-->Confidence Game
The Daily Reckoning
Paris, France
Wednesday, 2 April 2003
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*** Nikkei drops below 8,000...bad news in February...a
second dip?
*** Profits at half-century low...the Brooklyn method...
*** Poor Fannie...Land of Liberty...and more!
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Japan is back in the news. Readers will recall that Nippon
enjoyed a New Era in the late '80s, when investors lost
their heads and bid the Nikkei Dow up to nearly 40,000. In
January, 1990, stocks began to fall and the New Era was
over. But nearly everyone was sure that the miracle economy
would soon recover. The Economist, for example, ran a major
article explaining why a serious slump in Japan was out of
the question.
Since then, the country has been in on-again, off-again
recession...with stock prices falling. And yesterday, the
Nikkei dropped below 8,000...effectively wiping out nearly
20 years of stock market gains.
In this space, 3 years ago, we wondered if what had
happened to the world's second-largest economy might not
happen to its first largest. We made the suggestion not
because we knew what was coming, but because we didn't. If
a long, slow bear market is what happens to a modern
economy following a bubble, why wouldn't the same thing
happen in the U.S.?
America's bubble began almost exactly 10 years after
Japan's...and reached similarly absurd proportions. Then,
stocks began to fall in America...almost exactly 10 years
after the Japanese top. Again, economists at first
dismissed the bear market. All seemed sure that America's
miracle economy would quickly bounce back. But here we are,
Anno Domini 2003, and the latest news is bad.
A USAToday business poll tells us that 43% of those asked
think business is worse than expected. Only 26% think it is
better. In February, almost all indicators were negative.
Durable orders, retail sales, payrolls, business activity -
all fell.
GM, desperate, is offering to finance its cars at zero
percent interest for up to 5 years.
And profits? As reported in this space yesterday, by Kurt
Richebächer, profits are disappearing. As a percentage of
GDP, profits were 6.7% in '97. They declined to 4.3% in
2000...and are now near 3% - their lowest level in the
entire post-war period.
And now, economists are beginning to wonder if we are
already back in recession.
"Is this the second dip?" asks a CNN headline.
We don't know. But it looks to us as though the U.S. is
still following the Japanese example. In Japan, GDP growth
slipped to near zero in '93. Then, it went negative in '95.
In '96, it looked like the country was back on a growth
path...but then, in '98, it slipped into a severe
recession, with falling prices and growth rates at nearly
negative 5%.
Faced with the same peril in America, you can expect the
Fed to make a further rate cut...which may be followed by
another flurry of refi activity...and a final top in the
bond market...and, oh yes, buy gold.
Eric, what do you see?
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Eric Fry in New York...
- What was it that inspired the bulls to buy stocks
yesterday? Was it war, or was it pestilence?...Or both? The
experts tell us that war is bullish. So war and pestilence
combined must be doubly bullish, right? Let's look at the
facts: We've got a war raging in the Middle East and a
fatal disease raging in Asia...What could be more bullish
for stocks than that?
- Yesterday, the Dow rallied 78 points to 8,070, and the
Nasdaq gained half a percent to 1,348. Perhaps war and
pestilence had nothing to do with yesterday's rally. Maybe
the bulls bought stocks because the economy is floundering
(which means that the Fed will cut rates, which is bullish
for stocks).
- The Institute for Supply Management's index imploded to
46.2 percent in March from 50.5 percent in February. In a
healthy economy, the ISM number rises above the 50 level
and stays there. Let the reader decide what a reading of
46.2 might portend.
- While stocks advanced yesterday, the safe-haven assets
backpedaled a bit. Gold for June delivery dipped $1.70 an
ounce to $335.20; crude oil for May delivery dropped $1.26
to $29.78 a barrel; and the benchmark 10-year Treasury note
retreated 11/32 to yield 3.84%, up from 3.80%. When, dear
reader, might investors demand more than 3.84% per year to
lend money to the US government for 10 years?
