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The Daily Reckoning

Paris, France

Monday, 10 March 2003

-------------------

*** Economic conditions decline...back into recession?
Where does this lead - to Japan?

*** Mr. Market's 'Hollywood Story'...a happy ending?

*** Manipulation on Wall Street...speaking the
language...and more!

-------------------

"Payrolls plunge by 308,000 in February," says a Reuters
report."Hundreds of companies may slash pensions," adds
CNN."Pilots' retirement threatened by airline losses,"
notes the Washington Post.

The U.S. economy"may be slipping back in recession,"
declares another article.

"Chronic budget deficits forecast," continues the
Washington Post...

Let's see...

Record trade deficits...record federal deficits...

Stocks still preposterously high, while profits and capital
investment lag...

And even though consumers are furiously refinancing in
order to take advantage of the lowest rates since the '50s,
consumer spending is dropping as saving rates rise...

Where does this lead?

For the last 3 years, we have been pointing East...as in
the Far East...as in the Land of the Rising Sun. If that is
where this leads, Daily Reckoning readers have cause for
concern, but no reason to put a gun to their heads.

Japan's unemployment rate just reached 5.5% - its highest
level since WWII. But in the U.S., 5.8% of working stiffs
are not working, which is not so bad.

And the Nikkei just made the news, too - falling to 8,144
last Friday, its lowest level since 1983, wiping out 20
years of gains. If the U.S. were to continue following the
Japanese example - with a lag of 10 years - Wall Street's
Dow will sink to 3,355 by March of 2013. (In our typical
cheery way, dear reader, we give you something to look
forward to...)

Still, no collections are being taken in church destined to
feed the poor in Japan. By all accounts, the Japanese are
still living well - even after 13 years of on-again, off-
again recession, a bear market, and deflation. If only we
should be so lucky! But after writing a book on the
subject, we have come to believe that the U.S. will not
follow Japan after all, for two reasons. First, Japan
entered its slump in a very good economic position; its
people had a thick cushion of savings on which to fall. And
then, Japan had no geo-political ambitions.

All the many circumstances which were so favorable for
America at the end of the 20th century seemed to have
turned against her at the beginning of the 21st. Her people
are deep in debt; many are nearing retirement - with little
resources set aside. Her currency is weakening. And she is
beginning expensive military campaigns...at a time when she
must rely upon foreigners to lend her money. How will she
manage? She must almost certainly betray her creditors by
destroying the dollar. But how? When?

We will have to wait to find out...

Eric?

--------------

Eric Fry, reporting from New York...

- Something vaguely resembling springtime arrived in New
York City over the weekend. For what seemed like the first
time since August, the mercury inched above 40 degrees. The
chilly conditions on Wall Street also thawed a bit at
week's end. On Friday, for what seemed like the first time
since August, the Dow converted a steep 100-point decline
into a respectable, 66-point advance.

- The one-day wonder was not enough to lift the blue-chip
index into the black for the week, but it was a welcome
moral victory, just the same. For the week, the Dow slipped
151 points to 7,740, while the Nasdaq slumped nearly 3% to
1,350. The Dow still remains squarely within the trading
range of 7,600 to 8,100 that has bracketed the index since
late January. What's next for the blue chips? North of
8,100 or south of 7,600?

- Notwithstanding the worrisome"fuschia alert" signaled by
the Paris office of the Daily Reckoning, the New York
office continues to expect the Dow to head north of 8,100,
before resuming its epic bear market...At least, that is
our guess. (If it fails to rally, however, we are fairly
certain that it will fall.)

- There is, to be sure, absolutely no reason why stocks
ought to rally anytime soon, except that everyone seems to
expect a continuing decline. However, stacking up against
this touchy-feely contrarian rationale for a rally are
innumerable negative factors - a dismal job market,
sluggish retail sales, soaring oil prices and a looming war
in Iraq, to name a few.

-"Last week brought fresh evidence of how down the economy
is," writes Alan Abelson in today's Barron's."The
Institute of Supply Management began [last] week with a
discouraging report...Particularly ominous was that new
orders fell off a cliff last month and so did hiring...The
unemployment report for February was, to put it mildly, an
unmitigated disaster: 308,000 jobs were lost...And to judge
by the recent surge in weekly claims for unemployment and
other disturbing soundings, this seems destined to remain
very much a jobless recovery - and we're starting to wonder
about the recovery part."

- Mr. Market has fallen on hard times, no question about
it. His downward spiral since March of 2000 resembles the
first half-hour of an"'E' True Hollywood Story" - a
schmaltzy, formulaic, made-for-TV biography. The show's
first half-hour is when the rock star/celebrity with a
mega-hit record gets all the drugs and girls he could
possibly want. But then, his career hits the skids and he
hits"rock bottom"...even contemplating suicide.

