Contrarian Lethargy

The least desirable asset today is cash. Therefore a contrarian investor should consider holding above-average cash positions. Marc Faber outlines his views on the future of the global economy…

A friend of ours recently described the stock market as boring and lethargic.

It is true that the indexes display little volatility and that all the volatility indexes are hovering near multiyear lows. But not too much importance should be assigned to the present low volatility, except that it indicates complacency among investors because, during major market sell-offs such as we had in 1987, 1998, 2001 and 2002, volatility picks up sharply.

Nevertheless, volatility can stay low for years, as was the case in the 1991-1996 period, when the stock market was rising. Therefore, if for years volatility stayed low while the market was rising, I suppose that volatility could remain at very low levels for a long time while the market is sliding the slope of "the mother of all hopes" among the investment community.

Moreover, while low volatility tends to be associated with complacency, within the stock market internals there, are some powerful trends that are diverging strongly. Moreover, in recent weeks, an increasing number of stocks have hit air pockets, tumbled and failed to recover.

Contrarian Investors: A Dangerous Incentive

These strongly diverging trends may well be exacerbated by the $1-trillion hedge fund industry, which is under tremendous performance pressure (in order to retain their assets under management) and is therefore almost forced to take a long position in the strong sectors of the market and to short stocks in the weak sectors. In this respect, I should remind our readers that historically low returns on cash – courtesy of the Fed – are a colossal, and dangerous, incentive for not only hedge funds, but also all investors to speculate in just about anything – from art, propert, and direct investments in oversaturated industries in China; homes in the United States, the UK and Australia; foreign currencies, commodities, emerging market bonds and stocks; and funds of funds; to a plethora of the most imaginative derivative products.

Like in a casino or lottery, some players who are particularly skilful or lucky will leave with huge profits, while the majority will end up with losses. I suppose that, eventually, even the casino (the investment banking industry and other financial service providers, real estate and all kinds of other commission agents) will lose money when the majority of players, discouraged by their poor returns, leave the global investment bazaar or when a systematic crisis puts them out of business for good. In fact, if we look at the recent performance of brokerage shares (note the well-defined "head-and-shoulders top" formed between November 2003 and June 2004), one gets the impression that the casino is already under some considerable stress.

So, what should the prudent and wealth preservation- oriented investor do in this environment?

As I have explained in earlier reports, the least desirable asset today is cash. Therefore, a contrarian investor should consider holding above average cash positions. Cash won’t provide you with a high return, but in an environment where the stock market is unlikely to climb this year above the January-March 2004 highs, this may be the proper strategy for the average investor. I am purposely writing for the average investor, because it should be clear that some investors with a particular knowledge of the market, individual sectors and stocks will be able to capitalize on the diverging trends that I discussed above.

Contrarian Investors:  Everyone Above Average

Now, I am perfectly well aware that every investor is convinced that he is an above-average investor, but, as one can imagine, this cannot be the case from a mathematical point of view. (The evidence from the performance of equity mutual funds, which are run by mostly diligent professionals but tend to underperform the market, does rather support the view that most investors are below- market-averages investors. This is likely due to the casino’s fees and the transaction costs involved in playing the game.)

The question then arises of what kind of cash to hold. There is at present a widespread consensus that the U.S. dollar is in trouble, and while this may be true as far as the long-term is concerned, counter-trend rallies will repeatedly occur, as (with the exception of the Asian currencies) paper currencies such as the British pound, the Australian, Canadian and New Zealand dollar, and the euro don’t appear to be particularly undervalued against the U.S. dollar.

Over the longer term, all paper currencies will lose their purchasing power, as they have done so since the invention of central banking and the end of currencies that are fully backed by gold. Hence, it makes sense to hold some cash in gold and silver. The return on holding gold and silver may be low, and at times even negative (in an environment of a strengthening U.S. dollar), but over longer periods of time, precious metals whose supply increases at a far slower rate than the supply of paper money will at least maintain their purchasing power. Moreover, as we wrote in recent reports, we believe that other commodities such as sugar, orange juice and coffee will perform better than precious metals and industrial commodities over the next two years.

The other widespread consensus that stands out is that U.S. bonds will decline as the economy and inflation pick up. I agree that, eventually, U.S. long-term interest rates will be higher than they are now, as inflation is bound to accelerate in the next 10 years or so.

Contrarian Investors: What Now?

