Political Shakedown, R.I.P.
As Europe plays catch-up to the American economy, the US struggles to maintain its top-dog status. How’s the contest coming? "The regrettable trend in the United States is virtually the same as it is in Europe: more taxation, more regulation, greater government spending, and less freedom," remarks Dan Denning. In other words, no ‘winners’ yet. "If Europe risks too little with credit, America risks too much…"
Thank goodness the shameless pandering of the American elections is now over. Politics is a subject religiously avoided here at the Daily Reckoning…or at least, serious political discussion is shunned. On the long list of things we know little about, it’s near the top. Yet it’s nearly irresistible for me – since the rest of the crew is away in New Orleans, and my beast IS the geo-political – to offer a comment or two on what’s been a momentous week on both sides of the Atlantic.
Fortunately, my observations on politics don’t depend on the results of elections or the meetings of European bureaucrats. That’s because I start with the assumption that politics is inherently corrupt, and the only thing that matters less than voting itself is the result of an election.
Having said that, a lot DID happen this week. And as editor of Strategic Investment, I operate under the assumption that investment values are determined by economics. And economics, unfortunately, are affected by politics. So, our investment forecasts usually begin with a political forecast. I will keep the political portion of this mercifully brief and move on to investment values.
In Europe, a lot’s being made of the suddenly revitalized French-German alliance – the vaunted motor of a greater European prosperity. Europe is getting ready to expand again. And the French – feeling their oats from staring down the U.S. at U.N. meetings over the issue of Iraq – would like that economic expansion to include a unique European defense force.
I’m all for that. It’s high time Europe should be able to defend itself. The sooner the French and the Germans take over policing internecine wars in Europe, the sooner the United States can bring home the troops who don’t belong in Europe anymore anyway.
But it would be a mistake for the French or anyone else to think that taking over the military role of the United States in Europe suddenly puts them on equal economic footing. True, the U.S. has some serious structural economic problems…more on that in a moment. And the EU’s GDP nearly matches that of the U.S., at around $11 and $13 trillion, respectively. Size can be deceiving, though. Europe has its own pot of bitter news to stew in.
In short, despite all the sturm and drang, the Continent is beset by chronic labor problems, excessive taxation and regulation, government budget deficits by its largest economies, and a political culture that can’t stop making promises it knows it can’t keep.
None of this is good for that Frankenstein of currencies, the euro. Yet despite reaching parity with the dollar briefly earlier in the week, the euro has failed to deliver any of the anticipated advantages its founders hoped.
Quite the contrary. The 12-nation EU economy will grow at less than 1% this year. And the commissioner of EU Monetary Affairs says next year’s growth rate will be "considerably" lower than the estimated 2.9%. Even by Europe’s slow-growth standards, this is awful. Business confidence is declining, notably in Italy, France, and Germany.
And the EU stability pact, which EU President Romano Prodi called "stupid" last week, is exposing all the faults of an artificial currency. The central bank is trapped between two alternatives at odds with each other. On the one hand, it would like to lower rates and stimulate growth in Europe’s large economies. Fiscal policy (deficit spending), in France and Germany especially, hasn’t produced economic growth. Easy money might. But on the other hand, the EU’s smaller countries actually abided by the spending limits imposed by the stability pact. A rate cut now would stimulate inflation in those economies.
The dilemma causes the ECB to dither. And while the currency reached parity with the dollar earlier this week, recent events in Europe show that if the euro is a refuge against dollar-denominated assets, it’s by default, and not by design.
Are American markets any better off after the elections this week? Even with Tuesday’s changes, Congress remains so evenly divided that it will be very difficult for the President to pass any meaningful tax cuts. And as I’ve told my readers at Strategic Investment, I believe the regrettable trend in the United States is virtually the same as it is in Europe: more taxation, more regulation, greater government spending, and less freedom.
Structurally, America might have freer labor markets than Europe. But it’s got its own systemic albatross in the form of credit markets gone wild (Fox special soon to follow, for those who enjoy creative cable reality series). American economists always talk about American "dynamism" being the saving grace of the American economy. But if Europe risks too little with credit, America risks too much.
The American credit markets are like no other invention in financial history. There’s no precedent for the kind of debt burdens America has racked up. And it’s not just consumers. It’s corporate America and the government. The United States is intent on proving to the rest of the world that you can spend your way to prosperity.
While the stock market cheers this, the dollar does not. Most unusual.
