Faith and History, Fear and Greed

“Faith,” wrote Paul, “is the substance of things hoped for, the evidence of things not seen.”

The received wisdom of Wall Street is that the stock market is driven by the twin emotions of Fear and Greed. And for hundreds of years, that wisdom has been true. But there is now a new emotion asserting its right to move markets: Faith.

Specifically, it is a Faith in the power of the Federal Reserve to either forestall recessions or that any recession will be such a short-lived event that stocks must shortly and surely take off thereafter. In an ominous sense, it is really Faith in just one man to so manage the economy of the world that we avoid the twin shoals of inflation and recession.

This trust supplies the substance of a quick recovery, and the evidence of large and growing future profits. As a basis for their Faith, members of the Church of the Fed point out that one year after the Fed begins to cut rates, historically the stock market was up an average 20%. During market dips, they repeatedly chant that mantra as they buy even more Cisco and Oracle.

While these faithful cite this one shaky premise (see below), History itself dredges up a Pandora’s box full of contradictions. Thus we become witnesses of a titanic boxing match between Faith and History.

A brief perusal of economic history yields this crop of facts:

* Never have we had a negative yield curve as appeared last August and not had a recession four quarters later. The yield curve tells us a recession should begin in the third quarter of 2001.

* Industrial production has never dropped as it has for seven straight months without having a recession.

* We have never seen such large losses in non-farm payrolls without a recession in the last four decades. Increases in unemployment usually PRECEDE recession buy 7 months. This means a recession should begin in the third quarter. Further, many recessions started from employment rates better than we currently have, so the fact that we only currently see 4.5% unemployment gives us no encouragement, at least from a historical perspective.

* Manufacturing and trade sales have dropped 1.6% since last August. Such a decline has never occurred outside a recession.

* Many, if not most, of the one-year recoveries the Greenspan acolytes seek confidence in began at reasonable or low P/E ratios. History tells us it has taken index investors 10 years to eke out a profit when P/E ratios are at the current level.

* Seriously slowing world trade, the debt markets, trade deficits, decreasing profits, more lay-offs, etc. Many of these are also in statistical territories that historically suggest we are facing a real honest-to-Alan recession in our near future.

So what is the problem? History tells us that the stock market declines over 40% in an average recession.

The bursting of the NASDAQ was not brought on by a recession. That was a greed-based, irrational bubble. We have yet to see how serious a decline, if any, will be precipitated by a recession which History tells us is right around the corner.

If we are going to avoid a recession beginning in the third quarter, SOMETHING needs to start showing some signs of a recovery. But as I survey the statistics, I ask myself where? What reason do I have to think that unemployment won’t increase? That would seriously erode consumer confidence. Then, how long can consumer spending hold up? When is production going to start back up? What country is going to rally and pull the world back from the brink? Japan is in a deflationary spiral and Europe is starting to show real signs of weakness. Everywhere I look, there are far more negatives and questions than positive aspects and answers.

The Fed (Alan Greenspan) is in a death match fight with History. History tells us we should see a recession, lower stock market prices and higher bond market prices.

And yet, the S&P and the Dow do not go down, and even the NASDAQ rises 30% in the face of what many think is a coming recession. Those of us who look to History are amazed at the Faith of investors in Greenspan.

In a way, Greenspan is not so much fighting History as he is trying to change future History. If he pulls this off, he will become History. By that, I mean that in the future, we will look at the possibility of recessions from a new vantage point. Analysts such as myself will not be able to point to History and say (as above) when these 10 things happen, we have always had a recession. We will always have to acknowledge that the Fed can “manage” economic History.

Those who have put their Faith in the Fed are basically saying that one man, or at the most, 5-6 men, can effectively direct the entire course of human economic commerce, and that they can do it with very limited tools.

History tells us that the stock market declines over 40% in an average recession. If the S%P 500 declines to its historical average value, it would drop below 800. Typically, one would expect the pendulum to bring us down to 600 or lower.

On the other hand, for the S&P 500 to go up 10% by the end of the year, you would have to believe that P/E ratios will remain in the absurdly high 25-28 range, and that 2002 earnings estimates will be 20% higher than actual 2001 earnings.

That takes a lot more Faith than I have. Investors are risking a 40% downside for a 5-10% upside this year.

The Fed has been giving History a real beating in the first few rounds. But like Ali fighting Foreman with his rope-a-dope tactics, History has staying power. Bet on History in the late rounds by a knock-out.


John Mauldin
Paris, France
June 20, 2001

(John Mauldin is president of Millennium Wave
Investments and a frequent contributor to the Fleet Street Letter. Daily Reckoning readers can get his weekly e-letter for free by going to:

*** “Americans’ Debt Soaring” declares a headline in the Chicago Sun Times. “More and more people are at the crisis point,” the paper quotes a debt counselor. The details:

* The second-highest number of personal bankruptcies on record – 356,836 – were filed during the first three months of this year, according to the American Bankruptcy Institute.

* The average amount of debt per household has reached 14.29 percent of disposable income, the second-highest rate ever, according to the Federal Reserve.

