The Roaring 2000's?

Please consider the following excerpt from Dent’s latest special report, “What Happened on the Way to the Roaring 2000’s?”:

“Just as the ‘tech wreck’ in the newly emerging auto industry was a golden opportunity for investors 80 years ago, today’s investors have the greatest buying opportunity of this entire economic boom, perhaps of a lifetime, right now…Our most likely forecast shows that the Nasdaq could reach 13,000-14,500 by the top of this boom, 6 or 7 years from now, which is more than ten times from its low of 1114 in October 2002.”

Let’s see…the Nasdaq at 14,500 by 2010? In my mind, the above forecast could use a large dose of reality.

Let’s rewind the tape to late 1999. I can’t remember whether it was Las Vegas or San Francisco, but both Dent and I were speaking at a large investment conference. I spoke first, telling the some 3,000 attendees there was a recession in our future and the market was headed down. Small (but polite) applause at the end of the speech.

Harry Dent: Nowhere but up

Dent spoke a few minutes later, making fun of the doom-and- gloom speakers who were on the podium earlier. We just didn’t get it, he said. He then showed us lots of charts, which clearly demonstrated the markets and the economy were going nowhere but up. Technology was in its innovation stage, ready to explode. He quoted Schumpeter. The performance of Harley-Davidson was the clincher. Lots of (very enthusiastic) applause.

Fast forward to today. There has been a small bump on the road to the Roaring 2000s. Dent tells us that has merely slowed things down, but now we are back on track. Starting with this year and going into 2004, the consumer is coming back. Technology is once again going to drive the markets to new heights. Climb on board.

Let’s examine his arguments and then see the logical and, in my opinion, absurd conclusions.

Dent points out that GM dropped more than 75% from late 1919 to early 1922. GM then went on to rise more than 22 times at its height in 1929. At the time, automobiles were the ‘new, new thing.’ Even with a shakeout of automobile companies, which saw many fail, the market still experienced a boom. Coincidentally, we are having a shakeout of technology companies today.

He then overlays the chart of GM from 1912 to 1922 with the chart of Intel from 1992 through 2002. Again, coincidentally, they match.

Then, we leap to the conclusion that since GM went up 22 times after its crash, the technology markets are poised to do the same. Quote: “We fully expect a generation of technology giants in today’s new economy to parallel GM’s spectacular rise. Who wouldn’t leap at the chance to see their investments grow as much as 22 times in the next 6 to 7 years?”

Harry Dent: An S Curve of Growth

He begins Part Two of his report by telling us that the Internet, mobile phones and broadband are going to drive this explosion. He shows the “S” curve for these innovations. This “S” curve denotes the very sound and reasonable theory that innovations (cars, phones, TV, electricity, railroads) start out slowly, then slowly rise until the point where their growth is dramatic, often changing the entire economic structure, until the growth flattens out as everyone adopts the technology.

Dent is right about the future growth of these technological innovations. They will grow dramatically. But will they drive the Nasdaq to grow 10 times in just a few years? That is where we part company.

There are some very large differences between 2002 and 1922. First off, in 1922, the stock market was coming off a decades-long bear market. The S&P 500 in 1921 was almost exactly where it was 20 years earlier…investors had actually seen a compounded negative 1% growth for the 20 year period. In short, there is no comparison between the value of the market in 1922 and 2002. We are talking historical extremes. Dent is effectively suggesting that the next bull market is going to start from the highest valuations in history.

Dent also tells us that: “[The] transformation of the Internet will accelerate the emergence of the bottoms-up or consumer-driven network corporation…This revolutionary business model will usher in a new era of productivity just as Alfred Sloan’s new corporate model at General Motors did starting in the early 1920s.”

The problem is that so far this decade, the impact of this increased productivity has, arguably, not been a net positive. Instead, corporations are using the new productivity to lay off employees. Further, the Internet is making it possible to send jobs to lower cost countries like India and Ireland.

