Mr. Greenspan must look at himself in the mirror each day. Does the world’s most powerful central banker look tired, he must ask himself? Saving the earth can be hard work, he must observe…with a sparkle in his eye…
But perhaps the Fed chief notices a change. Does he see himself “turning Japanese” a little more each day…as rate cut after rate cut fails to boost the economy…and consumers, investors, and businessmen turn cautious?
In December of 1996, stocks in America reached an unheard of level…nearly 6500 on the Dow. It was a case of “irrational exuberance”, said Mr. Greenspan on December 5th. The next day, stocks recoiled.
Stock market valuations had reached such a high level, that they had out ran imaginations. But soon after, imaginations caught up…inventing a whole cluster of explanations and justifications. A galaxy of “New Era” rationales launched into space. Within days, the astronomers of Wall Street began to discover the distant stars…”the productivity miracle”…”the Peace Dividend”…”the information technology revolution”… “the new economy”…”long-term buy & hold”…and so on. And within days, the stock market rocketed skyward…and didn’t stop until January of 2000, when the Dow hit 11,722 – more than 5,000 points higher
Was Mr. Greenspan alarmed by this even-more-irrational exuberance? Quite the contrary. Thanks to the twinkle of so many New Era stars, the Fed chief was able to see stocks in a new light. In the 4 years from 1996 to the market’s peak in January 2000, he had turned his face to the heavens and become a believer.
Since January 2000, the Dow has fallen as low as 8,235. The Wilshire 5000, as noted above, has lost 40% of its value – a sum estimated at $5 trillion. And the Nasdaq has suffered even worse damage.
But the “New Era” stars still shine in the autumn sky – brightly enough to lead perhaps an entire nation to destruction.
“According to the latest survey of fund managers by Merrill Lynch,” writes Marc Faber in his latest letter, “84% of managers expected higher equity prices within the next year, compared to just 10% who saw lower prices.” Abby Cohen, the permanent bull, has become even more bullish. And Wall Street strategists now advise holding 70% of your assets in common stock.
Star struck investors, such as Mr. Watkins, mentioned above, have stood their ground…even in the midst of war, recession, and a bear market. Stocks have gone down, but there has not been a single day of panic. Mr. Watkins, and millions of others, still believe that a steady hand on the tiller and a close eye on the star of “long-term buy & hold” investing – even through a bear market – will lead to investment success. (He seems unaware that a good navigator needs to recognize the point of departure as well as the destination. Buying stocks at the top is almost guaranteed to be a losing proposition…unless you are as a long-lived as Methuselah. Adjusted for inflation, investors who bought at the ’29 peak waited more than a quarter of a century to get back to where they began.)
And yet, there, half a world away, the world’s second largest economy has enacted “a morality play designed for our edification.” Does anyone bother to watch? Apparently not. While the U.S. was getting better and better – far better than anyone expected – Japan was going in the opposite direction…with an economy that has proved more intractable than anyone could imagine.
“In one way…,” explains Paul Krugman in his NY Times article, “our situation is actually worse than Japan’s. For the past decade, Japan has been an island of depression in a sea of prosperity, its economy stagnating even as other major economies, ours in particular, boomed. That was, you might say, quite an achievement. Our current problems, on the other hand, are shared by much of the world – not the least by Japan itself.”
As long as Americans were willing to buy more than they could afford, the Japanese economy managed to keep growing…though barely. Now, things look worse than ever for the Japanese. The economy shrank at an annual rate of more than 3% in the 2nd quarter of this year. Prices are falling. Banks and huge corporations – kept afloat for years by easy money and the “convoy system” – are in danger of sinking. Unemployment is already 5%… and rising. “If Japan slips into the abyss,” writes Paul Krugman in his NY Times piece, “that will have a direct adverse effect on our economy dwarfing anything the terrorists did.”
But, now, the entire world seems to be slipping into a deflationary abyss. Who will buy Japanese products? Who will buy anyone’s products?
And who will suffer most? Low-cost producers such as China and India…or high-cost producers such as the U.S. and Japan?
