-->Richard Russel's Remarks: June 7th., 2003. (Dow Theory Letters)
June 7, 2003 -- I'll start by asking all of you to read the long but critically important piece sent to me by John Mauldin -- It's a piece written by Porter Stansberry, and it's"must" reading. It appears at the end of this site.
This piece explains, at least to my mind, why you and I shouldn't worry about timing our gold investments -- the metal or the stocks. The need for holding gold investments overshadows all considerations of timing. You buy gold or gold shares, and you put 'em away, and you call it insurance or"the last stand" or"my survival material" or whatever you want to call it. But forget the timing -- it can't be done. And it shouldn't be done.
Besides, nothing has more emotion or political pressure on it than gold. The government really wishes you'd forget gold, the Fed believes that gold competes with its junk-paper, the Treasury denigrates gold to the extent that it values its own gold holdings at a ridiculous $42.22 an ounce, and the Commercials hold a huge short position in gold derivatives.
The hell with them all. Hold your gold. You're going to need it somewhere ahead when the dollar comes under massive pressure from around the world.
The fact is that the US not only faces unfunded liabilities of $44 trillion, but the US continues to build deficits and debts. What has saved the US up to now is the fact that it can pay off its external debts with paper that it alone can manufacture. This is because the US alone possesses the world's"reserve currency." How long can the US get away with this farce? That's the multi-trillion dollar question, and it's a question that no one can answer. But I believe that the answer is looming closer and closer. The madness is accelerating. The action of both the dollar and gold indicate this acceleration.
At any rate, be sure to read the Stansberry piece. I purposely put the piece in for the weekend so you would have time to read it at your leisure.
On to the current markets. The stock market has been on a tear. Lowry's Selling Pressure Index has dropped to its lowest level since September 2000. The decline in the desire to sell has been the story all along. The decline in Selling Pressure started in February of this year. Then in early March, in the absence of selling, buying started to come into the market. The buying accelerated, and over the last three weeks we experienced what I call a"breadth stampede." Suddenly,"everybody" (think hedgers and funds) wanted to get aboard.
The result was a rise by the Dow to over 9000 and by the S&P to over 980 and by the Nasdaq to over 1600. It's been a race by the hedgies and the funds to get aboard, and hopefully, to"erase" some of the dreadful performance that was recorded by the three-year bear market.
We now hear talk of"It's a bull market, it's a new bull market." Relax, it's just an old fashioned correction in a primary bear market. I've seen dozens of these types of corrections. Every bear market produces them. These corrections serve to let some steam out of the market boiler. When too many investors are hurt by the bear, when too many investors"believe" in the bear, then the market does what it does best -- it turns the tables on investors. It shows them that they've been wrong again. They've been wrong because they've sold their stocks at the lows, and damn it, the market is rallying again and worst of all --"Maybe it's a new bull market, and you dummy -- you sold your stock, and now you're afraid to come back in!"
So it goes, and it's a good (read tragic) example of why the public inevitably loses in the stock market -- maybe not right away but over time the public always loses.
But when you think about it, why should they win? Wall Street isn't there to create wealth for the masses. Wall Street is there to distribute securities to the public. Wall Street is a selling organization. Everything else you hear about Wall Street is bull shit. If you can understand and accept that, you will be far ahead of the game.
But relax. If you treat securities as potential income vehicles then you have a chance. If you treat the stock market as Wall Street's answer to Las Vegas (which is the way most people view Wall Street and its securities), then you're on your way to ultimate losses.
Yet how many people do you know who buy stocks for income? Back in the '40s and '50s when I started in this business, people still retained skepticism built from years of trying to survive the Depression. In those days when you mentioned a stock (and few people did), the first question asked was"What's the dividend?" When's the last time you heard that? When's the last time you mentioned a stock to your best friend and he asked,"What's the dividend? What does it pay?"
Ah well, each generation must kill its own snakes. But this generation has an even worse problem. It has to deal with a government and a gang of politicians who are on their way to bankrupting the nation. And I'll remind you that there's only one area of wealth that can't be bankrupted, can't be bankrupted because it has no debt against it. I'm talking about gold, pure tangible wealth, the item which has been accepted as money for 5,000 years -- gold.
Of course, the Fed and the Treasury would like you to believe that Federal Reserve Notes (we mistakenly call them"dollars") represent real wealth. But which would you rather leave to your children's children's children -- a hundred thousand of today's dollar's or a hundred thousand dollars worth of gold coins? That's your answer, my dear subscribers, that's your answer.
"Distribution days" are days when the market is down on volume that is higher than the preceding day's volume. A rising number of distribution days is a harbinger of trouble. We saw two distribution days out of the last five on the Nasdaq and two out of the last seven for the S&P.
Investors Intelligence keeps track of buying and selling climaxes. A buying climax occurs when a stock makes a new 12-month high during the week -- but closes down for the week. Last week was the fifth week out of the past seven when there were more than 100 buying climaxes. Recently there have been over 500 buying climaxes, notes Investors Intelligence. This is a sign of distribution.
The market is now flagrantly overbought, and I'm expecting the McClellan Oscillator to drop below zero in the next week or so. Keep close stops under your DIAs and SPYs.
Bonds appear highly vulnerable, but with Greenspan vowing to keep rates low, the bonds have been hanging on. If the stock market corrects in the next few weeks, I believe a rate cut of at least.25% and maybe.50% is in the cards.
For the week ended June 6, the true (common stocks only) advance-decline ratio figures are June 2 plus 2.50; June 3 plus 2.55; June 4 plus 3.10; June 5 plus 3.35; June 6 plus 3.31.
For the week the Confidence Index rose to 72.3 from the previous week's 71.0. This is an improvement but still a very low figure for the Confidence Index.
The week ended with the S&P selling at a fat 32.59 times trailing earnings while providing a mini-yield of 1.67%.
So far, the Dow is up 8.65% for the year, the S&P is up 12.27% and the Nasdaq is up 21.86%.
Note -- As subscribers know, I'm no fan of the"new" Barron's or the"new" Wall Street Journal. However, every once in a while Barron's does something right like retaining the weekly services of Alan Abelson. This week Barron's did something very right -- they included an interview with one of the smartest guys on Wall Street -- Seth Glickenhaus.
I've been following Seth ever since he made million on the great three-way split of AT&T back in the early '60s. At any rate, Seth, to my knowledge, has always been an optimist. But read the interview on page 25 of this week's Barron's. If you don't get Barron's, go out and buy this issue (or subscribe on-line). It's worth a full year's subscription. I'll say it again -- do not miss the interview with Seth Glickenhaus in the June 9th issue of Barron's.
And that about does it for this week.
Your old pal,
Russell
.........................................................................................................................................................................................
Russell says -- the argument below from a subscriber may be too technical for many subscribers, but it is a very important argument --
One of the most important determinants of future stock returns that was left out of the otherwise lucid and compelling discussion of the equity risk premium and expected equity returns was the starting level of the P/E ratio. The 6 ½%-8% future return calculation assumes no decline in the P/E from the current 24 (based on 10 yr earnings).
But that won’t happen. The 8% future return is what John Bogle calls investment return. But the market return actually earned includes changes in the P/E ratio. Do you really think a 24 P/E will hold up over the next several years? Is equity investing so accepted and safe and the financial market environment likely to be so benign that investors can tolerate a 70% greater P/E than the 14 long term average? Not likely. The more realistic arithmetic of returns runs like this (over the next ten years):
Equities: 2% dividend + 5% earnings - 4% avg decline in P/E (to 14 in ten yrs) = 3%
Bonds*: 5% + 0 - 0 = 5%, which is a NEGATIVE RISK PREMIUM - 5%, a NEGATIVE.
*10 yr A rated corporate bond
Notice I didn’t use Government bonds as the comparison. Why? Because a rational investor choosing between risky assets considers either lending to the Company (the average S&P 500 company has an A credit rating) or becoming an owner. The use of Government bonds is not appropriate.. The choice is not between lending the Government money and becoming an equity owner.