* The average credit card debt per household hit $8,123 in 2000, nearly three times the average amount owed 10 years ago, according to, which tracks the credit card industry. We owe $568 billion to credit card companies, up from $172 billion in 1990.

* The percentage of credit card loans considered delinquent – as well as the number of Americans behind on mortgage payments – at the end of last year hit their highest levels since 1992, according to the Federal Reserve and the Mortgage Bankers Association.

*** As you will recall, the health of the economy requires Americans to spend themselves even further into debt. Americans may be immune to prudence, but they are surely vulnerable to incapacity. Either might bring on an attack of thrift, of which, even a mild case could be fatal.

*** But let’s see what went down on Wall Street yesterday. Over to you, Eric:

– Thanks to a not-terrible earnings report by Oracle, the Nasdaq jumped to a 3% gain shortly after the opening bell. “We think, we hope that the worst is over,” Oracle announced, “Hopefully, we hit bottom in our fourth quarter.”

– But one hedge fund manager with whom I spoke called the Oracle announcement, “A big ‘So What?’ Nothing has changed…Oracle’s operating earnings fell a considerable amount. I’m not prepared to call that ‘the bottom,’ no matter what Larry Ellison says.”

– The early gains didn’t last, anyway. On the day, the Nasdaq snapped its string of seven consecutive losing sessions by gaining only four meager points…but I saw no spontaneous celebrations on Broad Street. The Dow fell 49 points.

– How tough are things becoming in this ol’ economy of ours? Agilent CEO Ned Barnholdt provides a clue: “Frankly, the speed and severity of the slowdown [is] unlike anything I’ve seen in my 34 years in business.”

– Fred Hickey provides a second clue: “Even the $1 billion on-line adult site industry is struggling… One site owner despaired, ‘Lots of people are canceling memberships saying they’ve lost the job or are stacked up with credit card debt.'”

– Clue #3: A friend of mine who is vice president of a commercial real estate firm in Manhattan reports that the real estate market is noticeably slowing down…on Martha’s Vineyard. A perennial renter on the island, he relates that an astonishing number of houses remain available for rent even though the season is almost underway. “Rental agents are returning my phone calls on the very same day,” he reports with amazement. “That’s never happened before.”

– One imagines that commercial real estate agents in Manhattan are promptly returning phone calls as well. “Manhattan office leasing dropped dramatically in the first four months of this year,” Crain’s reports, “with the volume of space rented in midtown and downtown just half of what it was in early 2000. And nearly 6 million square feet more space was vacated than was rented…”

– Exacerbating the trend, companies like Cisco Systems are dramatically scaling back plans for office space in New York. Instead of the half-million square feet of office space on Times Square that Cisco had planned to lease, the struggling tech giant has decided to lease no more than 100,000 to 200,000 square feet.

– Many public company insiders have been stepping up their selling lately, according to Thompson First Call’s insider-selling guru, Paul Elliott. Sales of so-called restricted stock totaled a hefty $11.2 billion in May up from $6.9 billion in April.

– Charles Biderman, editor of Liquidity Trim Tabs, tells me that the insiders at many former tech highfliers are leading the charge to unload shares. Biderman also notes a remarkable surge of initial public offerings (IPOs). He reports, “The five days ended Wednesday June 13, had $15.5 billion in new offerings – which was a 5-day record. The $57 billion sold in the last seven weeks is also a record.”

– I don’t know what all these selling insiders see, but I suspect it is not a “second-half recovery”.

*** What else? Well, I took my mother to see “Pearl Harbor” last night. I thought she might enjoy reliving an event in which her husband, and my father, played a small role. What a disaster! I mean, the movie. It lasts longer than the attack itself and is so revoltingly shallow and silly, it makes the viewer embarrassed. Only the Japanese seem to know what they are doing – and go about their business with dignity and skill.

*** In one scene, President Roosevelt struggles to his feet – which is not easy for a cripple to do. It is hard not to laugh as the old humbug tries to shame his military commanders with his show of determination and the battle courage of a man confined to a wheel chair 10,000 miles from the front lines.

*** I was curious about the French reaction. The French fleet was the object of a surprise attack, too. On July 3, 1940, British warships pulled up in front of the harbor where the French were moored at Mers el Kabir and proceeded to blast them to pieces. More than 1,200 French sailors died. No pretentious films have been made to record the incident.

*** The children are in the home stretch. Just ten more days of school. Sophia is studying hard for her final exams…and will then take a year off before college. Maria needs to pass a single test – the brevet. Without it, her scholastic possibilities are limited, in France anyway. But Maria has already turned her attention away from school. She figures she will be able to make a career for herself in show biz, no matter what happens on the brevet. Jules seems to be squeaking by this year – or at least he thinks so. We won’t know until next week. And Henry and Edward are doing okay and ready to move ahead to the next level. Henry, 10, enters the ‘college,’ the French equivalent of junior high, next year.

*** You have no reason to care about my children, of course, but what the heck…the Daily Reckoning is free so I feel I have the right to bore you with the details of my family life…

Until tomorrow…

Bill Bonner