No Time to be Swayed
Dr. Martin Weiss explains why Argentina’s default is but a sneak preview of debt crises around the globe and why Enron-like time bombs still await U.S. investors in 2002.
By the time Enron went belly-up late last year, its stock price had cratered from $90 to 26 cents a share. Over $66 billion in capital – and almost every single penny invested by 58,920 investors – was wiped out.
It was the largest bankruptcy in US history.
When Argentina announced in the last days of 2001 that it was officially defaulting on its $155 billion in debts, it devastated the assets of hundreds of banks and tens of thousands of investors around the world.
It was the largest debt default in the history of the world.
Now, despite all this, Wall Street is telling you that "a recovery is around the corner" – that it’s once again time to spend with passion…or buy with lust.
They’re lying through their teeth.
I just returned from South America, where I had a ringside seat to the collapse of Argentina. Larry’s just back from Asia. Our staff has been scrutinizing the balance sheets of thousands of other corporations at high risk of failure.
I can tell you flatly: This is going to be a global disaster. The flood of bankruptcies and defaults has barely begun.
And the stock market rally is just another hot-air balloon – hype from Wall Street and spin from Washington.
For example, they’re telling you Enron’s collapse is unique. Baloney! Bethlehem Steel, Phar-Mor, Polaroid, and 352 other publicly traded companies also went belly up last year. This year, companies at high risk include Ford, JDS Uniphase, Kmart, Xerox, plus 1,381 others.
They’re telling you "the profit picture isn’t all that bad." Oh, really? Then why did JDS Uniphase announce the largest loss in U.S. history last year? Why did AOL just announce write-offs that will smash the JDS record?
They’re trying to get you to believe that Argentina’s collapse is "isolated." I’d prefer to believe in Santa Claus and the tooth fairy. The reality: FleetFinancial, J.P. Morgan Chase, Bank of America, and a batch of European banks are taking big hits from Argentina’s default.
At the same time, Avon, Colgate-Palmolive, Gillette, and hundreds of other companies with business in Argentina are taking big hits from Argentina’s devaluation.
But that’s just the beginning. Brazil’s debt is over twice as large as Argentina’s. Colombia’s is $38 billion with unemployment close to 17%. Venezuela suffers from the same kind of overvalued currency, the same kind of recession, and the same potential for an explosive public uprising.
Japan, Indonesia, Thailand, Hong Kong, Singapore, and the Philippines are sinking fast. Europe’s a mess. All suffer from ailments that are similar to Argentina’s.
In fact, the collapse of Argentina is far worse than anyone dreamed possible. Even in the "worst-case scenario," those with big stakes in Argentina were expecting either a default or devaluation. Now they’re being slammed with both at the same time.
This puts the bigwigs at the IMF between a rock and a hard place.
If they continue to hold back aid for Argentina, they will be blamed for looting, rioting, and even a violent public uprising, potentially causing thousands of deaths.
But if they dish out more money, a half dozen other indebted nations will be tempted to default and devalue, just as Argentina did.
How did it happen? Peel off the multiple layers of financial mumbo-jumbo, and you will see the two key forces that drove Argentina into its hellish nightmare: Debt! And deflation!
Then look back at my writings, and you will see that these are the very same explosive ingredients I’ve been warning you about – not just for countries like Argentina, but also for Asia, Europe, and the U.S.
Debt is dangerous. Deflation is worse – it destroys the ability of borrowers to pay back the debts. Throw the two into the same pot, and the resulting explosion can blow up the "strongest" economies, sabotage the most "astute" central bankers, and destroy the wealth of the "smartest" investors.
This is exactly what happened in Argentina.
This is also very similar to what will happen throughout the globe for the simple, irrefutable reason that many other key countries are prone to the very same twin ailments that destroyed Argentina: Debt and deflation!
Japan is the classic, paramount example, with one, huge difference: Investors can try to ignore Argentina. They cannot ignore Japan.
Japan was the technological leader of the late 20th century. It is the world’s second largest economy, the engine of growth for all of Asia, and the largest investor in America. When Japan collapses, there is no force on Earth that can hold up America or Europe.