This notion is wrong headed and has been used by Wall Street and other equity dreamweavers to pump stocks for years. The equity risk premium, properly defined, is negative. There is no relative valuation argument for owning equities at such lofty P/E’s
and still attractive rates on corporate debt. The salad days for bonds are not over.
.........................................................................................................................................................................................
The extraordinary piece below was sent to my by my friend, John Mauldin. Please read it carefully -- Russell
The Bankruptcy of America
And the Number Is?
Where are the Profits?
Inflation and the Fall of the Dollar
from John Mauldin
June 6, 2003
Today we have a guest writer for Thoughts From the Frontline, as I am
in Puerto Vallarta sipping margaritas by the beach. I asked my friend,
Porter Stansberry, to give us his take on the recent (and very
important) study which shows the US government is $44 trillion dollars
in debt. I think you will like his easy reading style, even if the
analysis is sobering. Then, to end on an upbeat note, I asked him to
give you a free link to a recent study by David Lashmet, one of his
analysts from the Pirate Investor, on new cancer treatment
breakthroughs just announced last week at an industry meeting. We have
all lost friends to cancer. There is real hope we may lose fewer in
the near future. Now let's read Porter's thoughts:
The Bankruptcy of America
By Porter Stansberry
"There's nothing unprecedented about interest rates beginning with the
numbers 1,2 or 3. They were the rule rather than the exception in the
days of the gold standard. But, as far as I know, no rates such as
those quoted today ever appeared in a monetary system unballasted by
gold or silver." -- James Grant, Forbes 6/9/2003
America is bankrupt.
This from Jagadeesh Gokhale and Kent Smetters.
No, these men are not a Saudi terrorist or Southern right wing
extremist respectively. Instead the former is the Senior Economic
Advisor to the Federal Reserve Bank of Cleveland, and the latter is a
full professor at the Wharton School of the University of
Pennsylvania.
Credentials notwithstanding, the men's conclusion would seem
preposterous. America has never seemed more prosperous. Even this
recession has been minor.
On the other hand, their source seems reliable: Gokhale and Smetters
got their data from the U.S. Department of Treasury. And they
performed their present value calculations on the order of then
Secretary of the Treasury Paul O'Neill. Smetters was, until recently,
on staff there, as the Deputy Assistant Secretary for Economic Policy.
The Treasury needed new numbers because the Office of Management and
Budget's numbers have almost no connection to reality. (For example,
OMB projects a constant 75-year average lifespan in its Social
Security and Medicare cost estimates even though the average lifespan
in America is already 78...and increasing at the rate of three months
every year.)
When you look honestly at our government's future obligations, the
numbers in the red quickly become so large they require entirely new
measures to describe them. Gokhale and Smetters invent the term
"financial imbalance," to measure Uncle Sam's impending bankruptcy.
Financial imbalance means:"current federal debt held by the public
plus the present value of all future federal non-interest spending
minus the present value of all future federal receipts."
Or, in other words, Gokhale and Smetters use FI (financial imbalance)
to estimate how broke Uncle Sam is when measured in constant dollars,
today. FI is how much Uncle Sam owes now and will garner in the
future versus how much he is on the hook for now and later.
And the number?
"Taking present values as of fiscal-year-end 2002 and interpreting the
policies in the federal budget for fiscal year 2004 as current
policies, the federal government's total fiscal imbalance is equal to
$44.2 trillion."
Huge numbers like $44.2 trillion don't mean much to anyone without a
comparison. So, consider: Uncle Sam's"financial imbalance" is 10
times the size of our current national debt.
In order to achieve current solvency, the government would have to
raise payroll taxes by 68.5%, beginning today. Alternatively the
government could cut Social Security and non-Medicare outlays by 54.8%
immediately and forever. (How do you think either policy would go over
at the polls?)
It's unlikely that either huge tax hikes or huge Social Security cuts
will occur. Most likely nothing will happen. And so, the government's
insolvency will grow much larger. By 2008 FI will reach $54 trillion.
To reach solvency at that point, taxes would have to increase by
73.7%.
Looking at the government's finances in a serious way is like
expecting a Ponzi scheme operator's numbers to add up. They don't. And
they never will; that's the game. Making political promises is easier
than paying for them. Theoretically these debts could be inflated away
by printing more dollars. But legally this would require the repeal of
the 1972 Social Security Act, which pegs benefits to inflation.
And that will not be a simple matter.
Worse, these financial imbalances stem from direct wealth
redistribution, from one generation to the next. They're a
disincentive for saving and investment. They hinder current growth
today while bankrupting America tomorrow. But politically they're
sacred cows.
Ironically, the people most threatened by this hydra-headed financial
and political monster are the very same people these programs were
designed to benefit: the middle class.
Your typical 50-year old, middle class American isn't prepared to
retire without a lot of help. In fact, most baby boomers will never
even pay off their mortgages. Lawrence Capital Management notes in the
last 19 quarters total mortgage debt increased by $3 trillion (+58%).
To put this in perspective, prior to 1997, it took 13 years to add $3
trillion in mortgage debt. Or, said another way, before 1997, around
$50 billion a quarter was being borrowed against homes. Today the run
rate is near $200 billion per quarter, or four times more. Household
borrowings now total $8.2 trillion in America and they continue to
grow at near double-digit rates.
And it's not just mortgage debt that's problematic...
According to the Federal Reserve Bank of St. Louis, US household
consumer debt is up more than 12% from last year. Debt service, as a
percentage of disposable income, is above 14%. Only twice in the last
25 years has debt service taken as large a chunk of America's income -
- and that's despite the lowest interest rates in fifty years.
When you look at these numbers you quickly see the problems our
favorite weekly scribe, John Mauldin, hopes we can"muddle" through:
The government is making promises it can't keep without bankrupting
the nation; the individual American has made promises to his bank he
can't keep without bankrupting his family. And we haven't even looked
at the biggest borrowers yet - corporations.
Corporate America has been on a borrowing binge for most of the last
25 years. Even the very best companies are now loaded up with debt.
GE, for example, has been a net borrower since 1992.
And IBM borrowed $20 billion during the 1990s, while at the same time
buying back $9 billion worth of its stock on the open market. Why
would you take on expensive debt while buying back even more expensive
stock? It made the income statement look good, converting debt to
earnings per share. And that made Lou Gerstner's bank account look
good, because he got paid in options whose value was influenced by
earnings growth. Meanwhile the balance sheet was covered in the
concrete of debt.
Then there's Ford - one of America's greatest companies. Debt on the
balance sheet is now 24 times equity.
Lower interests rates aren't necessarily helping, either.
Yes, firms can restructure debts and improve earnings thanks to lower
interest expenses. But these lower interest rates are also keeping
companies that should be bankrupt, alive. Consider Juniper Networks,
which shows a cumulative net loss of $37 million after ten years in
business. Despite having over $1 billion in debt, Juniper was able to
close a $350 million convertible bond deal that pays no interest
coupon two weeks ago. The company is borrowing $350 million dollars
until 2008 for free. Bankers say similar deals are closing at the rate
of two a day.
Why? Because investors once burned by stocks are now plowing into
bonds. Through April of this year, investors sank $53.7 billion into
bond funds, compared to only $4.5 billion into stock funds.
The money isn't going into new capital investment. Instead, this
"free" money is paying off more expensive, older loans. Corporate
America is repairing its balance sheet. The ratio of long-term debt to
total liabilities now stands at 68.2%, the highest level since 1959,
according to economist Richard Berner of Morgan Stanley. And cash is
staying put: corporate liquidity (current assets minus current
liabilities) is at its highest level since the mid-1960s. The
combination of cash and extended debts is easing the credit crunch.
Bond yield spreads have narrowed between investment grade bonds and
government treasuries, from 260 basis points in October 2002 to only
108 basis points currently.