What ails the dollar? Why hasn’t it joined the party? We think we have an answer.
There are some times when a stock market rally reflects a genuine confidence in the economic and business prospects of a country. And there are other times when the rally is financial joy riding by speculators who care not a whit for economic reality. I’ll give you two guesses to figure out which kind of rally I think we’ve just had.
The dollar, having been through its share of bullish benders and bearish busts, knows this. It knows that even lower interest rates won’t cure the ills of a credit-sick American economy. It knows that debt does not create prosperity. And it knows that lower rates don’t make up for already-high stock values.
So what’s a Strategic Investor to do in a market where no single currency is capable of becoming the alpha male? You could always buy gold. In the long term, gold will probably outperform both the euro and the dollar over the next year. But what about the short term? My advice is to try and correctly read the underlying trend, stay out of the bear’s way, and if you have the appetite for it, trade the trend.
What do I mean by trade the trend? The trend of this secular bear market is to destroy purely financial wealth and reward hard assets. A simpler version: short financials and go long hard assets. During rallies, buy calls on the indexes, especially the S&P and the Dow.
And as for the destruction of financial wealth…I’m targeting banks, brokerages, credit card companies, mortgage lenders and a basket of retail stocks. Granted, the last month has proved exceptional for bulls. But I believe it’s been exactly that, an exception. The rule is this: don’t be long in bear markets. And if you’re looking for some speculation, look for weak financials and retailers to under-perform this holiday season.
for the Daily Reckoning
November 7, 2002
Editor’s Note: Dan Denning is the editor of Strategic Investment. His focus on little-known stocks has led investors to profits as high as 5,182%…as well as over 570% on Isle of Capri Casinos, 457% on Big Entertainment, 411% on Gentner Communications and 130% on Total Research Corporation.
Denning is also the editor of Strategic Trader Alert, an email service to investors interested in fast-moving trades. Amid trading profits of 84%, 88%, and 120%, nimble STA Readers have profited from the likes of a 6-day, 112% gain on Freddie Mac puts. And, as Denning mentions above, in "a market where no single currency is capable of becoming the alpha male", one way to win is to "trade the trend"…
As we were in transit again yesterday, we don’t know what happened in the stock markets. But, we’re not sure we care. Stocks go up and go down. We think they’re headed for a major bear market bottom – but it could take 20 years to get there…as it did after the crash of ’29.
The market’s function, we realized only today, is not to make us richer, it is to make us wiser. The great bull market of ’75 to ’99, the biggest and longest bull market in history, turned Americans into a race of geniuses, who – as Oscar Wilde put it – knew the price of everything and the value of nothing.
The bear market will make them poorer and wiser, we think. As time goes by, we will think more of the value and ignore the price. If that is not the way it works…well, it ought to work that way.
It is the end of the world as we have known it. Gone are the days of 18% per-year stock market gains. But going, too, are the illusions of the great bull market.
Money isn’t everything, we are likely to rediscover.
The thought occurs to us after spending a couple of days in wild, wonderful West Virginia. For there, even with some of the most beautiful scenery in the country, and probably more natural resources per square mile than any place on earth – with coal, gas, wood, stone, and clean, fresh water everywhere – and easy access to the world’s richest consumer market, as well as its most efficient capital suppliers…
…despite every advantage, people still manage to live like pigs.
In a big, long boom, many things get overbought. Stocks, of course. But in America, money itself came to be priced at an epic high. People began to think that money was the solution to all life’s problems. Men and women worked overtime in the getting and spending of it. Each month, like my gardener peeking into our vat of fermenting plums, they ripped open their portfolio statements to see how much of it they had. They started new businesses at a record rate. They borrowed it as never before, and spent it, too – as if spending money would make their lives richer and better. Money took on such a huge importance, it seemed to many people that nothing else mattered.
As Eric, here with me at the New Orleans Investment Conference, happens to be giving a speech at the moment, Dan Denning, trader extraordinaire and a recent addition to our Paris headquarters, has graciously offered to fill you in on the latest happenings in the market.
Dan Denning, reporting from Paris…
– So, the Fed cut rates by 50bps instead of the expected 25…sticking to its doctrine that when you’re hunting bear with only a few bullets left in your rifle, you might as well make as big a bang as possible, hoping that if you can’t kill the beast, at least you can scare him away. Mr. Market was certainly appreciative: the Dow and Nasdaq gained 1.1% to 8,771 and 1.3% to 1,419, respectively.