Harry Dent: IT Doesn’t Matter

The extent of the productivity ushered in by the Internet – and certainly its future growth – is also in question. In his HCM Market Letter, Michael Lewitt aptly summarizes a recent article entitled “IT Doesn’t Matter” by Nicholas G. Carr in the Harvard Business Review:

“‘[T]here are many signs that the IT [Information Technology] buildout is much closer to its end than its beginning.’ Among the reasons: First, IT’s power is outstripping many of the business needs it fulfills. Second, the price of essential IT functionality has dropped to the point where it is basically available to anyone. Third, there is more than enough fiber-optic capacity to accommodate further build-out.”

Besides, it is all well and good to choose the chart of GM to compare to Intel. But that’s 20-20 hindsight, isn’t it? In 1922, there were scores of automobile companies which did not make it until 1929. If you had picked one of those, the comparison would not look so pretty.

Even if there were numerous small tech companies to pick from, which all happened to grow ten times over, their statistical impact upon the Nasdaq would not be that great. To account for the type of growth Dent is projecting, we would need to see scores of the largest companies grow not ten times, but 20-30 times or more to make up for the companies which will not grow more than GDP plus inflation, or about 50% (at best!), over that time.

These is where Dent’s argument really hits a wall. Today, June 18th, the Nasdaq is at 1668. For the Nasdaq to grow to 13,000 in 7 years, it would have to do so at a compounded growth rate of 29% every year for seven years. If it reached his upper target of 14,500 in just 6 years, the compounded growth rate would be 36%! This means a doubling of the Nasdaq every two years!

Meanwhile, the P/E ratio of the Nasdaq is in nose-bleed range. The Wall Street Journal recently reported the trailing 12-month P/E ratio of the Nasdaq 100 at 227, based upon reported earnings. Compare that figure to the estimated P/E ratio for the next 12 months – 36. The Thompson First Call estimate is even lower: 32, based on pro-forma earnings or EBBS (Earnings Before Bad Stuff).

Harry Dent: 30% Compound Earnings Growth?

For Dent to be right, earnings would have to grow over 30% compound a year for the entire Nasdaq index for seven years. I am not even going to bother to check the record. There has never been a time when a major broad-based index has seen average real earnings grow 30% a year for seven years.

Either that growth happens, or the genuine P/E ratio will have to get even worse. It will have to rise to levels that will make the last Nasdaq bubble seem like a blip. Can it rise to 500? Will investors forget so soon the last bubble?

Looking at the problem in another way, Dent is suggesting the market cap for the Nasdaq will be more than the entire GDP of the United States in 7 years. Depending upon where you start and finish, he is suggesting growth to well north of $15 trillion for the total worth of the Nasdaq market. Microsoft is currently 10% of the total Nasdaq market cap. Will Microsoft grow to a market cap of $2 trillion? Will Cisco be worth $1 trillion? Can Intel rise to $1.25 trillion?

For Dent to be right, those companies would have to rise to such levels, and scores more would have to rise along with them. If these companies do not grow to such levels, then which companies will? To get to $15 trillion, you have to have some VERY large companies in the mix. We are talking companies of a size and scale which dwarf anything we have today, or even at the height of the Bubble.

I won’t even touch overcapacity in the technology world (e.g. the huge amount of excess fiber), which will hold down growth and profits, the coming turmoil in telecom from the WorldCom debacle, the massive investment that must be made to build out the broadband world, etc. etc. This is not the stuff from which steady and historically high profit growth will come.


John Mauldin,
for The Daily Reckoning
June 18, 2003

P.S. Despite these realities, a large number of people continue to follow Dent, as his books and writing are compelling. It seems so logical: the large number of Baby Boomers means more consumer spending until they retire. This will foment unprecedented growth in both the economy and the stock market. Look at the charts. I am sure Dent is well meaning and sincere. But his math, not to mention the logic, is simply AWOL in these reports.


Microsoft rose 2% yesterday, following an analyst’s upgrade. Just like old times…ha…ha…ha…

What’s so funny?

Well, just that anyone would take analysts’ upgrades seriously. You haven’t forgotten, dear reader, have you? Four years ago, analysts were recommending something like 98 ‘buys’ for ever 2 ‘sells’ – just before $5 trillion worth of capitalization was wiped out in the bear market that began in 2000. And of the celebrity tech stock analysts, 3 out of 4 have been fired or indicted. Jack Grubman, Henry Blodget, Frank Quattrone, Mary Meeker…only Meeker remains at her post, older but as clueless as ever.

