Smells like Desperation

Something stinks in the stock market. Marc Faber explores the impact of America’s decline in excess money.

For the last few months, we have argued that U.S. economic growth was more likely to disappoint on the downside than surprise on the upside. We therefore recommended initiating trading positions in long-term U.S. government bonds, which were at the time oversold and almost totally out of favor. We also felt that, contrary to expectations, a weakening U.S. economy was likely to strengthen the dollar, as the foreign exchange market would begin to discount trade and current account deficits, which were likely to be less ominous than was widely expected. Our view was largely based on the sharp deceleration in the growth of U.S. monetary aggregates.

The 12-month rate of growth in M2 is, at 3.6% year over year, at the lowest level since 1995. As a result of the decline in the rate of growth of money supply, "excess money," as defined by the growth in money supply in excess of nominal GDP, has also plunged over the last 18 months

The impact of decelerating money supply growth is not only leading to disappointing economic growth figures, but usually also precedes a poor, or at least indifferent, environment for equities. As our friend Gerard Minack of ABN AMRO explains, "When there is too much money around, it often works its way into asset prices – which is why high levels of excess money growth usually lead to strong equity markets. Conversely, when excess money shrinks, it usually bodes ill for stocks."

Decelerating Money Supply Growth: The Euro is Worse

On the other hand, for as long as money supply growth continues to be muted and, ideally, decelerates, the U.S. dollar has further recovery potential. And while I admit that I cannot see anything particularly positive about the U.S. dollar, I feel that the euro has, for now, even worse fundamentals and could, as a result, break down against the dollar.

With regard to bonds, we continue to be reluctant holders of U.S. dollar bonds. Bonds are no longer oversold the way they were two months ago, but should the economic news continue to deteriorate, as we expect, a further simultaneous advance with the U.S. dollar seems likely. The deceleration in money supply growth, negative real personal income gains, uninspiring employment gains and the end of the impact of the tax cuts are all bringing about a deteriorating consumer environment, which is evident from a slowdown in the growth of retail sales and now also, for the first time, some deteriorating trends in the housing market.

In addition, weakness in consumer durable stocks, such as General Motors, and the ultimate discretionary spending beneficiaries, such as Coca-Cola and Starbucks, as well as the recent collapse in the shares of Krispy Kreme certainly don’t augur well for consumers’ staying power or for the entire stock market! In fact, what I find most remarkable about the most recent weakness in consumption is that this weakness coincided with another upside explosion in consumer loans. To me this smells like desperation!

Given these unattractive fundamentals, I would use any strength in equities as a selling opportunity. Still, I am also reluctant to be overly negative about equities and to sell them short too aggressively. I am concerned that parties interested in a Bush election victory, as well as the momentum players, might have another attempt to push stock prices higher, which in the present low-volume environment might succeed – at least for a short while.

Decelerating Money Supply Growth: Commodities

Turning to commodities, we note that some prices have come off rather abruptly. Soybeans are a good example of what happens when the Chinese suddenly step aside from their normal buying pattern. Of our recommended breakfast commodities, sugar and coffee have recently entered a correction phase. (Coffee, however, seems to have again stabilized and is likely to resume its bull market.) In the meantime, it looks as if orange juice has made a major low and we would use any weakness to add to positions.

We still remain confident that oil prices will rise in the long run, as demand is likely to continue to increase, while supplies will level off or decline. However, prices may have temporarily overshot, and some caution is in order. Oil shares have not confirmed the most recent strength in oil prices, and this negative divergence should raise some concerns about the potential for immediate further price gains.

In general, I see limited opportunities for large capital gains with low risks. For me, being at best just an average investor, there are far too many insiders and smart people operating in the financial markets. In this environment, it is difficult to take advantage of any inefficiency without exposing oneself to undue risks.

As most of my readers will know, every year, I visit numerous financial institutions and attend quite a few conferences. As a contrarian, I am always interested in the most frequently and least frequently asked questions. During the last three years, I have never been at any conference or company presentation at which a question was raised about Africa! I was recently in South Africa and was actually surprised by how well the transition from apartheid to black majority had worked. And I was quite interested to hear about the numerous positive developments on this largely overlooked continent, which will be one of the prime beneficiaries of rising commodity prices and of trade with China.


