Imperial Over-Stretch Marks

"Political history is largely an account of mass violence and of the expenditure of vast resources to cope with mythical fears and hopes."

Murray Edelman

Both high and low, the world is full of regrets. Women often regret the men they didn’t marry; men regret the women they did.

George Bush, Sr. regrets not having taken out Saddam Hussein when he had him in his sights.

Alan Greenspan must regret not having warned against a collapsing bubble. Even if he didn’t want to prick it himself, all he would have had to do was to say something and today he might be regarded as a sage, like Warren Buffet, instead of a mountebank.

Dennis Kozlowski must regret trying to save a few dollars in sales tax…and Martha Stewart must rue the day she met Sam Waksal.

Maybe James K. Glassman really was just trying to explore how stocks should be valued in his 1999 book. But he must surely wish he had chosen something other than "Dow 36,000" for a title.

Of course, many of today’s regrets might list 1999 as their date of conception. For that was the year that inhibitions were at an historic low. People were ready to sneak into the cloakroom and embrace anyone and anything – no matter how absurd.

"Think of the Internet as an economic-freedom metaphor of our time," Republican economist Larry Kudlow declared to Barron’s in August of that gossamer year. Kudlow’s problem with alcohol was history. He can’t even claim he was drunk when he said it: "I believe the future economy will outperform all expectations. The Dow Jones Industrial Average will reach 15,000, then 30,000, then 50,000 and higher."

Kudlow was no longer drinking. Instead, he had been driven mad by sobriety and the New Era. Nine months later, "it was the Fed that killed the market," he raved in The American Spectator. The policymakers had been spooked, he ranted, "by too much prosperity…too many investors creating too much wealth."

"But the underlying forces driving the New Economy are real and not easily suppressed," he continued.

In Kudlow’s mind, there are no natural cycles in capitalism. People just get richer and richer…unless government functionaries and elected officials err. "Had Washington moved earlier [by lowering interest rates]," he said, "the demoralizing $5 trillion stock market wealth deflation, a crippling manufacturing recession, tens of thousands of job layoffs in technology and service industries, and a general rollback of risk-taking animal spirits all could have been avoided."

If the Fed had merely been able to see into the future… it could have figured out the interest rate that the market needed just when it needed it. Maybe then, there would have been no bear market, no Enron, no ImClone, no telecom disaster, no bust, no profit collapse.

And if the Fed does make a mistake, which he seems to admit is a possibility, no problem. It just "represents investor pleas for new government policies."

Of course, the proposition is absurd. As Hyman Minsky pointed out, and the experience of the last 10 years illustrates, nothing fails like success. All it takes is a period of stability to lure investors into believing that the market is risk free. That is when they begin doing things they will later regret – like buying at $200.

Once bought, what government policy could make the stock worth what the investor paid for it? People do stupid things all the time; the worse that can happen is that they succeed…for that sucks them down into even greater mistakes. Better to meet with failure right away…and regret it sooner rather than later.

And so we come right to the point of today’s letter: we think there will be a lot more regrets before the present down cycle is completed – and not all of them will be matters of money.

Homeowners will regret adding to their mortgages, for example. Deflation will lower their expenses, but it will make money harder to come by. If the nation sinks into outright deflation, real interest rates will rise, even as nominal rates hold steady. Homeowners will find themselves paying high real rates on big mortgages while real estate prices fall.

Investors will regret holding onto their stocks too. If we’re right, the Dow will eventually fall below 5,000… and it could take 10 years to do so. It could be a long, miserable period for stockholders.

But what does Kudlow think the government should do about it, we wonder…(if only for amusement)?

"The shock therapy of a decisive war will elevate the stock market by a couple of thousand points," he says.

There are probably people who would bomb Paris for a few thousand Dow points. But we are doubtful if war really will produce the advertised benefits. In fact, we suspect that he may be courting fresh regrets.

