Lunch with the Mayor

"No amount of observations of white swans can allow the inference that all swans are white but observation of a single black swan is sufficient to refute that conclusion."

– Karl Popper

Which would you rather have, dear reader – a case of beer or a case of psoriasis?

Which would you rather do – spend a single night with Maria Bartolomo, stark naked…or a whole week with a dozen big city mayors in business suits?

Which would you rather buy – an investment that has been going up for the last 20 years…or one that has been going down?

Some decisions look easy…but watch out, for often, it’s the easy choice that gets you into trouble.

Here at the Daily Reckoning, we are not fans of politicians. We hate all sin – including politics. But we love sinners; they are often even more fun than the righteous…especially when they are women.

Baltimore’s mayor, Martin O’Malley, is a handsome young man who might have made a good living in an honest profession. But politics draws in the good, the bad and the ugly. O’Malley seems like a good man and an ambitious one. At lunch on Thursday his enthusiasm for Baltimore and its problems spread across the table like spilt beer. Soon, we found ourselves touched by it, wondering what could be done to make the city a better place.

"What’s your biggest challenge?" I asked him.

"Cynicism," hizzoner replied, without hesitation. "People are so used to thinking of Baltimore as a urban dump that they can’t imagine it any other way. We need to get the word out…"

"Baltimore is a city under siege by illegal drug abuse and trafficking," says a Fact Sheet put out by the mayor’s office, "Baltimore is the heroin capital of American and 5th in the use of cocaine."

Among the facts on the sheet: 60,000 city residents are "enslaved by chemical substances." Another 60,000 come to the city regularly with the hope of becoming enslaved themselves.

Competition in the drug trade is cutthroat. "One a day," is the local vernacular for the murder rate. "Sometimes a few days go by without a killing," explains a friend, "but they usually try to catch up on weekends."

"Wait a minute," responds the mayor, "our murder rate is falling faster than that of any other city. Baltimore is making great progress, but no one seems to know it. People still have a bad attitude about the city."

Attitudes have a momentum of their own. As Karl Popper observed, when people see white swans on a pond every day, after a while they think all swans are white.

After 18 years of rising stock prices, investors have come to believe that "stocks always rise over the long run." And they rise especially quickly after the Fed begins cutting rates. "In fact," says a recent issue of the Liscio Report, "if one looks at nine or 12 months into an easing program, the S&P was lower only in 1930 and in 1981, two horrific recessions. The average for the 16 different easing periods that they cite was a gain of 14.9% after nine months, and a gain of 20% after 15 months. This, naturally, is why most people have been bullish, because they know the consequence of past Fed easings."

Why else would people buy stocks at 45 times earnings – 200% more than the long-term average?

The essential rule for making money in stocks is buy low/sell high. Whether stocks will go up or down we don’t know. But readers who violate the first half of the formula can expect no sympathy from us when the second half goes bad on its own.

Of course momentum investors have a different view of things. "A trend continues until it ends," says Jim Dines, helpfully. But even trend followers cannot justify buying stocks in today’s market – for the trend has been for stocks to go nowhere for the last 3 years. Not even the most aggressive easy-money campaign in Fed history could turn stocks upward. Alas, every once in a while, a black swan comes along.

And yet…the momentum of bullishness keeps people borrowing, spending and investing. The U.S. economy has suffered a wipe out in the tech sector, a recession, a collapse of profits, a breakdown in business investment, a crash in telecom, and the worst terrorist incident in history. Still, so little blood trickles down the gutters of Main Street, USA, that people think the American economy must be bulletproof. Nothing can stop it.

This "die hard" economy makes the choices easy. If stocks always go up over the long run…and the U.S. economy is indestructible…what do you have to lose? The only risk is that you will miss the next bull market move! Who but a fool would bury his talent in the ground under these terms?

It seems to us that it would take a miracle to begin a serious bull market at this point. But who knows? Besides, just becomes something is nearly impossible doesn’t mean people won’t think it imminent.

