-->Imminent Crash?

The Daily Reckoning

Paris, France

Monday, 31 March 2003

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

*** Stocks fall last week...except gold stocks.

*** World economy is 'dysfunctional'. Oil and gas - after
all!

*** The war against Iraq - like the Boer War? Or the
Algerian War?


Several headlines over the weekend mention"recession". The
prospect of 360,000 U.S. troops putting down roots in Iraqi
sand troubles the economy. Or at least, it troubles
economists. The economy was already troubled long before
George W. Bush decided to bring freedom to the desert.

The"shock and awe" campaign seems to have impressed no one
- neither the Iraqis, nor investors, nor economists. Stocks
are lower than they were a week ago. Gold is higher, by
about $6. And gold stocks? They rose about 6% last week.

The entire world economy is"dysfunctional", says Stephen
Roach. The U.S. has been the world's growth engine for
many, many years. But now, American consumers can't seem to
get their motors started.

Consumers continued to buy in February. But for the second
month in a row, there was no growth in consumer spending -
despite record amounts of new money entering the economy
through mortgage refinancings.

Where's the money going? Well, it appears to be just enough
to allow householders to stay in the same place. Mortgage
interest alone is running at about $265 billion annually.
Property taxes, up nearly 50% since 1995, add a couple
hundred billion more.

After servicing his debt and taxes, the consumer just
doesn't have enough fuel left over for his growth engine.
"War...and the peace that eventually follows...changes none
of this," says Roach.

We're not so sure. We old fuddy duddies here at the Old
School Daily Reckoning remember when a billion dollars was
real money. Now, people toss a few billion here, a few
there, as if it were chump change. Operation Iraqi Freedom,
alone, will probably end up costing about $200 - $300
billion...or about $2,500 per household. Since millions of
families are already at the edge of insolvency...the extra
costs of the war will probably push thousands of them into
bankruptcy. On the homeland front as well as the Iraqi one,
there may be more casualties than expected.

Eric...?

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

Eric Fry in New York...

- The stock market slowed its advance toward Dow 9,000 last
week, as it struggled to consolidate and fortify its
position around the 8,000-level. The pause may have been
necessary to enable the re-supply of buy orders to arrive
at the front lines. Complicating the efforts of the
investor-infantry, sandstorms of economic uncertainty
swirled through the ranks.

- By the end of last week's skirmishes at Wall and Broad,
the Dow had retreated 376 points to 8,145 and the Nasdaq
had pulled back 3.7% to 1,369. The dollar also beat a
retreat, falling back to $1.078 per euro from $1.052 the
week before.

- Meanwhile, the safe-haven asset classes charged ahead
into the macro-economic fray. T-bonds, oil and gold all
gained ground last week. Crude oil led the commodity
brigade by advancing more than 10% and reclaiming the $30-
level.

- Most oil and gas stocks gained ground last week, even as
all the major equity indices fell. The XNG Index of natural
gas stocks and the XOI Index of oil stocks both closed out
the week at their highest levels since the war started. The
surprising thing is not that energy stocks rallied last
week, but that they didn't rally more. The oil price jumped
more than 10% to finish the week above $30 a barrel. Even
so, the XOI Index gained less than 1%.

- Complacent bearishness toward oil and gas was one of the
earliest casualties of the Iraqi conflict. Prices are
soaring throughout the energy complex. Yet the shares of
most energy companies continue to lag behind."There are a
lot of cheap oil and gas stocks out there in the stock
market right now," says Robert Tracy of Apogee Research.
Your co-editor is inclined to agree, which is why he refers
to oil and gas stocks as"chicken longs".

- Many oil and gas stocks remain quite inexpensive, despite
the big rallies in their respective commodities. That's
because - prior to the war - most investors anticipated a
swift and decisive victory over Iraq that would bring an
equally swift and decisive end to soaring energy prices.
Since investors KNEW that oil prices would fall as soon as
the first Tomahawk cruise missile fell in Baghdad, they
also knew that they shouldn't buy oil and gas stocks.
However, the first tomahawk has now landed, along with a
few hundred more, and the Iraqi regime still stands. So oil
is flying to the upside once again.