-"The new consensus opinion in the bond market," writes
Jim Grant,"[is] that tactical reversals for American
forces are bullish, because the war will last longer than
expected, energy prices will not collapse as hoped, the
U.S. government will borrow more than planned and the Fed
will stay more accommodative longer than it would otherwise
have done. In other words - if we follow correctly - heavy
public borrowing, fast-paced debt monetization and high
commodity prices are non-inflationary. We had somehow
believed the opposite..."
- So had we...and we still do. Over here in the New York
office, we apply the"Brooklyn Method" to financial
analysis:"We calls 'em as we sees 'em." And what we see is
a far-flung military campaign, an out-of-control fiscal
deficit, a soaring current account deficit and a struggling
dollar. Which of these trends, we wonder, helps a
bondholder to sleep soundly at night?
- Your co-editor has let it be known that he considers the
Treasury's long-dated bonds to be financial landmines...Or
perhaps they are more akin to a blunderbuss - a weapon as
likely to fire at the intended target as to discharge in
the face of the shooter.
- Many are the reasons to steer clear of Uncle Sam's
obligations. For one thing, the Clinton-era budget
surpluses are a distant memory, as the federal budget
plunges into deficit. Making matters worse, the war meter
is running and the longer it runs, the higher the fare.
President Bush has procured $75 billion to pay for the
"liberation of Iraq". But that number is likely to grow.
Ironically, therefore, liberating Iraq will shackle
American taxpayers to a national liability that will almost
certainly exceed $100 billion, if not $200 billion...
- Congress, doing its patriotic duty, is prepared to spend
as much of our money as it takes to establish a beachhead
in Baghdad. The Federal Reserve, likewise, is prepared to
wrap the Stars and Stripes around its reckless monetary
policy...if need be.
-"The ancient role of the central bank in wartime is to
accommodate the national government," writes Jim Grant.
"The Fed, worried about deflation, was engaged in a
strenuous program of credit creation before the U.S.
invasion. 'Geopolitical uncertainties' only strengthen the
monetary tendencies in place. Heavy public spending doesn't
guarantee a rising inflation rate. Neither does easy money.
However, the two in combination make the bond market and
even more forbidding place for widows and orphans...
-"Perhaps the war will exert less influence on economic
and financial events than the unfinished business of the
bear market will exert," Grant continues."Whatever the
case may be, the new Wilsonian look in foreign affairs
(coupled with a continuing inflationary bank in monetary
policy) heightens whatever risk of inflation there was
before the bombs fell."
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Bill Bonner, back in the land of Liberty...
[France, that is; we have picked up the idea of renaming
everything associated with France with the word"Liberty".
In a gesture of solidarity with our American compatriots,
we will eat Liberty legs in a Liberty restaurant tonight.]
*** Why hasn't the dollar crashed? That it will crash seems
a foregone conclusion. For isn't the federal government
lowering taxes while conducting a war against terror...a
war against Iraq...and a war against recession - all at the
same time?
Oh how we miss America! You remember that great country,
don't you, dear reader? It was the country in which the
people's elected representatives were supposed to get
together and debate the merits of important issues - such
as war. It's right there in the Constitution...no kidding.
With furrowed brows and grave tones, they are supposed to
hash out the pros and cons...and solemnly vote on it. And
if they see fit to go to war, they also have the
responsibility to find the means to pay for it, typically
raising taxes to cover the bills.
But it is all fraud and hokum now. Congress has become like
the Roman senate when the empire began to decline -
cowardly, irrelevant, and repulsive. Members of congress
hide in the toilet rather than even discuss the war. And
how to pay for it? No one bothers to ask.
In war as in love, of course, you never stop to count the
cost until it is over. When the tally is finally done, we
don't know what it will show. But we have a fair idea of
how the bill is paid. The same Congress that could not find
the courage to raise the money for the war while it was
young and fetching...will find even less will for raising
money to pay for it when the affair is over. Instead, it
will pass the buck, so to speak, to the people who seem to
have the power to create bucks out of thin air, the Federal
Reserve. Always ready to provide credit, whether it is due
or not, the Fed will come through the war like a good
soldier. The Fed will do its duty; it will produce dollars
as if they were war supplies. And, sooner or later, the
world will have more than it can use.