And Japan is collapsing – right now – even as I write you these words. Why? Because of…debt and deflation!
Japan’s DEBTS are staggering – $7.5 trillion or 2.4 times their GDP, making Japan the most indebted industrial country relative to its size in the world, ever. Of that total, $4.3 trillion is owed by the government, 1.3 times GDP, also the worst in the world. Most dangerous of all: $1.5 trillion of the debts are held by Japan’s broken banking system, burning a hole in their vaults like a nuclear meltdown.
Japan’s DEFLATION couldn’t come at a worse time – consumer prices down virtually nonstop for the last 24 months…bankruptcies surging to 1,800 per month, the worst in 17 years…unemployment the highest in 55 years…the economy crushed.
No, Japan is not Argentina. You won’t see looters ransacking supermarkets or rioters burning furniture in Parliament. But Japan is going under just the same, in its own way, with a far more devastating impact worldwide than the collapse of a hundred Argentinas.
The first to fall in Japan’s wake will be the Southeast Asian economies – Hong Kong, which like Argentina, has pegged the value of its currency to the U.S. dollar… Thailand, where bad loans have soared to a record 30% of loans outstanding…Indonesia, South Korea, and the Philippines.
Europe is in the same boat. For every dollar of GDP, the 12 nations of the European Union have piled up $1.82 in public and private debt! Corporate profits are sinking. Industrial production has fallen 4.1% in a year. Unemployment in the Eurozone is 8.4%, headed for double digits.
Nearly every nation is on the verge of a debt-and-deflation blowup, threatening to drive its economy into the gutter and its stock prices into the toilet. As a result:
* U.S. banks and investors will be slapped down or even wiped out.
* U.S.-based multinationals will get killed, their exports gutted, their foreign subsidiaries in shambles.
* Worst of all, foreign investors, who now own a whopping $10 trillion in U.S. assets, will have no choice but to begin dumping their holdings at any price.
Don’t underestimate this. Earnings are the most powerful force driving the stock market. And right now, the stock market has recovered…but earnings have not!
In the second quarter of 2000, pre-tax corporate profits of non-financial firms reached a peak of $577.6 billion. Fifteen months later, in the third quarter of 2001, they had plunged 26% to $414.8 billion – the sharpest decline since the Great Depression. And despite tall promises, there is NO concrete sign of improvement.
Profits always sink in a recession. That’s normal. But what we’re going through today is far beyond the normal boundaries of any recession in my lifetime.
Indeed, the TOTAL results for ALL of the 4,000-plus companies on the Nasdaq was red ink last year. And that red ink was so huge, it wiped out every dime of profits the Nasdaq-listed companies made in the six years prior.
Sure, you may see some hints of improvement here and there as companies bounce back from the initial shock of September 11. But, fundamentally, the earnings picture isn’t getting better for one simple reason: Deflation.
Because of deflation, companies have lost their ability to maintain their product pricing. So for a rapidly increasing number of companies, profit margins are toast.
One of the most common comments I hear from Wall Street is about the "big September bottom" – the idea that the levels of mid-September last year are the lowest we’ve see in many years.
If you look at the market valuations of previous market lows compared to last September’s, you’ll see just how cockeyed that concept really is.
In the previous 17 bear markets (going as far back as 1929!), the shares were selling at an average of 13.8 times earnings. That’s relatively cheap. And that gives you an idea of what it takes to make a real bottom.
That was NOT, however, what we saw in September of last year – not even close. Instead of 13.8 times earnings, the market was selling at 21 times earnings! Conclusion: It was not the bottom.
The real bottom is yet to come, and it’s going to be FAR deeper.
for The Daily Reckoning
January 23, 2002
p.s. This is no time to be swayed by still more of the same Wall Street hype. But it’s also not the time to hide in a corner. You have a unique, once-in-a-century opportunity to harness the power of a great bear market to your distinct advantage.
Martin D. Weiss, Ph.D., the nation’s leading advocate for financial safety, has helped millions of Americans with his ratings of stocks, mutual funds, insurance companies, banks, brokerage firms and HMOs. Martin has testified repeatedly before Congress, advocating full disclosure of risk to investors.
