Predictions for 2002
"The public preference for stock is not only as marked as ever, but also the will to speculate is still a speculative factor not to be overlooked. The prompt return of huge speculation and the liberal manner in
which earnings are again being discounted indicate that it will be difficult to quench the fires of stock market enthusiasm for long."
Barron’s, March 24, 1930
Sylvie could not stop laughing. I had just revealed to her my approach to business.
"Ready, fire, aim…" I had said.
"You Americans are amazing," she replied, when she finally regained her composure, "you are so confident.
It is striking to me. I have other American students [Sylvie endeavors to teach me French]. They are always
so positive. You never seem to have doubts."
"That is a big difference between Americans and French people," she continued. "A Frenchman aims…and aims… and then wonders if he is doing the right thing. He may never fire at all. Maybe he reflects too much. But you Americans don’t seem to reflect at all."
All over Paris, the cafes, bars and salons are full of people reflecting. Over a cup of coffee or a glass of
wine, they talk, talk, talk…about everything. Politics, literature, philosophy…talk, talk, talk.
Most of the talk is as ignorant and lunkheaded as you might hear in the halls of Congress or at an Elks club
meeting. It sounds smarter, but only because they use big, Latinate words. The real benefit is that it keeps
people from doing something stupid; they are too busy saying stupid things. And there is always something new, something even more stupid to be considered before any action can be taken.
Is there something special about Americans that makes us so confident and quick to take action?
Today’s letter, among other things, argues that reflection is cyclic, not genetic…and that American confidence may be at a cyclical peak.
This letter is also the one in which we give our predictions for 2002. But we caution readers: we know no
more about what will happen than anyone else. Instead, we content ourselves with tall guessing about what
should happen. Of course, we know that Mr. Market may do some wild and wondrous things in the short term. In the short run, said Ben Graham, the market is a voting machine…thus, we might get outcomes as bizarre and unsettling as election results. If New York voters could elect Hilary Clinton to the Senate, is there any foolishness they might not work as investors?
But in the long run, we believe, Mr. Market will do the right thing – meting out a form of rough moral justice-– bankrupting the greedy and gullible…separating the fools from their money…and raising up meek value investors who patiently held onto good investments while everyone else seemed to be getting rich on Cisco and Enron. Our guess is that Mr. Market will also decide to punish Americans’ super-confidence.
So let us turn our attention to the 12 months ahead:
Last year, we guessed that stocks would go down. We were right. They did go down, but not as much as we expected. Now, everyone says that stocks are going up. Why? James K. Glassman, writing in the International Herald Tribune, explains: "It rains, but the sun comes out again. Stocks fall, but they always recover to a higher level."
"To believe that stocks will be rotten again in 2002 is to believe that they will buck a strong tide that has been running in the same direction for more than 60 years," he adds.
Glassman probably should have used a different metaphor. Tides run in both directions, in equal and opposite amounts. Yet, Glassman seems to think this is a tide that never reverses.
"Stocks tend to rise when investors least expect it," he points out. They "climb a wall of worry" is the Wall
But as we enter the year 2002, we find ourselves at a moment when almost nobody doesn’t expect stocks to rise. No wall of worry separates investors from the stocks they want to buy…Instead, Americans are as full of confidence as they were at the peak of the boom…
Even in our own publications, the voice of the super- confident American crows: "I have never been more
optimistic…about America’s cultural and economic future than I am now," writes Jack Wheeler in Strategic
Instead of a Wall of Worry, Americans see before them a big rock candy mountain where whiskey trickles down the rocks and the hens lay all day long. Hardly anyone can imagine that stocks may go down a third year in a row.
"To find a three-year losing streak in the S&P," writes Jim Davidson in his new letter, "you have to go all the
way back to the eve of WWII, when stocks fell by a total of 21% from ’39 to ’41…to find a period of four
consecutive losing years for the stock market, you have to go back to the depths of the Great Depression."
And yet, you could go all the way back to the Big Bang and not find a single instance when a new bull market
began when stocks were so expensive. The highest P/E ever from which a bull market was launched came in
January of 1967, when the S&P traded at 14.9 times earnings.
Today’s prices are more than two times that level. And the bull market of ’67 was hardly a great opportunity
for investors. It raised prices…but only to collapse them a few years later.
So we will stick with our prediction from last year: stocks will fall in 2002. Stocks are far too expensive
for an honest man. They need to work their way to lower levels before they will be attractive investments. The sooner the better, in our opinion. And if they don’t go down in 2002, well…they should…which is all you need to know. Only a fool buys stocks that should fall in price.
And what about the economy?
Hardly anyone could imagine that the nation would enter a real recession in 2001. Now, in 2002, hardly anyone can imagine that it is not already over.
And yet, why should it end soon…when it has hardly begun! Consumers have not yet begun to act as though we were in a recession. They borrowed and spent in the recession months just as they had in the boom ones.