You can also see this new debt isn't creating new demand by looking at
capacity utilization. If businesses were spending again, capacity
utilization would be up. It's not. Across the board in our economy,
capacity utilization has fallen from around 85-90% in 1985 to below
75% today, according to the Board of Governors of the Federal Reserve
System. The data makes sense: areas of our economy that had the
biggest investment boom show the biggest decline in capacity
utilization today. Capacity utilization in electronics, for example,
has declined from 90% in 1999 to under 65% today.
In the long term, debt restructuring does absolutely nothing to
improve America's economic fundamentals. Lower interest rates aren't
spurring new investment or new demand. More debt only postpones the
day of reckoning. Thus, the current bond market mania is just the
corporate version of the consumer's home equity loans: We're buying
today what we couldn't afford yesterday...
Where are the Profits?
What we need are genuine profits. But there aren't many real profits
in the leading companies of the baby boom generation, the generation
that's approaching retirement with a bankrupt social net and no net
savings.
Consider Adobe Systems, a leading software firm, headed by a baby
boomer (Bruce Chizen, CEO, was born in 1956). Sales are rebounding.
Earnings are up. But profits genuinely available to shareholders have
all but disappeared.
In the last five years, Adobe's net income has grown from $105.1
million to over $191 million. But stock based compensation in the same
period grew from $50 million a year to over $184 million a year.
Taking into account options expenses, net income shrunk from $54
million to only $6 million. Adobe, a firm valued by Wall Street for $7
billion can only produce $6 million in genuine net income.
Without profits, an entire generation of Americans will see their
retirement savings wiped out. Moving into bonds instead of stocks will
not save anyone - interest payments must come from corporate profits.
Even with zero coupon loans, principle must be repaid.
And there are still bigger threats to corporate profitability.
As was reported this week in the Wall Street Journal, New Jersey State
Senator Shirley Turner, upset that a firm hired by New Jersey would
use cheap Indian call-center workers, introduced a bill requiring
state contractors to use U.S.-based employees. As a result, New Jersey
wound up paying 22% more for the $4.1 million contract -- $100,000 per
job it saved. Politicians in five states - New Jersey, Connecticut,
Maryland, Missouri and Washington - are now partnering with the AFL-
CIO to craft new laws against using cheaper offshore workers for
service sector jobs like accounting, programming and customer service.
The goal, of course, is to prevent service sector jobs from leaving
the country, like we lost manufacturing jobs. And as with Social
Security financing, the politicians believe they can simply legislate
economic reality. They won't save jobs, but they will force more
investment capital away from America and make American professional
service firms less competitive.
Meanwhile, new FASB guidelines regarding stock options -- rules meant
to encourage genuine profitability -- are in danger of being stymied
by Congress. Congressman David Dreier (R, California) and
Congresswoman Anna Eshoo (D, California) have written new legislation
that would impose a three-year ban on the new rules. The FASB wants to
force companies to count options grants against earnings, where
excessive executive compensation would impact the bottomline (as it
should). Unfortunately, super-rich technology executives, who have fed
at the stock option trough for ten years are the main factor in
California political fund raising.
Legislation like these two recent items and the never-ending stream of
consumer protection laws, environmental laws, SEC regulations etc.,
will all combine to dampen any lasting economic growth and to
discourage entrepreneurial risk taking.
It's more to muddle through. All of which is reason to doubt corporate
profitability will rebound substantially before corporate debts, home
loans and America's retirement crunch begins in 2010.
And I haven't even mentioned the problems lower interest rates are
causing for insurance companies (annuities) and life insurance
companies...
So...what will happen? What's the financial endgame? What are the
consequences of America's bankruptcy...?
Inflation and the Fall of the Dollar
Like John, I'm sure we'll find a way to muddle through. In the end -
even if there's more deflation in the short term - our government will
end up monetizing its debts. Greenspan and others at the Fed have
already mentioned they're prepared to buy large amounts of long-dated
Treasury bonds. Retiring Treasury obligations with dollars the Fed
prints will cause a weaker dollar. That means, sooner or later,
inflation will be back -- and in a big way.
This is the real endgame, as I see it. Let me explain.
One of the smartest and best investors I've ever met, Chris Weber,
says we're entering the third dollar bear market. And if there's
anyone worth listening to when it comes to the currency, it's Chris
Weber. Starting with the money he made on a Phoenix, Arizona paper
route in the early 1970s, Chris built a $10 million fortune, primarily
through currency investing. He has never had any other job. When I met
him seven years ago he was living on Palm Beach. Now he resides in
Monaco. I saw him two weeks ago in Amelia Island, Florida.
According to Chris, the first dollar bear market began in 1971. It
ended when gold peaked out at $850 an ounce in 1980. This inflation
helped ease the debts the U.S. incurred fighting the Vietnam War while
wasting billions on the"war on poverty."
The second dollar bear market began after the Plaza Accord in 1985.
This inflation helped pay for Reagan's tax cuts and the final build-up
of the Cold War. (You should remember the impact the falling dollar
had on stocks. They collapsed in 1987 on a Monday following comments
over the weekend by Treasury Secretary Baker who said the dollar could
continue to weaken.)
And Chris thinks this - the third dollar bear market - will be much
worse than the last two. This time the falling dollar might lead to
the end of the dollar as the world's only reserve currency. He's not
the only one who thinks so. Doug Casey sees this happening too. And I
believe it's not an unlikely outcome.
Why? Because the imbalances inside the U.S. economy have never been
this large, nor has our current account deficit ever been this big and
never before has the United States been more dependent on foreigners
for oil.
This possible move away from the dollar as the primary reserve
currency for the world is high-lighted by a recent comment from Dennis
Gartman (The Gartman Letter):
"At what has been promoted as"The Executives' Meeting of East Asia-
Pacific Central Banks" (The EMEAP), those attending took the
preliminary steps toward creating an Asian bond market fund to be
managed by the central bank's central banker, the Bank for
International Settlements (The BIS). According to the Nihon Keizai and
The Japan Daily Digest, the EMEAP is a co-operative of eleven regional
central banks and it intends to create a fund with contributions from
its member banks and to use the money to invest in dollar denominated
government debt... initially. Then from our perspective, the fun
begins. Given that the idea works in practice, the fund will proceed
to increase its size and to start buying debt denominated in local
currencies, moving away from the US dollar. The idea according to the
Nikkei is to give the Asian central banks a place to invest the
dollars their economies generate in something other than U.S.
Treasuries. The intention is ultimately to keep the foreign currencies
that these economies generate available in the region for investment.
They are apparently weary of washing these earnings back into the US
dollar, and that weariness has become all the more emphatic in light
of Mr. Snow's ill-advised comments over several weeks ago. President
Bush's comments over the weekend might have assuaged those concerns
somewhat, but they are still looking above for other avenues of
investment. Were we in their shoes, certainly we'd be doing the same.
The EMEAP's member central banks include Australia, China, Hong Kong,
Indonesia, Japan, South Korea, Malaysia, New Zealand, the Philippines,
Singapore and Thailand. Other's may join, making the effect even more
material. Snow's comments created a veritable blizzard effect."
If this happen, it will accelerate the drop of the dollar predicted by
both John and myself for some time.
For investors, while we muddle through this mess, it will pay to
remember: America is bankrupt. Another big inflation is coming. And
that's bad for equity investors. From 1968 through 1981 the Dow lost
75% of its value, in real terms.
What should you do? Imagine the 1970s, but on an even bigger scale.
Doug Casey says fair value for gold right now is $700 an ounce. And he
expects it to go to $3,000. It's hard for me to imagine that he's
right. But then I look at my fellow American's finances, at Uncle
Sam's balance sheet and the mockery corporate America has made of
accounting standards...and suddenly gold looks pretty good.