The Wall Street Journal says Weiss runs a "feisty firm," and Esquire noted that his is "the only company…that provides financial grades free of any possible conflict of interest." Forbes calls Dr. Weiss "Mr. Independence."
Well, that’s it. We can all pack up shop and go home. There’s no need for anymore reckoning. Amazon finally turned a profit.
I guess the New Economy is real, after all. Every day, every thing in every way will get better and better for ever and ever, amen. It must be true; everybody says so.
But wait, what’s this…? Even after getting bashed down 90%, Amazon’s stock is still selling as though the company were worth $3.7 billion. That’s a lot of money for a company that just produced its first profit – a penny a share – ever.
And that was just for the quarter. Over the year, the big River of No Returns recorded a net loss of $567.2 million. And for next year, things don’t look that much better. The company says it will most likely lose money in the first quarter of this year.
Investors must be as brain-damaged as consumers. They’re paying $12 per share for a company that has never made a profit and is now growing sales at a modest 15% annual rate.
"In what kind of recession do investors do such things?," we ask ourselves.
"In one that hasn’t happened yet," comes the answer.
The financial press saw nothing not to like in the Amazon report. "I’ve always known this business model worked," said Jeff Bezos, quoted by an Associated Press reporter. "We were very, very focused on it."
"The results were helped by lowered prices and company wide penny-pinching," continued the AP story.
But, what’s this…? Penny-pinching may have helped…but it was from another currency that the juice really flowed.
Would you believe it, dear reader? Bezos must be a regular follower of the Daily Reckoning. Amazon raised so much money when the going was good that it still has about $1 billion in cash. Its financial report shows that it invested much of the money in a "euro-denominated debt security" from which it earned $16 million. This was in the same quarter in which the company reported total net earnings of $5 million. So, what really happened was that the company must have lost $11 million from its business.
Hey, a euro’s a euro, as they say over here. Who cares where it comes from? But investors might someday notice that if they want income from their investments in euros there’s a more efficient way than buying Amazon shares.
Eric…what’s the news from the Street?
Eric Fry in the City That Never Sleeps…
– Amazon finally did it! The pioneering online bookseller turned a profit, and not just one of those "pro forma" jobs, but an honest-to-goodness profit based on generally accepted accounting principles! In the company’s latest quarter, it earned one entire penny per share, and the stock skyrocketed 24% on the news.
– But this spectacular profit performance was not enough to lift the rest of the stock market out its funk. The Dow dropped another 58 points to 9,713.80, while the Nasdaq tumbled 2.5%, to 1,882.53…Nasdaq 2,000 seems very distant now…and a third consecutive losing year in the stock market seems very near, even though there are more than 11 months left to go.
– And hey, if only a few more companies could report earnings of just one cent per share, the Nasdaq might reverse course and return to 5,000 in no time.
– While Amazon shareholders broke out the champagne, the shareholders of another big-name retailer broke out the handkerchiefs. After 39 years in the "big-box" retailing business, Kmart filed for bankruptcy protection. The retailer’s story is a familiar one: too much debt and not enough profit. Kmart is the second S&P 500 member this year to declare bankruptcy – the first one being Enron.
– Although few American corporations are so financially impaired that they are teetering on bankruptcy, many are carrying debt burdens that are sizeable enough to cause them to slash their capital spending budgets…But don’t tell that to the V-recovery crowd.
– In America’s nationwide "Debt Derby," corporations are running neck and neck with consumers. Moody’s points out that the amount of corporate bonds outstanding totals well more than three times annual corporate profits. By comparison, throughout most of the 1990s, corporate bonds totaled only about two times annual profits.
– Even more worrisome, while corporate indebtedness has been increasing, overall credit quality has been decreasing.
– "In 2001, downgrades outnumbered upgrades for a fourth consecutive year and by the widest margin since 1991," Moody’s reports. The ratings agency downgraded almost $1 trillion in debt in 2001 – a record total.
