Rotten Apples: $900 Million a Bushel

Dow 14,000…we barely knew ye.

Yesterday, the Dow headed down again…losing 146 points. This follows a few days last week when it went down 580 points…making July the worst month for U.S. stocks in three years.

But now, we’re in a new month. Stocks are dropping. Will they continue to drop?

Oh…dear reader…you know better than to ask us that. If we knew the answer we’d be borrowing millions in yen in order to speculate. Heck, we’d start our own hedge fund and charge 2 & 20…no, 3 & 30. We might even be tempted to charge for The Daily Reckoning!

But no, we continue to offer these humble insights and reflection at the price they deserve. Because, alas, we are mortal too – just like you. And it is not given to man to know his fate…or the fate of his Dow Jones Industrials.

Besides, it doesn’t matter to us whether stocks go up or down. We’re not speculators. We’re moral philosophers and kibitzers. We believe you never get what you hope to get…nor even what you expect to get. You get what you deserve. And even if you don’t get it, you ought to. And you ought to believe you will get it, even if you don’t.

In the words of Doug Casey, who was a speaker at last week’s Agora Financial Investment Symposium, “Whatever is going to happen will happen…just don’t let it happen to you.”

In other words – position yourself in a way that you are protected from whatever is around the bend. Doug has a lot of insight into how to properly pad your portfolio.

Well? What is it? The beginning of a correction? The end of a bull market? The end of a rally in a bear market?

Over the long run, investors have judged stocks to be worth about 20 times earnings, on the high side…and about five times earnings on the low. This implies an earnings yield between 5% on the low side, and 20% on the high side. People have traditionally wanted yields (or, implied yields…investors don’t normally receive 100% of a company’s earnings in dividends) from stocks higher than what they would get from bonds or from current accounts. Why? Because stocks are inherently risky. Most people nowadays would say that they are inherently “volatile,” but that’s not the same thing.

Volatility is a type of risk. Stock prices go up and down, depending on what mood the voters are in. Sometimes they are fearful and won’t pay more than 5 to 10 times earnings. Sometimes, they are greedy and hopeful…willing to pay 20 times – and more – for a stock (because they think it will go up). This movement in prices makes stocks unreliable. If you need to pay your child’s college tuition and the stock market has just corrected 30%…it is small comfort to know that in 5…10…or 20 years stock prices might be back to where you got in. In the past, investors demanded a little extra compensation from stocks to make up for this inconvenience and uncertainty.

But then, after a period in which stocks have been stable and rising, the voters forget about the premium. They begin to think that stocks have been under-priced in the past, because past generations of investors weren’t very smart. They run up stocks to the point where bond yields are actually higher than earnings yields…that is, to the point where the premium for volatility has disappeared. Then, in Mr. Market’s own sweet way, stock prices suddenly go down…and investors wish they hadn’t been so bullish.

There is also risk of another sort – real risk. The real risk is not a feature of the voting machine; it is the harsh judgment of the weighing machine. Sometimes stocks go up. Sometimes they go down. Sometimes they go away.

That’s why some investors – those that aren’t afraid of a little risk – have learned the art of trading options. We say a ‘little’ risk because with options, your risk is limited to the amount you choose to invest. You can buy one option contract for as little as $100… or buy hundreds at a time. It depends on how much of your money you want to risk. Yet the upside profit potential of any investment is virtually unlimited…just ask Steve Sarnoff, our resident options guru.

We bring up the topic of options, though, because in today’s volatile market, options offer you the opportunity to make solid profits in rising or falling markets – and off of good companies and bad ones.

A stream of interest earnings from a bank…or a bond…or the Treasury is not guaranteed. But it is usually much more sure than a stream of income from a business. In the short run, anything could happen that could affect business earnings. In the long run, everything does. Businesses go bankrupt, lose their competitive edge, miss important innovations, mis-invest, run out of money, are embezzled and mismanaged, become obsolete, and fail. Some fail every day. All fail eventually.

*** A reader writes: “The American people and the people of the world stand behind the dollar. So do not say the dollar has no backing.”


Americans are not all sinners; but neither are they all saints. Like every other race, they will support their paper money as it suits them to do so.

One of the most remarkable trends of the past 10…20…years has been the build up of dollar credits overseas. That is, people who live in foreign countries and who speak foreign languages and who often worship foreign gods, control trillions worth of dollar assets. These dollars – whether dollar bills or U.S. Treasuries – are essentially claims against U.S. wealth.

For the last 30 years – more or less – foreigners have been eager collectors of these claims. They pile them up in central bank vaults and stuff them into mattresses. Drug dealers use them. The oil industry uses them. People selling houses in South America quote prices in them. Year after year, foreigners have taken in more dollars than they’ve spent.

