The Prophets of Doom and Gloom
Here at The Daily Reckoning, we are often told that our outlook on the world at large is too pessimistic – we were actually called "sourpusses" recently. We aren’t alone – Marc Faber shares his views on being referred to as a "doom and gloomer"…
"The people that once bestowed commands, consulships, legions and all else, now concerns itself no more, and longs eagerly just for two things – bread and circuses."
Juvenal made this very pertinent social observation in the first century AD, but it was another 300 years before the Roman Empire totally collapsed. Moreover, the empire experienced repeated periods of glory and power – among others under Trajan, Hadrian, and Marcus Aurelius – until its final collapse, in the fifth century, at the hands of Visigoths, Ostrogoths, and Vandals.
Despite the up-and-down nature of its fortunes, the value of its currency was in a continuous steep decline. The Denarius, which under Nero, who carried out the first debasement of the currency, still had a silver content of 94% had declined by AD 268, under Claudius Gothicus, to a negligible 0.02%!
Prophets of doom and Gloom: Peter Bernstein’s Opinion
I mention this because a recent report by my friend Peter Bernstein entitled "Cheers", begins with the following paragraph:
"The prophets of gloom and doom are increasingly prolific and apocalyptic. As we admitted in our June 1 issue, this publication has contributed its fair share to this process. But the dark voices we hear are always the same dark voices, and the sheer volume and lack of variety in argument has begun to dilute their impact on us. The sound of impending disaster is now so deafening, in fact, that we have been seeking for any rays of sunshine we could spot, if only to relieve the monotony and perhaps to find something substantive that might counter the deep pessimism flooding our mailbox."
Peter then goes on to show in his excellent report that "the overvaluation in the stock market may be less awesome than it appeared when judged by the Shiller 10-year P/E alone, largely because of the dramatic movement in the bond market in recent months. But there is hope in the fundamentals as well, in the CEPS [Corrected Earnings Per Share – ed. note] data and in impressive evidence from the corporate sector as a whole."
Now, I suppose that Peter also had me in mind when he talked about the "prophets of gloom and doom." However, I consider that, at least by my standards, I have in recent times been relatively cautious about expressing negative views of the U.S. stock market. This is largely because printing money, as the Romans did 2,000 years ago, enables economic policy makers to keep the party going for longer than would be possible under a rigid gold standard.
Also, I haven’t quoted Peter Bernstein in order to defend my not so-rosy views about the economies of the United States and Europe, but because – unlike his mailbox – both my post mailbox and my e-mail inbox are overflowing with rather positive comments about the U.S. economy and the financial markets. The positive sentiment and almost total absence of negative views is most apparent from investors’ intelligence sentiment for stocks. Bullish sentiment remains above 50% while bearish sentiment hovers around record low readings. Moreover, since 2003 the Bulls-to- Bears Ratio has only occasionally dropped below 2.
Another symptom of investors’ complacency and confidence is that the volatility index for both bonds and stocks hovers near record lows – hardly a sign of excessive bearishness. Still, Peter makes a very good point that the stock market may now be less overvalued or, as some observers will argue, even undervalued following the collapse of bond yields. At the same time, it’s also true that the corporate sector is at present highly liquid. The question, however, isn’t so much about the present as about the future. Are the current low interest rates sustainable? Also, why are corporations in such a great shape financially, while the debts of the household sector have been mushrooming? Is this situation sustainable? Finally, equity prices may be reasonably priced or even inexpensive when one only takes their earnings yields compared to bond yields into account. But, as I have tried to show in recent reports, macroeconomic, geopolitical events, natural disasters, or possibly soaring commodity prices (energy) could, some day, overwhelm in terms of importance the pure U.S. equity earnings yield and bond yield comparison and make both U.S. stocks and U.S. bonds unattractive.
In short, all the pros and cons of U.S. equities must be dealt with, and they should be compared with alternative investments, such as foreign equities and other asset classes. After all, U.S. equities could be a bargain compared to U.S. bonds, but in a world of "inflated asset values" both could conceivably be in fantasyland at the same time.
