Forecasting Fairy Tales

The German multiword “schadenfreude” means “the malicious glee at the misfortune of others”. But I derive no such pleasure from the results of Wall Street analysts’ forecasts over the past year. It is, however, worth pointing out that most of the financial press is just plain wrong about what is going on in the markets and economy. I have also been wrong many times in the past about the same issues, and I know how it can hurt.

I was quite premature, for instance, about turning bearish on the stock market. As a value-oriented security analyst (emeritus), I could only point out the absurdities of the developing mania and subsequent bubble. When young and foolish, I participated in several manias, and had a complete wipeout in the devastation that followed in one of them. With an almost uninterrupted 18-year bull market (1990-91 and the Gulf War were only a minor interruption), few, if any, of the 2001-2002 economists and market strategists would have had a comparable experience.

To illustrate how off-base market strategists have been during the last two years, Jim Stack of InvesTech Research compiled a list of predictions by prominent market strategists at the beginning of each year for where the Dow Industrials and Nasdaq Composite would close at the end of 2001 and also 2002. The list was published in the January 6, 2003 issue of Barron’s.

Stock Market Predictions: Predictions Sure to Go Wrong

The 22 market strategists were panelists on the television show “Wall Street Week with Louis Ruckeyser”, shown in January 2001 and 2002. The names are listed in Barron’s and include many well known market strategists. The Dow Industrials closed at 10,768.85 at the end of 2000, and every one of the panelists predicted a resumption of the bull market. The high prediction was 13,170, the lowest 11,400 and the Dow’s actual close was 10,021.50. Jim Stack didn’t calculate the average prediction, but the median was 12,100 – meaning another double-digit gain of 12.2% was projected for 2001. In actuality, at the end of 2001, the Dow closed at 10,021 – 2,079 points or 17.2% below the median prediction.

The 2001 results for the Nasdaq predictions were even further off. The high prediction was 4600, the low 2250 and the actual close was 1950 – below every forecast. The median was 3000, so that the actual close was 35.1% below that average. For last year, the 22 panelists predicted a high close on the Dow Industrials of 13,750 and a low of 10,000 for the end if December 2002. The actual close for the year was 8,341.63. The median of the 22 predictions was 11,200, so that the close was 2,858 points, or 25.5% below the average.

This time, however, it really is different. The post-bubble stock market will be quite different from previous experiences. The low in the Dow may have been made last October, although I doubt it, but I do not think that a new bull market has begun.

So that I will not be accused of picking on those 22 panelists, the record of market strategists around the world, and economists in general, has not been much better. The Financial Times of January 2, 2003 had an article highly critical of British market strategists: “…you would hope that professional analysts would forecast the direction of the market correctly – at least some of the time. Sadly, during the three years of declining equity markets since the FTSE 100 peaked at 6930.2 on December 31, 1999, this has not been the case. None of the analysts surveyed correctly forecast the direction of the market. They all got it wrong, and the accuracy of their predictions is getting worse.” London’s Financial Times Stock Exchange 100 (FTSE-100) closed yesterday at 3597, for a loss of 3333 points, or 48% from the high point cited above.

Stock Market Predictions: Tightly Packed Around the Average

The Wall Street Journal’s survey of 55 economists for 2003 expectations was released on January 2nd, and their record has not been good over the last few years. Only one or two forecast the recession that started in March 2001. Except for the near unanimity in forecasting higher interest rates this year, their average projections are very similar to what was looked for in their January 2002 estimates.

If anything, the 55 are even more tightly packed around the average (except for A. Gary Shilling, who expects a recession this year). This near unanimity always bothers me, since it expects future conditions to continue pretty much along the same path – and does not factor in any possible changes. Another thing – most are predicting a rebound in capital spending, but just about every quarterly report I read mentions cuts in capital expenditures, and excess capacity exists in virtually every sector. Without pricing power, layoffs mounting, and profit margins under pressure, I don’t see the case for a rebound in capex.