Globalization is a great thing during a business expansion. It extends the division of labor…allowing for more specialization and lower cost goods and services. A company in Cleveland, for example, opens a manufacturing plant in Bangladesh to supplement its U.S. production facilities. Everyone benefits – consumers get lower prices, Bangladesh gets capital investment and employment, and the U.S. company gets higher profits.
But when profits are squeezed, the Cleveland company may have to close one of its plants. Which one will it shut down…the one in Bangladesh that exploits workers at $2 an hour? Or the one in Cleveland that is exploited by workers at $20 an hour?
Another difference between Japan and the U.S. is that Japanese householders never abandoned their saving habits. Even at the very height of the Japanese mania, when the Nikkei Dow was near 40,000 and confidence had reached epic levels, savings rates never fell below 12%. In America, savings rates at the peak of confidence dropped below zero…and presently hover around the 1% level.
So at least the Japanese could face their downturn with more grace and equanimity than Americans. They had savings upon which to fall.
Still, who knows what will happen? Nature, with her sense of poetic symmetry, could insist that we Americans follow the Japanese script. Mr. Market, more mischievous and destructive, may even add a more desperate scene or two.
And Mr. Greenspan, if he still has his wits about him, is sure to observe a moment of confused silence as the Dow reaches his point of “irrational exuberance” – and regret that he did not retire when his popularity was at its peak. He is an old saxophone man, after all. He must know that you should stop while the crowd still wants more.
Perhaps he will pick up his old speech from years ago…shake it to get the dust off…and recycle it. “The market is reacting,” he will say, “to irrational desperation.”
Then, the skies will cloud over…and the market will fall another 50%…
Your correspondent…watching the stars…
P.S. When the Dow crosses the 6,500 mark on the way down…peoples’ imaginations will go back to work. Soon, they will discover a new cluster of stars…reasons why stocks are doomed to fall even further…and why the world economy will never climb out of the abyss. It will be a “new economy,” they will say…in which the dollar is doomed, economies are ruined…and stocks will never recover.
Then, a new boom can begin…
The cannons boomed Sunday…and again last night. And the stock market stood its ground…more or less. No panic. No euphoria either.
Investors are still “hanging in there” – even as the economy goes sour and the Wilshire 5000, the broadest measure of the stock market, has fallen 40% from its high.
“We are depressed about the news and about what happened,” says Paul Watkins, member of an investment club quoted in the Philadelphia Enquirer, “but we are confident the market will rise again, like it always does. Once you get yourself to accept that this is real, you have to look at what will happen in the future.”
I don’t know what that last sentence means. But I feel a little sorry for these poor naifs. Mr. Watkins said that his portfolio has grown 11%-12% a year since he joined the club in ’84. He can’t walk away from that kind of growth, he says. “And however it goes, whether there’s full-blown war or recession,” he went on as if he had a clue, “(the economy) is going to come back, because people are going to need the same goods and services.”
Yes, they will need goods and services…but not necessarily stocks at 30 times earnings. Mr. Watkin’s group’s latest purchase included shares of GE – which fell another 2% yesterday.
Eric, what else happened on Wall Street?
Fry in New York:
– Considering all the obstacles that the stock market faces these days, it looks like it’s performing pretty darn well. Looks can be deceiving, of course. A dead cat only bounces so high, and then it falls right back down.
– The Dow fell 52 points yesterday to 9,068. The Nasdaq gained a sliver to 1,606, but these stocks seem to be lacking their recent elan – they’re “trading heavy.”
– Maybe it’s the gunfire in Alaska – not in Afghanistan – that’s weighing on the market. “Get this, a 37-year old drunk with a high-powered rifle caused the second- largest oil spill ever in the Alaskan pipeline on Friday,” observes the DR Blue’s Dan Denning. “The single-gunshot wound to the pipeline effectively shut down one-fifth of all domestic U.S. oil production.”
