God, Man, and Alan Greenspan

“Tell me why do fools fall in love…”

fragment of popular song from the late ’50s

Why must stocks fall in price?

I pose the question again today, dear reader, because I know it interests you, as it does me. If stocks do not have to fall in price, we could buy the big names of the S&P – even at 28 times earnings. Maybe they would rise higher…and stay higher…forever.

Stock prices rise from time to time – as if on an irregular, unpredictable ocean tide. Waves of bullishness rise up…between troughs of despair…and crash into the rocky shoreline. No matter how high the waves, nor how low the tide might ebb, sooner or later, as Jeremy Grantham reminds us – stock prices regress to sea level. The memory of man runneth not to the contrary.

Theory confirms experience, in this case as in others. After all, why should investors be willing to pay more for a dollar of earnings this year than they were 5 years ago? Why would they settle for a return of 5% on one investment when they could get 10% on another?

Stocks are nothing more than partial ownership of businesses. People rarely buy businesses for fun. They buy them for the income they will produce and let the price of shares rise and fall along with business earnings.

Over time, share prices tend to rise…but only in line with increased and accumulated earnings. If there were no competition and no alternatives, businesses might increase profit margins year after year. But that would be a different world than the one we live in. Without alternatives, there would be no stock market and no decisions for an investor to make.

As it is, competition holds profits down and directs investors’ money so as to force all investment profits down to the same sea level of returns, adjusted for risk and other variables.

Over time, an article in this month’s Fortune tells us, companies’ earnings grow alongside GDP, inflation, and stock prices. Investors should expect only about 6% per year…plus dividends of, currently, only 1.2%.

But during a 17-year bull market, stock market returns rose far above the mean. A drop back to sea level requires either a long period of low or zero returns…as long as 10 to 15 years. Or, stocks could fall sharply – with the S&P down about 60% estimates Fortune, reducing P/Es from 28 to about 10 – and then resume its normal rate of return.

But, look carefully. For there, standing on the beach, an aged, care-worn little man holds out a staff. It is King Alan Greenspan Canute, bidding the waters to hold fast. ‘Stay where you are,’ he commands. “Resist the tug of the business cycle, ignore the tilt of the credit cycle, and ignore the lunatic phases of investor sentiment…that inconstant moon of irrational exuberance and unreasonable gloom…”

“It takes faith to believe in the invisible hand,” said Mark Skousen at last week’s lecture in Paris. “You can’t see it. And yet, we know it works.”

Everyone has faith in something, dear reader. Some have faith in Adam Smith’s ‘invisible hand’ of God. Others have faith in Mr. Greenspan’s wrinkled mitts.

Some people believe they can think their way to the truth. Others wait for it to be revealed to them. But one way or another, we arrive at a truth we find convenient and hold to it…until the real thing finally falls upon us.

Your correspondent…
Waiting for the truth to fall upon him

Bill Bonner
Paris, France
June 8, 2001

P.S. “Did you miss us?” asked Maria, upon our return from London.

*** “Hope” was the big story yesterday, hope that Intel would offer up some encouraging comments in its late afternoon conference call.

*** Hopeful investors bought stocks in sufficient quantities to carry the Dow Jones industrial average to a 20-point gain and to spur the NASDAQ to a 46-point advance. After the close of regular trading, Intel announced that its business is awful, but not disastrous. Investors responded jubilantly to the not-miserable news. Shares of Intel, which rose $1.32 to $31.14 ahead of the midquarter conference call, rose another dollar or so, in after-hours trading.

*** As Hank Herrmann, chief financial officer at Waddell & Reed Financial Services, tells smartmoney.com, “The market is putting its hands over its eyes and saying ‘It looks good to me.'”

*** Bill Fleckenstein offers a similarly skeptical reaction to the notion that the tech sector is recovering: “Today, retail companies with PC exposure gave a first-hand view of souring conditions. Circuit City (CC) released its same- store sales, which were down 25% year-over-year, led by poor PC sales. And Ingram Micro (IM) announced layoffs. It is no secret that demand stinks and PC inventories are up. There is not one single shred of evidence that anything is getting better for Intel.”