- Apart from the low valuations that typify most oil and
gas stocks, the sector seems to be sitting in a win-win
position. A swift U.S. victory in Iraq would likely boost
the stock market, permitting oil stocks to trade higher in
sympathy with the general market trend. Alternatively, a
lengthy campaign in Iraq would likely boost the oil price,
thereby boosting the profitability of oil and gas stocks.

- Then too, there's the whole issue of resurgent inflation,
the possibility of which Alan Greenspan and most other
experts have ruled out. Weighing in against these expert
opinions is a $100 billion - and growing - tab for the
Iraqi conflict, a $300 billion - and growing - federal
deficit and a $500 billion - and growing - current account
deficit. A little bit of inflation would make those debts a
lot more manageable. And even a little bit of inflation
would do a lot of good for oil and gas stocks. That's
because the oil price is most often one of the items whose
price inflates during an inflation, thereby inflating the
profits of oil and gas companies.

- An investor could do worse, we imagine, than to sell
long-dated U.S. Treasury bonds and buy high-yielding oil
and gas stocks. One institutional bond salesman recently
mentioned to Jim Grant, editor of Grant's Interest Rate
Observer, that he was selling an 8-year Treasury note
yielding 3.41% to buy the common stock of British Petroleum
(BP), yielding 4.55%. BP has rallied a smidge since then,
but still yields 4.07%. By comparison, the 10-year Treasury
note closed out the week yielding 3.90%...Pick your poison!

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Back in Paris...

*** From Tim Freeborn in our London office:

I've been checking my history books and have found uncanny
parallels between the Iraqi war and the Boer war:

1) An Imperial power, apparently at its zenith, but in fact
in serious relative economic decline.
2) Huge international opposition.
3) Struggle for control of key resources: gold, oil.
4) Fairly early conventional victory followed by massively
expensive guerrilla campaign lasting two years.

The London market rocketed when war was declared in 1899.
Then, interest rates went up as government borrowing
soared. Equities fell on early defeats...and then generally
suffered with the economy. In the end, Britain did win, but
its economic performance in the following decade was poor.

***"I don't like the way this war is going," said Col.
Aubray, after Sunday's mass. Rare among the French, the old
soldier seems sympathetic to Bush's war. But it brings back
bad memories.

"It reminds me of the Algerian War. You know, we had a huge
military advantage. And we actually won the war,
militarily. I remember I was stationed at a tiny
village...I was the only European for miles around. And
they encouraged us to bring our wives...to show that it was
all very safe and ordinary. So Marie-Noëlle came with me.
We had friends in the village. But we were never sure when
they might try to cut our throats.

"And Algeria was not like Iraq. The French had been there
for hundreds of years...it was a department of France, like
a state in the U.S.. But once the locals decided to get rid
of us, we couldn't stop them.

"And we paid a terrible price. I don't mean just money,
either. That kind of guerilla warfare - house to house,
where you can't trust the civilians and never know who's
going to try to blow you up - degrades an army. Terrible
things were done during the Algerian war...on both sides.
And in the end, we had to leave. It was just too costly to
stay."


The Daily Reckoning PRESENTS: A real estate bubble? An
imminent crash? Au contraire, says Dr. Steve Sjuggerud...
also suggesting that"whenever the cocktail party crowd
reaches a unanimous conclusion about an investment, it may
pay to consider the opposite possibility."


IMMINENT CRASH?
By Dr. Steve Sjuggerud

Argh! I should have bought back then!

About six years ago, I lived in Delray Beach, Florida. My
wife and I had considered buying a place on the beachside,
within walking distance from the beach. At the time, large
two-bedroom townhouses were going for between $130k and
$170k. We even made a few lowball offers, which weren't
accepted. I ended up moving to Baltimore. But friends of
ours did end up buying places we looked at, and my parents
also bought as an investment.