Dr. Sjuggerud compiled this list of the annual returns of various
asset classes from 1968 to 1981, during the last major collapse in the
dollar:
19.4% Gold 18.9% Stamps 15.7% Rare books 13.7% Silver 12.7% Coins
(U.S. non-gold) 12.5% Old masters' paintings 11.8% Diamonds 11.3%
Farmland 9.6% Single-family homes 6.5% Inflation (CPI) 6.4% Foreign
currencies 5.8% High-grade corporate bonds 3.1% Stocks
Chances are pretty good that you don't have a big position in these
assets (with the exception of housing). It might be time to consider
moving some of your savings out of stocks and bonds and into things
more attuned to the declining value of the dollar.
We'll muddle through...the way we always do.
Your filling-in-for-my-friend analyst,
Porter Stansberry
Editor's note: Porter Stansberry is the founder of Pirate Investor
(www.pirateinvestor.com), a publisher of independent financial
newsletters. Pirate Investor titles include: Porter Stansberry's
Investment Advisory, Steve Sjuggerud's True Wealth, Extreme Value and
Diligence, a small cap research service for high net worth investors.
Copyright 2003 John Mauldin. All Rights Reserved
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June 7, 2003 -- I'll start by asking all of you to read the long but critically important piece sent to me by John Mauldin -- It's a piece written by Porter Stansberry, and it's"must" reading. It appears at the end of this site.
This piece explains, at least to my mind, why you and I shouldn't worry about timing our gold investments -- the metal or the stocks. The need for holding gold investments overshadows all considerations of timing. You buy gold or gold shares, and you put 'em away, and you call it insurance or"the last stand" or"my survival material" or whatever you want to call it. But forget the timing -- it can't be done. And it shouldn't be done.
Besides, nothing has more emotion or political pressure on it than gold. The government really wishes you'd forget gold, the Fed believes that gold competes with its junk-paper, the Treasury denigrates gold to the extent that it values its own gold holdings at a ridiculous $42.22 an ounce, and the Commercials hold a huge short position in gold derivatives.
The hell with them all. Hold your gold. You're going to need it somewhere ahead when the dollar comes under massive pressure from around the world.
The fact is that the US not only faces unfunded liabilities of $44 trillion, but the US continues to build deficits and debts. What has saved the US up to now is the fact that it can pay off its external debts with paper that it alone can manufacture. This is because the US alone possesses the world's"reserve currency." How long can the US get away with this farce? That's the multi-trillion dollar question, and it's a question that no one can answer. But I believe that the answer is looming closer and closer. The madness is accelerating. The action of both the dollar and gold indicate this acceleration.
At any rate, be sure to read the Stansberry piece. I purposely put the piece in for the weekend so you would have time to read it at your leisure.
On to the current markets. The stock market has been on a tear. Lowry's Selling Pressure Index has dropped to its lowest level since September 2000. The decline in the desire to sell has been the story all along. The decline in Selling Pressure started in February of this year. Then in early March, in the absence of selling, buying started to come into the market. The buying accelerated, and over the last three weeks we experienced what I call a"breadth stampede." Suddenly,"everybody" (think hedgers and funds) wanted to get aboard.
The result was a rise by the Dow to over 9000 and by the S&P to over 980 and by the Nasdaq to over 1600. It's been a race by the hedgies and the funds to get aboard, and hopefully, to"erase" some of the dreadful performance that was recorded by the three-year bear market.
We now hear talk of"It's a bull market, it's a new bull market." Relax, it's just an old fashioned correction in a primary bear market. I've seen dozens of these types of corrections. Every bear market produces them. These corrections serve to let some steam out of the market boiler. When too many investors are hurt by the bear, when too many investors"believe" in the bear, then the market does what it does best -- it turns the tables on investors. It shows them that they've been wrong again. They've been wrong because they've sold their stocks at the lows, and damn it, the market is rallying again and worst of all --"Maybe it's a new bull market, and you dummy -- you sold your stock, and now you're afraid to come back in!"
So it goes, and it's a good (read tragic) example of why the public inevitably loses in the stock market -- maybe not right away but over time the public always loses.
But when you think about it, why should they win? Wall Street isn't there to create wealth for the masses. Wall Street is there to distribute securities to the public. Wall Street is a selling organization. Everything else you hear about Wall Street is bull shit. If you can understand and accept that, you will be far ahead of the game.
But relax. If you treat securities as potential income vehicles then you have a chance. If you treat the stock market as Wall Street's answer to Las Vegas (which is the way most people view Wall Street and its securities), then you're on your way to ultimate losses.
Yet how many people do you know who buy stocks for income? Back in the '40s and '50s when I started in this business, people still retained skepticism built from years of trying to survive the Depression. In those days when you mentioned a stock (and few people did), the first question asked was"What's the dividend?" When's the last time you heard that? When's the last time you mentioned a stock to your best friend and he asked,"What's the dividend? What does it pay?"
Ah well, each generation must kill its own snakes. But this generation has an even worse problem. It has to deal with a government and a gang of politicians who are on their way to bankrupting the nation. And I'll remind you that there's only one area of wealth that can't be bankrupted, can't be bankrupted because it has no debt against it. I'm talking about gold, pure tangible wealth, the item which has been accepted as money for 5,000 years -- gold.
Of course, the Fed and the Treasury would like you to believe that Federal Reserve Notes (we mistakenly call them"dollars") represent real wealth. But which would you rather leave to your children's children's children -- a hundred thousand of today's dollar's or a hundred thousand dollars worth of gold coins? That's your answer, my dear subscribers, that's your answer.
"Distribution days" are days when the market is down on volume that is higher than the preceding day's volume. A rising number of distribution days is a harbinger of trouble. We saw two distribution days out of the last five on the Nasdaq and two out of the last seven for the S&P.
Investors Intelligence keeps track of buying and selling climaxes. A buying climax occurs when a stock makes a new 12-month high during the week -- but closes down for the week. Last week was the fifth week out of the past seven when there were more than 100 buying climaxes. Recently there have been over 500 buying climaxes, notes Investors Intelligence. This is a sign of distribution.
The market is now flagrantly overbought, and I'm expecting the McClellan Oscillator to drop below zero in the next week or so. Keep close stops under your DIAs and SPYs.
Bonds appear highly vulnerable, but with Greenspan vowing to keep rates low, the bonds have been hanging on. If the stock market corrects in the next few weeks, I believe a rate cut of at least.25% and maybe.50% is in the cards.
For the week ended June 6, the true (common stocks only) advance-decline ratio figures are June 2 plus 2.50; June 3 plus 2.55; June 4 plus 3.10; June 5 plus 3.35; June 6 plus 3.31.
For the week the Confidence Index rose to 72.3 from the previous week's 71.0. This is an improvement but still a very low figure for the Confidence Index.
The week ended with the S&P selling at a fat 32.59 times trailing earnings while providing a mini-yield of 1.67%.
So far, the Dow is up 8.65% for the year, the S&P is up 12.27% and the Nasdaq is up 21.86%.
Note -- As subscribers know, I'm no fan of the"new" Barron's or the"new" Wall Street Journal. However, every once in a while Barron's does something right like retaining the weekly services of Alan Abelson. This week Barron's did something very right -- they included an interview with one of the smartest guys on Wall Street -- Seth Glickenhaus.
I've been following Seth ever since he made million on the great three-way split of AT&T back in the early '60s. At any rate, Seth, to my knowledge, has always been an optimist. But read the interview on page 25 of this week's Barron's. If you don't get Barron's, go out and buy this issue (or subscribe on-line). It's worth a full year's subscription. I'll say it again -- do not miss the interview with Seth Glickenhaus in the June 9th issue of Barron's.
And that about does it for this week.
Your old pal,
Russell
.........................................................................................................................................................................................
Russell says -- the argument below from a subscriber may be too technical for many subscribers, but it is a very important argument --
One of the most important determinants of future stock returns that was left out of the otherwise lucid and compelling discussion of the equity risk premium and expected equity returns was the starting level of the P/E ratio. The 6 ½%-8% future return calculation assumes no decline in the P/E from the current 24 (based on 10 yr earnings).
