The Curtain Rises

We still wonder…

What’s so different about this recovery? What was so different about the recession? Couldn’t it turn out to be not-so-different after all?

Act I was different. In the recession-that-no-one- seemed-to-notice, business investment practically fell off the stage. "The drop in nominal corporate earnings during the recent so-called recession has been one of the worst experiences of the last half century," according to Contrary But consumers paid no attention…

"All previous postwar recessions were of the so-called ‘garden-variety’ pattern," writes Richebacher, "in that they mainly reflected a temporary inventory liquidation. Once this had been accomplished and the Fed eased in response to lower inflation rates, the economy promptly took off in a steep trajectory."

Businesses and consumers typically responded to easier money by asking for it. Consumers bought the cars and the other large-ticket items they’d been eyeing in shop windows throughout the recession. Businesses – sensing an opportunity – borrowed in order to build new plants and buy new equipment. New workers were hired too – as the next boom got underway. Pretty soon, more people had more money in their pockets, and did with it what seems to come so naturally to Americas: they spent it.

"The incredibly simplistic transmission mechanism is as follows," explains the Contrary "Corporate earnings increase, labor conditions improve, consumer incomes rise and consumer spending increases."

But nothing about this recession/recovery has followed the script. Every line has been flubbed. The leading man – Alan Greenspan – played the same character he always plays…Mr. Easy-Money-to-the-Rescue. But the audience neither booed nor cheered. Instead, they sat like nephews at the reading of a poor man’s will. No one seemed to care.

Nearly 18 months ago, the Greenspan Fed began heroic efforts to fight off the downturn and save the economy. But consumers had never felt that they were in any danger anyway. The man on the white horse, from the Fed, was greeted with puzzled expressions. Consumers found no way to express their gratitude. They could not go out and borrow more money, for they had borrowed more and more throughout the darkest days of the recession. They could not celebrate by buying a new car; they already had two of them in the garage.

That was the real problem with Act II…The story had not been developed properly; it lacked dramatic tension. Greenspan rushed to center stage with his cash and credit. He was ready and willing to bring the economy to a quick recovery. But from what? That was where it all seemed to go wrong. There was no pent up demand. No pent up savings. No nothing with which you could put on a proper recovery. So, the audience yawned as if it were watching a contemporary opera and had forgotten to have a strong cup of coffee before the curtain went up.

Some critics even got the whole story line wrong. Many thought the consumer was meant to play the lead role. Consumer spending – in the face of recession, bankruptcies, layoffs, and war – was widely regarded as patriotic self-sacrifice, as if the patsies running up credit card debts were like the troops at Valley Forge. More recently, pundits, politicians and hack journalists have proposed what might be called the "Rotten Egg" theory of economics. Forget market cycles, bulls, bears, and the madness of crowds, they say; it’s just a few bad eggs like Kozlowski and Lay who are giving American capitalism a bad name. The sooner these scoundrels are chained together and put to work breaking rocks, the sooner the rubes will return to the market, bid up prices and make each other rich.

And, of course, there are the Republican dreamers and technological hallucinators. They see the whole drama as a political piece – where the real heroes are off stage altogether. Instead, they’re the economists and policy wonks helping the Bush Administration choose the right policy initiatives. Cut taxes and keep the dollar strong, says Arthur Laffer, and the genius of American capitalism will bring the house down.

Maybe. But the first 2 acts of this spectacle have been different from the common post-WWII fare. Would it surprise you if Act III had an unusual plot twist too?

We’ll wait to find out.

Bill Bonner, ending abruptly because the train just arrived at Waterloo Station.
June 13, 2006 — Train to London, England

The IMF is worried. But like everyone else, the IMF blames the stock market’s problems on a few rotten apples, now spoiling the whole barrel…

"Enronitis" could cause more stock market losses, warns the IMF.

"The word that is going across everyone’s lips right now," the TIMES of London quoted someone at ABN Amro, "is ‘derating.’"

Strange…"derating" is a word we’ve never heard cross a single pair of lips. We need to listen more closely.

What the Amro source means is that investors are marking down earnings claims. "We don’t know what they mean," he continued and then launched into a perfectly decent description of a bear market…without ever using the ‘d’ word again: "People think they paid too much for earnings that they can’t really value…that were inflated or manipulated, or were produced by corporates that are now looking a little dodgy."

Every day, we hear more about dodgy corporates…In the news, profit announcements, stock splits and IPOs have been replaced by indictments, investigations and Congressional hearings. To hear the media tell the story, you’d think that a few shady characters had brought darkness to all of Wall Street… But there’s another way to look at it – as a major bear market.

Eric, what’s the latest news?


Eric Fry, our eyes and ears on Wall Street:

– The stock market bounced a bit yesterday, recovering a portion of the prior day’s steep losses. The Dow regained 100 points of the 128 it lost the day before, to finish the session at 9,618. Similarly, the Nasdaq recouped 22 of the 33 points it forfeited on Tuesday to close at 1,519. The beleaguered Nasdaq 100, which is composed of the 100 largest non-financial Nasdaq companies, also fared well yesterday by gaining 2% to 1,123.

– Even so, the Nasdaq 100 has become the first major American index to dip below its post-9/11 low-water mark…Once upon a time, the Nasdaq 100 was the hottest stock index on the face of the planet. Its parabolic flight of fancy in 1999 and 2000 epitomized the bubble era. At its peak of popularity, this one-time Brigitte Bardot of the financial markets attracted larger crowds of fawning hangers-on than any celluloid starlet ever did. But not any more.

