Sucker High

The Daily Reckoning PRESENTS: So…the Dow hit a “new high,” but as Justice Litle points out, more than 70% of the stocks that compose it are well and truly under water. When will Wall Street get a sense of perspective? Read on…

SUCKER HIGH

“Crisis has been averted. Everything is Super.”
-The Simpsons

Sad but true: inconsistency and short-sightedness are virtues on Wall Street.

To be a successful talking head, forget about logical arguments. Sound bites and bullet points are the way to go. The key is not consistency, but opportunism; the goal is to make the facts say what you want them to say.

Take oil, for example. If the price of oil is going up, that is bullish because it indicates strong global demand. If the price of oil is going down, that is supposedly bullish too because it acts as a tax cut for consumers. Never mind that the second argument contradicts the first. If rising oil is bullish because it indicates healthy demand, then shouldn’t falling oil be negative in terms of weakening demand? There are many more subtleties to consider here; the point is that for the talking heads, just about anything oil does is good news. In fact, just about anything at all that happens is good news. To the man with a bullish hammer, all the facts are nails.

When there is an excuse to strut and crow, watch out. Consider the recent
Dow high so many are jazzed about. Clearly a sign of how wonderful things are going, right? Maybe not. Richard Russell, editor of the Dow Theory Letters since 1958, recently noted, “21 of the Dow stocks (71%) are 20% off their all-time highs and 17 Dow stocks (57%) are at least 30% below their all-time highs.”

Hmm. So even though the Dow just hit a ‘new high’, more than 70% of the stocks that compose it are well and truly under water. More amusing still, we last saw these ‘new high’ levels in January 2000 or so. So the Dow is like a man who took a tumble down a flight of stairs, and has taken nearly seven years to climb them again. And of course, if you are a long-term foreign investor, your Dow investment is still a big fat dud. The dollar has given up much ground this decade, making index measurements a rubber yardstick. Hurrah! Celebrate! Champagne for everyone.

In my opinion, we’d all be better off watching cartoons than the big financial networks. These what-me-worry pundits are little more than bobble head dolls, tilting their heads in the direction du jour. They are paid to chatter, not to think.

To understand how a talking head sees the world, imagine a racetrack where you are allowed to change your bet mid-race. If Deuces Wild starts nosing ahead of Miner’s Daughter, you can switch your bet to Deuces. If your nag stumbles and Farmer’s Folly takes the lead, you can switch to Farmer’s Folly. It doesn’t matter that they are completely different horses – or, for the sake of the analogy, completely disparate arguments. The talking head’s goal is to win the race by hook or by crook, even if that means throwing consistency out the window. Of course, ‘winning the race’ in this context has everything to do with making the pitch and looking good… and nothing to do with consistency or providing information of value.

I titled this missive ‘Sucker High’ because I think that is what Wall Street is on right now. All these people jumping for joy are in danger of being just that: suckers without a sense of perspective. The classic kind who are ecstatic when they make a little money… only to give it back in the long run. These suckers cheer on the talking heads, nod obliviously when the horses are switched, and never really seek to understand the game.

The global economy is complex. There are many factors constantly at work. Some factors are more important than others, some are trivial, and many cancel each other out. This makes it devilishly hard to figure out what’s really happening.

But this reality has been abused by Wall Street, in a sort of post-modern fashion, to justify the notion that anything can happen at all. Because it is hard to uncover the truth, talking heads make truth anything they want it to be; Derrida would be proud. Tortured statistics are used to bolster utterly ludicrous statements. Logic is debased regularly. A world in which the indebted consumer can borrow his way to infinity? A world in which cause and effect decouple, where consequences for actions cease to exist? Sure, why not – if the numbers can justify it here and now. Tomorrow they’ll just make up something else.

As Jesse Livermore noted, the speculator’s greatest and truest ally is underlying conditions. At Outstanding Investments, we are confident because we have underlying conditions on our side. They are like the rock of Gibraltar for us. Unlike the bobble heads, we have been making the same handful of arguments for quite some time now – arguments that still very much apply, and will go on applying for many years to come.

Our argument – the Outstanding Investments argument – is essentially two fold. There are long-term global growth trends on the one hand, bullish for energy and resources, and the Austrian endgame on the other, in which bloated Western welfare states must eventually open the printing presses.

There are two ways the current downdraft can play out. If we avoid a global meltdown – that is to say, if the developing world is able to stimulate domestic demand and wean itself off the American consumer in time – then demand for energy at the margins will not meaningfully decrease. Demand will in fact increase along with the new middle class in this scenario. Fossil fuel technologies and new alternative technologies will have to go full out to keep up with demand.