Business Week also had a survey of 67 market strategists and 67 economists in their December 31, 2002 issue, but I have no way of evaluating their past predictions. Only three of the 67 market strategists forecast a decline in the Dow Industrials, and just two expected the Nasdaq Composite to be lower at the end of the year. For the 67 economists, the growth of real GDP for the year ranges from 1.5% to 4.8%, but 50 of them are in the 3.0-3.6% area. Elsewhere, they are almost unanimous – CPI inflation at 2.2%, federal funds at 2.0%, 10-year Treasuries at 4.8% and unemployment at 5.7% at the end of this year. I think the areas they are most likely to be terribly wrong in are inflation and interest rates.

It’s not only market strategists and economists that have been wrong over the last two years. The January 2, 2003 New York Times had an op-ed article by James Ledbetter (formerly an editor of the defunct Industry Standard) entitled “The Boys in the Bubble”. It shows “how journalists covering the new economy blew it,” by essentially becoming cheerleaders, rooting for the “new economy” companies and failing to dig for the details and underlying fundamentals. Basically, that’s what the cheerleaders on CNBC have been doing – and continue to do.

Stock Market Predictions: Expected Bullishness

The magnitude by which so many ‘experts’ were wrong over the last two years brings up some disturbing implications. Some of the bullishness of those 22 Wall Street panelists can be attributed to the natural or expected bullishness that goes with their jobs, as well as their lack of conditioning from the experience of a bad bear market. But none of the 22 got the direction of the markets correct in each of the two years. For the Dow Industrials and Nasdaq, that amounts to 88 wrong projections about the direction of the stock market.

The Financial Times evaluation was similar: “…the accuracy of their predictions is getting worse.” Only three of the 55 economists in the Wall Street Journal’s January 2001 Survey forecast a decline in real GDP of one quarter or more. Their forecasts for 2002 cannot be graded yet, but except for the direction of interest rates, it looks like it would be a “Gentleman’s C.”

What bothers me is that if these people are “The Best and the Brightest,” the most highly paid, highly motivated and the best in their professions, what happens when you go downscale to the people who advise policy makers in Washington, D.C.? So far, the Federal Reserve’s response to every crisis, perceived or real, has been to cut interest rates and flood the system with liquidity. But 11 interest rate cute in 2001 and one last November have failed to achieve “policy traction” – the ability of those measures to pull the economy into a reasonable recovery.

What happens now – with only 125 basis points to go? What will those advising policy makers suggest now? All we can do is wait and see…and hope that decision makers learn to take ‘expert’ advice with a grain of salt.

Sincerely yours,

Raymond DeVoe
for the Daily Reckoning
February 7, 2003

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“January sales fail to lure U.S. shoppers,” says a Financial Times headline.

America’s ‘shop ’til they drop’ consumers are finally dropping. Two million of them have lost their jobs since the U.S. economy went into recession in 2001. Their ‘just in time’ cash management system worked fine when jobs were plentiful. But now it is under stress from a ‘not soon enough’ recovery.

The recession and bear market on Wall Street were supposed to have corrected the excesses of the boom…leaving the way clear for a new phase of growth.

But what sort of recovery is this?

Answer: one as phony as the recession that preceded it.

Stocks didn’t sink to real values in the bear market – they’re still priced at 2 to 3 times historic bear market lows. Nor did consumers stop buying and pay down their debts. Instead, they were lured to go further into debt. So the bad loans of the late ’90s turned into the bigger, badder loans of the ’00s.

And now, day by day, the whole world economy seems to sink into a long, soft, slow slump – à la Japan.

But wait. There’s a major difference between America ’03 and Japan ’93. Japan was a major net creditor. America is a major net debtor. Japan had an interest in keeping its currency strong; its people had savings and were owed money by the rest of the world. America is in a very different situation – with trillions of dollars worth of debts, denominated in its own currency. It may discharge those debts by cutting back on its expenses and diligently beavering away to pay them down. It might also be tempted – under pressure from voters – to discharge them in a less honorable way…the way Germany dissolved its war debts to the allies after WWI, for example. ‘Cranking up the presses’ occurred to Finance Minister Karl Helfferich, just as it did, 4 score years later, to Fed governor Bernanke. In a few months, the German mark was completely worthless.