Just as investors got a little light-headed and foolish when they saw how much money they were making in the late ’90s, we worry that many people have been driven a little mad by military success.

Politics is not our beat here at the Daily Reckoning. We readily admit that we know as little about it as we want to know – which is almost nothing.

But we can’t help but notice that the waves of boom and bust, madness and regrets, that overpower the markets also seem to swamp politics. And a few people – such as Larry Kudlow – seem to be sopping wet almost all the time.

Your editor,

Bill Bonner
October 11, 2002

P.S. Kudlow officially converted to Catholicism (your editor became a Catholic more or less by inattention) after he got out of a treatment center for his booze-and- cocaine habits. Now, he thinks God follows him around and smiles on every footstep.

And we read in the news that the entire Republican Party is being taken over by Christians:

"Christian conservatives now hold a majority of 36% of all Republican Party state committees…plus large minorities in 81% of the rest, double their strength from a decade before."

From the press reports, not a single one of these Christians has proposed turning the other cheek to Saddam Hussein. God is on their side, they think.

Jesus, asked how often he should forgive those who trespass against him, said he should do so 70 times 7 times. We can get the point without even doing the math.

We cannot recall even Saddam Hussein’s first offense against America. But, the Christians in Washington propose to bomb the hell out of him anyway. That way, he won’t get a chance to smite us even once.

Stocks rallied yesterday. But something was missing: volume. So far, the rallies have been thin and selective – not enough to sustain a major upswing in prices. Insiders are buying, say reports. But most investors sit tight. They’re taking a "wait and see" attitude to rallies.

Nor do they panic when stocks turn down. They seem to have taken "buy and hold for the long run" so seriously that they have become immobile, paralyzed not by fear, but by a lack of imagination. Not that we know which direction stocks are going. But a person who bought in ’99 because he thought they were going to the heavens might perfectly well come to the conclusion that they are headed to hell now. His imagination seems to fail him just when he needs it.

So stock prices neither move up sharply nor crash. Instead, they just gradually wear away.

Paul Desmond, at Lowry Reports, tracks buying and selling ‘pressure’ in the stock market. "Currently, investors’ buying enthusiasm is at its lowest level, and the desire to sell is at its highest level, since June 1962," Desmond told Thom Calandra. "To get rid of that desire to sell, and to reinvigorate the desire to buy, we need one more period of intense selling – probably four or five more 90 percent downside days – before we reach a significant market bottom."

A 90% downside day is what you get when 9 out of 10 investors try to get out of the same stocks on the same day. So far this year, only once – on Sept. 3rd, when the Dow dropped 355 points – have we had a "90% downside day." We doubt it will be the last one.

Let’s hear from Eric about yesterday’s market action…


Eric Fry in New York…

– It was bound to happen eventually…The stock market finally rallied yesterday, and the bond market tanked. The Dow bounced 248 points to 7,534, while the Nasdaq jumped 4.4% to 1,164. Over in the bond market, the 10- year Treasury note fell three quarters of a point, pushing its yield back up to 3.65%.

– Will these counter-trend moves prove to be just the latest of many one-day wonders?…Stay tuned.

– Speaking of stock and bonds, has the Bubble Queen passed her scepter to a new Bubble King?…Or, to put it differently, has Abby Joseph Cohen abdicated her role as the supreme financial market prognosticator to Bill Gross, the bond-fund manager from PIMCO? One thing is certain; Ms. Cohen’s prestige and reputation have been closely tracking the downward trajectory of the Nasdaq Composite. We don’t think it’s a coincidence.

– Meanwhile, Bill Gross’ prominence as a financial guru is soaring in lock-step with the soaring bond market… Freaky, isn’t it? Just maybe, Bill Gross does not become ever more brilliant and insightful with each new sunrise. Just maybe, "markets make opinions," and the leading opinion of the moment is that owning bonds is a smart thing. Therefore, anyone who owns lots of bonds must be super smart.