But that won’t happen. The 8% future return is what John Bogle calls investment return. But the market return actually earned includes changes in the P/E ratio. Do you really think a 24 P/E will hold up over the next several years? Is equity investing so accepted and safe and the financial market environment likely to be so benign that investors can tolerate a 70% greater P/E than the 14 long term average? Not likely. The more realistic arithmetic of returns runs like this (over the next ten years):
Equities: 2% dividend + 5% earnings - 4% avg decline in P/E (to 14 in ten yrs) = 3%
Bonds*: 5% + 0 - 0 = 5%, which is a NEGATIVE RISK PREMIUM - 5%, a NEGATIVE.
*10 yr A rated corporate bond
Notice I didn’t use Government bonds as the comparison. Why? Because a rational investor choosing between risky assets considers either lending to the Company (the average S&P 500 company has an A credit rating) or becoming an owner. The use of Government bonds is not appropriate.. The choice is not between lending the Government money and becoming an equity owner.
This notion is wrong headed and has been used by Wall Street and other equity dreamweavers to pump stocks for years. The equity risk premium, properly defined, is negative. There is no relative valuation argument for owning equities at such lofty P/E’s
and still attractive rates on corporate debt. The salad days for bonds are not over.
.........................................................................................................................................................................................
The extraordinary piece below was sent to my by my friend, John Mauldin. Please read it carefully -- Russell
The Bankruptcy of America
And the Number Is?
Where are the Profits?
Inflation and the Fall of the Dollar
from John Mauldin
June 6, 2003
Today we have a guest writer for Thoughts From the Frontline, as I am
in Puerto Vallarta sipping margaritas by the beach. I asked my friend,
Porter Stansberry, to give us his take on the recent (and very
important) study which shows the US government is $44 trillion dollars
in debt. I think you will like his easy reading style, even if the
analysis is sobering. Then, to end on an upbeat note, I asked him to
give you a free link to a recent study by David Lashmet, one of his
analysts from the Pirate Investor, on new cancer treatment
breakthroughs just announced last week at an industry meeting. We have
all lost friends to cancer. There is real hope we may lose fewer in
the near future. Now let's read Porter's thoughts:
The Bankruptcy of America
By Porter Stansberry
"There's nothing unprecedented about interest rates beginning with the
numbers 1,2 or 3. They were the rule rather than the exception in the
days of the gold standard. But, as far as I know, no rates such as
those quoted today ever appeared in a monetary system unballasted by
gold or silver." -- James Grant, Forbes 6/9/2003
America is bankrupt.
This from Jagadeesh Gokhale and Kent Smetters.
No, these men are not a Saudi terrorist or Southern right wing
extremist respectively. Instead the former is the Senior Economic
Advisor to the Federal Reserve Bank of Cleveland, and the latter is a
full professor at the Wharton School of the University of
Pennsylvania.
Credentials notwithstanding, the men's conclusion would seem
preposterous. America has never seemed more prosperous. Even this
recession has been minor.
On the other hand, their source seems reliable: Gokhale and Smetters
got their data from the U.S. Department of Treasury. And they
performed their present value calculations on the order of then
Secretary of the Treasury Paul O'Neill. Smetters was, until recently,
on staff there, as the Deputy Assistant Secretary for Economic Policy.
The Treasury needed new numbers because the Office of Management and
Budget's numbers have almost no connection to reality. (For example,
OMB projects a constant 75-year average lifespan in its Social
Security and Medicare cost estimates even though the average lifespan
in America is already 78...and increasing at the rate of three months
every year.)
When you look honestly at our government's future obligations, the
numbers in the red quickly become so large they require entirely new
measures to describe them. Gokhale and Smetters invent the term
"financial imbalance," to measure Uncle Sam's impending bankruptcy.
Financial imbalance means:"current federal debt held by the public
plus the present value of all future federal non-interest spending
minus the present value of all future federal receipts."
Or, in other words, Gokhale and Smetters use FI (financial imbalance)
to estimate how broke Uncle Sam is when measured in constant dollars,
today. FI is how much Uncle Sam owes now and will garner in the
future versus how much he is on the hook for now and later.
And the number?
"Taking present values as of fiscal-year-end 2002 and interpreting the
policies in the federal budget for fiscal year 2004 as current
policies, the federal government's total fiscal imbalance is equal to
$44.2 trillion."
Huge numbers like $44.2 trillion don't mean much to anyone without a
comparison. So, consider: Uncle Sam's"financial imbalance" is 10
times the size of our current national debt.
In order to achieve current solvency, the government would have to
raise payroll taxes by 68.5%, beginning today. Alternatively the
government could cut Social Security and non-Medicare outlays by 54.8%
immediately and forever. (How do you think either policy would go over
at the polls?)
It's unlikely that either huge tax hikes or huge Social Security cuts
will occur. Most likely nothing will happen. And so, the government's
insolvency will grow much larger. By 2008 FI will reach $54 trillion.
To reach solvency at that point, taxes would have to increase by
73.7%.
Looking at the government's finances in a serious way is like
expecting a Ponzi scheme operator's numbers to add up. They don't. And
they never will; that's the game. Making political promises is easier
than paying for them. Theoretically these debts could be inflated away
by printing more dollars. But legally this would require the repeal of
the 1972 Social Security Act, which pegs benefits to inflation.
And that will not be a simple matter.
Worse, these financial imbalances stem from direct wealth
redistribution, from one generation to the next. They're a
disincentive for saving and investment. They hinder current growth
today while bankrupting America tomorrow. But politically they're
sacred cows.
Ironically, the people most threatened by this hydra-headed financial
and political monster are the very same people these programs were
designed to benefit: the middle class.
Your typical 50-year old, middle class American isn't prepared to
retire without a lot of help. In fact, most baby boomers will never
even pay off their mortgages. Lawrence Capital Management notes in the
last 19 quarters total mortgage debt increased by $3 trillion (+58%).
To put this in perspective, prior to 1997, it took 13 years to add $3
trillion in mortgage debt. Or, said another way, before 1997, around
$50 billion a quarter was being borrowed against homes. Today the run
rate is near $200 billion per quarter, or four times more. Household
borrowings now total $8.2 trillion in America and they continue to
grow at near double-digit rates.
And it's not just mortgage debt that's problematic...
According to the Federal Reserve Bank of St. Louis, US household
consumer debt is up more than 12% from last year. Debt service, as a
percentage of disposable income, is above 14%. Only twice in the last
25 years has debt service taken as large a chunk of America's income -
- and that's despite the lowest interest rates in fifty years.
When you look at these numbers you quickly see the problems our
favorite weekly scribe, John Mauldin, hopes we can"muddle" through:
The government is making promises it can't keep without bankrupting
the nation; the individual American has made promises to his bank he
can't keep without bankrupting his family. And we haven't even looked
at the biggest borrowers yet - corporations.
Corporate America has been on a borrowing binge for most of the last
25 years. Even the very best companies are now loaded up with debt.
GE, for example, has been a net borrower since 1992.
And IBM borrowed $20 billion during the 1990s, while at the same time
buying back $9 billion worth of its stock on the open market. Why
would you take on expensive debt while buying back even more expensive
stock? It made the income statement look good, converting debt to
earnings per share. And that made Lou Gerstner's bank account look
good, because he got paid in options whose value was influenced by
earnings growth. Meanwhile the balance sheet was covered in the
concrete of debt.
Then there's Ford - one of America's greatest companies. Debt on the
balance sheet is now 24 times equity.
Lower interests rates aren't necessarily helping, either.
