Quacks and Risk Premia
We return to familiar questions. What is wrong with this recovery, we ask? What was wrong with the recession that preceded it? We also return, just to warn you, to traditional values and how to find them.
We paraphrase Richard Russell’s comments from yesterday: The Fed began easing rates 18 months ago. Stocks are down 20% since then. Usually stocks are up by 20% following interest rate cuts. The major exception: ’29 to ’32.
The stock market is said to “look ahead.” We don’t know what it sees. But we think we know what it doesn’t see. It doesn’t see a major recovery of corporate earnings. For if Mr. Market could see even the first pullulating shoots of an earnings rebound, stocks would not be falling.
Of course, Mr. Market could change his mind…and does…as we noted yesterday. He could decide that stocks are too low…or that they are too high. As you know, dear reader, our guess is that he is presently grinding prices downward…and will not stop until the entire excess gain of the Great Boom of ’82-00 is ground to powder.
We note, for example, that as recessions go, the recent downturn was a total flop. It did none of the things recessions are supposed to do. Consumers did not slow their borrowing or spending. They bought new cars instead of making do with old ones. They bought new houses, and mortgaged more of existing ones, rather than just “getting by” in the old digs…Stocks did not go down to reasonable levels. Businesses did not pay down debt. If the recession were a duck, it neither quacked nor waddled…
Then, came the recovery. Long-awaited, much advertised, and keenly welcomed…this proved a strange duck too, a bird with cloven hooves like a pig, and a body to match…but with dainty little wings like a sparrow. Oh, if only it could fly!
Instead, the recovery merely grunts and stumbles along. The jobless rate is still near a 19-year high. Hourly wages are barely positive. Consumers go further into debt and retail spending continues to rise. But ‘final sales’ figures show that the important purchases are increasing at their slowest rate in 40 years…and the stock market signals more danger ahead. Both the retailers and the homebuilders seem to be topping out. Eighteen months after the most aggressive rate cutting in Fed history – and neither the stock market nor the economy show many signs of life.
Instead of rising like a phoenix from the cinders of recession…this porker-bird hunkers down. American capitalism itself is under attack…with every fool and crackpot proposing some pet ‘reform.’ The press – which provided daily hagiographies to captains of industry, technology, and finance when they were in the chips (taking even shills and dreamers such as Henry Blodget and George Gilder seriously) – now treats them all as if they were all quacks.
Kozlowski has been indicted. Komansky has been fined. Ebbers has resigned. Lay has been humiliated.
To make matters worse, American capitalists can no longer wag their fingers at foreign protectionism, cronyism, or any other ism…For all of the sins of which they accused others abroad have been exposed at home! Who could complain, with a straight face, about the opacity of Japanese financial reporting, when you could look right through ‘transparent’ U.S. reports and not see a thing? Who could complain, without having his fingers crossed, about European farm subsidies when the Bush Administration grants our own tillers of the soil a big welfare package? What kvetch about protectionism overseas wouldn’t be greeted with guffaws now – after the steel tariffs?
It is all entertaining. But we still wonder; where does it lead? Not knowing any better, we default to tradition. Stocks could go up or down. But when they are very expensive or very cheap, we notice, they tend to turn around and head in the other direction. Stocks are very expensive now – despite 3 years of a bear market.
At least some of the credit for holding up stock prices should go to James Glassman and Kevin Hassett, who proposed that – despite the wisdom of generations of investors – stocks should sell for more money. But day by day, the stock market seems to be working itself farther and farther away from the “Dow 36,000” they promised.
Traditionally, we note, investors paid 7 to 15 times earnings for stocks. They believed that a dollar’s worth of earnings from a stock was worth less than a dollar’s worth of interest from a bond. Because the stock market was a dangerous place. Even if it were true that stocks always go up in the very long run, they believed that they deserved a little premium to make up for the very long periods when stocks may be down.
The recession was like no other recession since WWII. The recovery is equally singular. Without knowing what happens next, we can’t help but wonder. What if these strange goings-on signal a strange time for stocks too – one of the strange, once-in-a-duck’s-age times that proves the wisdom of traditional values?
Rob Arnott (thanks to John Mauldin) shows that a portfolio of stocks bought in 1802 for $100 would have been worth – in real terms – only $400 by 1982 (forgetting dividends). But over the next 20 years, the value of the portfolio rose to $2,099. Recent experience leads investors to believe that the future will always be like the last 20 years. Longer-term experience tells us something else – that there is a reason for the risk- premium investors traditionally demanded from stocks. Stocks went down in ’29 and did not recover, in real terms, for more than 20 years.