It makes no difference to the lumpen-fund managers. They’ve got money to invest and benchmarks to hit. If they miss this tide of fortune (the Dow is already up 28% since October), they could be doomed to spend the rest of their lives wallowing in the brackish marshes of Wall Street, doing semi-honest work for semi-honest pay.

Who would want that? What everyone wants is what he doesn’t deserve. Barron’s promises investors double-digit returns from stocks this year. Do investors deserve double-digit gains? Of course not. They have not worked for it; they have not earned it. All they do is provide capital. Historically, what have people made on their capital? If the dead could talk, you could dig them up coast to coast and pose the question. You’d find out that the average real return has been only about 3% since the founding of the republic. Presently, it’s even less. By decree of the Fed, yields are lower than they’ve been since Buddy Holly and Patsy Cline enjoyed hit singles. Lenders cannot expect much. Investors should expect even less.

It is just one of those times. Sometimes people expect a lot; sometimes they don’t. We are still in one of those times when people think they can get something for nothing, or at least more than they deserve from what they have. Despite three years of a bear market, and an aggravating slump in the economy, people still have a remarkable confidence in themselves, their institutions and their leaders. They believe the dollar can do what no paper money has ever done: survive. They believe stocks can do what none have ever done: provide double-digit gains for everyone, forever. They believe that George W. Bush and Alan Greenspan can do what no man has ever done: look into the future and improve it before it happens.

They believe these things despite the testimony of millions of dead men. And they will continue to believe these happy fantasies until they are ruined by them…and join the chorus of the dead, too.

At least, that is our cheerful guess this beautiful morning in Paris…

Over to you, Addison…


Addison Wiggin, from across the desk in Paris…

– Exactly how will investors be destroyed? “Argentina, not Japan,” predicts Marshall Auerback.

– “A country with an unsustainable external debt burden, an overvalued exchange rate leading to increasingly large current account deficits, a huge and deteriorating fiscal position: Argentina 2001 or the USA 2003?” asks Auerback on the Prudent Bear site.

– “For all of the persistent talk of the need for the U.S. to avoid a ‘Japanese style deflation’, we think the more instructive parable is Argentina prior to the abandonment of its dollar-peso pegged rate monetary system at the end of 2001.

– “Like Argentina circa 2001, America no longer controls its own economic destiny. In the case of the United States, the Sword of Damocles is not the IMF, but China. The death knell for the U.S. economy may well be when the Chinese elect to float their currency because at that stage, many of the other Asian central banks (with the possible exception of Japan) may well find yet another compelling alternative to the U.S. greenback, thereby sending the latter into free fall, creating untold damage to the U.S. credit system.

– “American policymakers, who persistently call for the Chinese remnimbi to be floated,” warns Auerback, “ought to be careful what they wish for. It could well be the precipitating event for the final denouement in this extraordinary period of financial history.”

– Meanwhile, the lumpeninvestoriat remain in a holding pattern, as if waiting for air-traffic control signals from the Fed. Absent any clear transmissions from the tower below, the Dow meandered up 4 points yesterday to 9323…perhaps preparing for a spectacular nose-dive following Monday’s 200-point surge. If you recall, last summer witnessed a healthy sell-off through the first couple of weeks of July, ending in the year’s lowest point to date on July 21st. The S&P 500 closed up less than a point to 1011. The Nasdaq closed up less than 2 points at 1668.

– The 2-day closed-door FOMC meeting begins next Monday. Many a contributor to the financial chatter on-line and on TV expect a rate cut of 50 more basis points. Our friend John Mauldin expects 25…we here at the Daily Reckoning are left with a simple question for Alan G. & Company: why bother to meet at all? The first 12 rate cuts didn’t do diddly squat to help the economy back on its feet. Nor have a decades-plus worth of similar “monetary policy” decisions helped the Japanese scrub clean the mess left after their own bubble burst. Unless, of course, they’d simply like to see another spurt of speculation goose the DOW past 10,000…and another wave of ‘refi’ drive mortgage rates down to 4.5%…those events might be fun for everybody.