However, the question is: What will happen between now and then? From the monetary and other economic statistics I follow, and from the performance of economic sensitive stocks such as semiconductors, retailers and now also, increasingly, homebuilders, I wouldn’t be surprised if the economy didn’t gather strength over the next six months, but then weaken once again far more than even the pessimists expect as a result of shrinking real personal incomes. In this scenario, I believe, as indicated in last month’s report, that long-term bonds could rally another 5%, or even 10%, from their present level, as investors might panic out of equities into the highest quality bonds.

I should also like to mention that if this scenario of a weak economy does come into play, the dollar could surprise on the upside simultaneously with the bond market. Why? Because weakness in U.S. consumption will lead to an improvement of the U.S. current account deficit as imports falter. I should like to emphasize that this view of dollar and bond market strength isn’t a long-term call, but intermediate in nature, based on the prevailing negative consensus about bonds and the U.S. dollar and my expectation that the economy might suddenly fall off a cliff.

Lastly, whenever I hear that a market is lethargic, boring or without any conviction, I think of a market where most participants are paralyzed because they are either losing or not making any money. Maybe the big hedge fund returns of the last 25 years or so are a thing of the past, because in the good old days of hedge funds, a small number of smart operators made a living from "average" or "below- average" investors.

But today, there are, in my opinion, far too many hyper- smart operators in the hedge fund industry, who are constantly trying to outdo each other for this industry’s own good. Is it time to make a bet against the hedge fund industry altogether?


Marc Faber
for The Daily Reckoning
September 22, 2004

The Fed raised its key lending rate another quarter of a percent yesterday. Stocks and the dollar have gone nowhere for a very long time; this tiny little "baby step" is not likely to take them much further.

"Low interest rates were clearly a major stimulus to the economic recovery," writes our old friend John Mauldin. "The recession of 2001 would have been much deeper without aggressive Fed action combined with Bush’s repeated tax cuts. The lowest mortgage rates in 40 years led to a booming housing market as more people could afford to buy homes for the first time and more people could afford to move up to larger and newer homes. In addition, mortgage refinancing allowed consumers to lower their mortgage payments, as well as take money out of their home equity for other purchases. If interest rates (and especially mortgage rates) were to rise significantly in a fragile recovery that is largely stimulus driven, the recovery could be aborted before it has time to develop a firm foundation in business spending. Thus, Fed policy was to keep rates lower for a longer period than in any previous recovery.

"But what would happen next?"

What people expect is rising inflation, rising interest rates and, otherwise, more of the same.

"Interest rates are rising in an effort to calm consumption and housing in the Anglo-Saxon economies, now that the fear of Japanese-style deflation, falling prices and wages has passed," Alex Brummer tells us in today’s Daily Mail.

The danger of Japanese-style deflation may not have passed, but both the Fed and the lumpeninvestoriat seem to have conquered their fear of it. Nearly all of them look ahead to high prices, confidently. What they are likely to get is something different. Despite the most massive stimulus in history, inflation rates are still low. Despite the easiest financing terms of all time, consumer spending is weak…and possibly falling. Despite GDP growth rates of 3-5%, people are not earning more money…and have no way to increase consumption. Despite rising corporate profits, business is not investing in new plant and equipment.

These curious developments suggest a curious development: not a boom, but a bust – slow to develop and hard to get rid of.

More from the news team in Baltimore:


Tom Dyson, from Mount Vernon…

– Trends change. It happens all the time.

– These days, lobster is an exquisite delicacy, and each year, 60 million pounds of the armored sea-monster are pulled from the Maine waters and shipped to Red Lobster restaurants all over the country. In the last 15 years, the lobster catch in Maine has tripled.

– Actually, lobster has been in a 75-year bull market. Everyone loves it. Demand is hot. On the Internet, you can arrange for a live lobster to be delivered right to your boiling pot for the princely sum of $70. And if you don’t reside in the United States, no problem, they pack the crustaceans on ice and fly them to expensive restaurants and gourmet supermarkets all over the world.

– It wasn’t always so. Only a few decades ago, lobster was a meal that people in Maine ate reluctantly. The fishermen certainly wouldn’t eat the day’s valuable catch – swordfish or cod perhaps – and lobster bisque wasn’t exactly "fisherman’s favorite" after a long day on the trawler…so they only ate it if there was nothing else around. Lobster was junk food.

– Even further back, lobster was used to fertilize the crops…a kind of marine manure.

– So unlike the other fisheries, which, as Eric Fry reported yesterday, have been in a deep decade-long decline, lobstermen have been doing well recently.

