"The first thing to get straight is that this was – and still is – the most outrageous bubble economy in history, far worse than the U.S. bubble of the 1920s and Japan’s bubble of the 1980s."
– Dr. Kurt Richebacher
"What have you written in the last 2 years?" we asked the French analyst mentioned above. The last article we saw from him was dated March, 2000.
"Nothing," came the reply. "I only write when I have something to say."
Daily Reckoning readers may sigh.
"We write every day – whether we have anything to say or not," we explained.
But the trouble is, we never know if we have something to say or not until we’ve said it. In that spirit of adventure and discovery, we take up our laptop this morning.
You are warned, dear reader. We head out this morning with neither map nor compass…and will be as surprised as you are by where we end up.
First, we look around and notice that we have managed to stay well ahead of the crowd this past six months. We almost always march at some distance from the crowd; occasionally, we find ourselves in front of it.
"Our guess," written at the beginning of the year, was that "Mr. Market will decide to punish Americans’ super- confidence."
This he has begun to do. After 475 basis-point cuts, Americans are no longer quite so sure that Greenspan has the economy under control. Nor are they quite so confident that the American business model will forever be the envy of the world. Nor are they as ready to believe that a strong recovery – in both stocks and the economy – is coming in the next quarter.
Now, with the crowd headed in our direction, we look for open ground. "Don’t Bet Against America," says Barton Biggs. "Never underestimate the resilience of the American economy," say economists and investors all over the world. The particulars have proved disappointments. There was no economic miracle after all…no New Era…no technological utopia. The business cycle is still with us, and so is human greed and error.
What remains is an inchoate feeling that this great American economy – with all its innovators, risk takers, empire builders, and flexibility – won’t disappoint us.
But who ever underestimated the American economy, we wonder? Au contraire, it seems to have been over- estimated in every detail and by every measure. What economist imagined that it would produce fewer new jobs in the 21st century than it did at the end of the 20th? Who thought corporations would earn less money in 2002 than they did in 1997? What pension fund forecast was based on negative stock market growth for the last 3 years?
And even now that the Dow is down 24% from its peak, how many investors underestimate its prospects for the future? Almost none. Instead, surveys show that investors think these last three years have been the work of the some temporary devil…a brief interruption in the normal march of financial progress. Their estimates for the next few years have never been higher. And although unemployment levels have reached a 19-year high, what consumer worries that he will not be able to find a job in the American economy of 2003? Hardly a single one.
A man’s tendency is to think better of himself than he deserves. The latest figures from Dr. Kurt Richebacher show just how high Americans’ estimates of their extraordinary economic strength have become.
"For the fourth quarter of 2001," he writes, "the national income accounts show personal savings of $27.9 billion and business savings (undistributed profits) at -$3.5 billion, both at an annual rate. Aggregate net private savings thus amounted to $24.4 billion. This is virtually zero, compared to a total of about $473 billion in 1997."
Five years ago, private savings were 5.8% of GDP. Today, they are at less than 1%. If people save for a rainy day, based on current savings rates, they must think it will never rain again.
While Americans stopped saving, they continued spending at an even faster pace. "Private consumption grew at an average of 5.1% a year from 1997 through 2001," writes Richebacher, "far faster than the 3.1% average annual increase of GDP."
Not everyone’s estimates are so optimistic. Businesses, trying to figure out how they’re going to pay their debts and make a profit, see precipitation in the forecast. In contrast to individuals, businesses have become reticent about borrowing, hiring, and spending.
"Total business borrowing edged up in the first quarter at an annualized rate of $127.4 billion versus increases of almost $600 billion in 1999 and 2000, " Dr. Richebacher elaborates. "Corporate debt growth, meanwhile, fell even more sharply. After averaging annual increases of about $400 billion during 1998-2000, it increased at an annual rate of just $12.6 billion in the first quarter."
Who underestimated the fall-off in business investment? Who underestimates it now?
Who imagines that this marvelous economy – the strongest, most flexible and dynamic in the whole ding- dong world – might completely fail, just as Japan’s miracle economy of the 1980s fell apart in the 1990s? Who believes the U.S. economy is not underestimated, but still greatly overestimated?
