-->Generation Debt Bomb

The Daily Reckoning

Rome, Italy

Monday, 14 April 2003

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*** Mr. Market looks ahead - to more of the same

*** Number of stock funds falls...2.5 million jobs
lost...Europeanization of U.S. labor markets...

*** Pensions erase profits...churches,
saints...pillars...ruins...and more!

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"Where's the dividend?"

The Washington Post wonders what we wonder. The war went as
planned...it was so quick and easy, another one is almost
inevitable.

But so far, the stock market has failed to throw confetti
or splash champagne. Mr. Market, supposedly looking ahead,
does not seem particularly overjoyed. What does he see?

Barron's takes a guess. Bubble II seems to be forming in
tech stocks, says this week's paper, with our old friend
the river-of-no-returns stock, Amazon.com, trading at 80
times earnings. Of course, 80 times earnings is an
improvement over the Bubble I years...in which Amazon had
no earnings. eBay, meanwhile, has a P/E of 65...and Yahoo
trades at 69.

The S&P 500 sports a P/E of 30 times reported earnings.
Based on core earnings - which are closer to the truth -
these stocks sell at nearly 40 times earnings.

Stock buyers may be bullish on America...and bullish on its
military...but not necessarily bullish on its currency or
its stocks.

The number of equity funds fell in February for the first
time since Bubble I began in '96. In '97 there were 3000
stock funds. Today, there are 4750, and falling. In the
last major bear market, the number of funds fell for a
period of 9 years...so that there were fewer in '81 than
there had been in '70.

We are in the 4th year of a bear market. Stocks are lower
today than they were when the year began. Even with the war
behind us...Mr. Market seems to see little reason to change
course...

Eric, who is closer to Mr. Market, has more details...

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Eric Fry, reporting from Wall Street...

- Mr. Market is AWOL! For weeks, he had been bravely
charging ahead, shoulder-to-shoulder with the advancing
coalition forces. But last week, as coalition troops
stormed the Iraqi capital, Mr. Market turned tail and ran.
The Dow Industrials retreated 73 points for the week to
8,203, and the Nasdaq pulled back 1.8% to 1,358. Evidently,
Mr. Market encountered a far more terrifying foe than the
Republican Guard: a toothless American economy...Dodging
rocket-propelled grenades is nothing compared to ducking a
weekly barrage of initial jobless claims.

-"For weeks, perhaps even months, the market has been
hostage to the war - first in fearful anticipation, then
with its actual onset and breathtakingly swift resolution,
pure elation," remarks Barron's Alan Abelson."But no
sooner was it manifestly clear that the good guys had
emerged victorious and Saddam Hussein was history than the
celebration came to an abrupt end and the war, together
with its attendant triumphs and looming consequences, was
no longer front and center in investor consciousness."

- The Iraqi V-Day inspired no euphoric stock market
response. Perhaps that's because when the stock market
"Johnny" comes marching home again, he will not find his
sweetheart economy awaiting him with open arms. Instead, he
will find her conducting a ménage-à-trois with rising
unemployment and falling corporate profits.

-"In the past two months, employment has dropped by
465,000, in the past two years by nearly 2.5 million,"
Abelson observes."And the stubborn refusal of weekly new
claims for unemployment insurance to slip below 400,000
betokens an extension of this doleful trend this month and
gosh knows for how months to come."

- Making matters worse, says Dan Denning, the
"Europeanization" of the U.S. labor market will inhibit job
growth for years to come."Healthcare and pension
contributions, in particular, are making it more expensive
for the average American business to hire additional
workers," says Denning."The American labor market is
increasingly European, both in generalities and in
particulars. Generally, political pressure to provide
better healthcare and benefits is raising real employment
costs, making it harder for business to expand."

- And so, they are not expanding; they are cutting - both
workers and workspaces. The U.S. office vacancy rate jumped
to 16.2% in the first quarter - the ninth straight quarter
of rising vacancies and declining rents."One worrisome
sign," says the Journal,"was the return of so-called
negative absorption - a drop in demand for office space. In
previous real-estate cycles, demand always grew at least
slightly, even if vacancy rates soared because of
overbuilding. Tenant demand slipped 1.2% in the quarter in
the nation's top 50 markets, according to Reis Inc., a New
York real-estate research firm."

- The economy's other intimate companion, falling corporate
profits, just keeps hanging around. The S&P 500 is trading
for about 16 times forecast 2003 operating earnings. 16
times earnings, while not an obscene valuation, is not
exactly cheap either, especially when one considers that
energy stocks account for ALL of the S&P's anticipated
earnings growth.

-"Earnings for the energy companies in the Standard and
Poor's 500-stock index are expected to nearly triple for
the first quarter, far higher than the aggregate 7.2% rise
expected for companies in the broad index," observes the
Wall Street Journal's Ken Brown."Without [the contribution
from energy stocks], earnings for the index would be down
7.1% for the first quarter."

