Yesterday, I permitted myself to imagine that I might be right. That is, it really is a bubble, not a new era. And like all bubbles, it must somehow deflate.
So the question on the table was — how?
The optimistic view is that even if it is a bubble, Alan Greenspan has it in hand. He will engineer a “soft landing” by carefully manipulating the various levers and knobs in front of him. Yes, there may be a correction in the markets, but the underlying economy can remain strong…and soon, after the shakeout, stocks will resume their upward advance.
This view is supported by the work of Milton Friedman and his wife, Anna Schwartz, whose landmark book of the 1960s argued that the pain of the ’29 crash and Great Depression was not inevitable. The severe economic contraction could have been avoided, they say, had the levers been operated differently.
The action to which he refers is a pumping action…working the lever up and down so that sufficient cash flows from the nozzle offset the withering effect of collapsing stock prices.
Some $85 billion disappeared from the equity markets of late ’29 and the early `30s. Plus, the money supply contracted 42%. In Friedman’s mind, this latter detail is the decisive point. He believes the Fed could have pumped more vigorously and avoided the misery of the `30s.
The Japanese confronted more or less the same problem throughout the 1990s. Despite the fact that they had the latest pumps at their disposal…brought interest rates down to “effectively zero” and embarked on a program of public spending that has given Japan the biggest national debt in the industrialized world, it still has not been enough. Stocks have not recovered. And the economy is still in a slump. During the last three years, Japan has had no net growth.
But, as the optimists will be quick to point out…the United States is not Japan. Nor is the huge, dynamic, global and digitized New Information Age economy of the third millennium the same as the economy of the 1930s.
No, it is not. It is, by many measures, worse.
First, it is worth pointing out that both the boom of the late `20s and the one of the late `90s had the same source — a consumer spending binge sparked by a “wealth effect” courtesy of Wall Street. “In 1928-29,” writes Dr. Kurt Richebacher, “consumer spending accounted for 82% of real GDP growth. In 1999, that ratio was 86%.” And if you take out the phony computer numbers, it is closer to 95%.
The Dow doubled in the 20 months preceding the October ’29 crash. But even then, it traded at a P/E that never exceeded 16.2. And the total stock market capitalization at the ’29 peak was only 100% of GDP.
The U.S. market has surpassed every record set in ’29. The S&P 500 trades at a P/E twice as high as that of Black Monday. The Nasdaq P/E is around 200 — more than 10 times higher.
In GDP terms, too, this bubble is a lot bigger than the one in ’29. The combined capitalization of listed stocks now totals almost 200% of GDP — again, twice as high as ’29.
The money supply has been growing at a much faster rate, too. “During the four years from end-1995 to end-1999, broad money (M3) has grown by a stunning 41%, or more than twice the simultaneous GDP growth.” By comparison, the similar measure in the `20s showed only a 10% increase.
Inflation in the 1920s was close to zero. Now it is above 3% — even after crunching by the famously optimistic statisticians at the BLS — the highest level in the developed world.
American businesses were showing increased profits in the late `20s. What’s more, Americans were saving money. The foreign trade balance was in surplus. And the United States was the world’s largest creditor nation.
Today, the picture is like a photographic negative of the `20s scene. The areas that were lit up are now dark. Corporate profits have been flat for more than two years. Savings rates are close to zero. The current account runs at a deficit of about $1 billion every day. And the United States is now the world’s largest debtor.
Dr. Richebacher crosses swords, or whatever it is that economists cross when they do battle, with Milton Friedman. He maintains that it is impossible to avoid a bear market and at least a severe recession. “There is nil chance of a soft landing,” he says.
There is nil chance…because, in Dr. Richebacher’s view, the course of economics is not random. Nor is it entirely a product of policy decisions.
The United States has not been getting fantastically richer during the last decade. Earnings — both individual and corporate — have barely budged. Productivity, outside of the wavy gravy computer sector, has scarcely improved. And even the GDP has risen only modestly.
Many people think they are getting rich, however, because of the credit expansion and the “wealth effect” it creates. They feel wealthier…and they spend accordingly. What they are really doing is spending the capital that could make them wealthier. Instead of building new plants and equipment, people buy new cars or take extra vacations.
Richebacher sees economics as a way of understanding the reality of what is going on. Americans are not really getting rich. Sooner or later they will realize it. There are no levers, no knobs, no magic incantations or hocus- pocus to make this reality disappear.
