SUGAR PLUMS

THE DAILY RECKONING

PARIS, FRANCE

TUESDAY, 4 DECEMBER 2001

* * * * * * * * * * * * * * * * * * * * * * * * * * * *

*** Patriots, charge!"U.S. goes cheap car crazy"...

*** After tax incomes go down, bankruptcies mount,
mortgages go delinquent...but spending goes up...

*** Deflation in the Northwest...melting ice cubes and
the"Law of Perverse Outcomes"... and more...

* * * * * * * * * * * * * * * * * * * * * * * * * * * *

Patriots fixed their plastic bayonets and charged
last month, sacrificing their financial integrity in a
hopeless and lamebrained cause. As Eric reports below,
consumer spending rose while spending power declined.(angeheizt durch schwachsinnige Kommentare wie den von Bush, daß Patrioten kaufen würden)
Mortgage delinquencies rose to 4.87%, but that didn't
stop people from buying."U.S. goes cheap car crazy,"
said the BBC of Americans' car buying last month.

Consumers are voting with their pocketbooks - for
a new boom. Too bad it doesn't work that way.

"Economy shrinks at fastest rate for a decade,"
says the Financial Times. And not just the U.S. economy.
"Gloom Deepens in UK Economy," too, says the BBC. And
"Euro-zone manufacturing shrinks for 8th straight month,"
reports the Financial Times.

Unemployment in France rose for the 7th month in a
row, adds Le Monde.

Consumers can vote all they want - it won't change
the seasons or make water run uphill. Democracy is a bit
of a fraud, in the market as well as in politics. But
that is another subject.
(Aber wen interessieren schon die Idioten in der alten Welt. Wir haben alles neu erfunden und sind eh die größten)

Eric, what's shaking on Wall Street?

*****

Eric Fry in New York...

- Okay, now it's official, American consumers have gone
mad! Personal spending surged in October, despite the
fact that after-tax personal incomes FELL. Alan
Greenspan must be very proud of what his rate-cutting
extravaganza hath wrought.

- The Commerce Department reported Monday that personal
spending soared 2.9% in October - the largest monthly
jump since the data series began in 1959. (wie steigert man"völlig wahnsinnig"?) Meanwhile,
personal incomes were stagnant in October for the second
straight month - the worst showing in more than seven
years. It gets worse...Americans' incomes after taxes
actually fell.

-"The 1.7 percent decline in after-tax incomes and the
record increase in spending meant that Americans'
personal savings rate dipped to a record low of 0.2
percent in October," the New York Post reports."The
fact that incomes remained frozen in both September and
October raises concerns about the future course of the
economy." That's putting it mildly!

- Skyrocketing spending, despite falling incomes and
dwindling savings, does not look like the stuff of
enduring economic vitality.

- Are we becoming a nation of reckless spendthrifts? (Was heißt das? Konsumsüchtige, würde ich raten) Has
Enron become the new financial model for businesses and
individuals alike?

- Enron's $53 billion bankruptcy filing is exceptionally
large, but it is hardly exceptional. Enron has plenty of
company in bankruptcy court.

- A record 230 public companies with more than $182
billion in assets have already filed for bankruptcy this
year, according to Bankruptcy-Data.com. (den Link sollen wir vormerken) Last year, only
176 companies with a total of $95 billion in assets
filed for bankruptcy.

-"As the number of bankruptcy filings by public
companies surges to a record," the New York Times
reports,"companies are increasingly being forced to
liquidate instead of reorganizing as viable
businesses...The liquidation rate is far higher than a
decade ago, the last time there was a surge in
bankruptcy filings." One assumes that many members of
the Bankruptcy Class of 2001 were never"viable
businesses" in the first place.

- Henry Miller, vice chairman of Dresdner Kleinwort
Wasserstein, tells the Times"A lot of companies have
melting ice cubes for assets, and there's not a serious
prospect of restructuring on a stand-alone basis."

- Recklessly engineered finances seem to be the order of
the day. Remember that in 1999, Enron agreed to pay a
staggering $100 million over 30 years for the right to
name the Houston Astro's new ballpark"Enron Field." (wehe einer sagt jetzt, das wäre nicht die finale 5 gewesen!!:-))
Probably, most of the 4,000 newly unemployed Enron
employees could have found better uses for that cash.

- Then again...maybe not. Aren't a lot of folks busy
buying overpriced U.S. stocks? If you're going to invest
in money-losing companies, why not pay money to name a
stadium after yourself?

- Yesterday, the buyers took it easy on Wall Street. The
Dow lost 87 points to 9,764, while the Nasdaq shed 26
points to 1,905.