- Surprisingly, as we have pointed out previously in this
column, most energy stocks have been trailing behind the
S&P 500. Clearly, incredulity is priced into the energy
markets. Based on the uninspiring price trend of most
energy stocks, investors expect energy prices to fall...a
lot! Who knows, a little faith in rising energy prices may
be a rewarding bet.

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

Bill Bonner, back in Rome...

***"The Pension Chasm" is how the Washington Post
describes it. It is the deep crevice between what the
retirement people hope to have in retirement and what they
can actually afford.

"Within the next few weeks, many thousands of Britons are
going to receive the shocking news - in their annual
pension forecast - that the amount they can look forward to
when they retire will be up to 75 per cent less than they
expected," reports my old friend Martin Spring, from
England.

But what is true in the old country may be even truer in
the new one. Martin continues:

"In America, the pension, healthcare and insurance expenses
of former employees who have already retired account for
almost $900 of the cost of every vehicle sold by General
Motors. The $70 billion deficit in its employee benefit
funds threatens to swallow up its entire cash flow surplus
over the next few years, leaving nothing for shareholders."

*** We keep saying...but now cannot remember why...that the
glory days of American capitalism are over. The system no
longer rewards the capitalists - it is the proletariat,
their lawyers...their politicians...and the lumpen-voters
that benefit.

*** Looking out from our balcony this morning, in the
bright sun of an Italian spring, we count at least 16
churches. And there, off to the left, is a huge monument to
Victor Emmanuel II. Nobody seems to know what happened to
Victor Emmanuel I, for there is scarcely any mention of him
in the history books and not even a small monument. Behind
the grandiose edifice for the second Victor Emmanuel are
the ruins of the Forum...and the Coliseum up the hill.

*** On Saturday, we went to visit Hadrian's villa at
Tivoli. The place, of course, is in ruins. Edward, enjoying
the open air, jumped over 2000-year-old walls...explored
subterranean passages...ran around in what used to be
communal baths...

In his exuberance, he ran into a Doric column. And for a
moment, we feared Edward had done what the Goths and
Alamani and other barbarian tribes had done before him -
left the place in even greater ruin than he found it. But
the column held...

We are here wallowing in Roman history, bumping into
columns, tripping over statues, knocking against the bones
of an empire that once controlled almost all of Europe and
the Mediterranean basin...and after which almost all
Western governments have been fashioned. Senates,
parliaments, constitutions...lobbyists...demagogues...if
Rome did not invent them, she made them famous. And even
the monuments you find along the Potomac or the Thames are
little more than recreations of those here in Rome. Down
the hill from our apartment is a pillar commemorating
Trajan's victory over the Dacians. Except for the detailed
history in bas-relief on the column itself, the pile looks
almost exactly like the monument to George Washington
erected in front of our office in Baltimore at the end of
the 18th century. We would have to study the face more
carefully to be sure it's not the same person.

*** Yesterday was Palm Sunday, recalling Jesus' triumphal
entry into Jerusalem. He was greeted with hosannas, say the
gospels, and with the ancient world's equivalent of red
carpet; the crowd spread palm leaves on the ground for him
to walk on. We marked the occasion with a mass at the
Chiesa del Gesu, a spectacular church built for St.
Ignatius Loyola. We arrived early, fearing that the huge
house of worship would be mobbed by Catholics on one of
their most holy days. Instead, there were almost as many
priests as worshippers.

The church is stunning. Somehow it seems to have escaped
the impulse of the '70s and '80s that led Catholics to
strip their churches of adornments. Hardly a square inch of
the interior is free from gold leaf...statues...paintings.
There is even a statue of St. Ignatius Loyola so
extravagantly decorated in azure stone and polished silver
that it is worthy of Louis XIV. The ceiling is painted in
the marvelously voluptuous Italian fashion - with angels
and archangels and enough rosy flesh to give you a crick in
your neck by the end of the service.

The Daily Reckoning PRESENTS: Ominously for boomers
approaching retirement,"the best businesses of an entire
generation aren't producing long-term wealth," says Porter
Stansberry."Instead, they're merely producing compensation
and consumption..."


GENERATION DEBT BOMB
By Porter Stansberry

"Civilization and profits go hand in hand."

- Calvin Coolidge


Somebody should make a movie about the life and times of
David Wittig.

Just nine years after graduating from Kansas with a degree
in economics, Wittig made the cover of Fortune magazine
(November 24, 1986). He was the hero of an article entitled
"Wall Street's Overpaid Young Stars". At only 31, Wittig
was already making $500,000 a year at Kidder Peabody.

There Wittig sat, on the cover of Fortune, cigar in hand,
making sure you and everyone else knew just how rich he
was. I wonder if his mother was proud...or embarrassed.

But as with the market, so with market players: what goes
up usually comes down.

After attaining"master of the universe" status as a junk
bond trader at Kidder Peabody - a firm that imploded
because of the ethical lapses of its top traders - Wittig
moved on to Salomon Brothers. The questionable ethos of
Saloman at the time was documented aptly by Michael Lewis's
book"Liar's Poker". I can summarize the theme for you -
steal as much as you can from each of your clients and brag
about it to all of your friends.

