The Theory of Ignorance
“The same forces that have been boosting growth in structural productivity seem also to have accelerated the process of cyclical adjustment,” said the world’s top-rated bureaucrat, less than 60 days ago. “New technologies for supply chain management and flexible manufacturing imply that businesses can perceive imbalances in inventories at a very early stage – virtually in real time – and can cut production promptly in response to the developing signs of unintended inventory building.”
The New Era is already passe. Old. Even ridiculous. Yet as recently as two months ago, the best informed economist on the planet, Alan Greenspan, still believed in it.
“Even sober analysts,” writes Paul Krugman in the New York Times, “began to question the classic script for a slump, in which a slowdown in consumer spending and investment leads to a buildup of business inventories and businesses are then forced into severe production cut-backs to work off those inventories.”
Of all the companies that might have been able to harness this new advantage given them by the Information Age, perhaps none was better placed than Cisco. The company was so admired by investors that they gave it a market cap higher than any other company had ever received.
And even after the Nasdaq had crashed, Cisco’s CEO John Chambers explained to investors that Cisco would nevertheless continue to enjoy sales growth of 30% to 50% annually for as far as the eye could see.
But that is the problem, dear reader. The eye cannot see very far. And it sees what it wants to see anyway. Neither Mr. Greenspan, the world’s most celebrated macro-economist…nor Cisco Systems, recently one of the most envied corporations on Wall Street, really understood what was going on.
As reported in previous letters, it was this capital spending boom – not productivity nor New Era information technology – that made Wall Street’s numbers look so appealing. Businesses all over the planet felt the need to get into the swing of the New Era by spending on Information Technology. In the perverse logic of the late tech bubble, if they could spend enough, fast enough – their share prices would rise.
But now people seem to have all the routers and multiplexers they need. Even more than enough. Capital spending is falling by between 5% and 10% this year. And unsold equipment is piling up on the shelves.
John Chambers recently announced that, instead of growing 30%, sales were falling 30%. “This may be the fastest any industry has deteriorated,” he said.
Like an auto dealer in a downturn, Cisco finds itself with its lot full of various makes and models it would like to unload – new and used. “Cisco Systems Capital,” reports the company’s website, “now offers refurbished Cisco equipment with the same warranty protection and support as new…but at a lower price.”
Lower prices are the name of the game in the router and switch business these days. Discounts listed at www.usedrouter.com range from near 70% to as little as 20%.
Grant’s Interest Rate Observer quotes Mark Magee of Asset Recovery Center: “I can buy the equipment for 10 cents on the dollar…the stuff we are seeing right now is very often less than a year old and still under warranty.”
“I have several hundred Pentium III PC’s in my warehouse,” he continued, “that I will sell for probably $500 a system…”
Grant’s also interviewed the folks at usedrouter.com and got this comment: “[Internet Service Providers} can get equipment really, really cheap right now, brand new equipment.”
Errata. Everybody makes mistakes. Even here at the Daily Reckoning. Yesterday, for example, I misstated my own Theory of Ignorance. This time I’ll get it right:
Ignorance increases as the square of the distance between your personal experience and the subject matter.
Mr. Greenspan was just guessing…and should have said so.
Your correspondent, just guessing…
April 20, 2001
The world is full of mistakes and misapprehensions.
“I thought you were talking to someone,” I said to Mr. Deshais on Sunday, overhearing part of a conversation as I walked into the greenhouse.
“Oh, I was just talking to myself,” replied the gardener. “I always talk to myself. I could talk to the plants the way some gardeners do. But I’m afraid they would give me dumb answers. So I talk to myself…”
“But I like talking to myself,” he continued. “I find my companion so agreeable. And he always understands what I am talking about.”
Alas, a conversation involving more than one person is bound to result in misunderstandings. Married couples, for example, may go through their entire lives together failing to grasp what the other means, wants, or intends. Often as not, it is probably these malentendus that keep the couple together. If the truth ever were to get out, it would probably ruin the whole thing – like a teenage girl who discovers what they put in hot dogs.
*** “Rate Cut Glow Continues to Shine,” says TheStreet.com, describing yesterday’s market activity. Both the Dow and the Nasdaq rose. The Dow ended up 77 points. The Nasdaq made a 102-point gain.