Yes, firms can restructure debts and improve earnings thanks to lower
interest expenses. But these lower interest rates are also keeping
companies that should be bankrupt, alive. Consider Juniper Networks,
which shows a cumulative net loss of $37 million after ten years in
business. Despite having over $1 billion in debt, Juniper was able to
close a $350 million convertible bond deal that pays no interest
coupon two weeks ago. The company is borrowing $350 million dollars
until 2008 for free. Bankers say similar deals are closing at the rate
of two a day.
Why? Because investors once burned by stocks are now plowing into
bonds. Through April of this year, investors sank $53.7 billion into
bond funds, compared to only $4.5 billion into stock funds.
The money isn't going into new capital investment. Instead, this
"free" money is paying off more expensive, older loans. Corporate
America is repairing its balance sheet. The ratio of long-term debt to
total liabilities now stands at 68.2%, the highest level since 1959,
according to economist Richard Berner of Morgan Stanley. And cash is
staying put: corporate liquidity (current assets minus current
liabilities) is at its highest level since the mid-1960s. The
combination of cash and extended debts is easing the credit crunch.
Bond yield spreads have narrowed between investment grade bonds and
government treasuries, from 260 basis points in October 2002 to only
108 basis points currently.
You can also see this new debt isn't creating new demand by looking at
capacity utilization. If businesses were spending again, capacity
utilization would be up. It's not. Across the board in our economy,
capacity utilization has fallen from around 85-90% in 1985 to below
75% today, according to the Board of Governors of the Federal Reserve
System. The data makes sense: areas of our economy that had the
biggest investment boom show the biggest decline in capacity
utilization today. Capacity utilization in electronics, for example,
has declined from 90% in 1999 to under 65% today.
In the long term, debt restructuring does absolutely nothing to
improve America's economic fundamentals. Lower interest rates aren't
spurring new investment or new demand. More debt only postpones the
day of reckoning. Thus, the current bond market mania is just the
corporate version of the consumer's home equity loans: We're buying
today what we couldn't afford yesterday...
Where are the Profits?
What we need are genuine profits. But there aren't many real profits
in the leading companies of the baby boom generation, the generation
that's approaching retirement with a bankrupt social net and no net
savings.
Consider Adobe Systems, a leading software firm, headed by a baby
boomer (Bruce Chizen, CEO, was born in 1956). Sales are rebounding.
Earnings are up. But profits genuinely available to shareholders have
all but disappeared.
In the last five years, Adobe's net income has grown from $105.1
million to over $191 million. But stock based compensation in the same
period grew from $50 million a year to over $184 million a year.
Taking into account options expenses, net income shrunk from $54
million to only $6 million. Adobe, a firm valued by Wall Street for $7
billion can only produce $6 million in genuine net income.
Without profits, an entire generation of Americans will see their
retirement savings wiped out. Moving into bonds instead of stocks will
not save anyone - interest payments must come from corporate profits.
Even with zero coupon loans, principle must be repaid.
And there are still bigger threats to corporate profitability.
As was reported this week in the Wall Street Journal, New Jersey State
Senator Shirley Turner, upset that a firm hired by New Jersey would
use cheap Indian call-center workers, introduced a bill requiring
state contractors to use U.S.-based employees. As a result, New Jersey
wound up paying 22% more for the $4.1 million contract -- $100,000 per
job it saved. Politicians in five states - New Jersey, Connecticut,
Maryland, Missouri and Washington - are now partnering with the AFL-
CIO to craft new laws against using cheaper offshore workers for
service sector jobs like accounting, programming and customer service.
The goal, of course, is to prevent service sector jobs from leaving
the country, like we lost manufacturing jobs. And as with Social
Security financing, the politicians believe they can simply legislate
economic reality. They won't save jobs, but they will force more
investment capital away from America and make American professional
service firms less competitive.
Meanwhile, new FASB guidelines regarding stock options -- rules meant
to encourage genuine profitability -- are in danger of being stymied
by Congress. Congressman David Dreier (R, California) and
Congresswoman Anna Eshoo (D, California) have written new legislation
that would impose a three-year ban on the new rules. The FASB wants to
force companies to count options grants against earnings, where
excessive executive compensation would impact the bottomline (as it
should). Unfortunately, super-rich technology executives, who have fed
at the stock option trough for ten years are the main factor in
California political fund raising.
Legislation like these two recent items and the never-ending stream of
consumer protection laws, environmental laws, SEC regulations etc.,
will all combine to dampen any lasting economic growth and to
discourage entrepreneurial risk taking.
It's more to muddle through. All of which is reason to doubt corporate
profitability will rebound substantially before corporate debts, home
loans and America's retirement crunch begins in 2010.
And I haven't even mentioned the problems lower interest rates are
causing for insurance companies (annuities) and life insurance
companies...
So...what will happen? What's the financial endgame? What are the
consequences of America's bankruptcy...?
Inflation and the Fall of the Dollar
Like John, I'm sure we'll find a way to muddle through. In the end -
even if there's more deflation in the short term - our government will
end up monetizing its debts. Greenspan and others at the Fed have
already mentioned they're prepared to buy large amounts of long-dated
Treasury bonds. Retiring Treasury obligations with dollars the Fed
prints will cause a weaker dollar. That means, sooner or later,
inflation will be back -- and in a big way.
This is the real endgame, as I see it. Let me explain.
One of the smartest and best investors I've ever met, Chris Weber,
says we're entering the third dollar bear market. And if there's
anyone worth listening to when it comes to the currency, it's Chris
Weber. Starting with the money he made on a Phoenix, Arizona paper
route in the early 1970s, Chris built a $10 million fortune, primarily
through currency investing. He has never had any other job. When I met
him seven years ago he was living on Palm Beach. Now he resides in
Monaco. I saw him two weeks ago in Amelia Island, Florida.
According to Chris, the first dollar bear market began in 1971. It
ended when gold peaked out at $850 an ounce in 1980. This inflation
helped ease the debts the U.S. incurred fighting the Vietnam War while
wasting billions on the"war on poverty."
The second dollar bear market began after the Plaza Accord in 1985.
This inflation helped pay for Reagan's tax cuts and the final build-up
of the Cold War. (You should remember the impact the falling dollar
had on stocks. They collapsed in 1987 on a Monday following comments
over the weekend by Treasury Secretary Baker who said the dollar could
continue to weaken.)
And Chris thinks this - the third dollar bear market - will be much
worse than the last two. This time the falling dollar might lead to
the end of the dollar as the world's only reserve currency. He's not
the only one who thinks so. Doug Casey sees this happening too. And I
believe it's not an unlikely outcome.
Why? Because the imbalances inside the U.S. economy have never been
this large, nor has our current account deficit ever been this big and
never before has the United States been more dependent on foreigners
for oil.
This possible move away from the dollar as the primary reserve
currency for the world is high-lighted by a recent comment from Dennis
Gartman (The Gartman Letter):
"At what has been promoted as"The Executives' Meeting of East Asia-
Pacific Central Banks" (The EMEAP), those attending took the
preliminary steps toward creating an Asian bond market fund to be
managed by the central bank's central banker, the Bank for
International Settlements (The BIS). According to the Nihon Keizai and
The Japan Daily Digest, the EMEAP is a co-operative of eleven regional
central banks and it intends to create a fund with contributions from
its member banks and to use the money to invest in dollar denominated
government debt... initially. Then from our perspective, the fun
begins. Given that the idea works in practice, the fund will proceed
to increase its size and to start buying debt denominated in local
currencies, moving away from the US dollar. The idea according to the
Nikkei is to give the Asian central banks a place to invest the
dollars their economies generate in something other than U.S.
Treasuries. The intention is ultimately to keep the foreign currencies
that these economies generate available in the region for investment.
They are apparently weary of washing these earnings back into the US
dollar, and that weariness has become all the more emphatic in light
of Mr. Snow's ill-advised comments over several weeks ago. President
Bush's comments over the weekend might have assuaged those concerns
somewhat, but they are still looking above for other avenues of
investment. Were we in their shoes, certainly we'd be doing the same.