- (During the second half hour, the down-and-out former
rock star goes through rehab and gets his life"back
together". Finally, at the age of 50, he's happier than
ever, making cameo appearances on"Will and Grace" and
playing small clubs with his new band.)

- Unfortunately, Mr. Market is still stuck in the first
half hour of his"True Hollywood Story". He has not yet
gotten his life back together, and he's still in the down-
and-out, suicidal phase. Will he EVER make it into the
second half-hour?

- During the late 1990s, Mr. Market certainly achieved
rock-star status. He possessed a strikingly handsome
profile and he tossed money around like confetti. Who
wouldn't love a guy like that? But then his star crested.
Just three years after becoming the talk of the town, he
hit rock bottom. All of his former Wall Street groupies and
hangers-on have scattered, denying they had ever befriended
him. And all of his former strategist-buddies now say they
never really liked the man that much.

- We're all saddened to see Mr. Market fall to such a low
estate, and we're pulling for him. Unfortunately, the road
to redemption is paved with repentance. And there is little
sign that investors have turned away from their former
sins.

- From the looks of things, most investors have not yet
repented of paying bull market valuations for stocks. They
continue to view 30 times earnings as a"reasonable"
valuation, instead of a damnable excess.

- In other words, investors must acknowledge the error of
their former ways in order to clear the path for a new bull
market. A little more weeping and gnashing of teeth - not
to mention donning of sackcloth and ashes - might be
necessary before redemption will arrive on Wall Street.

--------------

Back in Paris...

*** The price of April gold dropped $6 on Friday. This is
good news for those of us who are buying...but it is
puzzling. How could the price of gold fall when the dollar
fell too? And how could stocks manage to climb - however
modestly - in the face of so much bad news and so many
risks (not to mention our own Fuschia Alert signal)? You
don't think anyone would be fool enough to try to
manipulate the markets, do you? We don't know, but the last
thing the Bush Administration would want, on the eve of its
war against Iraq, would be crashing stocks and soaring
gold.

*** Today is the 3rd anniversary of the Nasdaq's peak. Will
it fall a 4th year? Maybe...bear markets usually continue
until they have erased ALL the previous bull market's
profits in excess of the very long-term trend. The occasion
passed without much fanfare in the office, but we will
raise a glass to the New Era later on tonight.

*** What a strange war! The papers report that Iraq is
actively destroying its weapons. We have never understood
the administration's war aims, but shooting a fellow who
has put his gun down just doesn't seem very sporting, even
if he still have a knife in his boot. Alas, the lure to
empire is probably irresistible.

***"I was went to the Salon d'Agriculture," replied Edward
this morning.

The question was,"What did you do this weekend?" And the
answer conveyed the necessary information, but without the
customary grammar.

Edward, 9, has spent his entire educational career in
French schools. His French is not bad, but his use of the
Mother Tongue is sometimes alarming, and usually mixed with
French words.

Your editor wishes his French were as good as his English.
The task seems impossible; native French speakers cringe
every time he opens his mouth. But Edward gave him an idea:
he will not try to speak French better; instead, he will
speak English worse!

So, until he write again...tomorrow...


The Daily Reckoning PRESENTS: Looking at the 'full
picture', Dan Denning suggests that investors might have
something to learn from the errors of the Intelligence
community.


ALL-SOURCE INVESTING
By Dan Denning


"The September 11 story, therefore, should be an object
lesson in the perils of failing to share information
promptly and efficiently between (and within)
organizations, and in the need to ensure that intelligence
analysis is conducted on a truly 'all-source' basis by
experts permitted to access all relevant information - no
matter where in the intelligence community it happens to
reside."

- U.S. Senate Select Committee on Intelligence Report,
"September 11 and the Imperative of Reform in the U.S.
Intelligence Community"; Additional Views of Senator
Richard C. Shelby


The capture of al Qaeda thug and John Belushi look-a-like
Khalid Sheik Mohammed was a huge achievement for the U.S.
intelligence community. With luck, President Bush may soon
be able to put a big red"X" across the face of bin Laden
on the most wanted list he keeps in his Oval Office Desk.

While we appear to have some momentum in"huntin' down" al
Qaeda's network, it would be a mistake to think the U.S.
Intelligence Community is operating well. It isn't. And
remarkably, the problems facing intelligence community are
quite similar to the problems facing investors.

First, take an example from the intelligence world. Prior
to 9/11, the CIA had intelligence showing that two of the
eventual hijackers, Khalid al-Mihdhar and Nawaf al-Hazmi,
were living in San Diego under their own names.

Under internal rules, the CIA is required to provide a
"watch list" of suspected terrorists to a system called
"TIPOFF". (TIPOFF is a searchable database shared by
consular or Immigration and Naturalization Service
officials checking Visa applications.) The CIA did not put
al-Mihdar's and al-Hazmi's names on TIPOFF list. Both men
left and reentered the country freely, completely
unmolested by the INS. In fact, in a March 2000 internal
memo, the CIA noted the presence of both men in the country
- but added this remark:"Action Required: None, FYI".