– “The Bush administration’s ‘strong dollar policy’ may be lamely executed macroeconomic strategy, but it is masterful theater – it is a tragicomedy,” writes Apogee Research’s Andrew Kashdan. Mr. George W. Bush, letting on to his secret knowledge of international currency markets, recently tried to explain the nuances of the dollar decline…and predict its near-term direction vis à vis the euro.

– “[T]he interest rate differential had caused people to sell dollars to buy euros to get a higher return on investment,” George the Younger explains, “and that’s why you’re seeing pressure on the dollar…You’ll see different behavior as the interest rate spread begins to narrow between Europe and the U.S.”

– “How does our protagonist’s theory square with the facts?” Kashdan wants to know. “Not very well, unfortunately.”

– “The short-rate differential reached its peak last year and has been narrowing ever since alongside the significant appreciation of the euro. Although the differential between 10-year U.S. and European interest rates has widened a few basis points recently, its earlier narrowing also corresponded in large part to the euro’s rally. Even before the European Central Bank finally slashed rates last week, long-term rates in Europe had declined by more than half a percentage point in just the last few months.

– “So the president’s explanation doesn’t hold water…so much for the comedy,” writes Kashdan. “The tragic subplot is that the dollar is falling because there are too many of the damn things around, and lots of good reasons to sell them. Mr. Bush and Mr. Greenspan are no doubt thankful that U.S. asset markets have shrugged off the dollar’s woes so far. But there’s no escaping the fact that, all else equal, foreigners (and even domestic investors) will shy away from assets that include a loss on the exchange rate.”

– Kashdan: “Expect more dollar weakness before the final curtain falls.”


Meanwhile, back in Paris…

Two things…

*** Few people recall it; in fact, few people noticed when it happened. But it was on this day that General de Gaulle made his famous radio appeal to the French of 1940, urging them to continue resisting the Germans.

True enough, de Gaulle could never measure up to the stature of a great military genius such as George W. Bush. Still, he was a remarkable man who did a remarkable thing. Taken prisoner by the Germans after being run through by a bayonet (his third wound in WWI), de Gaulle recovered…and made 5 attempts to escape. Between the wars, like Stonewall Jackson, he taught military history, brilliantly, at the French military academy of St. Cyr. Then, in the opening days of WWII, he successfully fought off Heinz Guderian’s tank attack at Montcornet. The small victory had little impact on the war, however. By June 16th, it was clear the war was lost.

Churchill came up with a scheme to keep the French in action against the Germans; he proposed that France and England be united. The French government would flee to London…and the war would continue. Pétain, hearing of the plan, thought Churchill mad. He, and the French government in Bordeaux, prepared to lay down arms.

De Gaulle, realizing what was up, made plans of his own. Winston Churchill recounted the scene on the morning of the 17th of June, 1940:

“De Gaulle went to his office, made a number of appointments for the afternoon, in order to allay suspicions, and then took himself to the airport with his friend Spears. They shook hands, said goodbye, and then, when the plane began its take-off, de Gaulle jumped in and slammed the door behind him. The plane rose off the ground, leaving the police and military officers with the mouths agape. De Gaulle, in this little plane, brought with him the honor of France…”

The very next day, de Gaulle formed his government in exile…and went on the radio urging the French not to give up.

*** Last night, it was Edward’s turn in the spotlight. Somehow, in defiance of the chromatic scale, Edward, 9, got into the choir at his school. The boy has a rich voice, but a range as short as his attention span.

The choir performed in the beautiful church of Notre Dame de Grace. They knocked out pieces of Monteverdi’s Crucifixus, Mozart’s Miserere and Mendelssohn’s Herr Sei Gnadig hardly pausing for a breath. All the boys seemed completely focused on their work, with one exception; a little boy up in the front row yawned…scratched his head…and looked right, left, up, down – everywhere but at his sheets of music. Occasionally, his mouth moved, but rarely in unison with the other chanteurs. Of course, it was Edward.

“Well, Edward, we were very proud of you,” said his mother after the show. “But next year, let’s try break-dancing or acrobatics.”

The Daily Reckoning