Today, investors still see little risk in stocks – and a lot of potential profit. The risk premium that they used to ask for has gone to zero. Whether you are buying a dollar’s worth of earnings from a stock, or a dollar’s worth of interest income from a bond, you will pay about the same price. If, 10 years from now, the Dow is back to 5,000…will they feel the same way?
Your editor…always wondering…
June, 11, 2002 — Paris, France
We love this market…and everyone in it!
We love Dennis Kozlowski for revealing the comic truth about America’s late, degenerate capitalism – where working class CEOs get new Armani suits and the capitalists get taken to the cleaners.
We love the way the big man was brought down too…not for managing one of the biggest shareholder losses – $100 billion – in history, but for trying to raise his social standing by paying too much for works of art and then dodging a few bucks of sales tax. What healthy American wouldn’t do the same?
And we love Maryland Senator Sarbanes, the Washington Post, Goldman Sachs, the NY Attorney General and all the other low-lifes who bowed their heads towards the New Era heroes when it was fashionable…but now kick them aside like lame curs in order to get their own names in the paper.
Reform! No one was the least bit interested in reform while the Dow was rising and the IPO money flowed. But now the word seems to find its way into nearly every newspaper editorial. No, it was not investors’ own greed and laziness that led them into losses – it was the malfeasance of corporate bigwigs and scalawags on Wall Street. More on this subject…later.
And we love the housing bubble…just for the sheer, exhilarating insanity of it. Imagine, mortgaging more and more of your own home – at the top of a boom, no less – in order to buy SUVs and big-screen TVs!
“Don’t bank on your home continuing to rise in price,” cometh rare words of wisdom from the Christian Science Monitor, “depending on where you live, it may be overpriced already.”
Just imagine buying the house in the first place. The photo accompanying the article shows a group of expensive houses, set one next to the other, cheek by jowl, with their phony brick facades and phony plastic siding nearly touching one another like two mannequins in a sterile kiss. Who would want to live in these mass- produced, soulless dumps….let alone pay for them?
Who knows. But the Monitor remembers that housing prices actually fell throughout the Northeast from 1989-99. Adjusting for inflation, the average home from Maine to Maryland was worth less at the end of the period than it was in the beginning. Not surprisingly, in areas where the previous run-up had been sharp, the pain that followed was also sharp. In parts of Connecticut, for example, aggressive home buyers often found themselves with a mortgage larger than the value of their home. Many were forced to walk away with nothing.
What will happen as the real estate story evolves? We don’t know, but it will be fun to watch.
And now over to Eric, our intrepid reporter in Lower Manhattan, bringing us the latest news…even on his birthday…
Eric Fry in New York…
– The stock market – by withstanding both the Intel revenue-shortfall warning last Friday and yesterday’s news of a thwarted terrorist plot – scored something of a moral victory, which is ironic given the tales of immoral corporate behavior that are clogging the newswires. “The page-one news summary of The Wall Street Journal reads like the prundefinedcis of the next installment of ‘Cops,'” quips Jim Grant.
– Despite the Intel bombshell on Friday and the disclosure yesterday that a terrorist was plotting to explode a radioactive bomb in the U.S, the stock market has held its ground…more or less. The Dow is slightly ahead over the two-day span, while the Nasdaq has slipped a little more than 1%.
– Yesterday, the Dow gained 55 points to 9,645, while the Nasdaq shed 4 points to 1,530. Gold, meanwhile, did its best Mike Tyson impersonation – staggering through the trading session, and winding up battered and bruised. The yellow metal fell $5.90 to $318.50 per ounce.
– Economics and finance seem to have little to do with the stock market’s behavior these days. Rather, the stories that captivate – and terrify – investors feature mind-boggling acts of greed by America’s here-to-fore revered corporate bourgeoisie. “What is eating most at the market,” Barron’s Alan Abelson observes, “is epitomized by Tyco, but scarcely restricted to that particular mess.”
– This week we learned that multimillionaire, and former Tyco CEO, Dennis Kozlowski, doesn’t like paying sales tax. By trying to dodge those nettlesome taxes on a few paintings he purchased in the Empire State, he earned himself an indictment from the New York State DA.