– "[The Nasdaq 100] is now down 77 percent from the crazy peak it reached in March 2000," observes Floyd Norris of the New York Times. "But perhaps more important is just how far the index has fallen since its recent high of 1,720.91, set last Dec. 5. In a little more than six months, the index is down 36 percent." By contrast, the Dow Jones Industrial Average is still 16% above its September nadir.

– The Nasdaq 100’s death-spiral is no mystery. It possessed very little enduring value in the first place. The index is chock-full of the kinds of companies that embraced the bubble-era corporate lifestyle, with its degenerate practices like pro forma earnings announcements, lavish executive option grants and ridiculous, billion-dollar VC investments.

– That the Nasdaq 100’s "values" would vaporize more rapidly than those of the Blue Chips is hardly surprising. And as value turns to vapor, the stench of scandal and corruption wafts through the entire stock market – blue chips and tech stocks alike.

– Bear Stearns’ inimitable equity market observer, Joanie McCullough, sums up what ails the US capital markets:

"I logged on to the Wall Street Journal electronic version first thing this morning only to find that every darn front page story has to do with some form of alleged illicit behavior, running the gamut from tax avoidance to massive overstatement of revenue to a money manager getting led away in cuffs to somebody else tryin’ to get around payin’ up on a 26 year old research agreement to lawyers gettin’ fired over shady stuff and resignations of board members. It is absolutely outta’ control. I can’t wait to get to the rest of the newspapers;…no tellin’ what you might find these days."

– "In the scandals of the last year, a few people have gotten rich and most investors have gotten poorer," says David Blitzer, chief investment strategist at Standard & Poor’s Corporation. "People seem to feel that for the matter to be settled, somebody is going to have to go to jail."

– To judge from the headlines, there is no shortage of jailbird candidates. But is jail time – usually a few months in a minimum security "country club" – really the appropriate punishment? How about sentencing these corporate scallywags to poverty? Why not confiscate their ill-gotten gains and return the criminals to society penniless? Now, THAT would be a punishment that fits the crime!

– Yesterday, we took a look at the Bunyan-size compensation of Edward Whitacre, the CEO of SBC Corp. We declined to mention whom approves these lavish pay packages – the Board of Directors.

– Ostensibly, an independent Board of Directors, acting in the best interests of shareholders, exercises prudent restraint when compensating CEOs. In the real world, the truth is far from there. On SBC’s board, as Roger Lowenstein points out, "most of the other 18 directors had either served with Whitacre for at least 10 years or were directors of companies that Whitacre acquired." Such cozy relationships between CEOs and board members enables many CEOs to obtain pay packages that vastly exceed the sums that a truly independent board would ever allow.

– Not surprisingly, the men and women in the corner offices are fighting tooth-and-nail to maintain this convenient status quo. "An effort by the New York Stock Exchange to require companies whose shares it trades to put all stock option plans to shareholder votes is coming under fire from the Business Roundtable, a lobbying organization that represents chief executives of large U.S. corporations," notes Gretchen Morgenson of the New York Times. "The pressure indicates that the already bitter war over stock option grants is likely to get uglier and corporate executives will fight hard to keep shareholders from gaining control of the stock option purse."

– Isn’t it funny how much the new and improved era of corporate governance continues to look like the old, flawed era of excess?


Back…uh….on the train to London:

*** The TIMES today has two major updates on the world’s progress towards democratic perfection.

*** First, in Zimbabwe, where Robert Mugabe was recently re-elected, an American reporter is on trial for passing along what he thought was news. A man claimed his wife had had her head cut off by Mugabe supporters.

*** A good reporter will sell his grandmother for a story. What newshound could resist such a tale? Imagine a Democrat beheaded at a Bush rally in Texas; even in Austin, a story like that would find its way into the papers sooner or later.

*** Well, a Mr. Meldrum took the bait and was then accused of a "breach of journalistic privilege" and faces up to 2 years in the hoosegow. Or maybe decapitation, whichever happens first.

*** The TIMES reports the first day of the trial was as big a farce as one might imagine. The judge, Sandra Nhau, had to leave the bench all of sudden when she realized she "had to go home to breastfeed her baby." Then, they brought the curtain down on the whole show when the government’s witnesses failed to show up…let alone remember their lines.

*** Meanwhile, in Afghanistan, democracy is running neck and neck with high comedy in the formation of the new government – staged in grand style, says the TIMES reporter, with "1,500 Afghans sitting together in a giant beer tent…."

*** The blab fest had scarcely gotten underway when "a brawl between militiamen and German peace-keepers" began. Then the Pashtuns walked out. Then, there were "complaints about the food…denunciations of murderous warlords…[and] a dispute about the national anthem…"

*** One man "screamed at the warlords around him, who had bribed and intimidated their way into the assembly…’…people with blood on their hands….Why are they here?’"

*** But it must have looked like almost everyone was there. Perhaps they were misled by the tent and had come in search of a tankard of Munichbrau. We don’t know. But the attendees were light-headed enough to break out in applause after a speech by the former king.

*** Clapping hands for the old monarch seems to have put the leading democrat off balance. Mr. Hamid Karzai, the allies’ puppet…I mean, the peoples’ choice for president of the new republic…thought he had been elected…"It is finished," he said. "The assembly has voted for me."

*** In fact, at least according to the TIMES man, it had done no such thing. It had merely warmed up to the old king. Later, Mr. Karzai was forced to admit his error.

*** But the whole event was preceded by a near-gun battle between Wali Massoud’s bodyguards and the peace- keepers, reports the TIMES. Guns were drawn and pointed, but not fired. "It was all a misunderstanding," said Mr. Massoud.

*** All of this happened before lunch time. After lunch, a woman claimed she was the victim of food poisoning. "This is not a democracy," another woman delegate remarked. "It is a rubber stamp. Everything has already been decided by the powerful ones."

The Daily Reckoning