Leaving Gracefully

“Consumer confidence is shaken,” according to Johan Ruper, CEO of luxury watch maker Richemont. “It could take six months before it is restored.”

Mr. Ruper is an optimist. We may never again, in our lifetimes, see consumers so confident.

Consumers have been feeling extraordinarily fat and sassy for a very long time. How do we know? Because they have been willing to spend more borrowed money than they ever did before. And, so sure are they that the future will be bright that they have been willing to mortgage more of their homes than ever before to do it. In the 1990s alone, homeowners gave up an additional 10% of their homes to mortgage lenders.

Investors, meanwhile, were so cocky they ran up stocks to a level never before seen. The long-term trend for stock market capitalization is a horizontal line at about 50% of GDP. At one point in the late ’90s, the figure had soared to 183% of GDP. Even now, 18 months later, stocks are valued at 135% of GDP.

And what kind of person buys a tech stock at 200 times earnings? Neither “timid,” “reflective,” nor “philosophical” seems to describe him. P/Es with three digits suggest a different state of mind…beyond mere faith “in the system.” It presumes a confidence bordering on lunacy…a belief that the world has reached near-perfection – where there will be no nasty surprises…no wars, no new technologies, no business cycle turnabouts, no inflation, no bear markets… nothing but good news.

This was the “Golden Age,” that Treasury Secretary Paul O’Neill and millions of other Americans thought they saw coming.

It was madness, of course. But it is a kind of madness that the mad men can now deny.

“The Twin Towers disaster has acted as a convenient excuse for those economists, strategists and soothsayers who’ve been dead wrong about what lies ahead,” explains Richard Russell in today’s commentary. “‘Oh,’ they say, ‘we were on the right track, but this attack on America has changed everything. How could we have seen this coming? Yes, the economy won’t do nearly as well as we thought it would. Instead of the rosy future we predicted, the nation may now be heading for recession. But please, the disaster in NYC has changed everything. We’re innocent.'”

“There is always some leveling circumstance,” wrote Ralph Waldo Emerson, 161 years ago, “that puts down the overbearing, the strong, the rich, the fortunate, substantially on the same ground with all others.”

If it had not been for the terrorists, the process of leveling American consumers’ confidence might have been slower, more gradual, more ambiguous. But, one way or another, it had to happen.

Mind cannot be completely separated from matter. Sooner or later, even the dullest consumer was bound to feel the pinch of declining income and rising debt payments. And what investor is such a fool as to not notice that his portfolio has been in decline for the last two years?

But now, consumers, investors and analysts all have a way to take their leave gracefully. They can cut back on spending without admitting that they ever spent too much. And they can sell shares without recognizing that they were damned fools for buying in the first place. Now, suddenly, unexpectedly, the world has changed.

Consumers no longer have to cut back out of financial necessity. Now they can downsize their lives simply because it is the fashion. They can now leave work a little earlier…and spend a few minutes more with their families. They can assume a more thoughtful pose, gazing out at the sunset or reading a book…and rediscover frugality as though it were a fancy new restaurant or the latest health craze.

The half-empty glass is suddenly half-full – financial prudence is a la mode again. Getting and spending has gone out of style.

Of course, there are fashion setters and fashion laggards. Here at the Daily Reckoning, you can just look at the cut of our coats and the styling of our hair and know that we are way, way ahead of the curve…

But, poor James Glassman is hopelessly behind the trend. He urges investors to ignore short-term fads. Instead, they should focus on the very long term. “U.S. stocks have provided the best protection against the vagaries of world politics and economics,” he argues.

“Imagine a baby girl born at the end of September 1929,” he writes. If her parents had had the foresight to buy $10,000 worth of S&P stocks on the day she was born, she’d have $9,270,000 today.”

Glassman is confident that the next 71 years will be like the last 71. Even if that is so, it is a source of little comfort. In real terms, the poor girl’s capital was worth little more in 1989 than it was in 1929.

Markets make opinions. In 1982 stocks were so unfashionably inactive that Business Week thought they were dead. “The Death of Equities,” it reported in a cover story. It was only in the last 10 years of the 20th century that stocks came to life…and it was only at the end of that period that their long-term performance looked so good that investors’ confidence knew no bounds.

Had Mr. Glassman written his article in 1989, he might have suggested that the girl’s parents buy her a house. She could have taken the money she would have paid out in rent and used it to buy other houses. Depending upon the neighborhood, she might have been far better off than if she owned stocks.

It is only the magic of compounding dividends and the bull market of the ’90s that sent her wealth into the big numbers. And the dividend yield today is only 1.42%, itself a reminder of the momentum of bull market fashions.

The inflation rate is running at approximately twice the level of S&P dividends, so you could compound your dividends until hell freezes over and still be poorer than when you began.

Bill Bonner
September 18, 2001

“Viewing Disaster Can Trigger Temporary Mental Disorder in Some” reveals a headline in today’s International Herald Tribune.

Ah, maybe that explains it. I refer to the “Patriot Rally” that was supposed to happen yesterday.

Greenspan did his part – overnight bank rates were cut to 3%, the 8th cut in 9 months. And central bankers all over the world opened up the money throttles; $208 billion was injected into the financial system between Wednesday and Sunday night.

And, of course, business and financial leaders were everywhere proclaiming their faith in America, its economy and its financial system…even Warren Buffett was on television, choosing his words carefully, declaring that he would not be a seller yesterday.

Still, the market functioned as it should – transferring the money of people who believed it was their patriotic duty to keep buying Krispy Kreme at 77 times earnings to people who took the time to read the handwriting on the wall.