– We – the Daily Reckoning’s New York bureau, that is – wonder if Gross’ skyrocketing reputation might not be one itty-bitty hint that the bond market has become something of a bubble. We also find it curious – and indicative of a possible bubble – that Gross’ main bond fund has become the nation’s largest mutual fund.

– "The bond king has earned himself another crown: He also now owns the title of mutual fund king," writes the National Post of Canada. "As of Sept. 30, the Pimco Total Return Fund, managed by Bill Gross…surpassed the Vanguard 500 Index Fund as the largest U.S. mutual fund by assets under administration."

– Pimco’s Total Return Fund boasted $64.6 billion in assets at the end of September – barely nosing out Vanguard’s index fund, whose assets dropped to $62.8 billion from $70.5 billion in August.

– Need more evidence of a bond market bubble?…Not only is Pimco Total Return the nation’s largest fund, it is also the most popular. It has been this year’s top- selling U.S. fund, raking in more than $10 billion over the first eight months of 2002. Vanguard is not yielding its coveted #1 spot without directing a little ill- mannered sniping in Gross’ direction. The mutual fund company sent letters to its investors warning of "irrational exuberance" in the bond market. Vanguard may have a point…

– Notwithstanding the stock market’s stellar action yesterday, serious macro-economic issues remain.

– "Suddenly, there’s a sinking feeling again. And it’s truly global in scope," moans Morgan Stanley’s Stephen Roach. "From Asia, to Europe, to the United States, and to Latin America, the world economy seems to have lost any semblance of upward momentum…An engineless global economy is simply lacking in any real source of growth. It’s starting to feel like a global double dip."

– "America, of course, is to blame for all this," Roach explains. "Since 1995, the United States has accounted for twice as much world GDP growth as its share in the world economy might otherwise suggest." So, like it or not, he says, "When America booms, the rest of the world goes along for the ride. When America sags, the rest of the world sinks like a stone."

– American corporations have been sagging for a while now. But so far, the credit-card-wielding consumer has charged into the breach to repel the dark forces of recession. Unfortunately, these courageous foot-soldiers are growing weary, and many are hunkering down in their financial foxholes.

– Therefore, says Roach, contrary to widespread expectations, the latest mortgage refinancing boom has not been boosting consumer spending nearly as much as one might expect. "Maybe," he speculates, "the profligate American consumer finally has all the cars, DVD players, and kitchen appliances that he or she will need for a long time…Who knows, maybe over-extended American consumers will use the windfall of reduced debt service to rebuild saving or even pay down debt. Stranger things have happened."

– Indeed…Saving money only seems strange if you’ve never done it before.


Back in Paris…

*** Where is all the mortgage refinancing money going? Stephen Roach may be right. Americans may be renewing an old acquaintance – with savings.

"Refinancers are Hoarding Savings," says a Reuters report. "Record-low mortgage rates spurred Americans to file more applications to refinance than ever before, but faced with stock losses and a soft job market, they are growing more reluctant to spend the money they save by refinancing," several reports said.

"They now plan to either save the extra money or use it to pay off credit card bills and car loans, according to a consumer survey released Monday by the Cambridge Consumer Credit Index."

*** Oh la la…gold down $3.40.

*** Maria was called back to Milan for a modeling assignment. The client flew her down in the morning, picked her up at the airport, spent a few hours shooting pictures and then took her back to the airport. She got back about 11 pm.

"I made $78," she reported. "But I went over the figures with the accountant. That month that I spent in Milan…I made $3,048. But the agency took nearly half of it. Still that’s not too bad, don’t you think, Dad?"

Dad did not think so. He reminded his daughter that she was doing a version of ‘pro forma’ accounting. Her P&L statement should show the money spent by him and his mother keeping her company. Subtracting the travel, hotel, restaurants, and telephone expenses would leave her in the hole by several thousand dollars.

"Dad…you’re so discouraging…"

The Daily Reckoning