Caution Ahead

Our friend John Mauldin heralds 2004 as a year investors may possibly enjoy…but warns that the rest of the decade will not be full of roses.

The most recent economic data tells us that the U.S. economy grew in the third quarter of 2003 by 8.2%. 4th quarter projections for the same year show another 4% plus. That is hardly middling growth – that is Red Hot. Further, it is highly likely that 2004 will turn out to be a good year, barring some shock.

How, then, can I continue to urge caution? Why won’t things simply continue to improve? First, let me be clear that I am talking about a much longer period than just 2004. Second, as we will see below, even in lengthy sluggish decades, there are always (thankfully!) some powerful interludes of growth.

I do not see a continual below-trend state of growth ahead of us. Then again, we have yet to do the difficult work of re-balancing the economic scales which were decidedly tilted in the last boom. Until we have adjusted these imbalances, we will be fighting an uphill battle for growth. It can and will be done, but it will not be easy. It may take the rest of this decade.

I believe the annual GDP growth of this decade will be somewhat below average or less than 3% at the end of the period. There will be some very good periods when the bulls will proclaim the return of the high-growth economy of the 90’s, and some years we would like to avoid, in which the bears will declare the Day of Reckoning is at hand. In my view, neither will be right, at least this decade.

Secular Bear Market: High GDP Even in the ’70s

Not many remember the period of the 70’s as good economic times. Between 1970 and 1982, the average annual GDP growth was 2.5% and for the period was a total of 37.5%.

Yet there were years when the GDP was very high. The years 1976-79 saw back to back growth in real GDP of 5.6%, 4.6%. 5.5% and 3.2%. The average for the four years is almost 5%. (Of course, inflation for that period was over 7% annually.) Yes, the 70’s had its moments. But on the whole, it was by no means a stellar growth performance.

In my opinion, the secular bear market really started in the third quarter of 2000. The market collapse in March of 2000 was the collapse of Nasdaq-related stocks. In a true sense, the resulting tumble was far more than a bear market. That was a bubble bursting.

The burst of the Nasdaq bubble did not have that much of an effect on other stocks until a few months later. The broader-based NYSE almost reached new highs in the third quarter of that year before starting into its own bear market. The non-Nasdaq component of the S&P 500 was not in bad shape until then, and value and small-cap stocks were on a run. Then came the beginning of the economic slowdown and the true beginning of the secular bear cycle.

The third quarter of 2000 was the slowest growth quarter since 1993 and the 2001 recession followed hard on its heels. In fact, the recession may have begun in 2000. The Bureau of Economic Analysis told us in December that they made a small mistake back in 2000…and gave us revised GDP numbers all the way back to 1929. According to the new figures, Q3 of 2000 had negative GDP of 0.5% instead of the reported +0.6%. The BEA are evidently removing the effects of hedonic pricing of computers [so often descried in these pages by the good Dr. Richebächer] as they now believe they might "distort" actual GDP numbers. No kidding. In his report at the time, Bill King sarcastically (and appropriately) wondered what effect an accurate announcement that we were in recession would have had on the presidential election? There wouldn’t be any home team bias in government figure, would there? Surely not.

Secular Bear Market: Less than 2.1% Annual Growth

Since that third quarter, the economy will have approximately grown at an annual rate of less than 2.1%, even given the explosive growth of the last half of 2003.

If the economy were to grow in 2004 and 2005 at the blistering pace of 4% as it did in the late 90’s, the average growth since 2000 would still not be 3% at the end of the period, which is less than the long-term trend of 3%. If the economy were to grow at 4% for the next three years before a historically mild recession (repeat – mild) the economic growth for almost 7 years would be back down to 2.5%.

A decade in which there are two recessions is almost by definition going to grow less than 3% on average. And the chances of the U.S. economy getting through the rest of this decade without a recession are not good. Congress and the Fed can create all the stimulus they like. Imbalances will only worsen as a result – and remain a drag on the U.S. economy.


John Mauldin
for the Daily Reckoning
January 15, 2004

Editor’s Note: John Mauldin is the creative force behind the Millennium Wave investment theory and author of the weekly e-mail The Millennium Wave Investor. As well as being a frequent contributor to The Fleet Street Letter and Strategic Investment, Mr. Mauldin is currently writing a book entitled Bullseye Investing.

A question for you, dear reader:

What moves voters to cast their ballots one way or the other?

