002 are all over the place…but bunch up in the $40 to $50 range.
Almost never have earnings increased so much from one year to the next. And in the coming year, what could make them do so? Consumers will only buy a car if the manufacturer is willing to lose money selling it to him. And what industry is so exuberant as to trigger a new burst of capital investment? Suppose earnings don’t rise much at all next year?
Sooner or later, we predict, foreign holders of U.S. dollar assets are going to become suspicious of the numbers and doubtful of the integrity of the people who prepare them. They may even want their money back…
"A major top is forming," say the Aden sisters, "and the dollar remains vulnerable. Once the dollar index declines and stays below 115, it will be a strong sign it’s headed even lower this year." Pamela and Mary Anne recommend "keeping a 40% position" in CD’s of Swiss francs, British pounds and euros.
Eric…bad day on Wall Street?
Eric Fry in New York…
– In a stunning reversal of the recent trend, investors took bad news to be bad news. Will this temporary lapse into sanity last more than one day?
– A couple of minor little companies named Intel and J.P. Morgan Chase reported that business conditions are not that swell in their neck of the woods.
– Meanwhile, in other news from the "recovering economy" file, industrial production slid for the 14th month out of the last 15. Capacity utilization also slipped to another new low for this cycle.
– The consensus – you know who you are – had been expecting both of these measures of economic health to improve during the month. But it was not to be. And neither was a rally on Wall Street.
– In response to the bevy of bad news, the Dow slid 212 points, to 9,712. And the Nasdaq tumbled into the minus column for 2002 by dropping 3% yesterday to 1,944.
– Output of the nation’s factories, mines and utilities fell 5.8% in 2001, the worst calendar-year performance since 1975. Capacity utilization also dropped 5.8% last year.
– Consumers might be brimming with confidence, but the manufacturing sector can’t seem to break out of its funk. And the prospects for a rebound are not very encouraging.
– "Corporate balance sheets are in grossly worse shape today than they were in 1929-30," asserts Dr. Richebacher. "[Therefore], cuts in capital spending have been aggressive as never before." Toss in deteriorating cash flow and the outlook turns ugly in a hurry.
– Which brings us to Intel – an iconic representation of the economy at large.
– Intel announced yesterday that it will slash its capital-spending budget for 2002 by 25% to $5.5 billion. "We’ve seen no signs of an economic recovery," Chief Financial Officer Andy Bryant told Reuters.
– Bryant’s stark assessment says it all. "After years of unprecedented support for their investments," InformationWeek Magazine laments, "IT [information technology] executives face mounting pressure to pick and to pay for only those technologies that offer a quick and measurable payback."
– Like paper clips, perhaps?
– In a recent survey of 300 IT executives last month by InformationWeek, only 33% of respondents said that they expect to increase their IT budgets this year. That’s less than half the 72% that planned to increase their spending last year. And remember, these results reflect PLANNED spending. "Actual results may vary," as the disclaimer goes.
– Still, "Many remain in a state of denial regarding the resounding collapse of activity in the high-technology, Internet and telecommunications industries," Moody’s observes. High technology/telecommunications companies alone accounted for nearly one-fifth of all credit rating downgrades in 2001.
– And their credit-worthiness, on average, continues to erode.
– Back in 2000, the fear of getting left behind powered IT spending. These days, it’s all about cutting costs. "Caution is the guiding principle," says InformationWeek.
– Caution however, is something that J.P. Morgan Chase executives seem to believe is best thrown to the wind. Find an area of high-risk banking and you will almost certainly find "The Morgan."
– Atop its roster of bad loans we find now-infamous debtors like Enron and Argentina. J.P. Morgan has also racked up sizeable losses investing in tech and telecom venture capital deals. All of which makes one wonder, "Does this swashbuckling money-center bank have any feet left to shoot?"
– Time will tell, of course. But yesterday, J.P. Morgan reported a pro-forma (there’s that term again) fourth- quarter profit of 12 cents a share, barely a third of Wall Street’s consensus estimate. Under GAAP accounting, the company reported its first quarterly loss in five years.
– But write-offs were the real story, both because they were so large and also because they might become even larger. The gang at Grantsinvestor.com is pretty darn sure that JPM has not finished airing its dirty laundry.
– "Despite the abysmal performance of JP Morgan’s venture capital arm – with total unrealized and realized losses topping $1.2 billion last year – it appears more charges could come down the road," Grantsinvestor reports. "For one thing, the fair market value of its top ten public holdings has plummeted nearly 20% just since the beginning of the year!"
– For now, Morgan’s write-offs for loans to Enron, Argentina and other deadbeats produced a net quarterly loss of $332 million. And the total non-performing loans at America’s second-largest bank have doubled to nearly $4 billion.
– Non-performing loans are like cockroaches; if you spot a couple scurrying across the floor, you’re probably living with 1,000s.
Back in Paris…
*** What are we worrying about? Abby Cohen says we’ll finish this year with the Dow at 13,000. That should be good enough for anyone. Still, we here at the Paris office of the Daily Reckoning are a skeptical lot. We decided to seek confirmation.
*** There is a puzzling, oracular character who loiters in our neighborhood from time to time. He is not French, but of some Oriental hue that no one seems to recognize. All we know about him is that he dresses in rags and sings at the top of his lungs when he gets drunk.
*** "We’re all going to paradise…" he shouts the words of a the popular song, while lolling in front of the Paradis Bar across the street. Then, he passes out on the sidewalk.
*** It’s been cold and rainy in Paris lately. I had not seen the strange little man for several days. But yesterday, upon leaving the office, I found him in the building, asleep on the first floor landing, with his head on the bottom step and an empty whiskey bottle still in his hand.
*** I stopped. And with the toe of my shoe I gave his tattered coat a little nudge.
*** No response.
*** I tried again…and again…finally, kicking him as though I were playing a field sport, he snorted and opened his weary eyes.
*** Bending over, I asked: "Will the Dow be at 13,000 by the end of the year?"
"Not a chance," he said. "We’ll all go to paradise first…"