Never Give Up!

Dr. Marc Faber suggests that, if in fact the recession is over, neither an expanding economy nor rising corporate profits guarantee strong stock market performances. But one neglected sector is sure to do well, either way.


Never Give Up!

“Never give up” seems to be the leitmotif of consumers and investors alike. And “shop ’till you drop” and “buy stocks because the recession and the bear market are over” are the guiding principles of the day.

Never mind that, in order to consume and to invest more, Americans have to go deeper and deeper into debt – financed largely by foreign investors; and that stock valuations are so high that future returns will be, at best, only modest. Because interest rates are so low, investors are betting that they are unattractive and that foreign investors aren’t about to give up on the purchase of U.S. financial assets.

Therefore, it is believed that the market can only go up. This strategy is so obvious and makes sense to so many people that the recent strong rise was reminiscent of the stock frenzy and euphoria that characterised the late 1990s. However, there are a few important points our readers should consider carefully before following the rallying cry to buy equities indiscriminately.

It is entirely possible that, although the stock market bubble of 2000 has been punctured, the market will remain in a volatile trading and high valuation range for a while yet. When I joined the prestigious Wall Street investment bank of White Weld & Co. Inc. in 1970 – when Kmart was the retailing darling of the investment community and Wal-Mart an obscure small discount chain – the U.S. economy was just beginning to recover from a relatively mild recession in the fourth quarter of 1969 and the first quarter of 1970. Expectations ran high that the bull market, which had driven stocks sharply higher in the 1950s and 1960s, would resume immediately. Alas, that wasn’t to be the case for the next 12 years.

Moreover, the bear market returned in 1973 and 1974 with a vengeance and led to devastating declines in most shares.

After 1974 the market recovered, but the leading sectors of the 1970s weren’t the “hot technology” stocks and conglomerates that had driven the market to speculative highs in the 1960s, but energy and mining companies. Also, mutual funds, which had performed sensationally well until 1968 and were run by “gunslingers” such as Fred Mates, Fred Carr, Gerald Tsai and Fred Alger, all failed to perform after the 1969-1970 bear market.

In fact, the returns of the S&P 500 in the 1970s were very disappointing – particularly when adjusted for inflation. (By 1982, the Dow Jones Industrial Average was down about 70% in real terms from its inflation- adjusted peak in 1966.)

Foreigners who held U.S. equities in the 1970s didn’t have much to cheer about either, since the dollar fell by about 70% against European hard currencies such as the Swiss franc and the German mark.

At the time, strategists attributed the poor performance of U.S. equities in the 1970s to a number of factors, such as accelerating inflation, the oil price shock, rising interest rates, and so on. In my opinion, however, by far the most important reason was that, by the end of the 1960s and into the early 1970s, stocks had simply become excessively valued.

Even if the Dow Jones Industrial Average managed to make a new all-time high sometime this year (a new high is less likely for the S&P 500 and practically impossible for the Nasdaq), such a new high may only be a temporary phenomenon, in the same way that the 1973 high wasn’t exceeded by the Dow until 1982.

In other words, if indeed the recession is over, as most market observers seem to suggest, the stock market may very well remain for some time in a volatile trading range amidst stock valuations that are still very demanding. Neither an expanding economy nor rising corporate profits guarantee strong stock market performances. The Dow made a high at 985 in 1968 – ahead of the 1969-1970 bear market – when the Dow Jones earnings per share were $57.89. By 1979, the Dow Jones EPS had risen to $124.45, yet the Dow’s high in 1979 was only 898!

Having said all that, I have serious doubts about the widely talked-about economic recovery. After all, it’s quite common that after an initial contraction in GDP, a recovery follows for a quarter or two before the economy slumps once again.

In December, I showed how optimistic economists, investors, and especially politicians remained after the 1929 stock market crash. They all felt that the crash would have little or no impact on the economy and they continued to forecast an imminent economic recovery in the 1957, 1960, 1969-1970, 1973-1974, and 1980-1982 recessions. In all these recessions GDP contracted, then expanded after the initial phase of contraction, but again fell thereafter.

It is interesting to look at the stock market performance during these double- or multiple-dip recessions. In 1957, the stock market bottomed out in October, whereas the trough of the recession was in April 1958. In 1960, the market bottomed out in October, while the economy began to recover in February 1961. In 1970, the market reached its low in May, whereas the economy bottomed out in November. In 1974, the market made a low in December and the economy reached a trough in March 1975. In 1982, the market’s low occurred in August, three months before the economy began to recover in November.