- The shares of J.P. Morgan Chase (JPM) were a
conspicuous loser, falling 3% to $36.55. JPM is among
the more prominent of Enron's creditors."According to
the U.S. bankruptcy court filing in New York, JPM is on
the hook for about $2 billion in unsecured loans to
Enron," Grantsinvestor.com reports."The Texas-based
energy company turned out to be all hat and no cattle."
(http://www.grantsinvestor.com/site)

- Grantsinvestor.com also points out that JPM may soon
have a new headache to worry about: Argentina. The
country imposed stringent capital controls over the
weekend in a desperate attempt to avert a default or
currency devaluation. As of September 30, JPM's exposure
to Argentina totaled $900 million. What will become of
this nearly $1 billion liability is anyone's guess.
"Other interesting tidbits: JPM's consumer credit card
exposure has increased 32%, from $403 million (Sept. 30,
2000) to $534 million (Sept. 30, 2001), with average
annual net charge-offs growing from 4.99% to 5.64% over
the same period." There's that heavily indebted Mr.
Consumer again! (Mahlzeit!

- Public Service Announcement: Starting today, Cisco
will be hosting its gala"Worldwide Analyst 2001
Conference" from Santa Clara, California - in the heart
of the Silicon Valley. No doubt, we can expect to hear a
lot of feel-good blather about"demand stabilizing" and
about an"improving long-term outlook." The current
quarter will be awful, of course...and so will next
quarter...and maybe the one after. But you can be sure
that, a few quarters out, things will start looking
okay...

- Don't they always?

*****

Back in Gay Pareee...

*** The financial media is beginning to catch on to the
threat of deflation - at least enough to be able to
dismiss it.

***"Almost anywhere you go this holiday shopping
season, you see the sale signs," says a report from the
Seattle Times."From The Bon March‚ to J.C. Penney, from
small boutiques to stalls at the Pike Place Market,
prices are down."

*** But while"most economists say the United States
likely will avoid another deflationary spiral like the
one that crushed the economy in the 1930s," reports the
Oregonian,"...they're not ruling out the possibility
that the nation could be gripped by at least a short
period of mild deflation in the wake of the Sept. 11
terrorist attacks."

*** Why not a long period of severe deflation? Who
knows! Who would have thought that the Fed would cut
interest rates 10 times with no improvement in the
economic situation? And who would have imagined that the
World Trade Center towers would be demolished by
terrorists?

*** Almost every news story or opinion we read here at
the Daily Reckoning is positive...confident...upbeat...
Whether it is the economy, the stock market, or the war
in Afghanistan - everything is going to turn out well,
and soon. This is the best time to buy stocks in 10
years, says one investment guru, because the stock
market will soar as our success in Afghanistan is
completed. (dann kauft mal munter!)

*** We don't know what the future will bring, dear
reader, but investors and consumers are voting for
success. If only it worked that way! Instead, when
investments are priced for success, investors pay a
heavy price for failure. And the Law of Perverse
Outcomes practically guarantees that some degree of
failure is what we will see. Where? When? How? More
below...

And stay tuned...

SUGAR PLUMS
by Bill Bonner

"It's beginning to look a lot like Christmas..."

Author Unknown (at least by me)


"Following a social movement," came the announcement.
"Service is interrupted on the #9 line."

"Social movement" in France means a strike. Like so many
things in public life, the words tell you exactly the
opposite of the thing they are supposed to describe.
Stopping the subways, by those paid to operate them, may
be more correctly called an"antisocial" movement.

Forced up out of the metro, I arose on the corner of the
Champs Elysees and Avenue Montaigne. Both were lit up
brightly, decorated for the holiday season. What a
marvelous time of the year! But it is also a difficult
time of the year for many people, the social scientists
and feeling meddlers tell us. People build up such high
expectations for Christmas, that they are often
disappointed - and even depressed - by the real thing.

It is still early in the year to be writing about
Christmas. But I do so not to spread holiday cheer, but
holiday gloom. For whenever expectations become
exaggerated - like a bum upon finding an unlocked liquor
store - the outcome is rarely as beneficent as
anticipated.

Investors are getting ready for Christmas."Wall Street
continues to believe that the current environment
represents the best time to buy equities in the last 16
years. We find it incredible that even the prospect of
war can't dampen their bullishness," says Richard
Bernstein, chief quantitative strategist at Merrill
Lynch.

The big bottom of their dreams has come and gone - they
believe. Visions of sugar plums dance in their heads.
Sadly, the more the candies twist and boogie in their
minds, the less likely that investors will get what they
want from Santa.

Anticipation, it turns out, is a fairly reliable
predictor. The more people expect a given outcome from
the market...the less likely they are to get it.

This is especially true when applied to professionals.
So regularly do Wall Street strategists get it wrong
that you can practically set your watch by them. When
they are extremely bearish, stocks rise. When they are
extremely bullish, stocks fall.