Marc Faber,
for The Daily Reckoning
October 12, 2004

Not only did the September new jobs report come in more than 50,000 short of expectations, the number crunchers also revised August figures and lost another 16,000 paychecks. It is unusual for revisions to go negative in an election year; generally, the numbers are recrunched into a more appealing shape, under pressure to re-elect whichever party is currently in office and in control of the crunchers. But sometimes the statistics don’t cooperate. Sometimes it is the statisticians.

What’s more, more than a third of the jobs created in September were the sort for which the term "gainful employment" hardly applies. They were jobs with the federal and local governments, the sort of jobs that drain away both capital and labor, rather than put it to productive use.

If this were a "normal" recovery, points out The Liscio Report, by way of Barron’s, the nation would have 9.3 million more jobs. The new jobs would be providing new income, which could be used for new purchases. Instead, the economy bumbles along – with more and more people going further and further underwater and counting on their houses to bail them out.

In September, Barron’s reports, "Even though the population grew by 264,000, the labor force shrank by 221,000. Over the past year, it has expanded less than half as rapidly as has the population and a mere one-third of the rate it enjoyed from 1990-2000."

Jobless recovery? Jobless it is. Recovery it ain’t.

Until now, it hasn’t mattered. Stocks have refused to go down, and houses have refused to stay put. In some hot spots, they’ve been going up from 20-30% per year since 2001. This, along with tax cuts and increased government spending, has provided consumers with enough rope to hang themselves. Mortgaging their houses, they were able to "take out" equity equal to a 6% after-tax pay increase last year.

But now, consumers are showing signs of wearing out. Jobseekers appear to be giving up. And Japanese and Chinese central bankers might have eased off. In light of the employment figures, Greenspan & Co. might be tempted to pass on the next rate hike. They have pledged to "normalize" short-term interest rates by moving them up to where they think they should be – around 3-4%. A weak economy will make them think twice. Then again, if foreigners are tiring of buying U.S. debt, they may have no choice but to move up rates. Like every other debtor in America, they will need the cash.

Stuff might begin to happen, in other words.

More news, from Tom Dyson in Baltimore:


"It’s all about the odds, isn’t it? Buying equities now is like pulling for that inside straight – not profitable over the long run. Investors had better pick their moment…"


Bill Bonner, back in London, with more views:

*** An Englishman has been done in by debt. "Dereck Rawson committed suicide in May after amassing 100,000 pounds in credit card debt," reports the Daily Express.

"Another recent high-profile case involved a penniless pensioner with 20 cards who suffered a mental breakdown brought on by the stress of a 30,000 pound debt," continued the Express. Apparently, the old man was perfectly at ease having no money.

The news prompted credit card companies to agree to a voluntary program of credit restraint. Swapping information on their customers, they agreed to limit each client to a maximum of six credit cards.

*** Old friend Doug Casey tells us that the government of Argentina is adding to its gold reserves. "The purchase is significant because before the most recent Argentine crisis, their central bank kept 100% of their reserves in dollars. This proved disastrous when the dollar stumbled from mid-2000 to early 2003 [when their reserves bottomed out at $8.3 billion]."

What the Argentines don’t know about worthless currencies is probably not worth knowing. They must "see the handwriting on the wall when it comes to the U.S. dollar," Doug writes.

*** "Church reviews its policy on ethical investments," reads a headline in today’s Daily Telegraph.

The Church of England has been unwilling to invest in weapons, pornography, gambling, alcohol, tobacco or newspapers. We understand about the newspapers; why encourage people to waste their time? But why the Church would have a position against tobacco is a mystery.

Still, the Church of England takes a flexible view of vice, at least where there’s money to be made. Church commissioners "are reviewing their ethical investment policy to ensure that they are maximizing their returns," says the Telegraph. With 3.9 billion pounds to invest, there is a lot of money at stake. Commissioners say their policies have cost the Church an estimated 70 million pounds over the last 6 1/2 years. Church finances are said to be in a "parlous state," requiring cutbacks of clergy posts. Commissioners say their policies may have been "overscrupulous."

*** "Any fool can be brave on a battlefield," said Ashley Wilkes in Gone with the Wind.

On the other hand, alone, in the dark of night, even breathing can take courage.

Christopher Reeve, RIP.

The Daily Reckoning