The Last Big Thing
We have seen the last big thing, dear reader – the huge tide of confidence that swamped the economy with the greatest debt ever. A question for today: have we seen the last of the last big thing?
To refresh your memory, debt has averaged less than 150% of GDP for most of the last century. But Americans went on a couple of binges in the past 100 years. First, debt spiked up to 260% of GDP in 1929. And lately, it has gone over 300%.
We do not know how, or when, the debt-to-GDP ratio will come back down. But we believe that investors could do worse than expect it.
You don’t need to make many investment decisions to stay ahead. Just a few, very simple ones. "An investor could have done very well over the last 30 years with just a handful of investment decisions," writes Marc Faber, a regular contributor to Strategic Investment.
"In 1970, a long-term investor should have bought gold, silver and oil (commodities); in 1980, he should have sold his gold and oil and bought Japanese stocks; then, in 1980, he should have switched out of Japanese stocks into the S&P 500 or, ideally, into the Nasdaq, which he should have sold at the beginning of 2000."
In the 1970s, the price of gold rose from $33 an ounce at the beginning of the decade to $850 at its end. Japanese stocks took off from 5,994 on the Nikkei Dow in 1980 to 38,712 on January 4, 1990. And the Dow, of course, rose from 2,753 in that same month to 11,722 in January of 2000.
"Market leadership changes over time," adds James Puplava, "…there is a time and season for everything. Once a long-term trend is broken, it is replaced by another trend."
"At such milestones in financial history, the rules of the investment game are altered; but alas, the vast majority of investors continue to play by the old rules and therefore either lose money or miss out on the substantial capital gains which the new opportunity or leadership brings about…I suppose that one reason the road to ruin is broad is to accommodate the great amount of travel in that direction…The key to successful investing is to understand that, with nearly 100% certainty, the bursting of a bubble leads to a permanent change in leadership."
Another question: what will take the leadership position now?
Puplava and Faber think they know: commodities. Maybe. Or, maybe Russian stocks will be the Next Big Thing, for all we know. Debt has been such a big hit these last ten years, it is hard for us to imagine that it will be popular for another 10. Might commodities take its place?
"Throughout the [last] decade," writes Puplava, "flooding the financial markets with money became the standard remedy for putting out fires in the financial system. It didn’t matter whether it was Mexico and derivatives in 1994, Asia in 1997, Russia and Long Term Capital Management in 1998, Y2k in 1999, or the recession and Trade Center attack of 2001. The standard prescription for any crisis was and is to flood the system with money and credit.
"The result is that the outlet of much of that money creation moved into the financial markets beginning in 1995. From 1995 to 1999, the stock market experienced back-to-back years of double-digit returns not seen since the mid-1920’s."
This was also the time when the vast lumpeninvestoriat came into the market. The public was lured in by double-digit returns, CNBC, and 401k plans.
Thus did the "virtuous" circle of a real bubble begin. Cash poured into stocks. Stocks rose. Investors, feeling richer, spent more. The economy, and Wall Street, boomed.
The credit boom has been one of the longest-running shows in American economics.
"Traditionally, the U.S. is a high-consumption, low- saving and low-investment country," explains Dr. Kurt Richebacher. "And despite all the supply-side fantasies at the time, this pattern only got dramatically worse under Reaganomics in the 1980s."
Every hero reveals himself also a fool – if he lives long enough. Reagan’s 8 years in the White House was long enough. His unprecedented 5-year $749 billion tax cut was supposed to cause people to work harder, save more money and invest it. "In all three respects," writes Dr. Richebacher, "the program proved an egregious failure."
"Contrary to euphoric expectations and prevailing perceptions," Richebacher continues, "Reaganomics effectively boiled down to massive capital consumption. Its key features were an extraordinary boom in consumer spending, a steep plunge both of national saving and of the rate of capital formation, and a soaring trade deficit.
"As a ratio of GMP, the level of net fixed investment averaged about 5%, nearly two percentage points less than the prior postwar average…massive domestic dissaving expressed itself largely in an exploding trade deficit. As a result, the U.S. in the ’80s went from an international net creditor position of 4% of GNP to net debtor position of 20% by the end of the ’80s. Today, that number has reached 35%-40%. In a few years, it should reach 50% – on a par with many underdeveloped countries."