– Apparently, Kozlowski was an equal opportunity thief. Not content simply to fleece Tyco shareholders, he (‘allegedly’) – shortchanged Uncle Sam as well.
– “The freshly indicted chief executive officer of Tyco International is a cardboard cutout for every market cycle,” Jim Grant writes. “In the boom of the 1990s, he was the epitome of the hard-driving, earnings-conjuring, ostensibly value-creating CEO. With his resignation and disgrace, he even more persuasively slips into the bear- market role of ‘boss.’ Bosses, of course, are reviled, and Kozlowski makes a corporate villain from central casting. It’s not hard to resent a man who, like Kozlowski, goes yachting as his stock price is falling, especially when he is quietly unloading his shares while protesting that he rarely, if ever, sells.”
– But, says Grant, “Americans, of all people, are slow to resent the success of their hardworking neighbors… The social contract implicitly struck in a capitalist society is that the rich can become as rich as they want as long as the poor can become rich, too. The contract is violated when the rich take what isn’t theirs.”
– Kozlowski’s behavior easily qualifies as a ‘contract violation.’ Even so, as long as stocks were going up almost every day, most investors were all-too-happy to overlook bull market excesses – like Kozlowski’s fully disclosed, but not less obscene, compensation. Investors feel differently, now that stocks are going down.
– “As employment and stock prices rose together,” Grant reminisces, “politicians chose not to make hay out of the corporate abuses paraded in front of them: too-lax accounting standards, unaccounted-for options expenses and monarchical executive compensation arrangements. In good times, vigilance and envy both sleep. In bad times, both wake up with a start.”
– Among the many side notes of the Tyco scandal is the fact that the stock’s implosion amounts to an analytical home run for David Tice, manager of the Prudent Bear mutual fund and columnist for Strategic Investments.
– Christopher Byron explains: “By the summer of 1999, Tyco had ballooned into a more than $40 billion financial erector set of businesses…At that point a well-known short-seller named David Tice began openly criticizing Tyco’s accounting methodology…Kozlowski instantly turned up on TV shows, attacking Tice as a short-seller who was simply trying to drive down Tyco’s shares. The press handled Kozlowski with kid-gloves throughout the affair, and when a Securities & Exchange Commission probe of the company ended the following year without bringing action, Kozlowski seemed vindicated. The stock thereafter recovered all its Tice-related losses and climbed by the beginning of last year to more than $61 per share…making it one of the 100 largest companies in America.”
– Tice, of course, was correct, as the stock’s $11 price tag testifies.
Back in Paris…
*** What else is new? Well, Gold fell a big $5.90 yesterday…while the dollar actually rose. But if we’re right – every pullback for gold is a buying opportunity. Every rally in stocks or the dollar, on the other hand, is a good occasion to get out.
*** “Stock Slump is Casting Doubt on Fledgling Economic Recovery,” said a Wall Street Journal headline yesterday. Greenspan began cutting rates in January of last year. Typically, rate cuts lead to higher stock prices as investors look ahead to the economic recovery that lower rates are supposed to bring. But instead of going up, stocks have gone down. Investors are beginning to wonder…
*** And our old friends at the River of No Returns are back in the news. Amazon.com has been fined $600,000 for helping another company phony-up its books. AMZN dropped $1.28 to $17.30.
*** “The Patriot Act…” writes David Kotok of Cumberland Advisors, “will govern all customers of nearly everybody who touches money or wealth items; their clients are about to experience the inquiry for more personal data, ID numbers, addresses, telephone numbers, etc…those who are able to transfer their wealth from under this scrutiny may presently be electing to do so…If they are, that would help explain…who could be selling the dollar and dollar- based investments.”
*** Meanwhile, my friend Jim Davidson reports an increase in interest in private placements. And why not, that’s the focus of his ‘investment club’, Strategic Opportunities.
*** Says Davidson, one company being followed intently by the group, a company that goes by the name BevSystems, recently completed a merger with rival Aqua Clare…”Early investors who started with $50,000 have seen it grow into $176,509.” According to Jim, they had apparently entered a second round of financing right before the merger and those investors who participated made 159% in just a month.
*** Now, Jim tells me he has another deal on the table, but the time is running out. He expects to make three or four times his investment in a few months. I don’t know if there is an opportunity here or not. But if you’d like to know more, you can check out Jim’s report below. Of course, these deals aren’t available to everyone.