Flight to Garbage

2003 was a remarkably kind year to investors. Will 2004 prove as amiable? Dr. Marc Faber thinks not: "The entire global investment community," writes Dr. Faber below, "has been seduced…into believing that all asset classes will continue to appreciate in 2004…"

A commentator characterized the year 2003 as an investors’ "flight to garbage." Indeed, some assets perceived to be of lower quality, such as Ecuadorian and Brazilian debts, Argentinean and Venezuelan stocks, as well as money-losing high-tech companies, enjoyed huge price gains in 2003.

In fact, 2003 will enter the financial history books as the year in which all asset classes – including equities in developed as well as emerging markets, government as well as any kind of corporate bonds, industrial commodities, precious metals, real estate, and art – increased in value.

That is, of course, with the exception of the U.S. dollar, which slumped not only against gold (mentioned here as a currency, whose supply cannot be increased ad infinitum by some intellectually dishonest central bankers), the euro, and the currencies of the resource-based developed economies of Australia, New Zealand, and Canada, but also against the currencies of more "controversial" economies such as Brazil and South Africa.

Dollar Weakness: 2003 US Equity Performance

As a result of the slumping U.S. dollar, the performance of U.S. equities in 2003 was nowhere near as "fantastic" as the media have suggested. It is true that, in U.S. dollar terms, the Dow Jones Industrial and the S&P 500 rose in 2003 by 25% and 26%, respectively; but in Euro terms, these gains were just 4% and 5%. Admittedly, the Nasdaq, and especially the Philadelphia Semiconductor Index (SOX), did better, rising by 50% and 76%, respectively, in terms of the U.S. dollar and by 25% and 46%, respectively, in Euro terms, but this was hardly a match for the emerging market gains (in U.S. dollars) of 138% in Thailand, 131% in Brazil, 119% in Venezuela, and 104% in Argentina.

Moreover, if we look at the performance of the Nasdaq since the Euro bottomed out in October 2000 at 82.27, the recent rise appears to be more muted in a longer-term context than the bullish camp is trying to convey to the "dollar weakness unconscious" investment community.

When asked about the performance of President Bush over 2003, the elderly but jovial Jewish taxi driver who took me to John F. Kennedy Airport in New York following the yearly Barron’s roundtable exclaimed enthusiastically that Bush was the "greatest American president ever."

Taken somewhat aback by this firm and unshakable support for the present U.S. government, and at the same time concerned that I might be offloaded somewhere in an alley on my way to the airport if I said anything wrong, I hesitantly, and as diplomatically as possible, asked my driver, who proved to be smart and honest, why he felt so positive about Mr. Bush’s administration. (He was evidently smart, since, while listening to Simon and Garfunkel tapes, he was smoothly and skillfully negotiating the fastest way to the airport: he took the Queensborough Bridge coming from the West side heading into Third Avenue, then went north on Third Avenue and turned left into 57th Street before turning right on to the bridge – thus avoiding the usual traffic jam on the Queensborough Bridge entrance at 58th Street. And he proved to be honest, since the total fare was just $29 – $35 with tip, which is the lowest fare I have ever been charged to go from New York City to JFK.)

"Bush doesn’t take any BS from anyone in the world," he replied. "And look at the stock market…it’s up!"

Fearing a confrontation, and concerned about missing my flight, I remarked in a conciliatory way that the dollar had declined in value, concurrently with the stock market’s rise, thereby largely neutralizing – currency adjusted – any stock market gain. But this stock market gain/dollar weakness issue didn’t seem to strike a chord with my driver, whose only concern seemed to be to enjoy additional price gains on his home and his stock portfolio in U.S. dollar terms.

Dollar Weakness: Seducing the Investment Community

After checking in at the airport, I reflected further on my driver’s views, which I initially considered to be rather naïve. But then it struck me that the entire global investment community has been seduced by strong economic indicators (published by governments, we must remember, which have a political agenda) and easy monetary policies into believing that all asset classes will continue to appreciate in 2004.

