-->Hip Dysplasia
The Daily Reckoning
Paris, France
Thursday, 27 February 2003
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*** Buying gold...a shortage of Krugerrands...
*** Hewlett Packard disappoints investors...non-GAAP
earnings and non-fish fish
*** Greenspan to retire, half a decade too late...gold
glitters
The Rue Vivienne is a street in Paris which runs from the
Bourse up towards Pigalle - that is, from the stock market
to the red light district...or from one group of whose
virtues are for sale to another whose virtues are both more
affordable and more enjoyable. It is to this street that
you must go if you want to buy gold coins. But the street's
coin vendors greet you as if you were applying for a bail
bond. You stand in front of a small window in a tawdry
stall of shop...like a ghetto liquor store...and count your
change carefully.
Buying gold is not as easy as buying stocks. Taking
advantage of last week's trip to America, and a $25 per-
ounce drop in the gold price, your editor decided to load
up. But a call to one coin company went un-answered.
Another informed us that Krugerrands were in short supply
and could not be immediately delivered.
Your editor left America disappointed and empty handed. But
his faith in gold was confirmed. No shortage of shares in
Amazon.com nor GE has ever occurred. Nor has any lone biped
with money in his pocket ever had any problem buying them.
If the shortage in Krugerrands persists, the South Africans
will mint more of them. But they will not be able to create
them out of thin air"at virtually no cost" (as Fed
governor Ben Bernanke described dollar creation at the
Bureau of Printing and Engraving). At current prices, each
one-ounce coin costs about $364 and contains about $354 of
gold. Plus, there is the actual cost of minting and
distributing the coin.
Most investors and financial analysts are amazed that
anyone would want to buy gold at all.
"It's mainly war talk that is driving gold higher,"
explains a report in the Detroit Free Press. Gold is
thought to be the duct tape and plastic sheeting of the
investment world - the last resort of the paranoid, the
hysterical and the delusional.
Will the price of gold collapse after the 'quick and easy'
war is over? We do not know. But yesterday the Bush
administration asked for $95 billion to fund the war
effort. This pushes the federal deficit to well over $1
billion per day. And there is the U.S. trade deficit, too -
more than $1 billion per day. Where will all the money come
from? Not from Krugerrands. Most likely, the Fed will
create it...at virtually no cost to itself, but huge cost
to dollar-based investors.
On September 10, 2001, an ounce of gold could be bought for
$271.50 per ounce. The central banks of the world - the
very same banks whom people believe to be capable of seeing
into the future and improving it - were selling tons of it
at this price. By February 2003, gold was selling for $100
more.
Even central bankers must have noticed. Seventy-five
percent of their reserves are in dollars - and losing value
- while the gold they sold rises. How long will it be
before we spot Bernanke, Duisenberg and Hayami on the Rue
Vivienne?
We will see.
Eric?
-------------
Eric Fry, reporting from New York...
- Another sloppy day on Wall Street. Stocks sloshed around
most of the day before running amuck in the afternoon. The
Dow slipped 102 points to 7,807 and the Nadsaq dropped 25
to 1,303. Meanwhile, the safe-havens attracted safety-
seekers once again. Gold gained $1.70 to $354.10 an ounce
and oil gushed $1.69 to new 12-year high of $37.75 a
barrel.
- Meanwhile, government bonds continued their incredible
ascent, as the yield on the 10-year Treasury note dropped
all the way to 3.77% from 3.82% on Tuesday. It's hard to
believe that bonds could sustain a strong rally in the face
of soaring oil prices, imminent war and rising government
deficits. But when have the financial markets ever been
rational? Perhaps bonds are simply the latest bubble to
come floating out of Alan Greenspan's macroeconomic bubble
bath.
- Tuesday afternoon, Hewlett Packard proudly trumpeted
quarterly earnings that exceeded Wall Street expectations.
Unfortunately, investors didn't buy the hype, as the stock
tumbled more than 15% yesterday. HP"beat the number" all
right, but not the right number. Revenues fell well short
of expectations, and that was the number that mattered most
to investors.
- Helwlett's quarter was not without notable achievements,
however - foremost among them was the company's
groundbreaking contribution to the Wall Street lexicon of
deceptive euphemisms for earnings. Hewlett's contribution:
"non-GAAP earnings."
- Hewlett's press release states:"Non-GAAP(1) (formerly
reported as pro forma) operating profit totaled $1.1
billion, up 25% sequentially...Non-GAAP diluted earnings
per share (EPS) for the quarter was 29 cents, compared to
24 cents in the fourth quarter, up 21% sequentially..."
- Move over,"pro forma"..."non-GAAP" is the new kid in
town! The term, translated loosely, means"non-earnings
earnings". For those of you who do not read accounting
textbooks for pleasure, GAAP stands for Generally Accepted
Accounting Principles. And GAAP earnings are the only ones
that qualify as the real deal. GAAP earnings, for example,
are the ones that appear in a company's annual report.
