Confidence Game

"It is widely hailed that consumer confidence surveys indicate great optimism on his part about the future. We have to say that we regard the results of such surveys as complete rubbish. The consumer just echoes what the media and all the experts are unanimously telling him. Don’t worry: recovery is around the corner."

Americans have perhaps never been more confident. And why shouldn’t they be? The most recent revision puts the U.S. GDP growth at 1.7% for the fourth quarter. Contrary to everything we’ve been saying in the Daily Reckoning, the U.S. economy… like the U.S. military… seems invincible. Nothing can stop it. Not war. Not recession. Not a bust in the stock market. Not debt. Not gypsies. Not nothing.

Still, the investors who made the most money in the quarter just ended were those who had their doubts. Gold is what you buy when you begin to wonder whether all this confidence is justified. The yellow metal ends the quarter above $300. Gold stock investors saw gains of 32% (the AUX index) to 52% (the Gold Bug Index).

"Gold is performing exactly as predicted," writes the "angriest guy in economics," the Mogambo Guru. "The buyers and holders of gold are making a nice piece of change, and have been for two years, while their friends stuck in stock and bonds are acting it on the chin. Nothing presages a rising bullish enthusiasm more than other people making money while you suffer loss after loss."

Eric, over to you:


Eric Fry on Wall Street…

– Another quarter bites the dust, and the stock market finished the three-month span about where it started. The Blue Chips gained a respectable 4.4%, but the Nasdaq slipped 5.3%, while the S&P 500 barely budged.

– But even if the financial world looks about the same as it did three months ago, most investors would argue that much has changed since December 31st. "The economy is lifting off from its mild recession and is now soaring heavenward," they would say. "Consumer confidence is surging; a new era of honest corporate reporting has arrived on Wall Street and robust consumer spending is sure to provide a big boost to corporate profits."

– And let’s not forget Alan Greenspan. So masterfully has he guided the U.S. economy from a mini-bust to a nouveau boom that he would surely win "Comeback Central Banker of the Year" if a vote were held today.

– The only thing that has not changed over the last three months is the coast-to-coast love affair with stocks, especially American stocks. Most investors still consider the S&P 500 to be an absolutely terrific, all- season investment, even at 44 times earnings.

– In short, bullishness is alive and well. Kevin Duffy, a private investor I know who tracks various sentiment indicators, says that bullish sentiment is "over the top" right now. And from a contrarian standpoint, when everyone seems to be buying stocks, it’s usually a good time to sell them.

– Duffy looks at the assets in various Rydex funds – a bullish and bearish mix. Recently, 75% of the fund company’s overall assets were in bull funds, a very high level according to Duffy. He notes several other ominous indicators as well. Over in the futures markets, for example, "large speculators" and "small traders" – considered the "dumb money" in the futures pits – hold a very large "long" position in S&P 500 contracts.

– The options volatility indexes are also flashing red, says Duffy. Yesterday, the VIX touched a new 19-month low of 19.08. Low readings indicate extreme bullishness, and therefore a high risk of a market sell-off. The last time the VIX touched levels as low as they were yesterday was August 31, 2000, immediately before the S&P 500 began a painful seven-month slide that dragged the index down more than 20%.

– But even if history merely rhymes, rather than repeating itself verbatim, the stock market is most likely heading into a rough patch, and maybe a very rough patch. "Of course, the market may go straight up from here," Apogee Research concedes, "but we’re prepared to consider the alternative."

– Investors do well to remember that a simple garden- variety bear market can inflict more pain than one hundred "Enrons."

– "Many people seem to think that since Enron’s Chapter 11 filing was the largest U.S. bankruptcy ever, its loss of shareholder value from its peak was also a record setter," writes Fortune columnist Geoffrey Colvin. "In fact it isn’t even close. Here are ten companies whose shareholders… have lost at least twice as much value as Enron’s: AOL Time Warner, Cisco, EMC, Intel, JDS Uniphase, Lucent, Microsoft, Nortel, Sun Microsystems, and WorldCom. These value declines range from $155 billion (WorldCom) to $423 billion (Cisco)."