*** “The gains will stick,” TheStreet quoted one trader, “as people are focusing on the second half.”
*** But “it is only a matter of time before the market realizes that lowering interest rates will not do very much for the US economy,” says Albert Friedberg.
*** Business is good at Countrywide Home Loans. The company is getting twice as many telephone calls as usual – following the Fed’s 50 basis point rate cut. Most callers are hoping to refinance existing mortgages at reduced rates. Could it be that they are looking for ways to reduce their expenses, rather than enlarge them?
*** People are still borrowing, but they are not necessarily increasing their spending. Caught between the millstones of higher energy costs, lower employment levels, and lower equity values…American consumers are feeling a little pinched…
*** “I have just come from Washington DC,” writes Jeff Randall of the BBC, “where my over-riding impression was that ordinary Americans fail to realize just how precarious their economic plight has become.”
*** “I see huge risks for the economy right now,” said former Fed governor, Janet Yellin. Alan Greenspan must have seen the same dangers. Industrial production turned up last month. Consumers are still borrowing. Home sales are surprisingly strong. So why the surprise rate cut?
*** A NY TIMES article addressed the question, coming to the conclusion that Greenspan & Co. have two major fears: 1) that consumers are near the breaking point – where they may be forced to curb expenditures, which could set in motion a Japan- style slump and 2) “a related pullback by companies in the purchase of computers, communication technologies and other types of equipment.” Why should the Fed care if companies purchase computers? Ah…more below.
*** If the U.S. sinks into recession, it probably won’t go down alone, warns Anirvan Banerji, of the Economy Cycle Research Institute. Japan, Taiwan, and South Korea will be dragged down too. So would Mexico and Australia. That would put more than half the world’s GDP in negative territory – the first such slowdown in a quarter century.
*** “Name a company that dominates its industry, that has 20% operating margins, 10% net margins, earns 30% on equity, 20% on total invested capital, generates $1 billion of free cash flow and trades under 10 times trailing earnings…” challenged Bill Miller of Legg Mason in Barron’s. That company is the very one that our own Porter Stansberry believes is doomed by the creative destruction of the marketplace: Kodak. At 9 times earnings, with a dividend yield of 4.12%, at least Kodak is relatively cheap. Cheap enough to buy? It is “not yet actually cheap,” judges Jim Grant, but it is “becoming cheaper, which, however, is progress.”
*** “The major averages need to decline another 30- 40% before they reach the median levels of valuation, never mind cheap,” calculates Michael O’Higgins. “While stock investors have experienced huge losses – over $6 trillion so far – there seems to be little in the way of the type of capitulation that normally prevails at market bottoms.”
*** What to do? Buy bonds, O’Higgins urges. “I have found that long-term US Treasury rates tended to fluctuate around a level 2 percentage points above the nine-year moving average of the Consumer Price Index (CPI). With the nine-year CPI currently at 2.58%, it would appear that long-term T-bond rates should approach 4.58% by year end 2001. If that happens, my long-term zeros should appreciate by another 20+% during a time when…the major stock averages should drop by 30-40%.
*** “What will I use as an indicator to signal the end of the great bull market in bonds that we have enjoyed for the last 20 years?” asks O’Higgins, rhetorically. “An indicator which has correctly signaled the course of the long-term T-bond rates in 26 out of the last 32 years is the price of gold. With the price of gold still lower than it was a year ago, it still looks safe to own long-term Treasuries.”
*** But the price of gold jumped $4 yesterday. And bonds didn’t seem to like it. Bonds were down, worried either about the dollar, inflation, or a quick business recovery (which would send rates higher). The gap between regular Treasuries and inflation-adjusted TIPS widened, suggesting that investors are worried about an uptick in inflation rates.
*** “We could have real economic contraction (2%, 3% 4% of GNP),” said Albert Friedberg recently, “plus a rate of inflation that will eat further into incomes. So you have a loss of income via unemployment. You have a loss of income via the shrinkage of the purchasing power of wages. And that’s a serious problem… We have a combination of wealth contraction or shrinkage, via the asset implosion, an attack on income via inflation, an attack on income via further layoffs. All the makings of a prolonged slump that can be pretty deep…”
*** I searched the British press for the usual “naughty vicar” story. But the vicars seem to be on good behavior recently, perhaps out of respect for the Lenten season.
*** Today, lest we forget, is Adolf Hitler’s birthday. Whatever else can be said about him, few
elected officials can boast such name recognition.