The EMEAP's member central banks include Australia, China, Hong Kong,
Indonesia, Japan, South Korea, Malaysia, New Zealand, the Philippines,
Singapore and Thailand. Other's may join, making the effect even more
material. Snow's comments created a veritable blizzard effect."
If this happen, it will accelerate the drop of the dollar predicted by
both John and myself for some time.
For investors, while we muddle through this mess, it will pay to
remember: America is bankrupt. Another big inflation is coming. And
that's bad for equity investors. From 1968 through 1981 the Dow lost
75% of its value, in real terms.
What should you do? Imagine the 1970s, but on an even bigger scale.
Doug Casey says fair value for gold right now is $700 an ounce. And he
expects it to go to $3,000. It's hard for me to imagine that he's
right. But then I look at my fellow American's finances, at Uncle
Sam's balance sheet and the mockery corporate America has made of
accounting standards...and suddenly gold looks pretty good.
Dr. Sjuggerud compiled this list of the annual returns of various
asset classes from 1968 to 1981, during the last major collapse in the
dollar:
19.4% Gold 18.9% Stamps 15.7% Rare books 13.7% Silver 12.7% Coins
(U.S. non-gold) 12.5% Old masters' paintings 11.8% Diamonds 11.3%
Farmland 9.6% Single-family homes 6.5% Inflation (CPI) 6.4% Foreign
currencies 5.8% High-grade corporate bonds 3.1% Stocks
Chances are pretty good that you don't have a big position in these
assets (with the exception of housing). It might be time to consider
moving some of your savings out of stocks and bonds and into things
more attuned to the declining value of the dollar.
We'll muddle through...the way we always do.
Your filling-in-for-my-friend analyst,
Porter Stansberry
Editor's note: Porter Stansberry is the founder of Pirate Investor
(www.pirateinvestor.com), a publisher of independent financial
newsletters. Pirate Investor titles include: Porter Stansberry's
Investment Advisory, Steve Sjuggerud's True Wealth, Extreme Value and
Diligence, a small cap research service for high net worth investors.
Copyright 2003 John Mauldin. All Rights Reserved
If you would like to reproduce any of John Mauldin's E-Letters you
must include the source of your quote and an email address
(John@FrontLineThoughts.com)
John Mauldin is president of Millennium Wave Advisors, LLC, a
registered investment advisor. All material presented herein is
believed to be reliable but we cannot attest to its accuracy.
Investment recommendations may change and readers are urged to check
with their investment counselors before making any investment
decisions. Opinions expressed in these reports may change without
prior notice. John Mauldin and/or the staff at Millennium Wave Advisors, LLC
may or may not have investments in any funds cited above.
Mauldin can be reached at 800-829-7273.
When considering alternative investments, including hedge funds, you
should consider various risks including the fact that some products:
often engage in leveraging and other speculative investment practices
that may increase the risk of investment loss, can be illiquid, are
not required to provide periodic pricing or valuation information to
investors, may involve complex tax structures and delays in
distributing important tax information, are not subject to the same
regulatory requirements as mutual funds, often charge high fees, and
in many cases the underlying investments are not transparent and are
known only to the investment manager.
|
-->Monday, June 9, 2003
Octogenarian money manager sees the U.S. becoming another Zimbabwe, or maybe Japan.
By SANDRA WARD
An Interview With Seth Glickenhaus -- After causing a stir last summer with his straight talk in these pages1 about what a mess the economy was in -- he dared to utter that deflation was a distinct possibility -- investment manager Glickenhaus is still making waves. At age 89, the founder and head of the $1 billion Manhattan-based firm that bears his name is as inciteful as he is insightful. He's also often right. He's delivered returns of 17% a year, on average, to his clients since 1981. That's why we enjoy talking with him, even when he insists on asking us the questions.
Barron's: Do you still think we're at risk of a depression?
Glickenhaus: There are some risks of a depression, though I would say the only difference between a recession and depression is that a depression is an extended recession. For the past 16 weeks, unemployment claims grew as people continued to be laid off. This is a continuing trend, and it is a new trend in the United States. New not for the last couple of years, perhaps, but compared with the past decade. Businesses expanded in a mindless fashion during the 'Nineties. Many marginal employees were employed. The unions grew in strength.
Q: They did?
A: Not numerically, but in their bargaining power. Companies needed employees and they were making so much money, they settled on absurd terms. The auto industry, the steel industry, the airline industry and the telephone industry set the pattern. Wall Street isn't unionized, but it became pervasive to raise salaries on Wall Street. It's become difficult to lower salaries. It was one of the excesses of the period. A boom is not bad; it is only bad in the excesses it creates. Now we're paying the piper because underneath everything there is a business cycle. Overexpansion and other excesses always creates a recession. This particular recession has been obscured and diminished sharply by extensions of credit and by historically unheard-of low interest rates. That, in turn, has cannibalized future growth in the auto industry and home building, and will continue to do so. Technically, from an economist's point of view, this may not be considered a recession, but tell that to the average person being laid off, or the person seeing other people being laid off or to those people approaching the limits of their credit capacity.
Q: So we're not out of the woods.
A: You know the expression"You should live so long?" After a 16-year cycle of boom, it is unreasonable to expect the readjustment to take less than 16 years. We are in for a very long period where the economy will not grow very much. This is intensified on a world basis by the deteriorating caliber of our political leaders. Bush has no fiscal sense whatsoever and is radical in his approach. The Republicans live solely to make the rich richer. The Democrats have no leaders or leadership and are barely conscious of the major issues of the day, which include growing unemployment, lack of affordable housing for the poor and the low end of the middle class, lack of health insurance, deterioration of our infrastructure -- our bridges, roads and sewer systems -- growing water shortages, drugs and crime. Just to name a few of the major issues. One of the major things they overlook is that we are currently spending $350 billion for military purposes. Meanwhile, Russia spends something on the order of $40 billion and China spends $20 billion. We spend more than all other countries together. At the same time, we are spending no more than $20 billion or so for children's health and correspondingly very small sums for education. Congress also spends all its time debating whether we should spend billions on anti-ballistic missiles, which any knowledgeable scientist would tell you cannot possibly work. The public, on the other hand, doesn't feel that extra submarines and needless new fighter planes really increase their standard of living. I am not a pacifist, and I want us to be strong, but we could easily save $200 billion a year by rationalizing the Pentagon and still be far and away the strongest nation in the world.
Q: What are your thoughts on Iraq?
A: We all wanted to get rid of Hussein, who is a very evil man. However, the price that is being paid in human lives and properties and the chaos that is inevitably ensuing in Iraq was far too great a price to pay for this war. It is totally unjustified. If we were to take on every evil man who runs a country, we would have at least 15 or 20 wars on our hands.
Q: Are you worried that we'll invade Iran or Syria?
A: The public thinks we won the war and that it is over. They don't realize we are going to keep more troops in Iraq than we thought. The deficit will grow. We are not going to win the peace. Iraq is so divided internally it makes Afghanistan look like one unified group. Do you think soldiers know how to straighten out a country? They know how to make war. Do you think the State Department has the people and the training to help the country rebuild? Do you think we have anything like that? No, of course not. Another evil that exists today, and one that is going to prolong our recession and one we could do something about, is the situation of the municipalities and the states, which in the boom period built up tremendous costs and activities and now don't have enough revenues and are, as a group, facing a shortfall of $70 billion a year. This will entail substantial contractions in many important areas of public employment, even after the tax-cut bill, which gets them about $20 billion.
Q: We have elections coming up next year. If the downturn persists, won't people vote their pocketbook?
A: In elections, 60% of the people don't vote. The 40% who do vote are people who are beholden to one political party or the other. What is in the public's interest is not represented in the electoral part of our so-called democracy.
Q: Isn't it when times are tough that people finally get interested in the issues?