The intelligence community made many such errors leading up
to 9/11. Significantly, there was a common reason behind
most of their mistakes: the complete collection of source
intelligence information never seemed to get into the hands
of someone capable of making probable connections. Of
course, there's no guarantee those connections would have
been made. But under the current regime - where analysts
simply aren't getting the full intelligence picture - the
intelligence community is almost doomed to fail.

Intelligence analysis, like investment analysis, is not a
matter of spotting the obvious. If it were that easy, there
would be no terrorists, and we'd never buy bad stocks.
Instead, good intelligence or investment analysis means
reaching probable conclusions based on a variety of sources
of data. A good investor analyzes all the data he has to
detect patterns or signals telling him what to expect...and
naturally, how to prepare.

It's an inexact science. You won't always be right. But
there are three keys to doing it well: using all the
sources at your disposal, recognizing informational
patterns, and constantly re-evaluating what you know as the
context changes.

Let's take an investment example. Last week, Michael
O'Higgins, author of the famous 'Dogs of the Dow' strategy,
gave an interview in the Miami Herald. In the interview, he
said that in the best-case scenario, the Dow would probably
fall another 25% to around 6,000. Then he added this
cheerful note:"When you say it can't be like 1929 through
1931 [when stocks lost 89% of their value], you're right.
It could be worse."

O'Higgins' worst-case scenario is Dow 3,100. Since that's a
forecast I've made in the past, I thought I'd use it to
illustrate the"all-source" method of investing.

Under the"all-source" method, you start with historic
stock valuations and examine the patterns of previous boom-
bust cycles - just as O'Higgins did, looking back at the
aftermath of '29. This provides the historical context.

Then you move to the present, analyzing background
"noise"...which, in practice, means looking at current
stock market and economic news. Using the sources I have in
the Strategic Group, I've reached a stark assessment: the
economic fundamentals in the United States are bad and
getting worse, which is obviously bad for stock prices.

When your general forecast is bearish, the natural question
to ask is,"Who has the most to lose?" This is not always
the best question, of course. Even in bear markets, there
are some exceptions. And in those cases, your question is
equally simple,"Who has the most to gain?"

But in this case, O'Higgins dire Dow forecast happens to
correspond with mine: namely, that the leaders of the past
bull market are never the leaders of a new bull market. The
next bull market won't be led by Cisco, Microsoft, Dell,
Intel, and Oracle. It's likely to be a totally different
asset class (my guess is hard assets).

But investors prefer chasing old losers - like finally
getting the cheerleader from high school...but at your 20th
reunion, when she's forty pounds heavier and her anatomy no
longer defies the laws of gravity. A better strategy is to
avoid the old leaders and mercilessly profit from their
demise. The obvious question that follows is:"How?"

Of course, you could buy puts on the Dow 30. But I've gone
one step further. I've picked ten particular Dow stocks -
the ones with the highest dividends - and"shorted" all of
them by buying puts. I picked the dividend payers because
if the dividend of the average Dow stock goes up (as it
must and has historically done before stocks trade at
reasonable values), the current top-10 dividend payers are
going to loose their present appeal. They'll soon have
plenty of competition. Paying a fat dividend won't be
enough to make them attractive, especially amid such dismal
business conditions.

But I'll let the cat out of the bag: I also picked them
because there's a way to buy all ten top Dow dividend
payers in one single stock. Better yet, there's a way to
short them, or buy puts on them all at once.

The vehicle I've picked is an exchange traded fund (ETF)
composed of an equal weighting of the Dow's top 10 dividend
payers. It was a happy coincidence that some of the
components were also on my list of"toxic" stocks to avoid,
or stocks I've shorted and bought puts on in my trading
service, Strategic Trader Alert. Prominent names include
J.P. Morgan, SBC Communications, and General Electric. If
you're bearish, or just realistic, it's a nice combination
of tired old tech, financial, and blue-chip leadership from
the last bull market. They all have a lot to lose from a
falling Dow.

Will this play be a huge success? As with any strategy,
there's no guarantee. I'll keep you posted.

But remember that"all-source" investing means not
confining yourself to pure balance-sheet analysis, or
analyzing only economic conditions, or exclusively trying
to figure out how changes in global politics affect
investment values. You cannot adopt any one of these
strategies well without adopting all of them - or in other
words, looking at the more complete picture all of them
together can give you.

In the end, there's still no guarantee that your analysis
of the available source information (no matter how complete
your sources) will be accurate. Even the best data is
useless in the hands of a poor analyst.

However, in the hands of an analyst with a sound knowledge
of economic and financial history, access to real-time
market data, and a specific"tool-bag" of investments
designed to maximize your gain and minimize your risk, your
chances of surviving the coming crash are a whole lot
better than blindly believing in any single approach.


Regards,

Dan Denning,
for the Daily Reckoning