More recently, Argentina went into a major slump owing massive amounts of money to foreigners. What was the result?

Yesterday’s press reports brought news that the Argentine peso lost 70% of its value last year…with domestic inflation running at about 40% per year. The Argentine economy collapsed another 12% last year.

Are we in America headed towards the pampas? Or the land of the sinking sun? We don’t know. For all we know, we have a ’round-the-world ticket, with stops in all the world’s troubled economies.

So we buy gold…and prepare to enjoy the trip…

Eric, your penetrating thoughts, please…

————

Eric Fry, reporting from Wall Street…

– How many more days, your co-editor wonders, must he scour the thesaurus to find synonyms for “pathetic?”…The stock market’s wretched, dismal and pitiable performance continued yesterday, as the Dow dropped 56 points to 7,929…Buyers are scarce and they are easily frightened.

– Gold retreated for the second straight day – pulling back $5.40 to $371.80 an ounce. Crude oil marched 32 cents higher to $34.25 a barrel, after briefly reaching a high of $34.50.

– “The U.S. consumer has water in his lungs,” says Greg Weldon, editor of Weldon’s Money Monitor, citing the plummeting ratio of household deposits to household liabilities. Back in the 1950s, Weldon points out, “U.S. household deposits covered a whopping 155% of US household liabilities.” Today, deposits equal a meager 60% of liabilities – a multi-decade low. The ratio continues to worsen in large part because folks aren’t cutting back expenditures as rapidly as prudence might dictate.

– To be sure, it isn’t easy adjusting to the post-bubble economy – not on Wall Street or on Main Street; nor, for that matter, on Broad Street. Yesterday afternoon, your co- editor strolled into the nearby Starbucks on Broad Street for his habitual double espresso. While waiting in line, the following conversation ensued between two laid-off, 20- something males:

– The first says: “You know, ever since I got laid off I’ve been trying to cut back, but I haven’t done much cutting.”

– The second says: “Yeah, it’s not easy.”

– First: “I should be cutting my cable TV, but we’re coming into the NBA playoffs and I just can’t do it…Yesterday, I got my electric bill and my Time Warner cable bill and I said, ‘I’ll pay the cable bill, electricity can wait.'”

– Second: “Well, getting laid off was a lifestyle enhancement. You don’t want to curtail your lifestyle already.”

– First: “I’m glad you see it that way also.”

– They chuckle as they exit with their $5 cappuccinos…

– Despite the consumer’s withering wherewithal to consume, record mortgage-refi activity has been providing just enough financial buoyancy to keep him afloat. But the refi- lifejacket is becoming a bit waterlogged, and, as yet, no other lifelines or rescue craft are floating nearby. Employment growth is not even visible on the horizon.

– Continuing Weldon’s metaphor, if the consumer is nearly drowning in debt, the state governments must be floating face down already. A recent Associated Press story summarizes – state-by-state – fifty tales of budgetary woes. (Actually, only 49 tales of woe, as Wyoming is enjoying a tax-receipt boom, thanks to a “large upswing in natural gas production.”)

– “I’ve lived in Iowa for 27 years and we have not faced the kind of fiscal challenges we have faced this last year in that period,” says Gov. Tom Vilsack. Down in South Carolina, meanwhile, the state’s $5.4 billion fiscal 2004 budget is due to fall short by a whopping $1 billion. In Maryland – the state that Agora calls home – Governor Robert Ehrlich hopes to plug a $1.2 billion shortfall by installing slot machines at racetracks…Hmmm…Seems like a gamble to us.

– It’s interesting to note that a couple of states consider themselves to be in a crisis due to relatively modest shortfalls. Utah Gov. Mike Leavitt warns, for example, that the state’s $117 million budget shortfall “could force the state to release prisoners early and lay off state troopers.” Is $117 really such a big deal? Isn’t that about what the average CEO made during the bubble years?