Prophets of Doom and Gloom: Gambling
PartyGaming, the owner of the world’s largest online poker site, rose 11% on the day of its recent London listing. What was remarkable was that it was the largest London IPO in five years, and following its listing (priced at 116 pence) the market value rose to almost US$9 billion. PartyGaming’sprofit growth is equally impressive. In the last three years, its pretax profits have risen from US$5.8 million to US$371.1 million. They are expected to increase to more than US$500 million in 2006. According to research by Dresdner Kleinwort Wasserstein and Global Betting and Gaming Consultants, the overall online gaming industry is expected to grow its revenues from US$9.3 billion in 2004 to close to US$19 billion in 2008.
In the meantime, in Macao, where gaming revenues now exceed those of Atlantic City, the number of tourist arrivals (mostly gamblers from China) is expected to rise from 16.7 million in 2004 to around 40 million within the next five to seven years.
In the United States, taxes from casinos, slot machines at racetracks, and lotteries make up more than 10% of state revenues in Nevada, Rhode Island, South Dakota, Louisiana, and Oregon, and will shortly reach 10% in Delaware, West Virginia, Indiana, Iowa, and Mississippi. (A clinic, officially licensed by the Chinese government, for treating online gaming addictions has opened in China. Patients are mostly aged 14 to 24 and are treated by a staff of 23 nurses and doctors. The primary cause of the patients’ addiction is said to be the pressure from parents on their children to do well at school, resulting in the child turning to online gaming to relieve the pressure….)
Our friend Raymond DeVoe, a veteran Wall Street watcher with loads of experience who publishes highly enjoyable commentaries with lots of insightful observations, recently described an experience he had while studying securities analysis at Columbia Business School under David Dodd (of Graham & Dodd). For one project, Ray had to evaluate a company "that had exchanged one division for two others from another company, and placed a value of $35 million on the new acquisitions." Ray found the stock unattractive, but Professor Dodd still had a point to make. According to DeVoe, the good professor told him the following: "Mr. DeVoe, you have just made one of the most basic and common errors in security analysis, assuming something is worth what management claims it to be. Let me tell you the story of the boy who brought home a stray dog. His father ordered him to get rid of it, but the dog remained in the house. The exasperated father finally said to get rid of it, sell it, or whatever. The boy said he would sell it for $50,000. The next day he came home and his father asked about the dog. The boy said he had gotten rid of the dog, but traded it for two $25,000 cats."
Focusing on me, Prof. Dodd concluded, "Mr. DeVoe, your company did the same thing, trading an almost worthless dog of a division for two overpriced cats – and then saying they were worth $35 million. Never take a management’s word for the value of something without checking it yourself."
Prophets of Doom and Gloom: Shifting the Base
DeVoe also refers to a textbook used in the statistics course – How to Lie with Statistics, by Darrell Huff. A chapter entitled "The Mystery of the Shifting Base" explained that anything could be proven by simply shifting the base period to one that gives you the desired results.
But statistics are not only faked by shifting the base; numerous other means include hedonic adjustments and fictive figures (birth-death adjustments in the employment numbers). Bill King who publishes a daily commentary on economic and financial trends, does an outstanding job of analyzing economic statistics in detail. When the May factory orders were announced on July 5, 2005 he wrote the following day,
"…some pundits attribute yesterday’s +2.9% reading for May factory orders as a rally cause. This is preposterous. +3% was expected, April was revised lower, to +0.7% from +0.9%. But most importantly, ex-transports, May factory orders fell 0.1%…. All day Tuesday and into last night Wall Street propagandists and the financial media extolled the factory orders numbers, even though few noted that it is down ex-aircraft orders. More importantly, we saw or heard NOONE mention that tucked into the report is the unsavory fact that inventories increased 7.5% y/y in May.
I might add that while it is wonderful news that Boeing will boost its future revenues and profits with its rising order book, as well as the overall U.S. factory orders, the bad news is that Boeing’s planes are increasingly becoming foreign made.