Alternatively, if the American consumer drags the world down, then Western economies will ultimately cower under a crushing overhang of debt. If things get bad enough, forced liquidation will be required, as Ludwig Von Mises predicted a long time ago. The world then chokes on paper, and turns to hard assets for refuge.

There are a number of moving parts at work here, and they are all connected. For example, as the price of oil falls, the petrodollar support of US treasuries falls with it. Long-term interest rates have been held down by the hundreds of billions being recycled into US government securities, as oil-exporting countries awash in cash sought to park their windfall. If that ends, the “sting in the tail” could be higher interest rates… which in turn leads to Austrian endgame pressures.

Another critical relationship is the one between consumer debt and corporate profits. US corporations are bursting with cash, but that is because consumers’ pockets have been voluntarily emptied. The Financial Times notes a similar situation in China; it is not consumer saving, but corporate saving that makes up the bulk of China’s war chest. The talking heads have never bothered to examine this curious point: the biggest run of corporate profits in history and the biggest run of consumer borrowing in history happened at the same time. This is another monster imbalance, with ultimately ugly consequence, that doesn’t get much press.

Those are only two of many considerations, of course. There are many others. But that is why Outstanding Investments has been developing many of the same themes, expanding on the same core ideas, for a good while now. The important elements of the big picture don’t flip and flop from week to week. They develop slowly over time.

My advice? Don’t be cannon fodder. With all thy getting, get thee understanding. Go out there and shore up your mental position with knowledge. Sell down to the sleeping point if necessary, lay hold of your convictions, and then rebuild in a way that makes sense to you. But don’t pay too much attention to the talking heads, the arguments du jour, or the sucker highs.

Regards,

Justice Litle
for The Daily Reckoning
October 5, 2006

P.S. Outstanding Investments is positioned on the strength of underlying conditions that will play out for years if not decades. The weak hands almost always get washed out before the big crescendo, so times like these are no surprise. You want to trade the swings in oil and gold, that’s fine – then trade them. But from a long-term investment perspective, the type of action we see here provides bargains. It allows the patient investor to scoop up assets from the weak hands without staying power… to profit from those who are neither traders nor long-term investors, but conviction less cannon fodder caught in the middle ground.

Editor’s Note: Justice Litle is an editor of Outstanding Investments, ranked number one by Hulbert’s Financial Digest for total return performance over the past five years. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall).

Yesterday, the Dow surged to a new record high, after a record high just the day before.

And the price of gold tumbled…to $566.

What to make of it?

On the one hand, our stock of humility rises. On the other, our gold falls.

We have been in a confessional mood all week. We have owned up to missing the great resurgence of the economy and the stock market. We knew what Greenspan and Bush were up to. But we doubted they could get away with it. But they pulled it off. Now, six years after the Dow peaked…it is still near its all-time highs…and at least in nominal terms, hitting new highs every day.

Of course, readers who ignored our advice to sell stocks in 2000 are still in a losing position, for, even at today’s level, the Dow is nearly 20% below its 2000 high in real, inflation-adjusted terms. On the other hand, readers who ignored our advice to sell stocks in 2002, 2003, 2004, 2005 and 2006 might be forgiven for feeling even huffier. Yes, they probably would have done better in gold…but that’s faint consolation if they didn’t buy it. What’s more, now gold is going down…it’s $150 dollars below its peak for this cycle.

With the Dow going up…and gold going down…some may have begun to wonder if we know what we are talking about. The question crosses our mind also, almost daily. And the unequivocal answer is, “no.” Still, that is what gives us an edge over most market commentators. They don’t know what they are talking about either…but they are not aware of it. The truth is, in the end, all any of us have are theories…ideas…notions…. we cling to like shipwrecked sailors hanging onto a broken mast. If we let go, we’re sunk.

The theory we cling to is that eventually people get not what they expect, but what they deserve. Hard work, honesty, modesty, discipline and forbearance pay off. Always have, more or less. Always will, more or less. In other words, the fundamentals matter.

But let’s look at them. What has changed? Have foreign competitors forgotten how to make things? No. Have foreign laborers thrown down their shovels and soldering irons? No. Has the trade deficit vanished? No. Has America’s debt disappeared? No. Has the stock of U.S. debt obligations in foreign hands diminished? No. Will Ford and GM make cars at a profit next year? No. Will the workingman get a raise? No. Will Congress balance the budget and the Fed back its dollars with gold? No…and no. So what then has really improved?

Stocks are trading at very high multiples of earnings…but at a time when earnings are also at record levels. How much higher could they go? And if you did buy at this level…could the reward really be worth the risk? Ultimately, don’t stocks depend on the economy?