Still, readers who can’t bear to do nothing might consider doing something other than buying U.S. equities. A better bet might be to buy an asset where a momentum of bearishness has kept prices low. Gold, for example…or something different.

"Bill, you won’t believe this," said a friend, "but they’re selling row houses down by the harbor for a quarter of a million. You could have bought them a few years ago for less than $100,000."

Would you believe it, dear reader? While cynics twisted the city’s motto from "The City That Reads" to the "City That Bleeds", property prices in some sections of Baltimore rose faster than stocks!

"And they’re going to continue to go up," the mayor explained, "because we’re getting control of crime, and cleaning up the streets…and when a citizen calls to report a pothole, we have a crew out there to fix it within 48 hours.

"Now, people from Washington are coming up, buying houses in Baltimore and commuting down to Washington every day to work. We’ve got a bid in to bring the next Summer Olympics to the Baltimore-Washington area…and might be able to get a new mag-lev train to cut the commuting time down to just 20 minutes."

Mayor O’Malley has begun a campaign to change attitudes about the city. "Baltimore Believe," he calls it. Can he really alter the currents of popular opinion? Or is he just slapping the waves like Darius’ troops at the Hellespont? We don’t know. But if people ever believe in Baltimore real estate the way they now believe in stocks and the dollar – it will be time to sell.

Ambassador Bill Bonner…
May 06, 2002 — Baltimore, Maryland

P.S. An addition to our Contrarian’s Glossary:

Momentum Investing: Find a trend and stick with it until you go broke

Corporations, eager to spiff up their shabby profits, are cutting payrolls. It might have been obvious that this would happen – but, on Friday, news that unemployment rose in April seemed to come as a complete shock to investors, analysts and economists.

The recession, you will recall, was strange. Consumers did not cut back, as they usually do. Nor did stocks fall, as they usually do. And now we seem to have entered a very strange recovery.

But investors are still looking on the bright side. If companies are laying off workers, they must be increasing profits, right?

Well, not exactly. Individually, companies can improve profits by firing people but if a large number of businesses hand out pink slips it quickly becomes a problem for the whole economy. People who live paycheck to paycheck tend to cut back on expenses when the paychecks stop. And even those who still have jobs found their hours cut back slightly in April, giving them less money to spend. If this keeps up, pretty soon the recession-that-never-was will turn into the recession- that-really-is.

Of course, just because it is inevitable doesn’t mean it won’t be unexpected.

Over to you, Eric:

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Eric Fry, our man on the Street:

– Is America’s profitless recovery also becoming a jobless recovery? In fact, it’s looking very much like a recovery-less recovery. Even the stock market is beginning to notice. Stocks dropped Friday on the back of a miserable employment report. Before the start of trading, news crossed the wires that the unemployment rate jumped from 5.7% in March to 6.0% in April, its highest level since August 1994.

– Responding to the grim report, the Dow Jones Industrial fell 85 points to 10,007, while the Nasdaq skidded more than 2% to a seven-month low of 1,613.

– "That jobs report for April, released by the Bureau of Labor Statistics on Friday, was simply doleful," writes Alan Abelson in today’s Barron’s. "Manufacturing employment, which took another dive, is now back to where it was in 1955."

– Making matters worse, the BLS changed its story about employment trends for the first two months of the year. The government agency initially reported that 66,000 jobs were added in February and 58,000 in March. But then, the BLS ratcheted down those numbers to a loss of 2,000 jobs in February and a loss of 21,000 in March.

– Isn’t unemployment supposed to fall during a recovery? There is something very wrong here.

– "Surprising" is the word many journalists used to describe the April unemployment report. We too, were surprised…that it wasn’t even higher. Clearly, much of corporate America is struggling to boost profits, or to staunch losses. So who wants to add costs by adding to payrolls? Without evidence of a sustainable economic advance, we should expect little good news on the employment front.

– But even though things are looking a little rough for the economy at the moment, a short-term stock market rally would not be a total surprise. That’s because many of the short-term sentiment indicators like the "Bullish Consensus" and the "MarketVane" are registering fairly extreme bearish readings, which, from a contrarian standpoint, is bullish.

