By Bill Bonner
“What are we waiting for?”
“We’re waiting for Godot.”
Waiting for Godot
Investors, waiting for the messiah of the “second half recovery” and the resumption of the bull market, are puzzled. The second half has been here for two months. We have just gotten our 7th rate cut in 8 months. But nothing seems to be happening. Why the long pause?
Some stockholders have become weary. A few have become surly – biting the hands that once fed them stock tips. But most have resigned themselves to wait. “Over the long haul,” they say, “things will get better. They always do.”
Or, as Porter Stansberry put it in this space two weeks ago: “The reckonings don’t last. Redemption follows… You see, common stocks afford individuals the opportunity to own the means of production – the machines and organizations that have produced this amazing trend towards wealth. And this is a system that, despite its best efforts, the government hasn’t yet been able to destroy.
“Capitalists and entrepreneurs continue to make the world a better place…and for this, they make a profit and their investors earn a return…”
Porter believes investors will be redeemed by technology and the spirit of enterprise. Long-term investors are supposed to be redeemed painlessly. “For the long term holders of equity,” he says, “there is no reckoning – only redemption.”
And despite our reckonings, says Porter, “we’re getting richer, not poorer.”
Here at the Daily Reckoning, dear reader, modesty forbids us from pretending to know the future. We further confess that we are scarcely more certain of the past or the present. But when we look through the glass darkly at the here and now, we do not see people making financial progress. To the contrary, we see them walking backwards…
And while we recognize that we cannot know the future, we have not outgrown the habit of making some guesses about it.
Regular Daily Reckoning sufferers will find no surprises in today’s letter. We guess today, as we did yesterday, that stocks have further to fall. But today we elaborate our theory…further explaining why markets give nothing without taking something away…and why redemption in investing, as in the rest of life, comes only after much suffering. Alas, people do not become wiser without becoming older and poorer, too.
We will begin in the beginning. A country that is rich is one that has capital – the resources with which to create goods and services. “Capital,” as economist David Ricardo described it, “is that part of a country which is employed in production.” Increasing capital is the very definition of getting richer. A man who takes $10 out of his wallet to buy a good cigar is not wealthier for it. He is $10 poorer – his $10 has gone up in smoke.
There is only one way to get richer – by setting aside resources for future wealth creation. “[P]arsimony, and not industry, is the immediate cause of the increase in capital,” explained Adam Smith. Or as Adolphe Thiers put it, “It is impossible to create more capital than society creates through savings.”
A man may sit in his basement and write a new software program that could be worth millions of dollars. But he will be no richer until the money is actually earned. What’s more, if he spends all of his earnings, rather than save them, he will be no richer at the end of his life than he was at the beginning. Wealth equals accumulated savings, nothing more or less.
Looking back at the last five years, we see many Americans smoking $10 cigars. First, the stock market bubble convinced them that they were getting richer – so they stepped up consumption. Now, their other major asset – their homes – are rising in price. So, they use their houses as though they were an extra revenue source – spending the additional equity almost as soon as it appears. Over a ten year period – from 1986 to 1996 – American homeowners’ mortgages walked backwards by a full 10%.
In 1945, Americans owned a full 86% of their homes. 51 years later, the percentage had fallen to just 55%. Fannie Mae, Freddie Mac and the third of the three amigos, the Federal Home Loan system, have together run up $3.2 trillion in debt – an amount equal to a third of the entire GDP.
Both stock market and real estate seemed to offer a substitute for savings. The first has already proven to be a poor substitute. The second will, if we were to hazard a guess, turn out to be even worse. When your stock market profits disappear – at least you don’t have to continue making monthly payments.
With ersatz savings in stocks…and now in real estate…real savings have been neglected.
“During the last few years,” explains Dr. Kurt Richebacher, “consumption gained its highest share in GDP growth in the whole post-war period. In 1999, it accounted for 84% and in 2000 for 71.6% of the increase in real GDP, and since the third quarter of last year, consumption exceeds total output.”
The consumer – still smoking $10 cigars – is still confident. Like the investor, he still has a few $10 bills in his wallet and he expects things to get better. But “consider that he supplemented his increase in current income of $492 billion in 2000 with $566 billion that he borrowed,” writes Dr. Richebacher. “Expecting him to sustain his spending in the present environment is absurdly unreasonable.”
“We have always warned,” Dr. Richebacher continues, “that the plunge in the personal saving rate is the U.S. economy’s single biggest macroeconomic problem. Yet a cottage industry of researchers has been busy discrediting the conventional measure of saving. It is their most absurd argument that the consumer’s balance sheet is in excellent shape as stock prices [and house prices] have risen faster than debts. These people even fail to realize that this burst of phoney paper wealth is precisely the key problem. It was the exploding asset bubble that lured the consumer into his conspicuous borrowing and spending binge. While a lot of that bubble wealth has meanwhile been wiped out, the greater part is still in existence – destined to follow suit in due time with the ultimate effect of restoring a reasonable personal saving rate.”
But spending beyond your means is a hard habit to break. People will not give it up easily. “Men, like dogs,” as John Maynard Keynes explained, “are only too easily conditioned and always expect that, when the bell signs, they will have the same experience as last time.”
The last time the Greenspan Fed threw a virgin in the volcano…I mean, cut rates…the economy boomed and stocks went up. For 18 years, stocks have gone up. Housing prices have been even more reliable, with only localized regressions, for more than half a century. It will be a long time before these habits are broken.
Prepare for a “prolonged, very painful adjustment process,” Richebacher warns.
How long? How painful?
“Just to give you an idea of how far out of historical whack the stock market is,” writes Ben Stein on TheStreet.com, “consider that stocks rise over the long term by about 4% a year, with immense deviations around the mean. If the earnings depression ends tomorrow and profits rise by 4% a year again, it will take roughly 14 years (not months) for the Dow’s P/E to reach historical norms…Or to put it another way, the Dow would have to fall in half for it to resume historical P/E behavior.”