Dear reader, we give you the short answer: Stocks are not a good investment. Not at these prices. That doesn’t mean they won’t go up any more. It just means that it is unwise for you to follow them. There’s more downside to worry about than upside to hope for. Take this little boost as a gift from the gods; sell on rallies.

Having said this, we return to our confession. It is true; we did not expect the market to hold up as long as it has. Our error was one of over-estimating the good sense of our fellow man. He is a bigger blockhead than we ever thought. Given the lure of easy credit, ARMs, and “stated income” lending – he took the bait greedily. Now, he’s on the line for more money than any man in history…with no greater income than he had before to pay it off.

Humility also does not prevent us from pointing out that, appearances to the contrary, we were essentially correct about the boom of 2002-2006. It was a fraud. People did not really become wealthier…they became poorer…ending it with more debt and no more in earnings than they began it. No gains, and already, some pain.

How much more pain remains to be seen, but even Ben Bernanke now admits that housing has begun a “substantial correction.” In New York, for instance, the number of apartments for sale has reached a level not seen in 15 years. This year, prices dropped 2.2% from the 2nd quarter to the 3rd quarter. And at the high end, sales have collapsed 40% from a year ago.

Meanwhile, homeowners will soon begin to show signs of cracking. About 20% of all homeowners in the United States are going to face higher payments in the next two to three years as their complicated contracts start kicking in. In Washington, D.C., for example, interest-only loans account for 28% of mortgages, while subprime loans make up a similar amount. Roughly the same holds true also in Florida. In California, the interest-only loans are even higher, at a shocking 39%.

And on the sell side of things, the numbers are also ominous. Brokers and builders are beginning to hurt.

According to a CNN Money article, during the housing boom’s zenith between 2002 to 2004, membership in the National Association of Realtors (NAR) rose 26 percent so that there are now over 1.2 million realtors on record in the country. But with sales predicted to fall 7.6 percent in 2006, the flood of agents is drying up.

How long can housing and stocks go in different directions, following different rules…as though they breathed different air and ate different bread? Not long, we suspect. If houses are already beginning to climb down from the clouds…stocks, cannot be far behind.

More news, from our team at The Rude Awakening:

————–

Eric Fry, reporting from Laguna Beach…

“Bonds are the new ‘black.’ Suddenly, these boring financial assets have become sizzling hot portfolio accessories…But we suspect this investment fashion is about to become ‘so last season.'”

For the rest of this story and for more market insights, see today’s issue of The Rude Awakening.

————–

And more opinions…

*** Sitting in our favorite café this morning, we watched a big, black GMC SUV try to get through the narrow street. The car is just too unwieldy for a European city. It was built for the wide-open spaces, which Paris doesn’t have.

There is a whole fleet of these black GMCs with dark tinted windows in town. They are owned by the U.S. embassy and other American government appendages…and used by staff to get around town. They were probably meant to be ‘low profile’ vehicles. But no one could miss them. Any terrorist who wasn’t seriously myopic could blow one up.

*** Meanwhile, last week, came more evidence that the Old American Republic is dead. It is a new imperial era. In this new era, we are no longer free citizens, with right…but subjects of the empire. We do its bidding, or else:

On September 27, 2006, Congress voted in HR 6166 into law as the Military Commissions Act of 2006. With lightning speed, a centuries old pillar of the law has been taken down with not a whimper from the mainstream press.

The salient portion of the Act runs:

“No court, justice, or judge shall have jurisdiction to hear or consider an application for a writ of habeas corpus filed by or on behalf of an alien detained by the United States who has been determined by the United States to have been properly detained as an enemy combatant or is awaiting such determination.”

What the act does is give the executive branch the power to declare not just aliens (which would be bad enough) but also U.S. citizens, “unlawful enemy combatants.” Then the state gets to lock you up and throw the keys away.

Anyone who donates money to a charity on a list of “terrorist” organizations, or who speaks out against the government’s policies could be declared an “unlawful enemy combatant” and imprisoned indefinitely now.

Anyone could be convicted on the basis of coerced testimony and hearsay and, without full judicial review of the conviction, be put to death.

And no one could challenge his detention in court.

Habeas corpus is a fundamental right that the state does not have the power to lock you up forever arbitrarily and without review of a court

It is part of the U.S. Constitution. Do you remember that document, dear reader? Most Americans have forgotten it. They think we’re in a ‘new era’ of politics, where the old principles and old rules no longer apply.

But as one group of diplomats wrote to the administration, “To proclaim democratic government to the rest of the world as the supreme form of government at the very moment we eliminate the most important avenue of relief from arbitrary governmental detention will not serve our interests in the larger world.”