The commodity bulls believe that we are at the beginning of a long-term secular bull market for raw materials and precious metals, while the stock bulls believe that the rise since October 2002 is the first leg in a multi-year stock bull market. Home buyers believe that the housing industry will continue to thrive and expand and never again be a cyclical industry in the way it has always been, and at the same time the "deflationists" remain convinced that deflation will lead to a resumption of the bond bull market. So, wherever you go and to whomever you speak, everybody around the world is very optimistic about some asset class or some kind of "very special situation."

In addition, every investor you speak with is convinced that he is savvier and smarter than the public, and that he will know, just minutes before it turns down, when to get out of his favorite market, stock or commodity! In other words, every investor seems to be suffering from the massive delusion that he is an above-average investor who will be able to "beat the crowd."

Yet it should be clear to any rational thinker that commodities, and especially the precious metals, cannot forever rise in price while at the same time interest rates decline and bonds continue to appreciate. At some point, continuously rising commodity prices must lead to higher inflation rates and depress bond – and probably also equity – prices. Conversely, bond prices can only continue to rise if global economic growth disappoints and deflationary forces reassert themselves.

The year 2003 was unusual in as far as all asset classes rose in price – that is, with the exception of the U.S. dollar. In 2004, we expect asset markets again to show diverging performances.

In my opinion, the surprise of 2004 could be renewed economic weakness, which would be temporarily negative for commodity prices and likely also for extended stock markets (developed and, especially, emerging markets) and sectors, which in 2003 performed superbly, such as home builders and semiconductors.

In the meantime, the U.S. dollar has become very oversold and sentiment is as negative about the U.S. dollar as it is positive about the U.S. stock market. Time for a contrarian to take the other side of the trade – that is, long U.S. dollars and short the U.S. stock market???


Marc Faber,
for The Daily Reckoning
January 28, 2004

Editor’s note: Dr. Marc Faber is the editor of The Gloom, Boom and Doom Report. Headquartered in Hong Kong for the past 20 years, Dr. Faber has specialized in Asian markets and advised major clients seeking down-and-out bargains with deep hidden value, unknown to the average investing public.

Dr. Faber is also a frequent contributor to Strategic Investment. If you’d like to follow his current analyses and learn how to apply them, subscribe to:

Strategic Investment

"Nobody knows anything"…they say in Hollywood. Because no one can predict which film will be a hit…and which will be a flop.

But people know even less in politics, finance, investment, or economics.

Economists pretend to project next year’s GDP…or estimate pension fund requirements 20 years ahead. But they cannot even tell you the price of oil tomorrow…or next week…let alone 5 years in the future.

At what rate will a man be able to refinance his house…what price will he pay for a gallon of gasoline? No one can say. And without these critical components, the rest of the future is as mysterious as a George Bush campaign speech. "Taking up the tasks of history…we live in a time apart…" he told us. We have no more idea what he meant that what the price of gold will do tomorrow.

Today’s economists know less than zero about everything. Because what they think they know about the present is as full of falsehood and flattery as a seducer’s promise.

All the numbers an economist has to work with are bound into the soft mud of dollars. He can feel the mire squish up between his toes. He can sling it around…but he cannot get it to stand still long enough to use it as a reliable measure. What is a dollar? No one can say. In 1971, it took 41 of them to buy an ounce of gold. Now it takes ten times as many – even though gold went into a bear market in 1980 and still has not recovered.

One day a man can take a few dollars and buy a share of stock; the next day he will need twice as many. Oddly, the stockholder feels richer…while his purchasing power has been cut in half!

When the dollar price of doughnuts or dishwashers rise… consumers become agitated. They call upon the Fed to ‘do something’ about this inflation which cuts into their family budgets. But let housing prices go up, and the same people are delighted. The less house they get for their dollars…the more eager they are to make the trade.

If the dollar were a mistress, she would be the source of heartache. For she is fickle, unreliable, uncertain and inconstant. Still, this is the same sweetheart after whom so many people lust; they can’t seem to get enough of her. They’ve been warned; she’s a harlot…a phony…a jezebel…a painted woman with a sleazy past…who will break their hearts and steal their wallets. Still, they take her into their homes and hearts and ask no questions.