A: Well, you are young, and you have optimism. I don't have it anymore. I lost it. I tried awfully hard to kindle interest in these things. I supported them. I've worked for them, and I've failed. The public seems indifferent to what could be a very severe collapse of the economy and political system. The United States may go under. Look at Zimbabwe. In Zimbabwe, people don't have water. There is a 300% or so inflation rate per annum, transportation is broken down, people cannot get to their jobs, 65% of their industry is shut down and the black market in food is soaring. Although this is an extreme case, the Congo and other African countries are similarly situated. The tax-cut bill will ultimately have negative effects on the our economy, because it increases the disparity of income and wealth between the wealthy and poor.
Q: You can't be suggesting that we'll end up like Zimbabwe?
A: I'm suggesting we may end up like Zimbabwe. Or Japan. When you consider that some major iconic industries in this country -- the automobile business, the steel business, the telephone business -- are lost or have at least suffered enormously.
Q: But isn't this part of a long cyclical trend? Manufacturing has been moving offshore for some time. Won't these industries be replaced with new"icons?"
A: Technology is a replacement, to some degree, but even there we are beginning to get very strong competition from abroad. We are becoming like England. We are becoming less important. The dollar is depreciating, and it is just beginning its descent because of our perpetual trade deficits and federal budget deficits. Foreigners will not only not invest in our bond and stock markets but will be pulling money out.
Q: Except that raises the question of where are they going to put it?
A: Gold. Perhaps diamonds. Old Master paintings.
Q: What's your solution?
A: Spend money for the infrastructure, reduce government, cut military spending by $200 billion, repair and build housing for the poor and middle class.
Q: Are you concerned about deflation?
A: Don't you think it is deflationary when municipalities fire people? Don't you think it is deflationary when week in and week out our businesses are letting more people go? France has the highest unemployment rate it has ever had, around 10% or 11%. Germany has a 12% rate. And our 6% rate is up from 4.5% and it is going to go much higher. We talk to companies every day. All of them are trying to reduce their capital expenditures, not increase them. And there are going to be fewer consumers. Greenspan has created a demand with these low interest rates that is abnormally high. The economy today is much stronger than it is going to be in the future because we are borrowing from the future. In the stock market you had technology stocks lose 75%-80% of their value from the top. The stock market has been way ahead on this because the stock market is very mistrustful of the economy. Now people are sitting on their tails and not buying stocks. Pension-fund money is still coming in because the funds have assigned a greater percentage of their portfolios to stocks and that keeps blue chips in demand. But those stocks often sell at very high multiples. Outside of blue chips, the corrections have been so severe that with a poor economy lasting probably into 2012 or longer, the market will be in a trading range for at least a decade. I think that the Dow is going to vibrate between 7000 and 10,000. People will have to study companies, find those that can do abnormally well and distinguish them from those that will have average performance and those that will have sub-average performance. They are going to have to buy on declines and sell on strength. There will be opportunities, but we are not making new highs until at least the second decade of this century.
Q: People seem to feel that Europe is much more at risk than the U.S.
A: They face the same risks we do.
Q: But at least we are pulling out all the stops.
A: What are we doing? Giving the rich a tax cut and the poor a very tiny one -- is that pulling out the stops? Have you seen a program to build public housing? Have you seen a program to fight drugs intelligently?
Q: What about the monetary stimulus? The low interest rates?
A: That cannibalizes the future.
Q: You don't think any of that is useful?
A: We would have had a real recession sooner but it might have been over already if Greenspan hadn't lowered interest rates. The best thing that can happen is a good fat recession because that produces the changes that we are hoping for but that are not yet happening.
Q: So with all this in mind, are you buying any stocks?
A: We're buying stocks with abnormally good prospects and that have a price/earnings multiple that is ridiculously low. Countrywide Financial is an example. The stock sells at 77.
Q: You recommended that last summer at 46, and it's up more than 60% since then. You would still buy it?
A: Its earnings have gone up to a projected $10 a share this year. It is selling at a little more than seven times earnings. This is a growth company. It has had magnificent growth and is continuing to have even better growth selling at seven times earnings. It sells below a cyclical value stock's price/earnings multiple.
Q: What's another stock pick?
A: Another stock we are buying and have bought below the current price of 11, but also at this price, is Pengrowth Energy. It is a Canadian energy company that has 44% of its assets in natural gas and 56% in oil. It's a relatively small company, set up as a master limited partnership, that has a 18% yield, payable each month. We found it when it had a 21% yield.
Q: What kind of risks does that reflect?
A: The risk is it is currently paying 25 Canadian cents a month, which translates to 18 cents U.S. Multiply that by 12 and you get $2.16. The stock sells at 11.91. Cash flow is strong and the company is eliminating a management-fee structure that should also improve cash flow. However, we believe the price of natural gas will come down somewhat and so will the price of oil and eventually the yield will diminish to somewhere between 12% and 15%, which is quite handsome.
Q: Everyone is saying that natural gas is going to go through the roof.
A: It is through the roof. Are you married?
Q: No. Why?
A: When you go out with a young man, and he tells you he loves you and this and that, do you believe him all the time?
Q: No.
A: OK. Do you believe what you read in the papers?
Q: Look, even Greenspan is going on about natural gas.
A: Why do you have such affection for Greenspan?
Q: It's very unusual for the Federal Reserve chairman to talk so specifically about an industry as he did about natural gas recently.
A: Natural gas is selling at a little over $6 [per thousand cubic feet]. You know where it was for years and years? At $2. It has tripled. So when I say it may come down a little, it's relative. But the high price of natural gas will lead people to look for new supplies. Coal is a third cheaper, so maybe companies will switch to coal.
Q: Are you buying coal stocks?
A: Yes, I am. We own the biggest one, Peabody Energy, which has moved to 32 from 28, but it still has more room to grow.
Q: What else do you like?
A: Old Republic International, an insurance company. It is a little too high now at 34, but if the price breaks somewhat, and it may, it is a very fine company that is worth looking at. It's a multiline insurer, all different lines. They do a remarkably good job and are very well-managed. And it has had good growth performance, and that will continue. But the stock price is as high as it has ever been. I would prefer to be able to get it at a better price.
Q: Are you shorting any stocks?
A: No, I'm too much of an optimist to be short stocks.
Q: Ah, so you admit to being an optimist!
A: I am really an optimist. That's why my pessimism today is so extraordinary and makes me so unhappy.
Q: If you don't short stocks, what are you avoiding?
A: Blue chips. In other words, the favorite stocks. They are selling at multiples that are too high. They don't go down, but they sell at ridiculous prices.
Q: What about certain sectors? Are you interested in pharmaceuticals?
A: I think generics are taking over and are making it difficult for the big drug companies. Plus, the fact that despite the discovery of the genome and a much more effective way of doing research, it is harder to come up with drugs that don't have a great deal of competition from existing drugs. That is a group that I would avoid.
Q: Media and entertainment?
A: They are having a very difficult time. The movie world and the music world are under terrible pressure. Costs are high and competition is very great. And the amount of pirating going on is excessive.
Q: Are you interested in bonds here?
A: Not really. The interest-rate picture has been very favorable. Greenspan's been cutting rates. There's no inflation. And bond prices have risen strongly. Generally speaking, governments and corporates are very, very vulnerable. Munis are modestly attractive versus taxables. But the whole bond market looks very vulnerable, and is a great sale at this time.
Q: What do you expect come fall 2004?
A: I expect we will be sitting here and having the same interview. I don't see any change in sight. I don't see the Democratic Party trying to revolutionize itself. The Democrats have all become sheep. Young people have the expression about living outside the box. No one is living outside the box here. There is only one great country: Norway. I didn't come from Norway, but I lived there. It is monolithic. There are 3.5 million people. It is the most constructive country in the world. They're for peace and they were just named as part of the enemy by al Qaeda. If you want a wonderful country, it's Norway. In my next incarnation, I hope to be born a Norwegian.
Q: Nice to see you, Seth.
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