The boost of debt and consumer spending did nothing to hurt Reagan’s popularity. The Clinton Administration saw no reason for a change of course. Instead, it decided to stay on the road to ruin…but at a faster speed.
"All these negative features of the 1980s have deteriorated even more in the 1990s," Richebacher explains. "After peaking at $413.4 billion in 1992, or 8.7% of disposable income, personal savings fell to $28.6 billion annualized in the last quarter, or 0.3% of disposable income. Business saving, meanwhile, (representing undistributed profits), fell from a peak of $220 billion in 1997 to an annual rate of $55 billion in the 4th quarter of last year. Combined, private sector saving has now collapsed from around $500 billion to less than $84 billion, or from 5% of GDP in the first half of the 1990s to less than 0.5% of GDP."
What lies ahead for the Bush years? Maybe Faber and Puplava are right. The trend of the last 20 years may already be broken. Credit is as much a prisoner of the law of declining marginal utility as everything else.
The first bit of it seems to work wonders. But the last of it falls like a splash of Moet Chandon on a subway drunk. At first, a dollar’s worth of additional debt might be expected to produce a dollar’s worth of GDP. But last, Dr. Richebacher calculates, each dollar of GDP required $65 of extra credit.
Sooner or later, (as we keep writing) the last big thing – the credit bubble – will come to an end. This is at least as good a time as any.
April 15, 2002 — Paris, France
P.S. "Gold has been the world’s strongest currency over the last two years," writes Puplava. "While the yen, Euro and dollar have lost purchasing power, the price of gold has risen."
"Money is not flowing into real estate stocks," writes Steve Sjuggerud, editor of a newsletter called True Wealth. "Just yesterday, 51 real estate stocks hit 52- week highs."
Why such an interest in real estate? Because it’s one of the few safe places on Wall Street.
"There’s simply nowhere else to safely earn a high yield and have the potential for a little capital gain to boot," Steve adds.
Analysts lie. Earnings lie. But dividends are honest. And if you can collect 7% on your money – you can afford to sit back and relax, even if the stock market goes nowhere.
Steve likes Simon Property Group. It "earns about $30 a square foot in rent. And tenants earn an average of $380 a square foot in sales. With numbers like these, you can see why tenants want to get in [Simon’s] malls."
Eric, over to you:
Eric Fry in New York…
– Everyone is talking about General Electric these days, and the talk is not very polite. Now that the once- invincible corporate titan is beginning to look somewhat less invincible, GE-bashing is all the rage:
"For the first quarter, GE reported that earnings rose 17 percent," says Gretchen Morgenson of the New York Times. But after subtracting a large one-time charge to earnings for a write-down of goodwill, GE earnings actually fell 2.7%. "Revenue, meanwhile, dropped in most segments of its operations," says Morgenson, "even at GE Capital Services, its powerhouse financing arm."
– The sharp drop in GE shares, triggered by its earnings report last week, demonstrates quite persuasively that the new era of corporate transparency is weighing on the stock market.
– "Jack Welch is gone," writes Alan Abelson in today’s issue of Barron’s, "and, eerily like [departing IBM CEO Lou] Gerstner, he obviously took the magic with him. Mr. Welch’s successor, Jeffrey Immelt…has yet to master the fine art of creating profits on demand, an art of which, as intimated, Jack was a true master."
– "Even the most sacrosanct [companies] are no longer above suspicion," Abelson says. "Fun and games are out. Probity and prudence are in. Awful, isn’t it? How long those bleak imperatives hold sway is anybody’s guess. But at the very least, investors should be aware of their dominating presence…"
– When it comes to GE-bashing, however, Apogee Research is the clear trendsetter. A little more than one year ago, when no one was talking about GE, except to sing Jack Welch’s praises, the team I was heading up at Apogee (then known as Grant’s Investor) produced a skeptical research piece entitled "GE Jitters?". The story highlighted some worrisome cash flow trends inside GE Capital Services.