So, whereas in the 1960s Boeing sourced only 2% of the content of its planes outside the United States, by the mid- 1990s this figure had grown to 30% in the case of the Boeing 777, large parts of which are manufactured in Japan. And in the case of the latest model – the 200-300-seater long haul Boeing 787, the first of a new family of aircraft – at least 70% will be built outside America – again, mostly in Japan. In the meantime, in order to reward Boeing for being one of the few successful U.S. exporters, the U.S. State Department has prepared civil charges against Boeing alleging 94 violations of the Arms Control Act because the company sold commercial airliners without obtaining an export license for a tiny gyrochip that also has defense applications. Boeing refers to the chip as "relatively unsophisticated" technology….
I am fully aware that some observers will argue that it doesn’t matter that U.S. companies are increasingly moving their own plants overseas or outsourcing altogether, because the improved profits that result from the outsourcing accrue to the parent company. For the valuation of that specific company and of the stock market today, this is a very good point. However, what about the long term? How beneficial is it going to be for the Western industrialized countries if IBM were to lay off 13,000 people over the next 12 months in the U.S. and Europe and hire 14,000 workers in India?
for The Daily Reckoning
August 25, 2005
Headquartered in Hong Kong for 20 years and now based in northern Thailand, Dr. Faber has long specialized in Asian markets and advised major clients seeking bargains with hidden value, unknown to the average investing public.
Dr. Faber is a regular contributor to Whiskey and Gunpowder, free e-newsletter, from Dan Denning and Byron King (among others) that covers resources, oil, geopolitics, military history, geology and personal freedom.
We check in with the financial markets, just to see if anything is happening.
But what’s this: the homebuilders are going down. Ryland and Lennar are clearly falling. What could be going on?
"Bulletproof house builders looking shaky," says TheStreet. From the look of the charts, they are not just shaky but bleeding. New house sales rose again last month. But existing house sales fell in July, after posting a record of 7.35 million in June. Inventories of unsold houses are at a 17-year high.
Our guess is that the inventories and the price of oil are finally catching up with the house market. To the old line – "they’re not making any more of it" – we reply with a headline we saw in Vancouver recently: "Condos, Condos, Condos!" Builders were putting up condos all over the place, and putting up houses on nearly every stretch of bare land they can get their hands on. Even in downtown, historic Annapolis we saw a stretch of luxury accommodations under construction across the street from St. John’s college. (More on the convocation…below… In Annapolis, every word gets an extra ‘e’ on it whether it needs it or not, so the condos will probably be sold as ‘historic condoes.’) All these extra units are bound to depress prices.
So is gasoline at nearly $3 a gallon. After they’ve filled up the strategic storage tanks in their SUVs consumers have less money to spend on other things – including housing.
And so, perhaps, we have finally reached the "Beginning of the end for real estate," as the NY POST put it.
What a run it has been. The Center for Economic and policy Research reports that the housing market added $5 trillion in ‘bubble wealth’ to the American economy, an amount equal to $70,000 for a family of four. That is the fraudulent money that has sustained Americans at a standard of living they cannot really afford. It is the source of the illusion that the U.S. economy is growing and healthy. It was psuedo-wealth, an asset that really didn’t exist. Too bad so many people spent it.
"House party, finally over?" asks the Financial Times.
We don’t know the answer. Maybe it is over today. Maybe it will be over tomorrow. Our advice to readers: don’t be the last ones to leave.
More news, from our team at The Rude Awakening…
Carl Waynberg, reporting from Vermont:
"But weep not for technical analysis. It boasts many fans. Technical analysis has its defenders, and their faith is not completely for naught. Over a narrow time span, stocks do tend to adhere to a trend. A number of academic studies have determined that winners keep winning over the short-run, even though they tend to underperform over longer time frames."
Bill Bonner, back in Baltimore…
*** We’ve been talking a lot this week about the inconsistencies and confusion that Homeland Security provides U.S. citizens under the guise of "protection." But Jonathan Kolber wants to touch on something a little closer to your pocketbook…
"Our friendly old SEC, a.k.a. the Securities and Exchange Commission. Among the SEC’s egregious violations is its total failure to regulate ‘phantom short selling’ – the phenomenon wherein shares of public companies are sold short without the shares ever existing!
"Incredible as it seems, this behavior is rampant and CEOs of several public companies have privately complained to me that millions of shares of their stock have been fabricated. A unique kind of thief practices this behavior. It drives down the market capitalizations of some of the most promising stocks in the world.