– Yet, despite the Nasdaq’s harrowing decline from its early 2000 peak, the tech-heavy index remains very pricey. The Dow and S&P 500, likewise, are hardly repositories of value. All the major indices are quite richly priced relative to their historic norms… and that’s not good news for investors.

– "A new study by David Hoisington and Lacy Hunt, Austin (Texas) bond investors, corroborates the message of the voice in the back of the head of every value-conscious investor," writes Jim Grant. "When the price is wrong, common stocks can suffer even in comparison with government securities. At prevailing prices, Hoisington and Hunt persuasively asserted, bonds hold the probable performance edge for years to come… Over the 131-year sweep of their study, observe Hoisington and Hunt, the dividend yield on American blue chips averaged 4.5%; it is now 1.3%. Compare this to the yield on the 10-year Treasury, at 5.33%… This suggests,’ write the two researchers, ‘that stocks will be severely disadvantaged in the future since their dividend yield is 350 basis points below the long-term average.’"

– Remember, buy low and sell high.


Back in Paris…

"You pride yourself on being contrarian," writes my very own assistant, Stuart Crampton, on my very own website, the Daily Reckoning’s message board, "but there could be nothing more pedestrian and unoriginally mainstream as such a championing of stereotypes." Here at the Daily Reckoning we try not to worry about saying the ‘wrong’ thing. In fact, from time to time, we say what we shouldn’t just for practice.

"Small minded…" Stuart continued, adding that my comments made me seem "ignorant and prejudiced." Maybe he is right. It would have been better if we had been assaulted in Madrid by cyclopean Sherpas from Mars. Who cares about them? By contrast, gypsies have a lot of defenders among Daily Reckoning readers. "How do you define a Gypsy?" wondered one. "Thoroughly despicable" thought another, referring not to Gypsies, but to your editor.

One poster posed a curious question: "If Goebbels had also been a dentist, would you have let him take care of your teeth on the basis that he was good at the job?" We don’t know what to answer, frankly. But then, we don’t know what to make of the comment from "Dan," either… who wrote: "I think [your editor] is an anti-Semite." [Are gypsies semites… or is it something else we’ve said?"]

A few posters tried, gamely, to defend us. But from the stack of papers Stuart presented me, they were out- gunned by the people for whom any negative reflection about any ethnic group is unwelcome.

Curiously, none of the posters offered any evidence on gypsy crime rates or asked for any. Gypsies are widely thought to be thieves. Is it true? Do gypsies really commit more petty larcenies than other groups? No one seemed to know or care. So, we turned to our harshest critic for research on the subject.

"There isn’t any…" Stuart said, after roaming the internet for a couple of hours. "I think they are just scapegoating gypsies… the data just doesn’t seem to be available. But you should have checked that before you made your comment."

Again, Stuart has a point. We don’t know anything about gypsies… except what we’ve observed in a very limited experience. But to set the record straight… we don’t hate them. Rather, we love them as we do all God’s creatures. Here at the Daily Reckoning, we find Gypsies are no less entertaining than Lutherans or Republicans. And we note that however much they may steal, it is peanuts compared to the amounts ripped off by politicians of various religious and ethic persuasions. Still, Daily Reckoning readers are advised to watch their purses when Gypsies are around.

*** A Reuters report from London tells us that "motorists talking on mobile phones while driving are more dangerous than those who are over the legal drink-driving limit." Tests conducted by the Transport Research Laboratory in Berkshire, England showed that talking on a hand-held portable phone reduced drivers’ reaction times by an average of 30% – compared to when they had been drinking alcohol. No mention was made of the danger posed by drunk gypsies using hand-held phones.

Kurt Richebacher

As reported here yesterday, U.S. consumer confidence recently took its biggest jump in more than 10 years. But we hardly need a survey to prove it. Nearly every price and every statistic reveals a startling lack of worry.

Even the War Against Terror is being conducted with remarkable confidence. "American troops have no qualms," reports a headline in the International Herald Tribune. "One of the most striking things about this unusual war," continues the article, "is the lack of doubt among U.S. troops about why they are in it. This may be the first U.S. military deployment since WWII in which almost no one questions the reason for it."