The dollar has become a universal hussy. She wooed and won over consumers, investors, and central bankers the world over. And everywhere she goes, she makes a scene: Foreign nations run huge trade surpluses with the U.S., then end up with surplus dollars…that enter their banking systems. Thus, America’s Fed becomes central bank to the entire world, dictating monetary policy for all the world’s economies. China’s money supply (M2), for example, rose at a nearly 20% rate in December – mostly as a consequence of absorbing U.S. dollars. Is it any wonder that China is enjoying a boom? Is there any doubt about how it will end?

A fool and his money are soon parted, it is said. But before they split up, they are invited everywhere. For the present, Americans and their dollars are invited to every party.

Nobody knows anything…but so what? Let the good times roll!

Over to Addison with more of what is happening now…


Addison Wiggin in Paris…

– Yeehoo! U.S. consumer confidence rose this month to its highest level since July 2002. Back then, of course, Wall Street was still 15 months away from its bottom, and the imperial dollar stood 40% up vs. today’s euro exchange rate.

– But pay no mind…the U.S. Conference Board’s index of consumer confidence recorded 96.8 in January – a big ol’ leap from December’s 91.7. Meanwhile, economists surveyed by Blue Chip Economics meanwhile reckon the U.S. may grow by 4.6% this year. And the monthly average of new jobless claims fell last week to 344,500 – the lowest since February 2001. The good times are back!

– Only they aren’t. At least, Mr. Market didn’t seem to think so. Success breeding arrogance as it does, he seemed to expect even better numbers. The Dow promptly lost 79 points to 10,609…the S&P slipped 10 to 1,155…and the Nasdaq plunged 36 to 2,116.

– Meanwhile, the dollar’s second attempt to rally in two weeks came to an abrupt halt yesterday. The euro rose a centime or so to $1.26 – reclaiming a good chunk of the three cents it had lost since Friday.

– Defying generally accepted laws of nature (gravity, for one, is an example), the housing market keeps rising. Yesterday, the National Association of Realtors (NAR) said that December existing home sales rose by nearly 7%. And for the year, sales of existing homes made a new record. Over six million homes changed hands in 2003, beating 2002’s mark of 5.56 million. Prices also rose at 7.5% – the fastest rate since the hostages were released in Iran (1980 for you history buffs).

– "Demand for housing is robust," says Strategic Investment’s Dan Denning, keeping a sharp eye on the housing market for us. "By the NAR’s count, inventories fell 7.3% in December. That leaves 4.3 months supply at the current sales rate. Based on those numbers, there’s no reason to think housing prices couldn’t keep going up…and that home sales will stay strong in 2004." New home sales data for December will be released this morning. Most economists surveyed by Reuters are expecting December’s numbers to come in over 1 million units.

– "All of this is pretty convincing," writes Denning, "if you don’t look beyond the surface: Housing demand is strong. Supply can hardly keep up with it. Home prices are rising and rates are low. The boom will continue, driven by new buyers, refinancing at low rates, and demographics (esp. boomers buying second homes.)

– "But underneath the surface," Dan continues, "lies economic reality: Housing activity is strong because money is cheap. It all hinges on low interest rates. The boom in housing is being driven by a credit binge…where the newest buyers are the biggest credit risks. In other words, if you just looked at the supply dynamic, you might be convinced that everything is fine. But the closer you look at demand, the more you see it’s been artificially stimulated and is now drawing in riskier and riskier borrowers. That can’t last forever."

– "Imagine Mr. and Mrs. Orange County buying their home some years ago for $500,000," writes Daily Reckoning reader David Cantwell (who moonlights as the Managing Director for the Orange County, California office of Studley, a leading national commercial real estate firm). "They put $100,000 down and have a mortgage debt of $400,000. Some years later, they sell their home for $1 million. They ‘made’ $500,000. Using this new money, and smitten by low interest rates, Mr. and Mrs. OC go buy a bigger home for $1,200,000. With all that extra money, they decide to put only $400,000 down on the new home. They now have a new mortgage debt of $800,000. They use the balance to buy cars, electronics, vacations and other things that will have little monetary value, if any, in just a few years.

– "What happened to Mr. and Mrs. OC’s balance sheet?" Mr. Cantwell wonders aloud, getting out the magnifying glass for a closer look. "First, one does not get richer selling a house that was worth a million dollars for a million dollars. There was no increase in value, the home doesn’t have any more value than before; it just costs more. It’s the same house. It would cost a million dollars to buy it back.