– At the time of the story, none of the universally bullish Wall Street analyst community dared to question GE’s "quality of earnings." Apogee decided to give it a whirl anyway.
– "General Electric epitomizes American capitalism; it is big, global and consistently profitable," Apogee wrote. "Indeed, its profitability has been so consistent as to defy statistical probability.
– "Year after year, quarter after quarter, like clockwork since what seems like time immemorial, the $130 billion conglomerate has brought it shareholders higher earnings per share. The stock price reflects Jack Welch and Co.’s amazing success, and GE shareholders don’t seem to be complaining. But the company’s latest 10-Q reminds us that maybe shareholders shouldn’t become too complacent."
– Apogee noted a 72% decline in cash flow from operations on the General Electric Capital Services side of the enterprise, and concluded, "[A]ll is not well on the subcontinent of General Electric. Could it be that even giant GE comes down with a case of the sniffles when the economy takes a chill?"
– We know now that the answer is "Yes." The plummeting cash flow at GECS that Apogee highlighted may well be the reason that GE gave GECS a $3 billion cash infusion in the fourth quarter of last year. And GE’s slumping revenues across the board suggest that the company is at least nursing a cold.
– "Even for GE," Morgenson observes, "gone are the days when investors accepted at face value what corporate management told them about their businesses and their books. Now investors are far more likely to dissect financial statements for themselves."
– During bull markets, "genius" multiplies like rabbits. When stocks are rising, almost everyone is a savvy investor, and almost every CEO is a brilliant manager. But the geniuses become pretty scarce when stocks stop going up or – heaven forbid – fall. In fact, many bull market geniuses are the kind of fools who expect current conditions to continue indefinitely.
– But the stock market never continues indefinitely in any direction. It is cyclical, and the best part of the current cycle is already over.
– "You only get to go from double-digit inflation to 2% inflation once, and you only get to go from an Old Economy to a New Economy once," says Pimco portfolio manager Paul McCulley in explaining the gigantic bull market of the 1980s and 1990s.
– In other words, the overwhelmingly favorable macro- economic trends of the last 20 years have exhausted themselves, and the richly priced stock market amply reflects the good things that have already occurred. Looking forward, however, there is no New, New Economy or other major macroeconomic trend standing at the ready to propel stocks even higher…unless the Federal Reserve buys the entire S&P 500.
Back in Paris…
*** "Last week the Fed expanded total credit by another $7 billion," writes the Mogambo Guru. "Thus, Greenspan continues hewing to the notion that constantly- increasing debt produces prosperity. It never has, and it never will. You cannot quote any reference, from any economics text ever written, that says it can.."
*** Doug Noland concurs: "The harsh reality is that faltering corporate profits and the bursting of the technology bubble are not cyclical ‘rough patches’ that will be successfully navigated by extending extreme Fed accommodation."
*** "This has always been a case," Noland continues, "of the Fed fighting the consequence of credit and speculative excess by inciting only more egregious credit and speculative excess. It’s a losing battle." And yet, debt has been a big hit for a long time…more below…
*** Life is funny, isn’t it, dear reader? All of my life, I’ve always been looking ahead…thinking about how to get from here to there…pulling against my traces like a dumb mule, with blinders on…climbing uphill all the time (or at least that is what it has felt like.)
*** And then, last week…walking back from dinner with my daughter, Maria, a strange feeling came over me. I remember the exact moment. We were crossing the bridge at Bir-Hakeim, admiring the dark water, stirred up by a cool wind…with lights sparkling on it from almost every direction.
*** "It’s so cold," Maria had said. And she took my arm as if to steady herself against the wind. "But isn’t the city pretty, Daddy?"
*** "I love Paris," she continued, "but I’m looking forward to moving back to the U.S. too. Maybe I’ll get an apartment in New York. My friend Erin and I used to talk about moving to New York together…"
*** We walked on like that for several minutes, Maria dreaming out loud about the life ahead of her. It was as if we were on the peak of a mountain…and I, wishing we never had to climb down.