Wow. They sure look smart now.

I returned to Delray earlier this month (to host our annual
Investment U seminar), and I couldn't believe what had
happened. Friends who I know paid around $135,000 (because
we looked at the same unit they bought) are putting that
place up on the market for $450,000. The unit next to my
parents just sold for about triple the amount my parents
paid. Good for them - they were in the right place at the
right time. (And we did well in Baltimore also; there's a
real estate boom going on there, too.)

A boom in the town known as"Dull-ray" Beach? A boom in
Baltimore? I know you're probably wondering,"Steve, how
can you say there's no real estate crash imminent?"

There are two things to point to: value and buyers.

In the last year or so, homes have been more affordable
than they've been in over 25 years. Today, a household that
makes $50,000 a year can easily afford a $150,000 house. At
5.5% interest, a 30-year mortgage would cost less than $900
a month - or about 20% of monthly income.

That's extraordinary. Take that same family in 1981. To buy
the median house back then (which was only $130k when you
adjust for inflation), it would have cost $1,630 a month in
today's dollars - nearly twice as much as right now... and
about 40% of income. This is because mortgage rates in 1981
were 15%.

Low mortgage rates have changed the buying dynamic.
Families that used to rent are now buying. Low mortgage
rates have caused a dramatic increase in the buying pool.

As for value, it may be hard for most to believe, but even
if we ignore mortgage rates, the fact is that housing
prices in the U.S. are still at about 1989 levels when you
adjust for inflation. Since 1989, stocks have tripled (the
Dow is up from 2,500 to 7,500 today, after nearly reaching
12,000 in January of 2000). Meanwhile, home prices in that
time are flat.

Another way to look at value is by looking at EARNINGS.
Just as we look at the price-to-earnings ratio of a stock,
you can look at the price-to-rental earnings ratio of a
house. Stocks would have to fall by about 50% to return to
being"in line" with the average price-to-earnings ratio.
Meanwhile, a study this month by the Federal Reserve Bank
of San Francisco shows that housing prices would have to
fall by 11% to bring the ratio back to its long-term
average. This may be a little worrisome, but it's not the
end of the world. The author of the study expects that home
prices may not even fall; rather, rents will simply catch
up by 2005, bringing us back to fair value.

According to a recent Economist magazine, home prices in
Ireland have risen 203% since 1995. In Britain and the
Netherlands, they're also up triple digits. The U.S.'s 5.7%
annual gain over that period seems downright paltry.

Similarly, in Australia and Spain, home prices rose by
about 18% in 2002. Meanwhile, in the fourth quarter of
2002, U.S. home prices only rose at an annual rate of 3.3%.

For the many years that I have been writing about
investing, I have never predicted a crash in U.S. real
estate. Yes, there are some"bubble" areas in the U.S., and
you know them if you live near them. But on the whole, I
don't think real estate is wildly overvalued. The gentleman
from the San Francisco Fed may be close, suggesting that
home prices are a little overvalued. But that definitely
does not mean that the bull market in real estate can't
continue. Stocks were overvalued for many years and kept
rising until the crash came in 2000.

The facts, as reported by the Housing Affordability Index,
suggest that in the last year, homes have become more
affordable than they've been in over 25 years - primarily
due to lower mortgage rates. At the moment at least, there
is demand from new buyers, and supply is tight. Prices
could move higher.

I don't have all the answers, of course. However, there is
one more point I'd like to make."Real estate is expensive"
- there's unanimous agreement on this fact at cocktail
parties. Of course, in late 1999, there was unanimous
agreement at cocktail parties that the way to instant
riches was through tech stocks.

Whenever the cocktail party crowd reaches a unanimous
conclusion about an investment, it may pay to consider the
opposite possibility.


Regards,


Steve Sjuggerud
for The Daily Reckoning