The Big Ugly

The Daily Reckoning Presents: A Guest Essay, in which Dan Denning offers some thoughts on the post-attack investment environment…


Into this neutral air

Where blind skyscrapers use

Their full height to proclaim

The Collective Strength of Man,

Each Language pours its vain

Competitive excuse

But who can live for long

In an euphoric dream;

W.H. Auden, September, 1939

Autumns sunsets in Manhattan are surreal, almost ethereal. An old film professor of mine called it “The Golden Hour” when the light from the setting sun would cause the entire New York Skyline to shimmer. It made New York look like El Dorado and the City on the Hill all at once.

Remember that look.

It will return someday. But it could be awhile. For the last 15 years, that look of golden resplendence was the image of America itself. We bathed in good fortune and prosperity. We were gleaming and unassailable, and the future was always ahead of us.

Today, eight days after the attacks on the World Trade Center and the Pentagon, we’re beginning to find out that our world wasn’t as invulnerable as we thought. The question now is: what’s next?

My aim today is to try to decipher what’s ahead in the investment markets and, if possible, to help you figure out what to do with your money. In future issues of The Daily Reckoning we will no doubt have a lot to say about America, terrorists, the war on drugs, Bill’s gardener, the bible, Alan Greenspan, and the like.

But today, let’s take a few minutes to lay out what you might expect if, in fact, the investment climate in America has changed.

First, you can expect to see more volatility and big swings. As I mentioned to you last Friday, the Dow was certain to crash on Monday’s opening in response to pent-up selling pressure around the globe. The Dow’s biggest ever one-day drop on Monday is not the end of the selling, but the beginning.

There will be mini-rallies in certain groups of stocks, defense for example. But even before last week’s attacks, it was getting harder for investors to make money in publicly traded U.S. stocks. At 26 times earnings, the S&P 500, even after a horrendous year, was still selling at a higher P/E than the peak of the great bull markets in 1929 and 1964.

And after declining from 180% to around 120%, the ratio between the total capitalization of stocks and GDP was still over two times as large as its historical average. For stocks to return to their normal value in the economy, they’d still have to decline by another $8 trillion dollars.

And even before last week’s attacks, the U.S. economy was at the end of a long cycle of prosperity. As with all other cycle ends, our economy had turned into nothing more than a circus. By the end, we had spent years overconsuming, overproducing, under-saving, and under-investing in businesses that created real wealth.

Is the U.S. slated for a 17-year bear market like investors saw in 1929 or 1964…or like the Japanese are seeing now? I don’t know. But I will say this – even if this down-cycle is half that long, or even just one quarter, you will have a very tough time making money being long on the major U.S. stock indexes.

Don’t get me wrong. All is not lost. Many investors will remember that while there was no bull market in U.S. stocks during the ’70s, gold, precious metals, and oil did quite well.

And even when there’s no bull market in U.S. assets, there is usually a bull market…somewhere. Latin America and Asia in the 80s; real estate at various times (but probably not right now); the Swiss Franc and the D-Mark back when the dollar was not King of the World.

“Money” seeks the highest return – no matter what’s going on in the world. Markets aren’t patriotic. As an investor, it will not pay to mix your emotions with your money. The bull market in the U.S. is over just as surely as the World Trade Center no longer stands.

You can wait, like the Japanese have for years, for some mythical event to turn things around. Another rate cut, increased government spending on military projects, the rebuilding of New York, all of these will be trotted out as reasons why the “bottom” is in and it’s time to be long stocks again.

Meanwhile, the primary trend of the market will remain bearish. And if you can afford to make 1-2% on your money over the next 20 years, then investing in the indexes should suffice.

But if you can’t afford to hold on to U.S. stocks while they return to historic multiples of earnings and go nowhere, you do have real options.

Readers of the DR Investment Advisory are positioned in several gold companies, several bond funds, and a select few U.S. stocks with stockpiles of cash. Expect to see the investment world get much more conservative and start rewarding unspectacular but safe investments.

We’re also long on a few foreign stocks that have strong natural resource businesses. If there is inflation in commodity prices due to the Fed’s rate cuts, we think these businesses will do quite well, and investors will flock to them, driving up their share prices.

As speculators, we continue to sell the dollar vs. the euro. The dollar too, has been in a long, unsustainable bull market. And already we’ve made triple digit returns selling it short via futures options.

Prior to Tuesday’s attack a correction of historic proportions was already bearing down on the U.S. stock market. It’s possible that the time-frame has now been accelerated. I say this not to make a grim situation worse. I say it to point out that you have a critical dilemma facing you as an investor.

There is much you can do to compensate for the slumber of U.S. equities. But unless you accept that the bull market is over, I believe you will find a very nasty investment climate, indeed.

Until that day when we bathe in good fortune again,

Dan Denning,

for The Daily Reckoning

Daniel Denning is the editor of the Daily Reckoning Investment Advisory. If you are not already a Bluesubscriber and are interested in the investment recommendations referred to in this article please click here:DR Blue

There is always some leveling circumstance…

Richard Branson has led a charmed business life since he launched Virgin Records more than a quarter of a century ago.

But Forbes estimates that Branson has lost $1.1 billion – or about half his fortune – since early 2000. Now, the worldwide airline industry crisis is hitting him hard. His only really profitable business is Virgin Atlantic, which has been forced to cut back drastically. “Atlantic losses could bring Branson empire down,” warns The Times of London.

Airline stocks are crashing. But so are other stocks. And the economy seems almost certain to fall into the long awaited recession.