- Of what possible use to common shareholders is a
calculation of non-GAAP earnings? Couldn't non-GAAP
earnings be just about anything, including non-earnings?
Are shareholders really clamoring to know non-GAAP
earnings? Wouldn't that be like standing in a long line at
the grocery store to buy"non-fish" fish? To be sure,
supermarkets would try to sell non-fish fish all day long,
if they could find buyers for the stuff...and that is
exactly what companies like Hewlett Packard are still
trying to do.
- The issue is not merely a semantic one. Hewlett's
audacious"earnings" report shows quite clearly that the
game-playing continues on Wall Street. Even now, in the
putatively"clean" post-Enron era, many U.S. corporations
find it difficult to shake their proclivity to deceive.
What's more, S&P 500 companies have been reporting non-
earnings earnings for so long, that very little of the real
stuff remains.
-"David Bianco of UBS Warburg reports...that from 1991
through 2000 GAAP earnings accounted for 84% of operating
earnings," Barron's relates."Put another way, one-sixth of
companies' bottom lines came from things that GAAP does not
deem 'real' earnings. Then came the write-off derby and
profit recession of 2001-2002, when only a little more than
half of operating earnings - the kind that analysts try to
forecast - counted as GAAP earnings.
-"Only eight S&P 500 companies reported 'pro forma'
earnings that equaled GAAP earnings for each of the last 12
quarters, and 85 of the companies never once had the
earnings measures they emphasized in their press releases
conform to GAAP.
-"The coming rules and the related effects on corporate
reporting practices could shave as much as 10% off the
published earnings forecasts for S&P 500 companies, Bianco
figures. Going a step further, Bianco estimates that 'poor
quality earnings' in the form of unearned pension income,
employee-stock option costs and off-balance sheet
transactions might make up $10 of the expected $52 per
share in S&P 500 earnings projected for 2003."
- In other words, honest earnings - let's call them
"earnings earnings" - for the S&P 500 are probably closer
to $42 than $52, which would make the S&P 500's"real" P/E
closer to 20 times earnings than 16 times earnings, neither
of which would qualify as a bargain.
- Anyone for some non-bargain bargains?
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Back in Paris...
*** Greenspan does not seem to want another term. Deficits
DO matter, he told Congress last week...and taxes shouldn't
be cut - thus contradicting the Bush bunch and ensuring his
retirement.
Alan is not alone in his thoughts."It's bad enough for
tax-cutters that Greenspan came out against them," says Dan
Denning, from whom we'll hear more below,"but now the man
behind the Bush tax plan, Glenn Hubbard, is leaving
government and heading back to academia. As of Friday,
Hubbard will no longer run the President's Council of
Economic Advisors.
"I don't know if this means the tax plan is headed for
defeat...but the twin deficits (trade and Federal) aren't
just theoretical economic issues anymore. They're starting
to end careers in Washington. Maybe deficits aren't all bad
after all...."
(For more on the subject - why deficits DO matter - see
Hans Sennholz's article:"Deficits Do Matter")
http://www.dailyreckoning.com/body_headline.cfm?id=2971
*** Greenspan's reputation is roughly the inverse of the
gold price. When gold was at an epic low - in the late-'90s
- every word about the Fed chairman was flattery. But now
we are three years into a bear market...with rising
unemployment and bankuptcies. Why didn't Greenspan puncture
the bubble when he had the chance, people wonder? Gold
gleams, while Greenspan's reputation rusts.
"Why didn't I retire when I was still on top of the world?"
Greenspan must wonder to himself. He could have followed
the (rare) example of Roman emperor Diocletian, who
voluntarily resigned at the peak of Rome's power...and
subsequently enjoyed a quiet life growing cabbages.
*** What will America be like in the post-bubble world?
Many times, have we looked at Japan for an example. But the
Japanese had huge savings...and were net creditors to the
rest of the world. In the years following the collapse of
the Tokyo stock market, the yen actually rose in value, and
the Japanese continued to live well.
Maybe Argentina is a better example. Last year, the
Argentine economy fell 10%. The peso lost 70% of its value.
And consumer prices rose 40%. Half the population lives in
poverty, say press reports. Crime is rising. But it is not
all bad news. You can buy a $300,000 apartment in Buenos
Aires for less than $100,000, reports my friend Lief Simon,
who is currently looking for bargains south of the Rio
Plata. And trendy restaurants offer all-you-can-eat
specials for less than $10.
-----------------------
The Daily Reckoning PRESENTS: If you still want to be in
the market, but don't trust individual stocks, Daniel
Denning suggest"the next big thing" in fund investing.
HIP DYSPLASIA
By Dan Denning
The investment and political worlds have, to borrow a
phrase from The Lord of the Rings,"abandoned reason for
madness". This shouldn't surprise anyone. Politics, like
investing, is driven by emotion, not logic.
Still, watching investors make the same mistake time after
time is like watching an old golden retriever of mine.