With the exception of 1970, the best time to buy equities was at the time of the second or third dip in GDP. This is certainly something to keep in mind for those investors who, like me, believe that the current recovery phase in the economy will be followed by renewed and more prolonged weakness. The question that we have to address here is, of course, from which sectors renewed weakness in the economy should be expected.

As we all know, the slowdown or recession has been concentrated so far in the manufacturing sector and was largely brought about by the negative effect of the acceleration principle in the capital goods sector. At the same time, consumption and the housing sector have stayed relatively buoyant.

What has really happened so far in the major economies around the world is that consumers have responded to the decline in interest rates by maintaining their consumption at a high level. Largely financed by foreign investors, consumers also maintain this consumption level through additional borrowings. Meanwhile, the corporate sector has reduced production because of the decline in capital spending in the IT sector, competition from emerging economies such as China, and in order to lower inventories. Thus, the recent rebound in manufacturing shouldn’t come as any surprise, but the question arises… is the rebound sustainable?

I have pointed out that consumers responded strongly to the decline in interest rates last year. In particular, declining interest rates fuelled the housing refinancing boom and allowed consumers to take out equity from their homes in order to boost their spending on consumer goods.

But interest rates aren’t declining any further and, judging by the recent behaviour of commodity prices and the poor bond market performance, we may very well see interest rates moving quite a lot higher in the near future.

It is worth considering what foreigners who have bought a record amount of U.S. bonds in the last two years would do if the American inflation rate began to accelerate and, as a consequence, interest rates were to rise by more than is expected. At the very least, under these conditions, foreigners would show less willingness to buy U.S.-fixed interest securities!

Don’t forget that in the 1970s we had rising interest rates in the U.S. and a decline in the value of the dollar. With respect to commodities, I should only like to mention that, so far this year, the Goldman Sachs Commodity Index as well as the CRB Commodity Index have risen by more than the S&P 500!

In my opinion, with or without an economic recovery, prices of commodities will rise. If the global economy indeed recovers, demand for all commodities will increase and will lead to higher prices – particularly for industrial commodities such as copper, cotton, crude oil, lumber, rubber (currently very depressed) and palm oil.


Marc Faber,
for The Daily Reckoning
March 27, 2002

P.S. The “economic recovery” could be played with the purchase of a basket of commodities or companies that are commodity-related and, ideally, located in countries which-like Russia, Indonesia, Malaysia, and Brazil-are sensitive to rising commodity prices. Moreover, I still recommend overweighting the stock markets of Asia, which are like a warrant on the global economy, but which-thanks to their relatively low valuation-have less risk than the U.S. stock market.

Dr. Marc Faber is the editor of The Gloom, Boom and Doom Report and a major contributor to Strategic Investment. Dr. Faber has been headquartered in Hong Kong for nearly 20 years, during which time he has specialized in Asian markets and advised major clients seeking down-and-out bargains with deep hidden value and immense upside potential. Dr. Faber was named earlier this year as a member of Barron’s Roundtable.



We regret to inform you, dear readers, that Bill will not be able to report for editorial duty today; while in Madrid, he was targeted by a craven retaliation campaign. It appears the zealots of the so-called “New Economy” are exacting their revenge on our valiant editor. Reports are sketchy, but we can tell you that, in an effort to do some daily reckoning with his readers, Bill made an attempt to connect his laptop to the Internet. Unfortunately, the effort was all for naught; Bill’s computer crashed badly. Early evidence recovered from the digital rubble of zeros and ones suggests that disciples of the “New Economy” are attempting to sabotage the editor who has warned you time and again, dear readers, to guard against their specious claims that Information Age technology is changing fundamental economic principles – and that it is a panacea for lagging productivity, sunburn, and upset stomachs.

Bill has sent word via homing pigeon to assure us that the Daily Reckoning will prevail.

Addison is currently in Australia forming a coalition and is expected to launch an investigation to determine whether a spiteful band of patsies is also involved in this cowardly reprisal.

This is Stuart Crampton, by the way, letting you know that Bill will make his triumphant return tomorrow. But since I’m home alone today, let’s go directly to Eric’s notes…


Eric Fry on Wall Street…

– And the Oscar for best “bull-market performance” by a bear market goes to… the Dow Jones Industrial Average, for its masterful rendition of a bull market from September 2001 to March 2002.

– Aspiring thespians take note; you might be able to learn a thing or two from the master. The Dow does not merely ACT like a bull market; he makes the audience genuinely believe that he IS a bull market!