But imagine that the foreigners should become net sellers of their dollar positions. Or, to put it another way…suppose they want to cash in all those dollar I.O.U.s they’ve collected.

From memory, net foreign claims against U.S. assets now total something like $3 trillion – equal to about a third of U.S. GDP. What will Americans do? Give the foreigners a quarter of their entire national output? Will the yanks and yahoos stand firmly behind their currency…cutting back on their own standards of living so they can pay off the foreigners? Or will they simply react in the time-honored tradition of scoundrels – by creating more dollars out of thin air?

What do you think, dear reader?

Until tomorrow,

Bill Bonner
The Daily Reckoning
August 1, 2007

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:

Empire of Debt

And now…some views from Short Fuse in Los Angeles:

*** As if to answer the above reader mail, Dan Amoss writes in today’s guest essay,

“The shift from bonds to stocks should only grow over time as these funds slowly realize that holding U.S. dollar-denominated bonds until maturity means holding the bag in the U.S. dollar’s inflationary endgame. The rest of the world already has far too many U.S. dollars. They are constantly getting flooded with more of them, and they are certainly going to take action that’s in their best interests.”

*** The crude price settled at $78.21 yesterday, and although some point to the Nigerian kidnapping and the possibility of a decline in inventories, by and large, the rising price has left analysts scratching their heads.

There is no real “smoking gun”…no hurricanes, geopolitical strife or refinery shutdowns. However, a few people are making the connection between high oil prices and the energy priorities of the House Dems, who are releasing their new energy bill on Friday.

House Minority Leader John Boehner, R-Ohio says:

“It’s ironic that the price of oil would hit a new high in the very same week Democrats intend to make far less of it available for production in America.”

Of course, we haven’t seen the bill yet, but the Washington Post reports that the bill will be imposing close to $16 billion in additional taxes on oil companies over a ten-year period, and they will use that money to “promote renewable energy programs and energy conservation and efficiency.”

Now, when someone mentions “renewable energy”, your mind immediately goes to ethanol…in fact, the investors are dumping money into ethanol investments left and right.

“Last summer, you could still make a buck processing ethanol,” our energy guru Byron King tells us. “$1.06, in fact. That was the average bottom-line profit for ethanol producers, when corn still sold at $2 a bushel and oil was up over $70 per barrel.

“Today, with oil and corn prices at all-time highs… the net is around 3 cents!

“Does that sound like a good business to invest in?”

Byron has found much safer – and more profitable ways – to play the energy markets…including a recommendation in the $15 billion solar industry:

The New Power Revolution

*** Addison headed over to Washington to shoot an interview with presidential candidate (and DR contributor) Ron Paul.

“I came to Washington in 1974,” Paul told us yesterday,  “because I had seen the collapse of Bretton Woods and no one in Congress was making the case for coherent economic policy.”

We asked him what it was like to be such a lonely voice for reason on Capitol Hill. “I’ve been that lonely voice for over 30 years,” Paul replied. “But I knew what I was getting into. I may not have very many friends here in Washington, but when I go home, I’m surrounded by my family and a great set of friends and supporters.”

“Do you really expect to win the bid for the presidency?” we asked. “Or is it that you hope your candidacy will inject your ideas into the national debate.”

“Of course, I hope to win,” he said. “If you join a race, you had better be in it to win, or you’re just wasting everyone’s time. Your own time, your supporters’. The people you know will vote for you. If in the end we can influence the national debate, so much the better. When I ran for Congress in ’74, it seemed like a long shot, too. But now I’ve been here for three decades. Most other people come here because they love power. I’m here to make sure Congress upholds the Constitution. It’s a rare argument in Washington, but an important one all the same.”

“When I talk to young people around the country, I’m highly encouraged. Young people get it. They don’t expect the government to provide for their health care or their retirement. They don’t expect the government to give them jobs. To young people, the idea of liberty makes sense.”

There’s no more economically literate speaker in Washington than Ron Paul. We’re thankful he agreed to the interview yesterday. And even more so, he’s invited us to join him at the Liberty Caucus, a luncheon he hosts in his office in the Capitol on Thursdays while the House is in session. Should provide some rare and unique insights for our readers this fall. Look for them…

*** And on a final note…

Wow. OK. The response to the “new” DR is overwhelming, to say the least. Thanks to everyone who wrote in with their comments. Let’s clear a few things up:

1. Bill is NOT going anywhere. He is still writing each and every day – we couldn’t stop him if we tried.

2. The guest essay will still be available to you – just not in its entirety. There will be a link to the guest essay in each issue. That way, we cut down on length, but you still have the option of reading the essay.  (See above…)

3. We agree – yesterday’s font was too small. Just one of those little glitches we were talking about.

Thanks to everyone who chimed in!

Short Fuse
The Daily Reckoning

The Daily Reckoning