Do they carefully study the arguments, the evidence, the logic of the contestants’ claims and promises? Or do they give their vote to the man who shakes their hand…who says the things they want to hear? Is it rational scrutiny or sentiment that moves them?

You probably know our answer. A man may be a perfectly decent brickmason or accountant. He drives down the road day after day and does the right thing most of the time. He poses no threat to his neighbors and can be counted on not hijack commercial airliners. But put him in a voting booth and he loses all his reliable points of reference. His experience counts for nothing. He has no way of judging the merits of the issues or arguments – ‘national security’…’better health care for seniors’…’fair tax proposals’…’peace in the mideast’…’democracy in Iraq’…they are all just hollow slogans and pet clichés.

All he has to guide him is the politician’s smile…a ‘feeling’ that things are going well or badly…and a guess about which humbug is likely to do the least damage.

In the short run, as Buffett points out, the stock market is a giant "voting machine." Investors place their money as recklessly as their ballots – based on nothing more than vague sentiments and feelings. When they are feeling bullish, they buy. When they are feeling bearish, they sell.

In markets as in politics, the masses’ sentiments are given shape and focus by the mass media. Thus do millions of people come to think just about the same thing at just about the same time.

We can judge the mood of the public – or what Gustave Le Bon called their "general belief" – by looking at the a few broad measures. In 1974, the average investor would buy a stock if, each year, it earned about 15% of what he paid for it. A quarter of a century later, he was willing to buy the same stock even though it only earned about 3% per year of his purchase price.

Another way of measuring popular sentiment is to compare the price of gold to the price of Dow stocks. There is no particular reason why the average lumpenvoter should prefer gold to stocks some times and not others…except that his general sentiment has changed. Sometimes he is hopeful, positive, optimistic, expansive, activist…and sometimes he is not. When he is feeling good about the future…he prefers stocks, for they represent growth, technology, business, profits and all the good things he sees coming his way. When he is feeling fearful, on the other hand, he sells the stocks and buys gold. "Just in case," he tells himself. The stocks might be worth nothing tomorrow. The gold will still be there.

According to Ian McAvity, the ratio of gold to the Dow has been about 5 to one since 1900. That is, it took 5 ounces of gold to buy the 30 Dow stocks. Gold trading was halted in the U.S. by Franklin Roosevelt, but resumed in 1968. Since then, the ratio has been about 8 to 1, says McAvity. But today it is nearly 25 to 1.

Mass sentiment can also be calibrated in terms of debt. When people feel expansive and positive, they are willing to go into debt to realize their project, confident that things will work out somehow. When they are feeling pessimistic, they pay off their debts, trim expenses, and wait until conditions improve.

How are Americans feeling today? The ratio of debt to GDP averages – over the first 8 decades of the century – only about 1.6 to 1. Currently, it is more than twice as high…a new record.

Never before have Americans been so confident…so optimistic…so expansive…so activist – so mad! They borrow more than ever before and go bankrupt at the fastest rate in history. They spend more…even as they earn less. They buy stocks, hoping they will go up…even though they have already gone up to levels that are about as high as they ever get. And their president has given them the biggest government deficits in history…and the most ambitious foreign policy. Not content to plant the flag in Babylon, today’s paper tells us he is aiming for Mars! We can hardly wait…

And now, over to Eric Fry…with more news:


Eric Fry, observing the raucous ballet on Wall Street…

– A "lap dance of liquidity" is powering the stock market, according to one female commentator on CNBC. Unfortunately, we have no firsthand experience with lap dances, so we must defer to her expertise on the subject and assume that the metaphor is apt…A "lap dance of liquidity" seems as plausible an explanation as any for the titillating trading action on Wall Street and for the ecstatic squeals and moans of delight issuing from satisfied – very satisfied – investors.

– But is the liquidity provided by the Fed really the main influence that’s getting a rise out of the stock market these days? Isn’t it more likely that a "strip-tease of speculation" is lifting share prices? Sadly, the strip- tease of speculation is always followed shortly thereafter by the frenetic "samba of selling."

– Yesterday, however, investors were too busy kicking up their heels to worry about the repercussions that might follow. A melodious combination of good news and hopeful rumors set an upbeat tempo for the day’s stock-buying. First up, the U.S. trade deficit narrowed in November to $38 billion, well below the trend of prior months. "The gap during November was the narrowest in 13 months," Bloomberg reports, "and followed a shortfall of $41.6 billion a month earlier…The trade deficit with China narrowed to $10.8 billion from $13.6 billion."