Of course, the war has produced very few American casualties. Even battle fatigue has been almost non- existent. "The two-week Shah-e-Koh battle," reports the IHT, "produced only one minor case of battle fatigue, far fewer than is statistically likely," said a combat specialist.

Likewise, in the economy, the absence of qualms or question marks is startling. Consumers increased personal consumption at a 6% rate in the 4th quarter of 2001 – the same quarter in which the economy was supposed to be reeling from the recession and the terrorist attacks of September 11th. "Never before have consumers spent with such abandon during a recession," comments Stephen Roach, chief economist at Morgan Stanley. "In the 28 quarters of the past six recessions, consumer demand rose, on average, at just a 0.5% annual rate. Moreover, fully 86% of last quarter’s consumption burst is traceable to a 39% annualized spike in the durable-goods category – mainly big-ticket items such as motor vehicles, furniture and appliances that are purchased infrequently."

Consumers go more deeply into debt only when they are pretty sure the extra debt will be no problem for them. Last year alone, they borrowed another $152 billion against their own homes. Even following a recession, they were sure jobs would be plentiful. Nor did they worry that interest rates would rise. Not that rates couldn’t rise – they just didn’t seem to think about it.

Nor do investors seem to worry much about what usually happens when stocks become as expensive as they are today. They are more concerned about how they will feel if stocks rise and they miss out on the bull market. So, they’ve bid up stocks to price levels the world has never seen… and is unlikely to see again in our lifetimes. The S&P trades at 44 times earnings. And the P/E ratio of the median Value Line stock has reached 20.3 (as figured by Ned Davis Research) – a new record high.

The confidence of American consumers and investors is taken as good news throughout the world. People think it means good things to come. Taking a contrary view, as usual, we believe it is merely a sign of good things that have already come and gone. Confidence is a trailing indicator, we think. The more there is of it… the greater the boom we are leaving behind.

Why are consumers and investors so confident? Looking backwards, they have plenty of good reasons for optimism. The Dow seemed to go nowhere but up for the last 2 decades (with a little leveling off in the last two years). Inflation and interest rates have been going down for about the same length of time.

Foreigners could ‘pull the plug’ on the U.S. economy at any time… simply by selling U.S. dollar assets. But why would they do that? They need Americans to continue spending, it is argued; otherwise, their economies go down the tube too. So, they have to keep financing the U.S., or so it is believed.

Meanwhile, the Soviet Union capitulated. The U.S. is in a class by itself militarily – not merely the world’s only super power… but the world’s only real power of any sort. Never before has there been such an imbalance between U.S. military spending and that of the rest of the world.

Recent challenges to America’s military and economic have been feeble; both the battle against recession and the WAT have been waged with almost no casualties. Is it any wonder that Americans look back with pride and the warm glow of confidence?

But looking forward is another matter. In a bull market, "stocks climb a wall of worry," say the old-timers. But upon this polished stone of self-satisfaction stocks will find few footholds.

Not that there isn’t plenty to worry about. There is the current account deficit, for example, and the dollar. Sooner or later, the rest of the world will begin to ask questions, even if Americans don’t. Then, the dollar will fall… and so will U.S. financial assets.

There are interest rates too. Gold is rising, and gasoline is up sharply. It’s "time to prepare for the next rate hike" says a headline in Barron’s. Mr. Greenspan’s operating method suggests a rate increase as the economy ‘warms up’ again. However, he might not need one. The market will make up its own mind about where long term rates should go. Already, long rates having risen a full percentage point over last three months. As long rates rise, its gets harder for debt-laden businesses and consumers to continue spending.

And, of course, there are stocks themselves, esteemed so highly by ordinary investors that there is almost no chance that they will be able to live up to the expectations that have been set for them. Sooner or later, it is reasonable to think, disappointment will lead to disinvestment.

But none of these things seem to worry Americans. They drive ahead confidently. Hands on the wheel… foot on the throttle pedal… and their eyes fixed on the road behind them! They will end up somewhere, we continue to predict, but not necessarily where they expect.

Your gypsy-loving editor,

Bill Bonner
March 29, 2002 — Paris, France

The Daily Reckoning