– "Second," Cantwell continues, "they have more than doubled their property tax liability (going from ~$6,000/year to ~$14,400 per year). Third, they have doubled their debt from $400,000 to $800,000. Fourth, since they spend some of the equity on other items (that depreciate to almost zero value in a few short years) they reduced both their cash and consequently net worth. Fifth, the selling costs were about $66,000. So, while they have a better house, and some neat stuff, they have twice the debt, twice the payments, twice the property tax liability, and reduced their net worth by over $66,000 (more if they bought things that depreciate in value quickly) and increased their mortgage debt by 100%. Are Mr. and Mrs. OC better off?

– "Many, of course, will be tempted to dismiss this analysis because ‘real estate always goes up’…" Of course, it does.

[Editor’s note: We took the liberty of posting Mr. Cantwell’s thoughts on the Daily Reckoning web page. Please see:

The Fed’s Housing Boom ]


Bill Bonner back in London…

*** Our old friend Marc Faber suggests the same investment as our new friend Hugh Hendry: buy coffee. The price of coffee hit $3.40 in 1977. Since then, it’s been in a bear market…with a recent price of 68 cents. Friends of ours in Nicaragua told us they didn’t even bother to pick their coffee anymore…it wasn’t worth the effort. In many areas, coffee growers have given up. They’ve pulled out the coffee bushes to plant soybeans and other crops.

"The Chinese will drink more coffee in the future," said Marc to Barron’s. "If China on a per-capita basis started consuming as much coffee as Taiwan and South Korea, they would take up the entire world production."

Other Faber recommendations: buy oil producers…short the homebuilders.

And one more: "In India, the geopolitical situation is improving. India and Pakistan are beginning to talk about a peace arrangement for Kashmir. In the last two years in India, there have been more business privatizations than in the previous 30 years combined. I would buy the India Capital Fund, of which I am a director. The Indian stock market has been very firm. We could have some profit taking in emerging markets that easily could send stocks down 30%. If you aren’t prepared to accept that, don’t touch them. In the longer term, the most attractive opportunity in India is the real-estate market. It hasn’t been developed for the past 50 years." (More from Faber below…)

[Editor’s note: Marc Faber contributes insights and recommendations monthly to Strategic Investment. If you’re interested in subscribing, we’ve arranged for you to get a free copy of the Strategic Investment report, "10 Ways To Survive A Crumbling Housing Market." Details here:

10 Ways To Survive A Crumbling Housing Market ]

*** Ah…India…! Our friend Michel is convinced that India, not China, represents the wave of the future. We have begun to study the matter in our own precise manner. We picked up a copy of India Today to see what is going on. As near as we can tell, an important election is coming up. The contest pits an aging, vaguely free-market conservative, Atal Behari Vajpayee, against a less-aging, vaguely social democratish Italian-born woman who just happens to have been married to Rajiv Gandhi, grandson of Jawarharlal Nehru before he was murdered in 1984. Vajpayee seems to have the edge, for the moment. The economy is booming. But Sonia has the legendary family connection. Her ex-husband’s family’s socialist policies brought much misery to India…but the masses are just as blockheaded on the subcontinent as they are in America.

*** "Today the Far East has most of the world’s fast- growing economies, generates more than half the world’s annual savings, is the principal force driving the expansion of international trade, and holds two-thirds of the world’s foreign exchange reserves in its central banks," writes our old friend Martin Spring.

"And that is only the beginning. Today, only one of the world’s four biggest economies is in Asia. But by the middle of this century, three of the four will be there.

"The investment bank Goldman Sachs recently forecast that if current ‘growth-supportive’ policies are maintained, then by 2040, China should overtake the U.S. to become the world’s biggest economy. India should be the third largest, while slow-growing Japan will retain its position at the top table.

"By mid-century, the Chinese should have living standards equivalent to those of Americans today, Indians equivalent to those of Italians today."

More on this tomorrow…

*** A quick update on the Cannibal of Rotenberg. Poor Mr. Meiwes told the jury that he was sorry he ate Mr. Brandes. There, we guess that does it; he’s admitted his mistake. That should satisfy the pecksniffs.

The Daily Reckoning