Merrill Lynch is so sure of this phenomenon that they
have developed what they call a"Sell Side Indicator"
out of it. Audrey Kaplan, quoted in the International
Herald Tribune over the weekend, calls it "the most
reliable quantitative market-timing barometer."

"We have found that Wall Street's consensus equity
allocation has historically been a reliable contrary
indicator," Ms. Kaplan explained."In other words, it
has historically been a bullish signal when Wall Street
was extremely bearish, and vice versa."

The Sell Side Indicator tells us what percent of your
portfolio Wall Street's brokerage houses are
recommending that you put into the stock market. Since
1985, the number has varied from a low of about 47% in
1989 to a high of 71% today. Until recently, the
indicator had never been greater than 62%. In December
of 1996, when Alan Greenspan warned of"irrational
exuberance" among investors, they were actually calm and
reasonable. Wall Street pros were recommending only
about 50% exposure to stocks. But while stocks fell,
beginning in the spring of 2000, Wall Street became more
and more bullish. In fact, it has never been more sure
that stocks are the place to be.

Other surveys tell the same story. Investors polled at
the end of August, notes Barton Biggs of Morgan Stanley,
found remarkably high expectations."You couldn't ask
for a much grimmer period," said Biggs. Household wealth
had already fallen by $875 billion in 2000 and another
$532 billion in the first half of 2001. But investors
were upbeat - the average one expected an 18% return on
equities next year. (Die Gen-Nahrung scheint das Hirn zu zerstören. Die MÜSSEN niedergehen!) Only 2% thought they would lose
money on stocks and 82 percent expected to end the year
richer than they began it.

Investors were far from capitulation in late August. If
anything, they are even farther from it today. The
American Association of Individual Investors also
surveys its members to get a reading of sentiment. At
the very peak of the stock market bubble - in December
'99, bullish sentiments had spread to 60% of the
members. A 60% reading is rare. But, again, as stocks
went down, bullishness went up. Last week, 69% of
respondents were bullish - while only 20% were bearish.

How could investors be so wrong, so often?

"In the short run, the stock market is a voting machine.
In the long run, it is a weighing machine," said Ben
Graham. In the short run, investors vote for whatever
outcome they want and/or expect. If they believe the
future will bring good news...and that Alan Greenspan
can avoid a recession...they will pay more for a stock -
because they look forward to compounded growth in
earnings over a long time. Or, if they are fearful, they
worry that they may have to sell the stock next year...
or that earnings may go down in the future rather than
up.

But whether they are extremely bullish, or extremely
bearish, their"votes" tip the scales in the opposite
direction. When investors are bullish, more and more
money is invested in a given stream of earnings (a
company...an industry...or even an entire economy only
produces so much profit)...leaving a smaller and smaller
return on investment for each investor. As long as
confidence in the future is building, prices rise. But
eventually, when the anticipation of future profits -
and bullishness - reaches its zenith, prices give way.
Smart investors notice that earnings will not be
sufficient to keep up with the stock prices. Stock
prices fall, until they are at last bargains again...and
then, the stupid investors sell.

There are no exceptions to this pattern. Over the long
haul, the market weighs out the real return on an
investment and brings it into line with the rest of the
economy. If stocks have gotten too high...they are
driven down. If they have gotten too low...a new bull
market begins.

Over the long run, the stock market cannot stray too far
from the underlying economy. (umso länger aber, je länger sich dumme Ausländer finden, die den Irrsinn mit ihrem guten Geld bezahlen!) Investors are paying for
earnings, after all, and earnings go up or down along
with everything else.

"The stock market does not grow faster than the
economy," writes John Mauldin."If it goes too high or
too low, it always comes back to trend." When investors
have become unusually confident, they are pulled back
down to the trend...when they have become unusually
fearful, they are pulled up by rising stock prices. The
more investors anticipate either outcome...the further
they have to get back to the trend.

At the bottom, they have an opportunity to buy stocks
for the right reason - because they are bargains. Later,
when stocks approach a top, they can buy them for the
wrong reason...because Wall Street and other investors
tell them to do so.

"Stock prices fluctuate dramatically," Mauldin observes.
"There have been 7 secular bear markets and 7 secular
bull markets since 1802. These are periods of at least 8
and up to 20 years where stocks are either generally
rising or falling over the entire period. There are, of
course, bear market rallies and bull market corrections,
but the long-term trend is still either up or down."

Up and down...down and up.

Mr. Market is never satisfied. He never sits still.
Thank God we have the professionals to tell us what
direction he is not going to take.

Your correspondent,

With his eye on the pros...and visions of sugar plums
dancing the can-can in his head...

Bill Bonner


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<ul> ~ Eldorado der Bankrotte</ul>
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