People who believe in automatic redemption over time may have a very long wait. Redemption is neither automatic, nor guaranteed by the passage of time.
Americans may be redeemed, but they will be nailed to a cross first.
Your correspondent, hoping for redemption, but doing the best he can in the long pause of life…
What a wicked world!
The world’s major economies are all in trouble: Just look at today’s headlines. “Japan’s Crisis Deepens,” says the BBC. “German Economy Stalled,” says Bloomberg. “Don’t count on U.S. recovery,” warns the Japan Times.
Meanwhile, Microsoft fell below $60 yesterday. Merrill Lynch dropped beneath $50. And Amazon.com slipped under $10, again.
Things have gotten so bad in the high tech sector that the Industry Standard – which like TheStreet.com thought it would rival Dow Jones – had to let its last 20 employees go and close its doors. “Jobless claims edge up,” summarized CNNfn as the number of unemployed hit a 9-year high.
The U.S. press is full of hard luck stories – investors who bet the farm on Nortel, Cisco or Amazon…and lost. Well, these are not super-hard luck stories. Maybe we should say they are semi-hard, like those soft-porn movies you find in respectable hotels. A man of 45 has been forced to go back to work…a widow in her 60s now has to wash her car herself…a high- rolling workaholic has been forced to take a long vacation…Almost all of them are suing their brokers.
But even with these life-changing stock market losses, stocks are still very expensive. Krispy Kreme is at 105 times earnings. Dell is at 40 times. The normal p/e is about 14…yet the Dow is now at 25, and much higher by WSJ/GAAP standards…
Richard Russell: “In the past, bear markets have taken stocks down to the point where a dollar would buy 17 cents and even 20 cents worth of earnings and anywhere from 6 cents to 10 cents worth of dividends.
“In today’s market, a dollar buys 3 cents or 4 cents worth of earnings and no dividend – it’s a sucker’s market. It’s a Las Vegas market…Today Wall Street is one step away form Las Vegas. The difference – Wall Street enjoys greater publicity: over-priced stocks are touted around the clock, and millions of people are living with the illusion that stocks at today’s prices are a good holding ‘for the long haul.'”
More on “holding for the long haul”…below. But let’s get the details on yesterday’s action on Wall Street first. Over to you, Eric:
Eric Fry writing from Manhattan:
– New Yorkers seems to care more about the sensational baseball team from the Bronx that is playing in the Little League World Series then they do about the stock market. Certainly, it feels good to root for a winning team and these “Mini Bronx Bombers” are definitely winners. Last night, led by ace pitcher Danny Almonte, they defeated the team from Oceanside, California 1-0.
– The results of the game on Wall Street yesterday was less pleasing. The Nasdaq fell 17 points to 1,843 and the Dow slid 48 points to 10,229.
– We are now almost two months into the “second half” that so many pundits had predicted would feature a recovering economy. It was to be a second half in which stocks rallied as well. They were partly right. It has been a good time for gold stocks. The XAU Gold Stock Index has rallied more than 12% so far in the second half. By contrast, the Nasdaq has fallen more than 14% over the same time frame.
– “The Fed is trying to cure our post-bubble economic hangover by the ‘hair of the dog’ – excess money growth,” says Northern Trust’s Paul Kasriel. “The ECB is getting ready to crank up its printing press, too.”
– Increasingly loose monetary policies in the U.S., Europe, and Japan will spark a renewed interest in gold: “With the Fed signaling that it is no longer prepared to guarantee global investors a positive return over inflation on their ‘parked’ funds, folks are starting to look for another place for their funds to hang out.”
– A kind of paralysis seems to be taking hold on Wall Street. All hope is not lost, but its wings are clipped a bit.
– I no longer overhear giddy boasts on the street or in restaurants like “After the cross-platform integration with Digilogicom, we’re gonna dominate the entire vertical.” Or “Yeah, we just closed a $30 million mezzanine round, which should carry us to IPO.”
– In fact, I don’t even overhear comments anymore like “I know Cisco’s down a little bit, but it’s a great company, right? I mean, if you’re a long-term investor, like I am, this is probably a great buying opportunity, right?” These days, it’s mostly inane conversations about anything but the stock market.
– It is hard to believe that it was only a little more than a year and a half ago that the Nasdaq put the finishing touches on its $25 million “Nasdaq Marketsite Tower” in Times Square. Meanwhile, Nasdaq Chairman Frank Zarb has been drawing an $8 million-per-year salary for presiding over the Tower’s construction and for doing whatever else Nasdaq chairmen do.
– But now, having spent all this money, the Nasdaq must concern itself with layoffs – lots of layoffs – and with trying to figure out how to make a dollar in a world where people don’t like stocks as much as they used to. The main problem is that the Nasdaq makes a lot less money now than it did during the bubble. In fact, it earned half as much money in the second quarter of this year as it did in the second quarter of last year.
– “I don’t see any respite in sight,” the new CEO, Hardwick Simmons, told the Daily News Express. Bill…
Back to Bill in Ouzilly, France…
*** Here is something interesting. Cleaning up the attic in my house in France, I discovered an old photograph. It is a picture of 5 American army officers from WWI. How it got into this attic, I have no idea, but there it is…where it has probably lain for the last 8 decades.
*** The names are written on the back: C.A. Leland of Atcheson, Kansas; H.V. Hayes of Waco, Texas; R.R. Reimert of Chicago; H.R. Schultz of the Sanford Ranch in Montana, and Dr. R. Arnold, also of Chicago. If any family members would like the photo, I’d be happy to send it to them.