Retrievers are great dogs, and usually smart. But as they
get older, they get hip dysplasia. The ball and socket
joints in their rear legs deteriorate, and it makes it hard
for them to get around.
As a young dog, my retriever (Riven was his name) would
chase a tennis ball all day. No side affects. As he got
older, he slowed down. But it wasn't really a problem until
I moved into a two-story log house in Colorado. My bedroom
was upstairs, and the steps weren't carpeted. They were
made out of varnished pine logs...which made them slippery.
Riven found this out the hard way.
I woke up one morning to find him sleeping at the foot of
my bed. When I got up to go downstairs for coffee, he
followed a few steps behind. Then I heard his dog toenail
scratch across the top step. I looked back to see him
surfing down the stairs, front legs out in front of him
like Superman, gaining on me quickly. I jumped the last few
feet to get out of the way and turned around to see him
crash, muzzle first, into the cabin wall.
It's okay to laugh. It looked funny. But from then on, I
stopped him from following me upstairs whenever I could.
But dogs are loyal...and when Riven's loyalty trumped his
memory, he paid for it.
I can't help thinking about this story when I see investors
piling into tech stocks. These pavlovian investors are
asking for it. Those investments may have been hip at the
top of the bubble...but, as history shows, it simply makes
no sense to keep investing in the best-performing stocks of
the previous bull market. Especially when there's a much
better way.
Let's take oil as an example. There's a good chance that in
a post-Saddam Hussein Iraq, oil production is going to
rise. Rising production will likely lead to lower global
oil prices. Big American oil companies won't do as well in
a free Iraq as they're doing right now. But oil-service
companies could do better.
This is a simple, direct piece of geopolitical investment
analysis. Yet most investors take it and do exactly the
wrong thing. Thinking in old terms, investors conclude that
if oil prices fall, this is good for the economy...and if
it's good for the economy, it's good for the stock
market...and if it's good for the stock market, well then
it must be time to buy tech stocks!!!
So, the poor saps run out and buy the most popular stocks
from the last bull market - AOL, Lucent, and GE, to name a
few.
The obvious problem with this strategy is that you're
exposed to all the risk of a falling market, while your
upside is limited to whatever the broad market does. Put
another way, if you choose to buy the biggest names because
they're"safe", you take all the risk of owning an
individual stock in today's market - fraud, disappointing
earnings, leadership in the negative sense - while limiting
your profits to broad-market moves.
Yet investors keep regrouping and charging right back into
the biggest names in the market. For example, even though
it's down from a remarkable $1 trillion (in 2001), Fidelity
still has over $700 billion in investor funds under
management in its family of funds.
Watching investors in this bear market is a lot like
watching my dog charge up the stairs after me, and then
realizing he's in trouble. If you're investing in today's
market with yesterday's techniques, there's no easy way
down.
Instead of doing the reflexively obvious thing - going long
stocks - it makes much more sense to pick an investment
that profits if you're right, but minimizes your risk if
you're wrong. A simple goal. But a lot easier to achieve
today with the emergence of"exchange traded funds" (ETFs),
iShares, and HOLDrs.
I hesitate to say that ETFs are"the next big thing" -
mainly because that would be tantamount to cursing them.
Plus, you can buy these new vehicles exactly the same way
you'd buy a stock, which means they're not exactly
revolutionary.
But the great advantage of ETFs is that you can invest in
general geopolitical insight, like an observation about oil
production in post-War Iraq, without exposing yourself to
the collateral dangers you get in a mutual fund or a single
stock. You can almost always find a liquid ETF to buy for
any idea you have. The expenses are low compared to funds.
You can use limit orders and stop orders. And, unlike a big
Vanguard fun, you can trade intra-day, rather than being
locked into the closing price.
With this next generation of investment vehicles, you have
a lot more flexibility to invest in specific ideas. What's
more, if you're inclined to trading rather than investing,
you can buy put or a call option and make it even simpler.
In fact, looking at our Iraq example, there are several
different oil service indexes for which you can buy
options. The Philadelphia Euro Style Oil Services Index
(OSX), is but one example.
When I look for the best vehicle, I look for something
that's liquid and leveraged. For my money, there are two
attractive options. The first is the Morgan Stanley Oil
Services Index (MGO). This index gives you exposure to 28
oil service companies. And its chart shows that it's more
responsive to fluctuations in the price of crude.
The other is an Oil Service"HOLDR" (a specific type of
ETF) traded on the Amex, which gives you exposure to the
ten biggest oil service stocks in the industry. And it
gives you leverage and liquidity in your call options. Once
you've got it narrowed down to this vehicle, then it's just
a matter of selecting the best option.
As a trader, this my preferred method for speculating on
the direction of the indexes. I usually look for either
near-term, in-the-money call options if I'm bullish or
long-term, out-of-the-money put options if I'm bearish.
Regards,
Dan Denning
For The Daily Reckoning
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