“America’s confrontation with reality will begin when the economy shows more distinct signs of slowing,” writes Dr. Richebacher in his April letter. “We wonder whether this may happen in the second quarter or in the second half of this year.
Paris, France April 26, 2000
*** They’re back — the TNT shares, that is. The Nasdaq rallied yesterday — rising 228 points. This was the second largest increase in Nasdaq history. And it followed one of the largest drops in history.
*** As usual, the market opened up and just kept going. “If I didn’t know better,” said SiliconInvestor.com’s William Fleckenstein, “I’d say someone was manipulating the market.” Bill King, too, notes that the Fed and other major players seem to orchestrate higher prices at important moments.
*** The Dow rose, too — up 218 points. The Dow’s rise added about $200 billion to America’s wealth — on paper. The Nasdaq, up 6.67%, laid on another $300 billion or so.
*** Taken at face value, we have a powerful bear market rally under way. It is still a bear market rally because both the Dow and the Nasdaq are well below their highs of 11,722 and 5,048 respectively.
*** Richard Russell believes the bear will continue to do his work by attrition — slowly bringing the average stock down in price…while keeping the indexes as high as possible for as long as possible. But with such volatility — especially in the TNT sector — it looks like a real crash is more likely. There is nothing to support the TNT shares. So when they really begin to fall — look out below.
*** “I lost more money in one week than I made in the previous two years,” said a Texas investor, (quoted by Dan Denning in the “Fleet Street Letter”), who recently sold his construction company and put the money into stocks. “It was the absolute worst timing.” The investor might be in better shape today than he was on Monday night. But bear markets typically destroy profits faster than it took to make them.
*** Yesterday the average stock on the NYSE exchange went up. Advances led declines 2,196 to 808. Still, fewer stocks hit new highs than hit new lows, 54 to 64.
*** The euro, meanwhile, continues to decline. It fell to 92.37 cents yesterday…a new record. The D-mark is below 50 cents. If you ever wanted to buy something in Europe, this may be the time to do it.
*** Of course, there is no guarantee that the dollar will not go higher. It’s at 7 to the French franc today. I recall that it was once as high as 10. But, if I remember correctly, it took Paul Volcker and 18% interest rates on U.S. Treasuries to get it there.
*** Gold rises and falls inversely to the dollar. It is, after all, a competing form of money. The dollar rose yesterday. Gold fell. You can buy an ounce of gold for just $278.80 today (June contract). Twenty years ago, you would have paid about twice that much. In real terms, it would have been nearly three times as much.
*** Is the dollar a bargain? Or is gold? Time will tell. But I’ll make a bold prediction…10 years from now, gold will be worth at least $279.
*** Lynn Carpenter, editor of the “Fleet Street Letter,” put together a list of what she called “The 10 best stocks for the next 10 years.” Her goal was to avoid the high-fliers in favor of solid, low-priced companies that would probably improve over a 10-year period. So far, the list is looking pretty good — with nine out of 10 of them rising. You can get a free copy of her report at http://www.fleetstreetletter.com (click the link on the right-hand side)
*** Lynn has also found a quirky bank with much higher profit margins than its peers. It is in a high-growth market, completely removed from the bubble economy, and has a P/E that is only half its estimated growth rate. http://www.fleetstreetletter.com
*** I occasionally glance at some of the “cool posts” on websites. A recent one, for example, tells me that “George Gilder is a moron.” Another asserts that “there is no serious threat to the overall market’s health.” There is occasionally something worth reading…but most of this is Internet graffiti.
*** The Internet is abuzz with outrage. Poor little Elian. The Miami family was in defiance of the law, say Reno supporters, she had to use force. But two of America’s most distinguished legal scholars — Alan Dershowitz and Laurence Tribe — say that it is the Attorney General who seems to hold the law in contempt. Agents burst into a private home with the wrong warrant. They had a search warrant. What were they searching for? Every biped in the universe knew Elian was in there. Even his father…who for reasons I have never understood, did not go himself and pick the boy up.
The whole spectacle gets curiouser and curiouser.
*** It finally feels like April in Paris. All of a sudden, the weather is beautiful. The sidewalk cafes are spilling out into the streets. And the tourists are ubiquitous. I hear American English almost everywhere I go. And the women…they seem to have come out of their winter cocoons and spread their wings.