*** Nor for anyone else. Yesterday’s employment data, for example, showed initial jobless claims rose yet again to 432,000 for the week ended June 2nd – the worst number since Sept. ’92. Continuing claims for unemployment benefits spiked more than 7% in a single week.

*** A few of the newly unemployed came from Wall Street’s ranks. So far this year, Wall Street firms have announced plans to eliminate more than 10,000 jobs.

*** Given J.P. Morgan’s dire earnings forecast two days ago, it is certainly not the only Wall Street firm that might be going on a “Slimfast” diet.

*** Says Goldman Sachs chief executive, Henry Paulson, “We are clearly in a down cycle, and I think you’ll get worse before it gets better.” Already, Goldman Sachs has announced plans to reduce its work force by 12%.

*** The slowdown affects numerous dependent industries of all sizes. At Patroon’s restaurant, a popular midtown Manhattan venue for “deal-closing” dinners, owner Ken Aretsky misses the dot.com bubble. “The days when $1,000 bottles of wine flowed like water are gone,” he tells Bloomberg News.

*** Still, the average fund manager made $436,000 last year, up from $322,500 in ’99. The average fund investor, by contrast, lost 17%.

*** The days of Manhattan office rents soaring ever higher are also gone. Yesterday, a commercial real estate broker e-mailed a brochure to me advertising office space from a “motivated sublessor” at nearby 14 Wall Street. (This building is directly across Broad Street from the Grant’s Investor offices at 30 Wall). It turns out that the motivated sublessor is none other than the struggling financial website, thestreet.com.

*** The revenue-starved enterprise is offering the entire 14th floor – 34,719 square feet – on a five-year sublet for about $30 per foot. All told that would be more than $1 million per year – money that the Street.com would rather not have to pay. Were somebody’s eyes bigger than their e- stomach?

*** US hotel room revenues are experiencing their largest decline in a decade. Likewise, airline revenues are experiencing extreme turbulence.

*** May was a particularly cruel month for the commercial carriers, to judge from Continental’s harrowing 10% revenue decline last month. According to the Air Transport Association, domestic airline revenues have been in a tailspin since January.

Eric Fry

And more notes…from Bill back in Paris

*** “Almost every statistic that involves consumer health is horrible and getting worse,” writes Chad Hudson of the Prudentbear.com. Consumers continue to spend money they don’t have, while their incomes go down and their costs of living go up.

*** Brian Nottage, with Economy.com, argues that the consumer is facing a second major crisis. After the blow-up of the dot.com bubble comes the explosion of the “lifestyle bubble” in which consumers have been living for the last few years.

*** But when the lifestyle bubble pops, corporate earnings and stock prices must fall. Consumers must reduce spending…pay down debt…and build savings. While there is no sure way of knowing when this will happen…or even if it will happen…it leaves stock market investors in a dangerously exposed position. “High risk, no return…no thanks,” concludes Peter Bernstein.

*** What’s the alternative? How about Morocco, Egypt, Jordan and other Middle Eastern markets? “There is a very low correlation between the Middle East and the rest of the world,” says a broker quoted in Forbes. How about CIB, an international bank in Egypt? “It’s like being able to buy J.P. Morgan Chase with an 11% dividend yield and a P/E of 5 times 2001 earnings.” Or, Eastern Tobacco, another Egyptian company, can be yours for only 4 times earnings.

*** Meanwhile, in the Western Hemisphere…”Haiti is an embarassment,” wrote my friend Doug Casey on a recent trip there. “Although the quality of the cuisine is at least as good as that in France, dining out at the few restaurants that are still open is about all that passes for entertainment these days; the lack of tourists and abundance of crime combine to severely limit possibilities. So does the fact electricity is predictably out at least several hours every day; every home and business must have its own generator. And crime really is a problem.”

*** Tony Blair, of course, won yesterday’s vote in Britain. “I just forgot to vote,” said a friend in London, “the whole thing just didn’t seem to make any difference.” And this from my friend, Martin Spring: “Britain’s election campaign is so boring that watching paint dry is more exciting. That’s not a throwaway line – investigators actually compared the pulse rate and blood pressure of a test group watching vinyl emulsion drying on a wall and vote-chasing politicians, and got higher readings for the paint.”

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