The Wild, Dark Night
“The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.”
The days grow shorter. The world, you will recall, is not a straight up and down thing. Instead, it is tilted on its axis, causing a seasonal oscillation as the earth makes it way around the sun. At this latitude, it is already darkening when Maria comes to the office at 7 p.m. Only a few weeks ago, it was still broad daylight.
All of life lists a little…as if it had too much to drink or one leg shorter than the other. Nothing is pure and simple. Nothing is quite as straight as we might like it to be. Everything turns out to be a little more complicated and cock-eyed than we might have first thought. And at times…things seem to go mad.
“I read that this economic slump could last as long as 10 years,” said Mario, an executive with the Danone company, at dinner on Saturday night. “It seems like madness…but I guess anything is possible.”
Few people want to stack firewood in the summertime. And at the end of an 18-year bull market, most people have come to believe that stock prices “always go up in the long run” and that the world economy will shamble along as though it were always headed for another 20-year period of growth.
But with each spurt of growth and bullishness a curious thing happens. New and better ways are found to do things. People specialize…the division of labor is extended. The days of progress grow longer, stretched on one end by new technology…with its electric lights, alarm clocks, and particle accelerators…and on the other end by people who tug themselves up into new economic niches…elaborating the division of labor to produce more and better things for less and less money.
Progress does not come without cost. As the economy expands, each part of it becomes more dependent on the others. The computer software salesman cannot live without the efforts of the bakers, the automakers, the miners, the central bankers…and so on. He counts on thousands of others to keep his lights on and his table set…
Thus does the whole system become at once more sophisticated…and more vulnerable. Before the development of commercial aircraft, a man armed with a knife was little danger to society. All men had knives. One was no more dangerous than any other, and much less of a threat than, say, the average city alderman or patent medicine monger.
Nor even was a man with a gun much of a menace. Yes, he might pick off a Lincoln or a Ferdinand. But what would it matter? There are always plenty more to take their places. In last week’s news, by contrast, was the story of a drunk with a rifle who shot a hole in a pipeline in Alaska and crippled a fifth of the nation’s oil supplies.
Imagine what a man with a pair of wire cutters might do to the power lines. Or what a man with a kamikaze complex and a bad, communicable disease might do. He would not have to smuggle a pocket knife onto an airplane. He would just have to board himself!
“The grim paradox is that terrorism, a particularly primitive act,” wrote George Will recently, “has a symbiotic relationship with the sophistication of its targets. And opportunities for macro-terrorism directed against urban populations and their water, food-handling and information systems multiply as societies become more sophisticated.”
The terrorists’ attack – primitive and economical as it was – will cost the world economy billions of dollars. An IMF economist estimated that as many as 40,000 children under the age of 5 will die…from starvation or lack of medicines…as a consequence of the economic damage.
But this could be just the beginning of a long, wild night. Sophisticated, prosperous economies require high levels of mutual trust. You can work in a skyscraper only so long as you can be pretty sure someone is not going to blow it up. And you can walk around, relying on credit cards for your spending power, only so long as you are fairly sure that no one will sabotage the ATMs and electronic clearing systems. And every time you get on an airplane, go into a restaurant, drive down the road, or sit down to dinner, you trust in the good faith and common courtesy of people all over the world – the engineers who designed the elevators and jet engines, the farmers who grew the wheat and the baker who cooked the buns, the guy at the next desk or next table…the vintner who made the wine…and so on. Any one of them could do you damage…( and yet, almost miraculously, they almost never do.)
In a different season – that is, in a period at the bottom of the economic cycle – a war might trigger a boom. But at the top, it is likely to have the opposite effect. People become less trusting. They are a bit less eager to buy…less eager to trade…less eager to open factories in Pakistan or take a vacation in Israel.
And what baby boomer, whose portfolio is now down about 40% from the peak, is not on the edge of panic? The “savings” he counted on for retirement suddenly looks vulnerable. He still believes that the market will bounce back before he needs the money. But what if it doesn’t? Will he not soon have a wild look on his face…as he desperately tries to replace the phoney savings of a bull market with the real money? Each 1% increase in the savings rate takes $75 billion out of the economy. Returning to the savings rate of the early ’80s would cost the economy more than half a trillion dollars a year. Other things remaining the same, this would mean a GDP loss of about 5% – the biggest since the Great Depression.
In a more straight up and down world, other things might remain the same. But in our world, it’s a rare act of Congress, act of war, or act of economy that doesn’t produce some misbegotten offspring. Who knows what will happen when the din and bustle of progress quiets, and – in the long, wild night ahead – war, fear, and frugality finally come together?
Your faithful correspondent,
Debt could be paid down. Or it could be inflated away.
Deflation, though, makes it tough to pay down debt. Often, debtors default and creditors are forced to write off the debts.
Providian, the nation’s 5th largest credit card issuer, announced last week that more and more people are defaulting. The company said its earnings were off as a result.
Polaroid couldn’t pay its debts either. The company went Chapter 11 on Friday. “U.S. corporations are quickly burning through cash,” says a USA Today article, pushing some towards bankruptcy and making it more expensive for others to borrow money.