But what about real estate? “Inventories of high- end houses are rising and some sellers are having to trim their asking prices,” reported the New York Times news service last week, describing the real estate market when the WTC still stood.

But rates have been cut another 50 basis points. Will that give housing another boost? A guess: not likely. The public mood is changing in America. “It’s a war-time economy, stupid,” says Marshall Auerbach of Prudent

Do people buy new houses in times of war…even strange, new wars? Stephen Roach, writing from Paris: “History tells us that blows like this instill a sense of fear, caution, and retrenchment that puts all but the most essential spending plans on hold.” Consumer sentiment – bruised and tender – is turning against big new houses with big new mortgages.



Eric Fry in New York City:

– Stock-buying patriots made themselves scarce on Wall Street for the second day in a row. The stock-selling patriots held sway. Stocks managed a small bounce early on, but slid into the red by day’s end. The Dow fell 17 points to 8,903, while the Nasdaq slid another 1.5% to 1,555.

– Nasdaq 5,000 seems like a very, very long time ago. Not much of anything gained ground yesterday. The 30- year Treasury bond lost nearly two points. (For you folks in the stocks-only crowd, a 2-point T-bond loss is about as severe as a 300-point loss on the Dow). Gold and oil also gave ground. December gold fell by $1.80 to close at $289.70 an ounce. October crude fell $1.11 to $27.70 a barrel.

– However seductive the idea that sheer patriotic fervor can power financial markets higher, we are discovering that earnings growth and underlying values are better goads to share prices. But didn’t we already know that?

– Last Saturday, New York Post columnist Bruce Bartlett urged, “[D]on’t let the terrorists win by showing that they got under our skin, that they frightened us, rattled our cages…I say ‘buy.’ Buy stocks – any stock – the company is unimportant.”

Dear Bruce,

The company IS important.

Eric J. Fry.

– Patriotism is an absolutely essential national virtue. So is investing wisely. They needn’t be mutually exclusive. But neither must they be joined at the hip. In short, there is nothing unpatriotic about selling bad stocks. It is safe to say that America did not create the world’s greatest economy and the world’s most powerful army by investing its financial and human capital unwisely.

– A successful hedge fund manager e-mailed me yesterday to say, “In my mind, selling stock to attempt to best manage your private affairs, is not a patriotic issue.” He’s got a point. Isn’t selling simply one half of the investment process?

– Of course, there is a world of difference between profiteering and investing wisely. Concerning the former, stories of Osama bin Laden, the terrorist- capitalist, are now gaining credence. Bloomberg news reports, “Trading skyrocketed in options that bet on a drop in UAL Corp. and AMR Corp. stock during the days before terrorist crashed hijacked United and American airlines jets into the World Trade Center and thePentagon.”

– Similarly, there was extremely heavy put-option buying on the shares of Morgan Stanley Dean Witter & Co. immediately prior to September 11th.

– Whoever purchased these various options made millions of dollars. Authorities hope that these apparent “insider trades” will lead them to other terrorists affiliated with bin Laden. “I suppose from [the terrorists’] standpoint,” Columbia University law professor John Coffee told Bloomberg News, “they’re trying to pay for future terrorist activities by profiting from their past terrorist activities.”

– Lynn Carpenter, who is not a terrorist, but who is the editor of both the Fleet Street Letter and the Contrarian Speculator, recommended buying put options on Morgan Stanley about two weeks before the World Trade Center tragedy. Those who followed her advice more than doubled their money.

-Yet, immediately after trading resumed on September 17th, Lynn apologetically urged her readers to close the position and to seek no additional profit from Morgan Stanley’s misfortune. Lynn says readers e-mailed to praise her character. They’re discovering what the rest of already know… Lynn is a woman of the highest integrity.

– We investors sometimes forget that the stock market is primal. It neither cares who suffers, nor who lives well. As we mourn the thousands of lost lives and the thousands more who will forever suffer the loss of lovedones, we do not assuage our grief by investing unwisely.

– If Cisco was a sell before last Tuesday (we think it was), it remains a sell now. Conversely, “if Consul Energy was a buy before last Tuesday,” writes John Myers, of Outstanding Investments, “it remains a buy now. In fact, if anything about the stock market has changed, it is that stocks like Consul Energy might be even stronger buys.”

– War or peace, the world will need Consul Energy’s coal along with all the other tangible commodities that enable a country to build, or to rebuild, or yes, even to wage war.


Back to Bill, now in London:

*** I must be hitting some raw nerve lately. “Take me off of your list immediately,” wrote one DR reader. “I can’t stand your doom and gloom attitude. This is a time to spread optimism, not pessimism.”

*** “I know this is a purely emotional response on my part,” admitted another, “but after reading this, I’m actually ashamed and embarrassed to be a subscriber.”

*** No doubt, it is an emotional response. But what emotion? Perhaps it is my scornful attitude to a “patriot rally” that triggers such disgust. Perhaps it is the mocking tone…or the irresistible schadenfreude of seeing the myths of the New Era finally exposed.

*** The Daily Reckoning is a free service, of course. Free in the sense that readers do not pay to receive it. It is also free in the sense that readers may come and go. And free, too, in the sense that I feel I can write what I really think. Since readers do not pay for it, I feel no obligation to write what they want to hear.

*** Still…this is also a business and it must be bad for business to offend customers. So, tomorrow, I will try a different approach. I will describe the world as we would like it to be. I promise.

The Daily Reckoning