– The mid-term election is at least as good an excuse for the rally. But let’s not forget the "law of perverse outcomes." There aren’t many things more perverted than politics, except, perhaps, the stock market. And in both cases, what you see isn’t always what you get. And what you get is usually what you least expect.
– Just ask Harvey Pitt. Mr. Pitt took over the SEC in August 2001, back when the Dow traded above 10,500. As a lawyer and accountant, Mr. Pitt was uniquely qualified to turn a blind eye as Wall Street and accounting firms took American investors for all they were worth.
– We don’t know Mr. Pitt personally. And by all accounts, he was an affable regulator. But during his 15-month tenure, he presided over the most scandal-laden era in recent financial memory. And we suspect the parade of earnings restatements that started with WorldCom might get even longer.
– WorldCom is just one example, although one that seems to revel in its own shame. Word from WorldCom is that total earnings fraud is now in the neighborhood of $9 billion, not the $7.3 billion figure it previously admitted to. Who knows, maybe this kind of candor is addictive, a little like an adulterer basking in his own sins during confession. It would certainly be refreshing, if a little tawdry. And there would be the added benefit of working off a lot of the excesses that are still in the system.
– But rather than working off past excesses, the market seems more interested in adding new ones. Just the thought of a rate cut from the Fed Chairman has sent the market up in the last four days. For the record, it’s not clear that cutting rates will actually do anything positive for the economy. Perhaps the contrary.
– According to U.S.A. Today, the average money market fund is yielding just 1.21%. Money funds closely track the federal funds rate – the one Alan Greenspan has lowered 12 times to its current 40-year low. The article continues, arguing that the latest cut "could force funds with high expenses and low returns out of business. IMoneyNet says 34 have yields of 0.25% or less. They might have to slash expenses to avoid having their share prices fall below $1 – ‘breaking the buck,’ in industry terms."
– If a fund "breaks the buck", it means that the yield becomes negative…and an investor actually gets back less than a dollar for every dollar he puts in. Last time we checked, this was not the goal of investing. And that’s why a fund that breaks the buck is not long for this earth. Jeff Tjornehoj, a research analyst at Lipper, says only once in the 31-year history of money market funds has a fund gone into forced liquidation after "breaking the buck."
– Even so, investors who’ve seen the yield on their money market funds fall to Japan-like levels can’t be too relieved. Forget about making a buck. How about hanging on to the one you have? That’s getting harder and harder, what with Chairman Greenspan’s determination to stimulate lending and spending by driving down the yield on liquid savings instruments.
– Still, the stock market is used to cheering rate cuts. And here we might be so bold as to offer a suggestion to the Chairman, given the demise of his regulatory comrade at the SEC. With the applause of Wall Street ringing in his ears, it might be a good time for the Chairman to make for the nearest exit.
– A new political landscape and a new economic policy- making team might be just the thing the Bush administration is hoping for to restore consumer confidence. And the Chairman would make out better than a crooked politician on election day, getting all the credit for the boom without any of the blame for the bust. Greenspan has always loved the political machinations of Washington. Now he’s got a chance to show he’s learned something from his tenure there – something other than gunning the monetary engine of an economy running out of gas.
Back in New Orleans…
*** There is high culture…and there is low culture, we meditated on our last day in Appalachia. But in West Virginia, culture of any sort is as rare as a steak in a sushi bar. We take for granted that there is no opera or beaux arts…no mountain Michelangelos…no backwoods Bachs, but where are the local cheeses? The local sausages? The local wines or beers?
The local furniture artisans do their work with chainsaws. The local cuisine is scarcely more refined…and probably lethal. Far more people die prematurely in the mountain state from their food than from their firearms, is our guess. We passed up "Fat Boy’s Pork Palace," and chose Dory’s Diner for lunch. The meat loaf special was edible, but the other customers were not a good advertisement for the long-run effects of Dory’s cooking. They looked like veterans from a life of pie eating contests. The waitress, a pleasant woman with doughy flesh, walked with a limp and updated all the regulars on the condition of her hipbones. The rhubarb pie was a disgrace; nothing but a sugary goo in a buttery crust. But the customers ate it as though they were shipping out to a fat farm in the morning.
Where are the healthy, good-looking people, we wondered? Rare is a pretty woman over 40, we noticed…rare too is a house you’d want to live in, or a restaurant worthy of the name.
Money might have something to do with it, but probably not much…