– The opposite phenomenon is occurring in the gold market. Suddenly, everyone seems to be bullish on gold. That’s quite a change for the "yellow dog." Over the course of two superb decades for stocks, most investors learned to hate gold, or at least to ignore it. But now that stocks are flirting with three straight losing years in a row – for the first time since the Great Depression – gold doesn’t seem so repugnant anymore. In fact, it is becoming dangerously close to being popular!

– Most of the short-term sentiment indicators on gold are very bullish, which therefore is bearish. Furthermore, the commercial traders (considered the "smart money"), tracked by the weekly commitment of traders report, have amassed their largest short position in gold in more than six years.

– Such extreme Commitment of Traders readings are certainly not foolproof indicators of market direction, but they do suggest that the metal is close to a near- term top. As for the long-term, who knows? But gold probably deserves the benefit of the doubt, given the precarious state of the U.S. dollar.

– The U.S. current account deficit is running close to 5% of GDP. In other words, we borrow more than $1 billion a day from foreigners just to keep the lights turned on at America, Inc.

– This massive current account deficit will not be a problem, the experts assure us, so long as foreigners continue to invest in the U.S. But the dollars’ recent weakness suggests that some foreigners, at least, are withdrawing from the U.S. already.

– "The most interesting development of late in global markets has not been the renewed weakness on Wall Street but the wobbles in the U.S. dollar," says Christopher Wood of breakingviews.com. "The intellectual rationale for pouring money into America in recent years, namely superior investment returns, has now been proven false given that this is the third year running that the U.S. stock market has so far failed to deliver positive returns." – Wood continues: "The Economist proclaims in its latest issue that the American current account deficit is ‘an accident waiting to happen.’ This may not be a particularly original statement. But, however seemingly banal, it happens to be true…"

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Back in…where am I…oh yes, Paris…

*** I began today’s Daily Reckoning from sunny Las Vegas. A couple of planes, a half dozen drinks and one movie later…and I’m ready to end it from Paris, where it is cold and rainy. (More on the "Entertainment Capital of the World"…tomorrow…)

*** While nearly everyone waits for the resumption of the bull market in stocks, most people expect the rally in gold to end any minute. "Equities always reward patient, long-term investors," say Rukeyser’s elves and other mythmakers. "Gold, on the other hand, always disappoints," they say. Gold timers were 90% bullish in February. But now that the metal is $10 higher, only 37.5% of their money is in gold; the rest of it is in cash.

*** "This is a textbook case of what is often seen at the beginning of sustainable rallies," explains my old friend, Mark Hulbert. "As contrarians constantly remind us, bull markets don’t like company; they thrive when relatively few advisers and investors have jumped on their bandwagon. This is why contrarians were not particularly surprised that gold’s rally stalled in mid- February…Today, in contrast, gold at $310 per ounce has fewer cheerleaders than it did three months ago when gold was trading at a lower price."

*** Gold up…dollar down. You might want to get used to the sound of that…it might be in the news for a long time. Last week, the dollar had its "biggest drop since January," according to the Bloomberg report. Since the end of March, the greenback index is down 4.3%. Friday’s trading left the euro up 142 points – to 91.52 cents. The smart money is leaving the dollar and moving to gold.

*** "Bill," said Mayor O’Malley, "since you live in Paris, I want you to act as an ambassador for Baltimore in Europe." Does that mean I have to stop referring to the city as a "hell hole," I wanted to know…more below.

*** And here are a couple of items of no real interest or importance, found in the Paris newspaper this morning: "The famous Bengali snake charmer, Duda Mia," reports the Metro, "claims to have eaten most of the 3,500 baby serpents that he had captured in the houses of Narayangang, near the capital Dhaka."

*** And this item (with a photo of a bevy of very fat women): "The contest for Miss Dumbo awards the crown to the participant who best exhibits the characteristics of an elephant…in order to promote the cause of elephants in Thailand. The winner, Lalita Songrath, weighs 191 kilograms (420 pounds)."