“We were already headed for a debacle of epic proportions in the stock market with the economy slipping into recession and rampant overvaluation in the face of a post-bubble world,” writes Lance Lewis of the Prudent Bear.com. “None of that has changed. Last week’s events will likely only accelerate the decline.”

But thank God for the patriots. Without them, to whom would foreigners sell? Eric, what’s your take on yesterday’s market?

*****

Eric Fry in Manhattan:

– I returned to my Wall Street office yesterday and it was a very different place from the gleaming, self- confident financial center I had left behind just a couple weeks earlier.

– Wall Street and the surrounding area feel more like Beirut than Manhattan. Thick dust covers everything. National Guardsmen and police stand guard behind barricades on every street corner. Some wear facemasks and mini-respirators. Some do not. Tourists and professional photographers of one sort or another press up against the various barricades clicking off photos of everything in sight. Many of these folks also wear facemasks. I felt a little out of place not having a facemask of my own.

– A weird kind of smoke still fills the air in lower Manhattan. But it’s not really smoke and not really dust – more like “smust.” And the odor is something quite unnatural. “Acrid” is too tame a word to describe it. Likewise, “sell-off” is too tame a word to describe whathappened in the stock market yesterday. Both the air andtrading action stunk – plain and simple.

– As most Daily Reckoning readers are aware by now, the Dow suffered its worst point drop ever, losing 685 points, or more than 7%, to 8,921. The Nasdaq also logged a miserable day, following 116 points, almost 7%. The S&P 500 index managed a slightly better performance by falling a little less than 5%.

– Where were the patriots?

– Whatever became of the millions of Americans who pledged to buy stocks on Monday in a show of patriotic support? Maybe they did, but were outnumbered by those unpatriotic Americans and indifferent foreigners who did not refrain from placing sell orders.

– Turncoats: 1, Patriots: 0. We’ll see if the patriots fare better tomorrow.

– Clearly, the stock exchange’s week-long shut-down did nothing to calm investors’ nerves. Nor did interest rate cuts by both Greenspan’s Fed and by the European central bank seem to make any difference whatsoever.

– Selling ensued from the opening bell and most stocks got absolutely hammered. Oil and gold stocks put in a strong day, but not as strong as one might have expected.

– A 7% stock market decline would seem to reflect a boatload of anxiety. Yet, the XAU Gold Stock Index gained only 2.5%. Anglogold (NYSE: AU), a recent recommendation from the Daily Reckoning Investment Advisory, was one of the sector’s better performers, gaining more than 4% yesterday.

– “The markets went back into battle yesterday,” writes John Myers of Outstanding Investments, “The combatants? Deflation v. Inflation. On one side of the equation, money is being destroyed by falling stock prices, rising unemployment and even insurance claims. On the other hand, the Fed is slashing interest rates while the Treasury is promising to inject billions of dollars into the economy. The result of all this could be stagflation – a situation where you have a stagnant economy and stirring inflation.”

– In the uncertain World that lies ahead it is not hard to imagine that investments in oil and gold will produce at least satisfactory returns. Maybe more than satisfactory.

– Several “knee-jerk” trades punctuated yesterday’s trading action. For example, the shares of Kroll Inc. soared 26%. Kroll “is a global risk consulting company specializing in investigative intelligence and security services.”

– Elsewhere in the knee-jerk trade category, defense stocks soared and airline stocks collapsed. The AMEX Airline Index fell a stunning 40% on the day. Congress is considering a $15 billion bailout of the airline industry. And rumor has it that Osama bin Laden had sold short airline stocks prior to last Tuesday’s attack (I’m not making this up). Now that would be a new kind of terrorist indeed!

– Perhaps the most bizarre thing about yesterday’s slide on Wall Street was how little most people I talked to seemed to care about it. A mini-crash on Wall Street seems trivial alongside the tragedy that has recently beset New York City and the rest of America.

– “On this day, even a sell-off qualified as a victory of sorts,” said Igor Greenwald of Smartmoney.com. “Wall Street reopened for business with its thoughts and prayers still focused on the smoldering mountain of rubble blocks away.”

– And what a mountain of rubble it is. The skeletal remains of the World Trade Center rise from the ruins like a massive gnarled hand. It is a very disturbing sight. Healing will take a while longer.

*****

Back to Bill Bonner in Paris:

*** So there you have it. Wall Street pulled comfortably ahead of Tokyo in the race to the bottom. The Dow closed yesterday at 8,921 while the Nikkei Dow lagged behind at only 9,810. But the Japanese are very good at losing money. One should think twice before betting against them.

*** On the U.S. side, we note that while stocks sold off yesterday, there was no panic. That means that a panic probably still lies ahead. Perhaps next week. Perhaps 10 years from now. But there is usually at least one day of panic selling in a major bear market. GE lost 11% yesterday. Cisco closed at $14.

*** And poor James Cramer. A year ago, he put $2,500 into each of 50 different mutual funds. He reports the results in New York magazine in an article entitled “Mutual Fund Hara-Kiri.”

*** “The results are in,” he writes, “and I am staggered by the losses. I gave it to magicians who made my money disappear. My $125,000 has been reduced to $84,000. Forty-seven of the mangers lost money, only three made money, and of those, only one made me enough money to offset the fees I paid to open the accounts and keep them running. Some of the managers’ performances were so shameful that I can’t believe these folks are still running money.”

*** Cramer’s experience is probably little different from that of other investors. How long will their faithin the system remain? When will they panic?

Miscellany:

*** Last Thursday one of our publications, Taipan, began an “Open for Business” disaster relief drive…readers, including some from The Daily Reckoning, have donated more than US$25,000.