Your editor, signing off until next week…
July 12, 2002
P.S. Daily Reckoning readers are surely better off than most investors. "Stocks will fall," we said, forgetting to hedge our bets. But stocks did fall. Investors who had the good sense to panic out of equities in January spared themselves a 12% loss on the Dow…and much more if they were holding the most popular stocks.
Doing nothing, as we advised, has been about the best thing you could do. Cash – what you end up with when you do nothing with your money – is at least even. And euro- cash, which we also advised, is ahead by 8% against the dollar.
Cash is the one thing most people don’t have. They have stocks. They have houses, with mortgages. They have SUVs and big screen TVs. They have bills. What they lack is cash.
Mr. Market favors what people most need, we notice. People with a lot of debt and a little savings need cash. As the months go by, we suspect Americans will come to appreciate what cash they have and wish they had more.
Looking back over our recommendations and predictions made in January, we find we were wrong on only one point. Consumer prices, we thought, would begin to head down in 2002. So far, they have not. But, the year is not over. Neither is the bear market.
Only 39 stocks hit new highs yesterday; 326 hit new lows. It is a bear market, after all. "The worst bear market since ’73-’74," says a headline. Stocks fell 48% in that period. By comparison, the S&P 500 is off 39% in the last 27 months.
The Dow, however, has only lost 24% of its value since its peak. But most people don’t own the Dow. They own a few popular stocks, like AOL, AT&T and Lucent – all down about 60%. Or IBM, down 43%. Or Intel, – 46%.
Oh la la, dear reader, don’t look! It’s not pretty.
"Ah, but people underestimate the resiliency of the U.S. economy," said a French analyst yesterday. "When I wrote that the techs were headed for a crash in 2000, people thought I was crazy," he continued. "But now I think we’re getting down to some decent values. While everyone else is turning pessimist, I am becoming more and more hopeful."
"We’re overdoing it on the downside," added economist Hugh Johnson, to CNBC.
And there’s the old bear, Barton Biggs, whom Eric quotes below, reminding us not to bet against America.
For the whole world has come to know what only we seemed to know a few months ago – that stocks go down as well as up. Forbes, Barron’s, even the International Herald Tribune have told their readers. Day by day, more investors catch on; stocks may not be the easy road to riches they once thought.
"Forget about the market hitting its old highs," said Hugh Johnson. "We just want to know when the pain will end."
When will the pain end?
A few years ago, people thought stocks were a guaranteed way to get rich. Now, they’re beginning to wonder. And now, smart bears are beginning to wonder, too…is it time to move to the buy side – ahead of the crowd?
Yet, while the thinking world comes to realize that stocks can go down for long periods of time, that still leaves the great number of people who never think at all – a majority big enough to elect a president, make a mindless TV show a major hit, or run up stocks in another bear market rally.
There are people, we remind ourselves with a shudder, who like Barbara Streisand’s singing and can’t wait to see Tom Cruise in a new movie.
When will the pain end? It will end when people stop asking…when they come to believe that owning stocks is always painful…and that the U.S. economy is less resilient than people thought. N’est-ce pas, Eric?
Eric Fry on Wall Street…
– The weather in Manhattan was glorious yesterday. As I was walking to work, I thought to myself that it was much too nice a day for a bear market…much too nice a day to destroy more of America’s savings.
– Apparently, Mr. Market agreed. The Dow rebounded from a harrowing 200-point drop in the morning to finish the session with a modest 12-point loss at 8,802. The Nasdaq also recovered from early morning losses to gain 2% to 1,374. The dollar, however, continued to slide – falling for the fourth straight day to 98.88 cents per euro. Gold gained $2.40 to $317.50 per ounce.
– The rumored spark for the stock market’s mid-day rally was a bullish missive by Barton Biggs, the perennially bearish strategist from Morgan Stanley. Barton’s remarks, patriotically entitled, "Don’t Bet Against America," gushed with bullish enthusiasm for stocks… especially American stocks.
– "In the long run there is no investment medium like equities," Barton proclaimed. "Never has been; never will be…Equities are wealth creators. Investors know that to get rich, you want to be an owner, not a creditor."
– Barton is correct of course, thanks to the qualifying line: "In the long run." Unfortunately, over the "short run" known as a bear market, few assets can compete with the wealth-destroying power of equities. But thankfully, time heals all wounds, including the self-inflicted wound of overpaying for common stocks. Over some number of years or decades, all but the very worst of stock purchases will produce at least a break-even result.