– And so have certain sectors of the markets. We notice that, yesterday, the FTSE made a new 2-year high at 4,608. We also notice that, today, treasuries are making new 5- month highs. The 30-year T-bond just hit 4.78%, at 1 p.m. on Wednesday, pushing to levels last seen in March.

– In equity markets, things continue to bumble along. Yesterday, the averages were all up. The Dow gained some 40 points. The Nasdaq gained 13 and the S&P 7. But today, they reversed course and headed lower again. The last time we looked, the Nasdaq had declined 1.72%, or 33 points to 1,888. And the Dow is down 143 points to 10,102.

– "Overfishing," said Eric, "also decimated the once- plentiful populations of humpback whales, Maryland crabs and California abalone, to name a few of the most prominent examples. Swordfish in the Atlantic have declined by almost 70% over the last three decades. The average size of fish landed has declined to 90 pounds, compared with 266 pounds thirty years ago. Bluefin tuna – a favorite of the sushi cognoscenti – are also becoming scarce."

– But not everyone noticed. At least, no one in the lobster crowd, or their bankers. "But the problem is," explains an article at, "if environmental factors change again, we now have more lobstermen, more traps, and they’ve all been doing really well.

– "For the previous generation, they didn’t make a lot of money, but they had a good life and they made enough to get by and they didn’t have a lot of expenses. One old hand took out one loan his entire life and paid it back in six months, but now people are taking out $200,000 and $300,000 loans just for new boats, so there’s a big problem with overcapitalization in the industry and banks loaning way too much money."

– Here at The Daily Reckoning, we’d be the first to admit that we know very little about markets and even less about lobsters. But to the untrained eye, the industry would seem ripe for a trend reversal.

– "Reversals of trend – who ever sees them coming?" says Addison from time to time. This is the point…

– Like taste for lobster, "Americans’ energy appetite doesn’t appear to be waning," observes CBS MarketWatch, "and Great Britain – self-sufficient with its energy needs for the past quarter century – now is a net importer of oil. ‘There isn’t enough of it in the ground,’ says Andrew Clark, a senior research analyst at Lipper. ‘Demand is either going to drive the price up until oil’s looking like gold or truffles, or some technology has to replace oil- burning engines.’"

– Unfortunately, the hoped-for, magical technology that would render crude oil obsolete has yet to appear. Thus, the world must continue to rely on its dwindling birthright of crude oil.

– On Monday, Yukos, the embattled Russian oil company, squeezed the world’s tight oil supplies a bit tighter by announcing plans to curtail some of its sales to China. The company says it will end shipments of about 95,000 barrels a day to the China National Petroleum Corp. on September 28. The announcement sparked a brisk 3-day rally in the oil pits here at the New York Mercantile Exchange, as crude prices jumped from $45.59 to $48.05 a barrel by midday today – the highest level in over a month. Oil is now just $1.35 below the all-time high hit on August 20.

– The Yukos maneuver seems more political than tactical. In other words, Yukos, which owes about $7 billion in back taxes, appears to be trying to pressure the Russian government for a little breathing room. If Yukos refuses to sell its oil, this turnip will have no blood to give to the Russian government. Perhaps Yukos is trying to demonstrate to the Russian government that a slow payment of back taxes would be better than NO payment.

– We suspect that Yukos will not, in fact, turn off the oil spigot to China. But we don’t pretend to be experts about Russian politics. What we think we know, however, is that global oil supplies remain quite tight. So whether a Yukos or an Iraq or a Venezuela or a Nigeria causes a supply disruption, the result will be the same – higher prices.

– The commodity bull market is real…you didn’t hear it here first, but you are hearing it here ad nauseam. On the narrow chance you’d like to learn more, see our updated report on the current state of the oil market.


Bill Bonner, back in London…

*** The French magazine Le Point reports that inflation isn’t quiescent everywhere. The price of Kalashnikov rifles in Iraq is skyrocketing. The famous AK-47 was priced at only about $30 a few months ago. Now the "street price" is said to be closer to $90. There are said to be 8 million of them in the country, and the supply is rising, too.

*** Oh dear, dear reader, what should we make of it? We seem to offend people so often. Gypsies, Republicans, neocons, Democrats, women, West Virginians, Farmingtonians…and now gays – is anyone left unoffended?

The Daily Reckoning readership seems to be evenly divided. Half think we should "stick to market commentary." The other half thinks we should give that up, too.