Typically, this is what happens in a recession: consumers cut back on debt; and they slow down their spending. Then, their cars wear out…and their houses need upgrading. After a few months, they need to buy new things – and, thanks to the economies they made in the recession, they have the money to buy them.
But what kind of a recession is this? Americans have been so confident that they have failed to react in a
normal way. If they’ve lost jobs, they are sure that a new one will be found soon. If they’ve lost income –
they are sure that their revenue will pick up as the economy recovers. If they’ve lost money on their
investments, they’re sure that that will be fixed too…it is just a matter of a few months! Instead of
paying down their debts, Americans have added to them.
"All past recessions had their obvious, immediate cause in a ‘credit crunch,’" Dr. Kurt Richebacher elaborates. "The last recession, 1990-91, happened against the background of a protracted, sharp slowdown of private credit growth from $632.5 billion in ’88 to $187.1 billion in ’91.
"The present recession has been unfolding against the backdrop of unbridled money and credit growth. Instead of a credit crunch, there has been a credit deluge. Since 1992, credit to the private sector has been expanding by more than one trillion dollars at annual rate. Yet the economy has abruptly stalled. Money growth keeps expanding at double-digit rates. This has no parallel in history…"
"No serious economic of financial crisis has ever come from tight money and a high interest rate," Dr.
Richebacher concludes. "Nothing is easier to reverse than this. Every depression or protracted recession has
been preceded by extremely loose money which – through credit excesses – tend to bring about far reaching dislocations."
Both bear market and recession have been imposters, like the boom that preceded them. The bear market has failed to shake investors’ faith in shares. And the recession has brought about no change of attitude by consumers. Americans are still super-confident that the Fed’s easier money and extra-super-spiffy U.S. economy will correct the world’s biggest bubble with the world’s softest downturn.
Maybe. But we doubt it. Instead, we believe that sooner or later, Mr. Market will do what he’s s’posed to do –
drive stock prices down and make the recession hurt… And Mr. and Mrs. Lumpen consumer will do what they’re s’posed to do too – panic. They should cut back on spending, sell off their stock, and lose some of their famous confidence. Only then will we be able to have a proper bear market and recession. And only then, can we have a proper recovery.
The dollar – down.
Gold – up.
Consumer prices – down.
Unemployment – up.
Bonds – up and down.
January 10, 2002 — France
P.S. "You know, people don’t really do any serious thinking unless they’re forced to do so," Sylvie
reflected. "They lose their jobs, or someone important to them dies…or they suffer some other major loss."
Setbacks encourage reflection. Success nourishes action.
The French were men of action under Napoleon. Bonaparte took on one adversary after another. A moment’s
reflection would have shown that it was lunacy to attack Egypt or Russia, for example…but he charged ahead in disastrous campaigns. Not long after his return from Moscow, his enemies ganged up on him and he was defeated, conclusively, at Waterloo.
Since then, the French have suffered one humiliating defeat after another. Against the Prussians in 1870
(Paris was besieged and people ate rats during that winter). Then, WWI was a catastrophe, with 6 million
French casualties. In WWII, outflanked, outfoxed…the French army collapsed within 6 weeks. In the ’50s, the
French did no better in Indochina than the Americans 10 years later…and then lost Algeria to an independence movement.
No wonder the French would rather think than fight.
"Consumer Debt May Stall Recovery," says an Atlanta JC headline.
"In most recessions," explains the Atlanta paper, "consumer spending on homes and vehicles plummets, then soars as recovery starts. This time, consumer spending has mostly stayed steady despite taking a plunge after Sept. 11. Consumers, for example, powered a gust of vehicle sales in the fall.
"But that continued strength means there is no pent-up consumer demand for big-ticket items to be unleashed at the start of recovery. It also means that the recovery could be delayed – or even scuttled – if
consumers turn skittish about spending."
People were not skittish about borrowing; in November they did more borrowing than anytime in history, $19.8 billion of it. And over the year, they bought more homes and cars than ever before…But by year’s end, they seemed to running out of money. Retail sales fell in the last week of 2001, making it "the worst shopping season in a decade."
Did the news rattle Wall Street? Let’s ask Eric…
Eric Fry, who, as you are probably aware, is hosting CNNMoney each morning this week between 9:30 and 11:30 am on CNNfn…
– News bad. Stocks good. That’s been Wall Street’s winning formula lately…until about noon yesterday.
Early in the day, bad news from Cisco and Merrill Lynch "helped" propel the Dow more than 100 points higher. At least that’s what all the TV talking heads were saying.
– You’ve heard the blather before: "The market is rallying strongly today because the news, while bad, was
much better than expected!"
– So when Cisco CEO John Chambers said the U.S. market for his company’s products is "still struggling,"
investors just knew that was a good thing.
– And when Merrill Lynch said it would be taking a $2.2 billion charge and cut 9,000 jobs in order to cope with slumping revenues, investors knew that was a good thing too. The shares of both Cisco and Merrill jumped higher in the early going.
– But then the market started dropping…slowly at first and then a little more briskly. Lo and behold, by the
time the final curtain came down, bad news had turned out to be just that – bad news.