– The pipeline is reportedly built to withstand gunshots. “It has an outer coating of galvanized metal, four inches of insulation, and a half-inch of steel,” says Denning. “But that wasn’t enough to stop a bullet from a .38-caliber rifle. Let me ask you this, if a drunk with a rifle can halt 1/5th of U.S. oil production with a single bullet, what do you think a couple of sober terrorists could do with a rocket launcher?” Hard to say, but it probably wouldn’t be bullish…except for defense stocks.
– Continuing recent trends, defense stocks like General Dynamics, Lockheed Martin, and Raytheon – maker of the Tomahawk cruise missile – all jumped to new 52-week highs yesterday. Meanwhile, hotel and lodging stocks slipped ever lower into the slough of despair.
– “I’m sure we are in a recession, probably a relatively deep and extended one,” Warren Buffett proclaimed last week, “but [recessions] are part of business life and we are prepared.” That’s all well and good for Berkshire Hathaway and Warren Buffett, but what about the rest of us? If I had a few billions of dollars stashed away for a rainy day, I’d feel “prepared” too.
– But as The Daily Reckoning highlighted yesterday, “savings are meager, debt is abundant.” Most of us are a little light in the rainy day funds department.
– “The first half of ‘stagflation’ is upon us – a stagnating economy,” writes Outstanding Investment’s John Myers. “What remains to be seen is whether inflation comes to bear. Certainly some of the precursors are present: the Fed playing fast and easy with the money supply and the threat of rising oil prices (which cannot be dismissed given the geography of the current conflict)…rising oil, rising energy… inflation.”
– “Stagflation,” in Myers’ opinion, “would deliver mega- money making opportunities to resource investors. Raw resources are every bit as underpriced today as they were in the 1970s. If just a fraction of the money from the bond market were shifted to hard assets, prices would skyrocket!”
– Mortgage refinancings to the rescue?! Now that 30-year mortgage rates have fallen to within 1/4 point of a three-decade low, homeowners are flooding into mortgage banks to refinance their home loans. The Mortgage Bankers Association of America reports that in the week ending Sept. 28th, refinancing activity soared to the second largest volume week in the twelve years that the Association has tracked it.
– “The latest burst of activity is effectively a boom on top of a bloom,” USA Today reports. “On the strength of the first nine months, the mortgage industry has already anticipated a record year: $1.65 trillion in originations.”
– It is tempting to shake our heads at all these heavily indebted consumers who are sucking the equity out of their houses. But maybe they are little smarter than we are giving them “credit” for. If you borrow money against your home at 7% and use part of the proceeds to pay off credit card debt costing 19%, the pretax return is 12%, guaranteed. Where else can you get a certain 12%?
– Oh…how nice. America’s new saving ethic. Time was, millions of Americans would borrow funds from their credit cards at 19% to invest in a stock market that seemed all but certain to produce 35% returns each and every year. Those were the days.
– How about you, Bill? You going to refinance the chateau to pay off your Visa cards?
Bonner back in Paris:
*** Hmmmm…thanks for the suggestion. Maybe I should refinance it twice…just to be safe. I can borrow at the lowest rates in 40 years. Shouldn’t I load up on debt while I have the chance?
*** But wouldn’t it be just like that crafty Mr. Bear…and that unforgiving Mademoiselle Nature…to drop interest rates even further, after I had refinanced…and maybe send the economy into an even deeper decline?
*** S’pose our own Alan Greenspan-san follows the trends set by his Japanese counterparts…and cuts rates to zero? And s’pose consumer prices fall just as they have in Japan – making debt even more of a burden? And s’pose business goes bad so I can’t afford to keep up with the payments?
*** No, Eric, this looks like a good time to own debt rather than service it. With a little luck, the U.S. economy will follow the Japanese model…interest rates will go to zero. Debtors will go bankrupt and bonds will soar. Buy bonds. Sell GE.
*** Besides, a man doesn’t want the banks to foreclose on his chateau in the middle of a depression…
*** Meanwhile, a housekeeping detail – Addison tells me cyber punks from Russia(!) seem to be causing mischief with our e-mail. Daily Reckoning transmissions have been disrupted. We thought about sending in missiles, but decided to negotiate…stay tuned.