– Municipal credit-worthiness is also in a downtrend. "Weaker tax revenues will prompt state and local governments to increase debt even if borrowing costs increase over the next year," Moody’s cautions.
– Even the Federal government is getting in on the act, as its budget surpluses slip into deficits.
– These onerous debt levels throughout the economy lead money manager Donald Smith to conclude, "I’m not so sure that this recovery is going to be nearly as fast or sustainable as the consensus believes. I certainly don’t think it will flow down to corporate profits enough to justify the current S&P price."
– "In an economy as leveraged as ours," said Smith in a recent interview with Kate Welling, "you can’t prime the pump every time there’s some international crisis, and just keep the thing going. You need time, or slow periods, or recessions to correct the imbalances, and we really haven’t had that. Which is why the excesses, particularly in asset valuations, got to such extremes."
– Welling countered, "Greenspan’s supporters argue that he spared us from unnecessary pain and stress to the system."
– "I understand," Smith replied, "but meanwhile, the leverage in every cycle gets higher and the system gets more dangerous."
– Dr. Kurt Richebacher agrees, "Many observers regard this rampant credit expansion as Mr. Greenspan’s great success." But it is a strange kind of success, Richebacher argues, because "corporate indebtedness has soared out of all proportion to the profit-earning, productive capital stock."
– In his January newsletter, Kurt Richebacher cited an 1844 quote from the British philosopher and economist, John Stuart Mill. The quote is amazingly apropos 158 years later:
– "The usual effect of the attempts of government to encourage consumption, is merely to prevent saving; that is, to promote unproductive consumption at the expense of reproductive, and diminish the national wealth by the very means which were intended to create it. What a country wants to make it richer is never consumption, but production. Where there is the latter, we may be sure that there is no want of the former."
– Amazon’s penny a share is probably not the kind of "production" John Stuart Mill had in mind.
Back in the City of Light…
*** The papers are full of absurdities, the worst kind of absurdities – those that have no profit built into them.
*** The European press is outraged over the treatment of prisoners at Guantanamo. It is inhumane, they say. We don’t know. But, from the photos, it appears absurd. In the photo, prisoners are trussed up with handcuffs, gloves, goggles, ear plugs, and respirators. The army must be trying to drive them mad.
*** It is beyond our beat to comment on politics, but we worry that the prisoners will turn out to be another irritant…making foreigners less inclined to support things American – its dollar, its trade deficit, its stocks and bonds. They are not prisoners of war, says Donald Rumsfeld. Then, what are they? What crime have they committed? Asked Tuesday, Rumsfeld did not seem to know.
*** Of course, the world’s only superpower…can do what it wants. But the U.S. is also the world’s biggest debtor, with a trade deficit that is headed toward half a trillion dollars per year. Whatever the marvels of its tanks and aircraft, they fade beside the wonders of its paper assets, especially its dollar. Foreigners may quake before the armed might of America…but, so far, no one has to hold a gun to their heads to get them to take dollars. Some day, we continue to predict, that will change. Foreigners will decide that possibly, perhaps, just maybe they have one or two dollar-assets they don’t really need. At that point, dear reader, the US will be at the mercy of the rest of the world…not the other way around.
*** Meanwhile, on the editorial page – where absurdities shout at one another like young Marxists in a coffee house – Michael Ardon, a professor of chemistry at Hebrew University, has a solution to a problem.
*** The problem is absurd: the fact that some people in the world are rich and others are poor. "If the gap between the two worlds is not narrowed," he writes, as if he knew something, "the poor countries will continue to breed forces that endangers the very existence of our civilization!" (I took the liberty of adding the exclamation point. Such a preposterously large and empty sentence seemed to need a little something at the end.) But the chemist is up to the challenge – he’s found a solution every bit as absurd. He proposes to "set a global minimum wage."
"Compliance with such a minimum wage might be achieved by a ban on imports from countries that fail to adopt it," he says. Then again, it might not.
*** Doctors, nurses and other health workers are on strike in France today. In analyzing mortality statistics from previous doctor strikes in other countries, a curious phenomenon emerges. When the doctors walk out, death rates go down. Alas, the doctors say they will return to work tomorrow.