– The Dow’s early triple-digit gain had become a 56- point loss to 10,094. The Nasdaq likewise yielded its
early 2% gain to fall 11 points to 2,045.
– But amid the sea of minus signs, one noteworthy stock stood tall. Oxford Health Plans, recommended by
Strategic Investments editor Dan Denning, soared 12% yesterday after the company announced some bona fide good news. Oxford’s business is growing faster than it had expected. The company will provide additional details today at the JP Morgan H&Q Healthcare Conference in San Francisco.
– "The market is not cheap," the ISI group admits, but the research firm predicts stock will keep rising
anyway. Here’s why: "ISI’s measure of total liquidity (M3 plus commercial paper) has risen from roughly 1% [growth] at the end of September to over 14% at an annual rate today." This "excess liquidity" has been pouring into financial assets, ISI theorizes.
– Also, dissatisfied owners of low-yielding CDs constitute another major tributary emptying into "Lake
Equities." The low interest rates engineered by the Fed are chasing billions of dollars out of savings
accounts and into a stock market that is expensive, but alluring nonetheless – somewhat like my wife.
– None of this liquidity would matter, of course, unless investors weren’t so easily persuaded to dive into the stock market.
– The S&P 500 now sells for nearly 30 times Abby Joseph Cohen’s best-case earnings estimate for 2002. But
investors don’t seem particularly troubled by the lofty valuations. Instead, they seem worried only about
missing the expected rally from 30 times earnings to 1,000 times earnings.
– The soaring money supply – a.k.a. liquidity – should also be good for what ails the economy, says Moody’s John Lonski. The so-called money of zero maturity (MZM) expanded at a blistering 20.7% rate in November. If past is prologue, says Lonski, this soaring money supply should produce nominal GDP growth and nominal retail sales growth of better than 5.5% by this time next year.
– The tech-stock-buying hordes seem to consider such rapid growth a fait accompli. We at the Daily Reckoning consider it a "fait inconnu" at best, because as Mark Twain said, "History never repeats itself, although sometimes it rhymes." To which we would add, sometime it rhymes badly.
– To be sure, easy money has produced a short-term bounce, both in the financial markets and in the
economy. But a sustainable advance is another story. For one thing, rapidly rising money supply tends to lead a rise in bond yields, which is the sort of thing that can choke off a young recovery before it even has a chance to grow. And that wouldn’t be very stimulating, would it?
– When rising interest rates collide with leveraged consumers and corporations, the much anticipated "V"
recovery could quickly become a "W," or even a dizzying "Z" to nowhere.
– "The economy fell into recession in 2001…[so] there’s going to be a bounce back from that," predicts
ex-Merrill Lynch strategist Charles Clough Jr. "[But] we might have more difficulty in the latter part of 2002 to 2003 sustaining [economic growth] because it’s going to be a while before the investment side of the economy comes back…The corporate sector has left itself very highly leveraged…"
-The resulting capital-spending bust, says Dr. Richebacher, "is the economy’s primary and dominant
– A spring that has "sprung" provides no bounce.
Back in Paris…
*** Another big news item yesterday was an analyst’s estimate that U.S. companies, led by AOL Time Warner,
AT&T, and Viacom, would have to write down $1 trillion in goodwill.
*** In the boom years, companies bought other companies for far more than the value of the assets actually
transferred. They characterized the excess purchase price as "goodwill." But then, along came a slump and
companies are now being forced to recognize that the "goodwill" for which they paid billions is actually
*** But the stock market still values many of these companies as if the "goodwill" were worth something. Mr.
Market might know something we don’t. Then again, this is the same Mr. Market who thinks EMC is worth 510 times earnings and prices the entire S&P at more than 48 times 12-month trailing earnings.
*** Mr. Market might be right, of course. Then again, he might need to have his head examined.
*** The price of gold rose to a 3-month high yesterday, closing at $283.70. Why? We don’t have any idea. Still, we write about it and other things – at length – below.
*** The esteemed John Myers, editor of our own Outstanding Investments, suspects we may be witnessing
the early signs of inflation. "There has been a sizable jump in the price of steel of late," writes Myers.
"Prices for hot-rolled steel, the kind used to build cars and trucks, have risen 15% since late November. A
little over a month ago hot-rolled steel was selling for $210 a ton. Prices are now running at $230 a ton."
"There has also been a recovery in copper and zinc prices…This after a disastrous 2001 when these two
metals hit their lowest prices in a decade. The price turnaround has been good news for base metal producers. Since September the Toronto Stock Exchanges minerals and mining index has climbed from 3300 to 4300."
*** It is relatively quiet in the Bonner apartment. Will and Sophia have gone back to their jobs and schools in
America. That leaves only two parents, one grandparent, and 4 children in the household.
*** Still, voices were raised at dinner the other night. Other diners turned their heads to find out what the
loudmouthed Americans were arguing about. The subject was evolution…which may or may not have something to do with today’s letter…below…