"How does a financial parasite benefit from this, you ask? Simple: find a friendly broker, cut them in on a percentage of the take, sell the stock and either buy it back later when the price declines or (ideally) the company goes bankrupt and you pocket all of the proceeds.
"In order to ‘protect’ so-called unsophisticated investors, half a century ago the SEC decided to restrict venture-capital type investing to persons with high net worth or high incomes.
"Venture-capital (a.k.a. VC) has offered some of the most spectacular financial returns in recent decades. But you’ll never, ever see these opportunities unless you’re someone who starts companies or consults to/invests in them like I do."
*** The students entering the class of 2009 were what we expected – skinny poets from New York, fat lesbians from Chicago, and earnest young men from the Plain States. The parents were a little less than we had expected.
"That’s the difference between the U.S. and Europe," Jules remarked. "Here, anything goes."
Europeans are a bit more careful what they look like. Many of the parents at yesterday’s convocation seemed worn out from too many years in earth shoes and too much tofu. Many seemed like aging hippies. Others looked like Middle America, which is to say, like us; they looked awful.
It is not our place to criticize our fellow Americans. There is no profit and no sport it. Nor do we care to look in the mirror and wonder what others may think of us. Perhaps we have merely reached a stage in life when every time we get together with people our own age we get depressed. Still, we comment on it only out of a spirit of mischief…and compulsion. For everywhere we look, we see signs of Late, Degenerate Empire. Down at the Oriole stadium are pictures of baseball fans from 1910 or so. Guess what, the men are wearing suits and ties. But that was back when the empire was just getting its start – when savings were high, collars were starched, the currency was hard, and the nation had the most positive balance of trade in the world. No economy was growing faster. Now, even at a college convocation Americans wear outfits that they wouldn’t have put on to pave a road in 1910. For proof, we turn to a picture on the wall of the Historic Inn where we stayed. There is a photo of paving West Street, early in the 20th century. We see no sandals, no shorts, and no tee shirts.
Fashions change with the evolving empire. Now, the whole society depends on elastic. Its credit stretches along with its waistbands. And its appetite for absurd vanities seems infinitely expandable.
*** We wandered over to Main Street to get a pair of glasses.
"These are designer reading glasses," explained the helpful clerk, pointing to a glass cabinet. "They start at about $300 a pair. In this box are regular reading glasses. They’re $20 each."
"What’s the difference?"
"Well, these $20 glasses are out-of-fashion, I guess. The midshipmen who come in here say they’re so out-of-style that they work as a form of birth control."
"Hmmm…I already have 6 children. I’ll take the $20 pair."
*** We have been disappointed in ourselves. We were determined to think New Thoughts this summer. We came up dry. But Christopher Nelson, St. John’s president, explained why:
‘There are no new thoughts,’ he seemed to say in his convocation speech.
"We struggle with the same questions that dogged Achilles, and Odysseus, and Socrates and Aristotle. Who are we? What are we doing? How can we find honor and happiness? What is our relationship to others? To our spouse? To our children? To our fellow men…to our government and our community?"
St. John’s is an unusual school, Mr. Nelson explained. It doesn’t seek to prepare students for careers; it tries to prepare them for life itself. "A boot camp for life," is how one student described it. Students read the great works of western thought…talk about them…and try to understand them. They begin with the ancients and work forward, chronologically, until they are discussing Einstein and quarks. At the end of 4 years they are not prepared for anything in particular; but they should be prepared for anything in general. Thereafter, many go into engineering or science…arts or literature. Whatever they choose to do, they have a solid foundation upon which to build…and many old thoughts to use as reference.
Mr. Nelson’s speech came amid much pomp and circumstance. The in-coming class marched into the theatre in black robes. Before them proceeded the entire faculty of the college, with its president in the lead carrying what we took to be a silver orb. Every member of the teaching staff was bedecked in doctoral robes, each bearing the insignia of the institution that granted it. And when all had taken their seats, the names of the new freshman were called, one by one. Each one walked to the center of the stage, shook hands with the college president, and wrote his name in The Book.
When this was completed, Mr. Nelson announced that the 215th annual class was installed:
"I declare the college in session," said he.