– The trade report’s release yesterday morning produced a simultaneous dollar rally and gold selloff, while also setting a bullish tone for the stock market. The greenback surged nearly 1% against the euro to $1.265. Gold swooned as much as $6.00, then recovered gradually throughout the day to finish the New York session down $2.00 at $422.00 an ounce.

– Here on Wall Street, rumors were flying all day that the upcoming earnings releases from Intel, Yahoo and Apple would "beat the number." Alas, all three companies reported merely respectable results after the close of yesterday’s trading. Investors had hoped for so much more from the three tech bellwethers that all three stocks slumped in after-hours trading. But enough about unrealized expectations…During Wednesday’s trading, investors seemed to enjoy the fulfillment of each and every expectation. The Dow jumped 111 points to 10,538, while the Nasdaq Composite added 15 points to 2,111.13.

– The surprising drop in the trade deficit seemed to validate – momentarily – Greenspan’s gospel of "salvation by devaluation." For two years, Greenspan and his pinstriped minions have been coaxing the dollar lower, while threatening to print limitless amounts of greenbacks if the currency refused to decline. And for two years, the chairman has assured us that devaluing the dollar would boost the economy and narrow the trade deficit. Unfortunately, for most of the last two years the economy languished and the trade deficit ballooned. And the trade deficit seemed destined to expand forever…until yesterday.

– The deficit finally narrowed, thanks to an improving balance of trade with every major trading partner. The deficit with the European Union, the second-largest trading partner of the U.S. last year, narrowed to $7.4 billion in November from $8.7 billion, while the deficits with Canada, Mexico, China and Japan all contracted as well.

– But the Fed did not allow itself even one brief moment to relish its achievement. Instead, it continued tirelessly preaching the gospel of "salvation by devaluation." One day after Greenspan amazed a Berlin audience with his audacious disregard for the dollar’s swoon, Ben Bernanke wowed another gathering of European bankers in Geneva with a similar message.

– Tuesday, you will recall, Greenspan strolled into a meeting with the German Bundesbank and methodically annoyed his European counterparts. "Ich bin ein self-serving American," seemed to be the main message of Greenspan’s Berlin address, as he praised the "productive" U.S. economy growth path and shrugged off the dollar’s steep decline.

– Bernanke picked up where Greenspan left off. A dollar crisis is "extremely unlikely," said Bernanke. "An uncontrolled decline is unlikely to happen because it is not in anybody’s interest, including the Japanese." Interesting theory…If we recall correctly, the 1929 stock market crash was not in anyone’s interest either, yet, somehow, it still managed to occur.

– Greenspan’s "salvation by devaluation" message has won very few converts on the European continent. Numerous European bankers and politicians have expressed their dismay over the very same currency trends that Greenspan dismisses as inconsequential. Monday, ECB President Jean- Claude Trichet called the euro’s steep ascent over the last two years, "brutal." The following day, Bundesbank head Ernst Welteke cautioned, "We fear that the appreciation of the euro could put a brake on the recovery."

– Certainly, the Europeans have cause for concern. The euro’s swift ascent makes life miserable for the Continent’s export industries. If the dollar doesn’t find its footing soon, the European Union might begin dancing the polka of protectionism.


Bill Bonner, back in the City of Light…

*** "The good news," said Hugh Hendry, interviewed in Barron’s a couple weeks ago," is that the Dow is going to be at 10,500 in 2020."

A comforting thought. Investors who are in for the long run can watch their money waste away for the next 10 years or more. Still, they might be made whole – eventually.

We turned back to the Hendry interview after realizing that we were having dinner with him next week; we wanted to know what he thought of things.

We found that Hendry, a hedge-fund manager, owns a company called Kanaden, a Japanese electronics-component manufacturer that must be about the cheapest publicly traded stock we’ve ever seen. For just $30 million you could buy the entire company…and get a billion dollars in annual revenue. But watch out, profit margins are slim…just 1.5% in earnings, before interest and taxes.

*** "Oil is $34.31," begins the King Report. "A Bubblevision [CNBC] expert and his guest blamed OPEC and the China boom. James May, CEO of the Air Transport Association, warned that the declining dollar is a factor. Long-time readers know we regularly state that historically a cascading dollar produces sharply higher oil prices. U.S. citizens and Wall Street shills might venerate the wonders of currency debasement, but the receivers of U.S. dollars, particularly OPEC, are not as gullible and detest payment in debased lucre.