– Yesterday for example, he sprinted ahead in response to the rousing consumer confidence report, just like a real bull market might do. By the time the final curtain fell, the Dow had advanced 71 points to reach 10,353, while the Nasdaq had gained half a percent to 1,824.

– Consumer confidence continues to grow by leaps and bounds. Indeed, it knows no bounds. The Conference Board’s Consumer Confidence Index surged to 110.2 in March from 95.0 in February. The Present Situation Index and the Expectations Index both soared a similar amount.

– “The latest gains are striking,” gushed Lynn Franco, Director of The Conference Board’s Consumer Research Center. “The jump in the Present Situation Index is the largest gain experienced in 25 years, while the Expectations Index has not risen this sharply in nearly a decade. This new boom in confidence should translate into increased consumer spending and stronger economic growth ahead.”

– Indeed, a confident consumer is a free-spending consumer, or so the theory goes. But why then are so many companies reporting such abysmal profitability? Or, to rephrase the question, why do so many companies talk about slashing payrolls and reining in expenses, rather than about gearing up for rebounding sales?

– Layoffs and cost-cutting continue to be the focus. Alas, as every CEO will admit, ’tis a pity that so many people must lose their jobs when times are tough. Even so, eliminating other peoples’ jobs is a sacrifice that most corporate chieftains are willing to make to ensure that their outrageous compensation packages remain intact.

– “One day last month,” the Wall Street Journal reports, “lobbyists from 30 of the nation’s biggest companies met in a conference room here [in Washington D.C.] at the offices of software giant Oracle Corp. Another 30 joined in via speakerphone… they were united in a common cause: saving stock options…

– “Their opponents [a group to which I proudly pledge allegiance] say stock options have bred a culture of irresponsible greed, showering executives with outlandish paydays that sometimes reach into the tens and hundreds of millions of dollars.” Amen!

– It’s little wonder why Oracle played host to this little get-together. The Journal reports that Oracle Chief Executive Larry Ellison reaped $706 million last year from exercising stock options. Not too shabby for a bear market.

– The corporate executive stock-option game has always been a farce, perpetrated under the ruse of “advancing shareholder value.” But now it has become a charade – a farcical charade.

– “According to a recent report by Smithers & Company,” notes Gretchen Morgenson of the New York Times, “the value of options granted at the 325 largest companies in United States equaled almost 20 percent of their pretax profits in 2000, the latest year for which data is [sic] available.”

– Oftentimes, the corporate pay packages are even more outrageous and costly, as I discovered three years ago while researching a story about Staples Inc. for Grant’s Interest Rate Observer. Jim Grant described my discovery as follows: “Last year, Thomas Stemberg, the Staples chairman and CEO, took down $63.1 million by exercising stock options on top of a fiscal 1998 pay package in the sum of $21.7 million. At $84.8 million, the chairman’s total compensation was equivalent to 35% of corporate net income (even his two-year pay was equivalent to 22% of two-year corporate net income). Furthermore, year- over-year growth in the boss’s earnings, $76.3 million, was greater than year-over-year growth in the company’s earnings, $67 million. At least, the shareholders won’t have to worry about the CEO worrying about money, or squandering his day on the Web shopping for the best deal on a 30-year mortgage.”

– As disgusting as Stemberg’s epic feat of avarice seemed at the time, it was mere child’s play compared to the Herculean acts of greed that would occur shortly thereafter, during the bubble years.

– “Few can top Gary Winnick, the founder and chairman of Global Crossing,” writes the New York Times. “Since 1998, he has sold Global Crossing stock worth $734 million and bought a $92 million estate in the Bel-Air section of Los Angeles. Even as the company struggles through a bankruptcy filing, major construction work is going on at his property.”

– Unfortunately, Winnick is not entirely unique. The Times continues: “Philip F. Anschutz, the co-chairman of Qwest Communications, who made millions in railroads, communications and oil and more recently sold $1.97 billion of Qwest shares – continues to live very well. He is a major collector of 19th- and 20th-century paintings of the American West and has a 30,000 acre ranch in Kersey, Colorado.”

Ahhh… the spoils of bankruptcy!

– Maybe Warren Buffett had Winnick and Anschutz in mind when he remarked in his latest letter to shareholders, “Charlie [Munger] and I are disgusted by the situation, so common in the last few years, in which shareholders have suffered billions in losses while the CEOs, promoters, and other higher-ups who fathered these disasters have walked away with extraordinary wealth.”

– On the other hand, if the chairman of a public company is selling $1 billion worth of his own company’s stock and buying 30,000-acre ranches in Colorado, you probably don’t want to be buying the stock that he is selling. It pays to pay attention to what the insiders are doing.

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