– If we had it to do over again, we might have withheld a few billion dollars from the CEO-compensation pool and added it to the state trooper-compensation pool…But how could we possibly have known that CEOs were not really worth $100 million per year?

– A final item from the post-bubble economy files:

– Your co-editor, while visiting with one of the traders near his office, found himself in front of a TV set broadcasting CNBC. The network’s lunch hour show, hosted by anchor-man Bill Griffith, featured a Q&A session with a “legal expert”. The approximate theme of the show seemed to be: “How to recoup your bear market losses through the court system”. Sometimes the discussion veered off-topic with questions like: “Hey, my roof leaks. Who can I sue?”

– But for the most part, earnest investors called up to ask earnest questions about where best to assign blame – and of course, recoup losses – for the consequences of their own greed and stupidity. As we have noted several times in the Daily Reckoning, most prospective litigants could resolve the basic issues of cause and culpability by purchasing a small hand-mirror and gazing into it.

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Back in London…

*** Wherever the American economy is headed, it is likely to have company. In a “surprise cut”, England’s central bank lopped a quarter of a point off its key lending rate. “Interest rates could fall to as low as 3% later this year, leading economists predicted,” said the TIMES of London. Why the cut? Manufacturing in Britain is slipping into recession…its stock market is falling…consumers seem to “running out of steam.”

*** Elsewhere in the world, the headlines are little different. Europe seems to be headed into a slump – with sagging confidence, sluggish consumer spending, and falling employment. Look for more rate cuts as central bankers everywhere try to stimulate their economies and keep their currencies from rising against the dollar.

*** China solved the problem by linking its currency to the dollar. It sells so much to U.S. consumers, it cannot afford a rising currency.

*** The following email has made its way around the Internet. Last seen, and picked up, from Richard Russell’s site, it explains America’s structural economic problem: “Joe Smith started the day early, having set his alarm clock (made in Japan) for 6 AM. While his coffeepot (made in China) was perking, he shaved with his electric razor (made in Hong Kong). He put on a dress shirt (made in Sri Lanka), designer jeans (made in Singapore) and tennis shoes (made in Korea). After cooking his breakfast in his new electric skillet (made in India) he sat down with his calculator (made in Mexico) to see how much he could spend today.

After setting his watch (made in Taiwan) to the radio (made in India) he got in his car (made in Germany) and continued his search for a well-paying American job. At the end of yet another discouraging and fruitless day, Joe decided to relax for a while. He put on his sandals (made in Brazil), poured himself a glass of wine (made in France), turned on his TV (made in Indonesia), and wondered why he couldn’t find a well-paying job in…..AMERICA…..

*** Q: “How many French troops does it take to defend Paris?”

A: “No one knows – it’s never been tried.”

This joke was sent to us by a friend. But here at the Daily Reckoning, we rather admire the madness of men at war, and history holds few examples of men who were madder, or better, at it than the French.

Napoleon’s troops were the envy of all of the world, of course. They fought, often under appalling conditions, with courage, madness and resolve – and brought the whole of Europe to heel.

The Franco-Prussian war went badly. Still, the French bravely defended a besieged Paris – to the point that citizens were eating cats and dogs to survive.

And in WWI, again, the French fought well. They struck the German flank at the Battle of the Marne (outside Paris). French troops were ferried to the front in taxicabs. This battle turned the course of the war. Effectively, the French had won the war – driving the Germans back to near the border, where they were stalemated for the next 3 years.

World War II was the only occasion on which you could say that the French did not defend Paris. But it was not that they would not…but that they could not. They had made a disastrous strategic error, leaving their armies near the Belgian border, where they were cut off by fast-moving panzer divisions. The French failed to understand how the nature of war had changed since WWI and paid a huge price. Their troops were in the wrong positions…they could not be supplied…nor could they be repositioned to defend Paris. The French did the best they could – they made peace. And Paris survived the war in good shape.

But the French military history of the last 200 years had a profound effect on the nation’s attitudes. Whether they ‘won’ or ‘lost,’ each war was a punishing…and often humiliating…experience. Few French people are eager to take up another one.