"Please recall that early in 2003, with the dollar in spirited descent, Russia and Saddam Hussein advocated changing the terms of oil contracts so that the euro, not the dollar was the medium of exchange."

*** "Consumers face rising energy costs," says one of yesterday’s headlines. "Core" inflation is going down, says the Fed, but consumers are getting it hard on a couple of fronts. In addition to the pumps, they face rising housing costs as the bubble in housing continues. The news from L.A. yesterday was that houses had appreciated in that fair land by 23% over the last 12 months. Wages, you’ll recall, are flat or falling.

*** The King Report also had this to say about the latest employment report:

"The details of the report are more troubling than the headline numbers. Temp workers (+30k for month; 166 for 2003), education & healthcare (21k, 301k for 2003) and other low-paying gigs are the main job generators.

"Manufacturing lost 516,000 jobs in 2003 and has shed 2.8 million jobs since July 2000…The average workweek for production or nonsupervisory workers on private nonfarm payrolls decreased by 0.2 hour in December to 33.7 hours, seasonally adjusted. The manufacturing workweek declined by 0.1 hour to 40.7 hours, and manufacturing overtime edged up by 0.1 hour to 4.6 hours. The index of aggregate weekly hours of production or nonsupervisory workers on private nonfarm payrolls fell by 0.6 percent to 98.8 in December."

*** Colleague Karim Rahemtullah asked us to pass on the following note:

"The Supper Club began four years ago. Your editor [he refers to ourselves, dear reader] dreamed up an organization that could take advantage of the private deals that float around back rooms, front offices, and in the minds of entrepreneurs. After all, who in their right mind does not want the opportunity to get into the next Microsoft? But for every Microsoft, you have to endure a slew of Enrons and Worldcoms. The point is to make sure that the one Microsoft returns so much money to your coffers, that the Enrons and Worldcoms are just welcome tax losses. The Club has uncovered numerhous high-return opportunities since its inception. Less than a year ago, for example, Supper Club members invested in Phoenix Matachewan, a junior mining company. As you know, the price of gold has taken off, and so have the shares of Phoenix. This investment is up more than 100% for our members AND trading in the public market. This year we expect several of our prospects to have significant liquidity events…that means they are getting ready to make our members some serious money."

Karim writes that the Club is looking at another 15 to 20 new ventures this year. If you have the stomach for these sorts of opportunities, we could not think of a better place to look for them…

[For details and a special incentive available to DR readers only, contact Vickie Beard at, or see: The Supper Club ]

*** The French are a funny race. The longer we live among them and learn their ways…the funnier they are. Last night, Elizabeth went to a meeting to plan a "rallye." A rallye is a rather formal, structured attempt to control teenagers’ social lives. They are a bit like the "cotillions" in the U.S. which your editor dodged, thanks to his low social standing.

Elizabeth’s report:

"It was strange. There must have been about 30 mothers…and one father…there. It was out at a house in Boulogne. You know, the house was fairly small, but it was packed with family heirlooms…so packed that you couldn’t even turn around. The meeting was in the basement, of all places…even there, there were ancestral portraits staring at us.

"The whole idea is to give the kids some social graces and keep them from falling in with the wrong crowd. With a little luck, they’ll even meet someone from a good family that they can marry and then their children can participate in rallyes, too. Henry will fit right in. He’s so competitive…and so French.

"It is whole series of events. One mother is taking a group of 60 teenagers on a bike ride through the parc de St. Cloud. Can you imagine? She must be out of her mind. Another is taking them bowling. I’m working with a woman I already knew to hold a party in which we teach them to dance."

"You mean, like le French rock?" came your editor’s question.


"But you don’t know how to do the French rock."

"No, silly, we’re not teaching the dancing ourselves. That’s done by the company that organizes these things. The whole business is so complicated and difficult that private companies act as consultants. They’re the ones that teach the kids to dance. We’re just responsible for having the party."

*** Finally, a happy note. Our model daughter, Maria, turns 18 today. As though a birthday present, yesterday, the girl got a contract to pose for Lancel handbags. If all goes as planned, we will soon see her picture all over Europe.

"Daddy," said she on the eve of her birthday. "I know I get in a bad mood a lot…but I just wanted to tell you how much I appreciate you."

Your editor rose off the ground…and has yet to touch the floor.

Stay tuned.

The Daily Reckoning