"What did you expect," asked a colleague. "This gay marriage issue is a sensitive subject. It’s become a campaign issue. Gays feel entitled to the same rights as everyone else. You were making the point that as debt builds up, people begin to think they can do what they want…whether or not it has any foundation in the traditional order of things. It’s like you’re always saying about the whispers of dead people – reminding us of the lessons learned many years ago and now forgotten. Of course, I don’t know what dead people would say about gay marriage…

"But I think you got sidetracked. It sounded as though you thought they should be treated differently. Or, as though you thought a gay couple was not as valid as a couple of straights. Or that you don’t like gays.

"I know it’s ridiculous. We have our office in the gayest quartier of Paris. Half of our fellow employees are gay. And I know for a fact that some of your best friends are gay."


"Maybe you should explain yourself…"

Well, dear reader, if people are going to be offended, they might as well be offended for the right reason. Of course, we love gays, just as we love all God’s creatures – saints and sinners alike. And as far as we’re concerned, people can do what they want; you won’t find us trying to amend the constitution in order to tell people whom they should get hooked up with or on what terms. Let them find out the hard way – like everyone else.

And gay "marriage?" Is it less valid? Or less happy? Or less full of trouble and strife? We don’t know. Our only experience is with marriages of the old-fashioned, un-gay sort. A union between two people of the same sex is definitely not a "marriage" as we know it; but for all we know, it could be an improvement.

*** More reader views…on other subjects:

"I continue to enjoy each issue of your newsletter. In particular, the issue ‘Libertad’ was well written and always informative. But, being the son of a pastor, I was quite saddened by the attitude of the two clergymen. I suppose my status as once removed from a man of the cloth does not qualify me to question these men, but my father taught me much, and it would be sad if they remain your only reference point on matters of God, faith and their impact on world events. "I believe what you were describing in ‘Libertad’ is the pervasiveness of evil done by humans to other humans, and not the work or insensitivity of God. God has revealed Himself through His son, Jesus, and has provided to the individual man or woman a way to redemption, and an eternity spent with Him.

"Those who accept this gift become part of His family, collectively known as the Church. God is not an American, nor is He French, Chinese or Australian. He places no nation state above any other, except as it may further His purposes, nor does He justify a particular way of national life; only a life led according to His principles as set forth in His written word. If a person’s way of life or a nation’s policy happens to champion moral laxness or plain stupidity, God does not guarantee, as Alan Greenspan does, that one will not experience the natural consequences of these actions, but He will help you get through the tough times by one’s faith in God’s grace. "This idea that Americans possess special virtues and the answers to unanswerable questions is bogus. Not so long ago, a man, Martin Niemoller, a Lutheran pastor, declared the Nazi ideal of ‘positive Christianity’ a distortion of true Christianity simply because it crowned the German people with ‘special virtue’ that needed to be shared with the rest of the world. I do not think Czechoslovakia, Poland or Russia appreciated the German point of view, and I suspect Iraq, Afghanistan and Iran do not subscribe to our American ‘special virtues’ or the way we go about imposing them on others. "We (Americans) find Afghanistan, Iraq and Iran places where people suffer every day, at least according to the sound bite on BBC World, if we watch it, but they are far away, and their experiences are not really applicable to us. We listen to government propaganda carried by the financial press (Joseph Goebbels would be proud), and we continue to enjoy our false wealth and shopping. The plight of those unemployed, facing foreclosure or declaring bankruptcy is sad, but doesn’t really impact us. When the ‘Greenspan Gambit’ plays out to all our detriment we will wonder why all this happened.

"The average German probably felt the same way. It isn’t God’s fault we got in this fix, nor is it His responsibility to get us out without the painful consequences. We collectively are responsible and will pay the price in whatever form it takes. History, after all, is supposed to teach us to avoid the mistakes already made by others but we still don’t get it. To paraphrase Bill Clinton, ‘It’s the Truth, Stupid.’"

*** "I’ve been reading the DR for a couple of years or so, and I look forward to it, just love it. Bonner is an interesting, wise essayist.

"But I have to agree with the woman in her 80s who finds the men of The Daily Reckoning sexist. (I’m a 61-year-old woman.) It’s the chivalrous way you view women, the way you view them as ‘other.’ It isn’t the worst attitude in the world, but it’s annoying at times. Women and men are different; but they are not separate species."

*** "I’m learning to speak RP," said Maria yesterday in a very posh accent. "You know, it’s Received Pronunciation. It’s supposed to be the best accent you can have in Britain. Still, our teacher said that when you open your mouth, half the country hates you."

Maria is in an acting school in London, where she is learning the ways of the world.

The Daily Reckoning