*** Poor Fannie Mae. The old girl had a spectacular
opportunity and made a mess of it. Refinancing activity hit
a record last year - running an approximately 9,300% larger
operation than in 1990. Yet, Fannie found a way to lose
money for shareholders. The company's net worth declined by
2% last year, reports TheStreet.com.
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The Daily Reckoning PRESENTS: While once a confirmed
"bear", an expert on negative prognostications, Jim
Davidson now councils: never become a prisoner of your
fear. And with good reason, perhaps...
CONFIDENCE GAME
By James Davidson
You would not find my late mother listed along with George
Soros, Julian Robertson and Warren Buffett in a compilation
of the leading investors of recent times. Yet she taught me
one of the greatest lessons an investor can learn.
Investment success begins with your attitude to life.
Following her advice in the summer of 2001 helped me add
$10 million to my balance sheet last year.
How?
When the depredations of the bear market had swept away $50
million and I was beginning to stagger and flinch from my
losses, my mother forcefully reminded me not to succumb to
the bear market mentality. She counseled me never to allow
myself to become a prisoner of fear and dwell on the
negatives."Believe in what you invest in and you will be
successful. You will find a way to make it work."
At times my mother's sense of accountancy seemed to rival
that of Enron's. But instead of capitalizing derivatives,
she saw it as an almost spiritual principle that you create
your own luck. This has been known for ages by first-
caliber athletes who understand that confidence is not mere
arrogance, but a necessity for performance. The top
basketball player or professional baseball pitcher can
seldom win if he approaches the game in a timid and
frightened way.
Without the kind of confidence that"bull markets" normally
impart to investors, an athlete lacks that little edge to
him that all the great ones have. And what is true of
sports is equally true in other aspects of life.
I was inspired by my mother's vision that I could create my
own bull market. Rather than count my pennies and prepare
for failure, I took her advice, mustered my remaining
investment resources and concentrated on creating value.
Where I might well have ducked opportunities because I
feared losses (the essence of the bear market mentality), I
convinced myself that good things would happen from
courting success. I took some real gambles on small-cap
companies that might have gone out of business. They
didn't.
In fact, by the end of 2002, I was $10 million ahead of the
weak position I was in during the summer of 2001, when I
found myself wobbling into fear and despair - only to be
turned around and steadied by my mother's apparently naïve
faith that I would surely succeed if I only"cast my bread
upon the waters."
Crippled by disease and fastened to life-support for the
final stage of her life, my mother was no Pollyanna. But
she was someone who instinctively understood that you must
choose happiness. Her cheery disposition was not a
calculated investment gimmick, but a profound expression of
her understanding of life, made more credible by the fact
that she had much to be unhappy about. She imparted to me
the conviction that I could succeed by creating my own bull
market without waiting for"safety in numbers" or the
approval of others. She understood that it is easier to
take risks when everyone is in a mood to do so. But
equally, the returns are higher when most investors are
pinching every penny as if it were their last.
Now that my mother is gone, I can no longer rely on her to
reorient me when I threaten to absorb the negative bear
market mentality that is underscored in every night's news.
While I once was a confirmed bear and made myself an expert
on threats to prosperity, predicting many of the unhappy
developments of recent years, I ultimately found that
focusing on my own predictions was self-defeating, rather
than a sound preparation for the future.
Stock market debacles, threats of"Code Orange" terror
alerts and bankruptcies may engross the headlines, but I
have learned not to let them engross my thinking and take
over my central nervous system. Whenever I find myself
being affected by the bleak civic mood that engulfs us, or
the equally bleak sentiments of market experts, I make a
point to pause for an internal dialogue with myself. I
think back to what my mother would have said to shake me
awake to the positive potential of life.
Although I am not a particularly religious man, I see a
version of this profound truth echoed in the Bible:"Anyone
who starts to plough and then keeps looking back is of no
use in the Kingdom of God" (Luke 9:62). I now look ahead
when I plow.
I recommend that you do, too.
James Davidson,
for The Daily Reckoning
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