“Nervous lenders have already cut back sharply on lending to upstart companies and those with heavy debt loads. But cash worries are spreading to well-known companies as earnings fall so fast there is less left to pay.
“Companies are going to sink in their own debt,” says Mitch Zacks. Consumers, too.
Eric…what’s happening in N.Y.C?
– “Overvaluation? What overvaluation?” Mr. Market seems to be asking. “Terrorism? What terrorism?” The Dow gained 2.5% percent last week – bringing its gains from the post-attack lows on September 21st to an impressive 13.5%.
– Psychologists might call this denial. Abby Joseph Cohen, on the other hand, might call it merely “a new bull market.”
– Is the bear market over already? Might there not be a little unfinished business? “Following Thursday’s mini-rally, the P/E of the S&P 500 reached its highest level EVER – at 35.99,” Addison reported in the DR Weekend Edition.
– For perspective, the average long-term P/E ratio of the S&P 500 is about 15. And a few notable bear markets in the past did not call it quits and yield to a new bull market until the S&P 500 Index was selling for lessthan 10 times earnings.
– Bear markets are supposed to correct the excesses of the prior boom – restore value to the marketplace and therefore, create opportunity for investors.
– But falling prices do not necessarily create value. Like a week-old salmon filet, some things lose value so quickly and completely that not even lower prices can make them a bargain.
– U.S. stocks, while not exactly week-old fish, are losing value even faster than they are falling in price. In other words, earnings are collapsing more rapidly than share prices. The result is that PE ratios remain stubbornly close to all-time highs.
– Happily, the S&P 500, unlike week-old fish, will offer value once again. Earnings will resume growing and growth prospects will improve. But we’re not there yet. Genuine bear markets end in gloom and despair. “In this bear market, however,” Albert D. Friedburg, of Friedburg’s Commodity and Currency Comments points out, “strategists of the major investment houses have progressively upped the percentage allocated to stocks, now running, on the average, at well over 70%.”
– Individuals also are keeping the faith. “So ingrained has the equity cult become that mutual funds have only recently begun to experience net outflows on a sustained basis,” Friedburg says. “It is only a matter of time before we witness a massive exodus. It is not the severity of the decline that will cause the outflows. Rather, it is the persistence, endurance and obvious hopelessness of the bear market that will flush out even the most committed.”
– “The stock market recently made a comeback, leading some market technicians to call a bottom,” says Fred Hickey, editor of the High Tech Strategist. “[Because] stock market valuations are still too high by a factor of approximately two times. I am on public record with predictions of the Dow Jones Industrial Average below 5,000 and the Nasdaq Composite below 1,000 before this bear market ends. I see no reason to change these forecasts now.”
– To back up his predictions, Hickey rattles off a few eye-opening statistics. The total valuation of U.S. stocks (approximately $11 trillion currently) is nearly 120% of the value of this nation’s GDP, with the historical average being just 54%. Prior to the late- 1990s’ mania prices, the all-time high in this indicator (81%) occurred in August 1929, just prior to the crash…every historical yardstick used over the decades to value stocks provides the same answer. Price/earnings, price/sales and price/book ratios all show that stocks are at least two times overvalued.”
– Despite the market’s extreme overvaluation, Hickey acknowledges, “The U.S. government is desperately trying to reinvigorate the economy with the steepest interest rate cuts in history, tens of billions of dollars of tax rebates and tax cuts, and promises of huge fiscal spending on infrastructure and other projects…with all this cash sloshing around, some of it can find its way into the stock market.”
– But just the same, he would be a seller of any rallies. “As the stock market comes down, more buying opportunities will become available,” he says. We’re guessing Hickey doesn’t expect this buying opportunity to present itself anytime soon.
– Without genuine value creation, it is difficult for the bulls to plant their flag and to claim the stock market as their own.
Back in Paris…
*** The Dow has recovered what it lost following the Sept. 11 attacks. “Conditions are almost back to normal,” observed a commentator on CNBC.
*** Yes, normal for this stage of a bear market…
*** Profits have fallen faster than stock prices – leading to the highest p/e levels ever, currently nearly 36 for the S&P 500.
*** Eddie Bauer says sales fell 21% last month. Overall figures show a 10% drop-off in the retail sector. All over the world, economies deflate. “French inflation rate slips below 2%,” says the Financial Times. “Worse to come for UK economy,” says the BBC.
*** “I was very impressed with your president,” said a Frenchman at a dinner party Friday night. “I stayed up until 3 am to watch his speech. That just goes to show how nervous I was. I mean…he comes across as a cowboy…I didn’t know what he might do…
*** “But he seemed very reasonable, calm…yet determined.”
*** “The problem is that he doesn’t know what he’s gotten himself into. No one does…”
*** Europeans are more accustomed to terrorism than Americans. For years, Paris lived with bomb blasts delivered by North African terrorists. The British have lived with violence from IRA bombers. And Spain has suffered the attacks of Basque separatists. Once unleashed, the dogs of guerilla war can be very hard to get back in their kennels.