– While Biggs is often provocative, he is almost never bullish. Did somebody kidnap him, lock him in a closet and write a mega-bullish essay in his name?…At this point, investors don’t seem to care. Anything that helps to stop the bleeding is fine by them. If a bullish essay from a bearish analyst can do the trick, so be it.
– We have only one thing to add to Biggs’ remarks: "Go stocks! Go!…RAH!…RAH!…RAH!"
– Even though the Nasdaq has collapsed more than 70% from its peak bubble valuation, a few vestiges of the bubble years remain. One of the holdovers is the corporate dress code known as "casual summer," which grew out of the bubble-era phenomenon known as "Casual Friday" – that’s the day all the 20-something investment bankers would show up for work wearing khakis and a golf shirt.
– For a few years, Casual Fridays satisfied the urge to "dress down." But eventually, the formal-Monday-through- Thursday routine started to feel a little onerous as well, especially during the steamy Manhattan summers. Thus, the casual summer came into being. During July and August, every day of the week would be casual Friday.
– The stock market was booming, so who cared?…Wear a suit…Don’t wear a suit…Or just wear a swimsuit…No one cared. Stocks were going up, everyone was going to retire in a year and nothing else mattered. But then the bull market ended. Inexplicably, the nonchalant dress code did not.
– I wear a suit and tie to work, mostly because I share an office with Jim Grant, who wears a suit and tie to work. (In fact, Jim might wear a suit and tie to bed). In any event, we value-investors down here in Lower Manhattan are traditionalists. During the peak of the casual Friday craze (sometime in early 2000) a hedge- fund manager I know asked Jim why he wears a tie to work. Jim answered, only partly in jest, "Out of respect for the written word."
– I recalled Jim’s remark yesterday as I was riding to work in a commuter train with about 100 Wall Street types dressed in their pajamas, and I thought to myself, "Maybe this is the problem! Perhaps this casual summer thing is why stocks don’t rally!…Maybe Mr. Market is annoyed that he gets no respect!" Shouldn’t a business engagement with Mr. Market require a coat and tie, at the very least?"
– If Wall Street really wants the bear market to end, maybe its employees should resume dressing for success. Of course, there is an alternate possibility…Maybe the bear market will not end until stocks become cheap enough to attract buyers.
– Barton Biggs is probably on track to suggest that values are starting to appear in some remote corners of the stock market. Even so, we aren’t prepared to buy into the "new bull market" just yet…other than for a trade.
Back in Paris….
*** What does Charles Allmon see coming? The Chicago Times interviewed the 82-year-old value investor recently: "More of the same," he said. "There’s something big out there we haven’t seen in 70 years, and I’m talking about trust. It’s gonna take a long time to get people to regain their trust in corporate America."
*** What should investors be doing?
"There’s a dirty four-letter word spelled "c-a-s-h" – and nobody wanted it six or eight months ago. Now they’re changing their tune. I think long-term investors should be holding at least 75 percent in cash."
*** And with the remaining 25 percent of their portfolio?
"All stocks don’t go up and down together so there are some buys. I have a few recommendations: Bristol Myers (yielding over 4 percent) and Philip Morris (a 5 percent yield). BMY has paid dividends since 1902, and at its very low debt-to-equity ratio (17 percent) the company is certainly not going to blow away. But overall, this stock market is still very expensive. So even 40l(k) investors should consider putting part of their contribution in the money market alternative."
*** When will the pain finally end?
"When they lay off half the stockbrokers."
*** Maria, Jules and I went to see the latest Schwarzenegger movie last night, Collateral Damage. "It was ridiculous," was Maria’s verdict. "I laughed at half the scenes that were supposed to be serious."
*** Jules and I enjoyed it, though. Give us a simple- minded action flick, a big box of popcorn, and we are happy. We also appreciated the ambiguous way Schwarzenegger handled the terrorism theme, avoiding the patriotic claptrap that might have easily ruined the film. Both terrorists and the anti-terrorists in the CIA are portrayed as accurately as you could hope for in an action-flick – as malign fools.
*** Dressing down has never caught on in the Paris headquarters of the Daily Reckoning. Looking out his office window, your editor, wearing a tie of course, sees American tourists who have dressed down so low they risk slipping into storm drains.