What was the encore to this fine Wall Street career?

In 1995, John Hayes, CEO of Western Resources (now Westar
Energy), Kansas's largest utility, wanted to juice things
up and move his firm into the new"unregulated" field of
power trading and services. He hired Wittig away from
Salomon to be the head of corporate strategy.

Soon, Wittig had Western Resources embroiled in several
high-profile, Wall Street-esqe takeover battles. One such
skirmish was for Kansas City Power & Light; another was
over ADT, a security firm being pursued by the acquisitive
Tyco.

In the end, Tyco agreed to fork over $800 million for
Western's shares of ADT. And on the strength this one lucky
deal, Wittig ascended into the corner office at Westar
Energy.

As CEO, Wittig turned out to be a one-trick pony. He bought
another security firm, Protection One - but this time there
was no Tyco waiting in the wings. The acquisition has cost
$2 billion in losses and prompted an SEC investigation.
Meanwhile, Wittig was paid millions in salary and benefits.
And it's alleged he took a little more than the board was
paying, too. Wittig was indicted on money laundering
charges after he"falsely borrowed" $1.5 million. (N.B. To
most of us,"falsely borrowing" means stealing.)

Wittig embraced all of the bad financial ideas of his
generation - from junk bonds to highly leveraged takeovers.
He found a way to make himself rich...but only at a steep
price to his partners.

Wittig's generation embraced a lot of bad ideas. I'd
include drugs, disco, free love, affirmative action and
conspicuous consumption for starters. But the worst ideas
of this generation relate to financial management...or the
lack of it. No other generation of Americans has ever been
so in debt. No other generation of Americans has ever made
so much...with so little to show for it.

The press calls this generation of Americans the"Baby
Boomers". I call this group, born largely in the 1950s,
"Generation Debt".

Private and corporate debts (owed mostly by Baby Boomers
and the companies they now control) are the single largest
threat to America's prosperity, thanks to America's
companies' buy-now-pay-later approach to life. As the
boomers have come to power since the late 1970s, American
corporations, in the aggregate, have suffered negative cash
flows. Profits have not equaled capital expenditures in any
year for the last 25 years. Even the very best American
corporations have become addicted to debt. GE, for example,
has been a net borrower since 1992.

Individually, meanwhile, Americans have leveraged their
home mortgages to a degree unprecedented in our national
experience. Lawrence Capital Management details the
phenomena by noting that 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 as much. Household borrowings now
total $8.2 trillion in America, and they continue to grow
at near double-digit rates.

Total non-financial debt (public and private) now stands at
$20.3 trillion, nearly triple annual GDP. Interest on our
debts alone now tallies 7% of GDP.

These numbers mean little in the abstract. But consider the
typical member of generation debt - your neighborhood's own
small-town David Wittig. Your neighbor, corrupted by the
same zeitgeist, spends more than half his income on debt
service and taxes. His total savings - on average - tally
around $40,000, including savings earmarked for retirement.
When something goes wrong - say your neighborhood's version
of Enron or Long Term Capital Management - your
neighborhood generation debtor doesn't have any financial
safety net. Over 400,000 Americans went bankrupt in the
third quarter last year, the most ever for one quarterly
period.

In their teenage years, members of Generation Debt brought
us"flower power" and Woodstock. As they grew older, their
ideas of sexual freedom and promiscuity led to the AIDS
epidemic we face today. In the 1970s, they embraced drugs
and disco. In the 1980s, they discovered money and began a
consumption binge like none ever seen before. In the 1990s,
this generation elected the Clintons to the White House...

But the worst damage wrought by the Baby Boomers comes from
their work in the boardroom and their ideas about business.
These people believe that profits are bad.

Last month, I was searching for a stock to recommend to the
readers of my newsletter. I almost couldn't find one. There
are lots of good companies - even in the tech sector - but
almost none of them are run with the goal of producing a
real profit for shareholders.

Consider Adobe Systems, a leading software firm. Sales are
rebounding. Earnings are up. But profits available to
shareholders have all but disappeared. In the last five
years, net income has grown from $105.1 million to over
$191 million. Sounds great, doesn't it? And it would be,
except stock-based compensation in the same period grew
from $50 million year to over $184 million a year. Taking
into account options expenses, net income shrank from $54
million to only $6 million. Adobe, a firm valued by Wall
Street at $7 billion, can only produce $6 million in
genuine net income. Bruce Chizen, Adobe's CEO, was born in
1956. Generation Debt.

Steve Jobs - the picture-child of baby boomers - is another
example. Apple Computer, the company he founded and still
runs, lost $25 million in 2001. It paid out $371 million in
stock-based compensation that year. In 2002, results were
better: the company made $65 million. But results for
shareholders were just as bad, as Apple spent $229 million
on stock-based compensation. Fittingly, Al Gore is now on
the board of directors at Apple. Jobs gave him 30,000
shares. And why not? He invented the Internet, so he must
know a lot about the computer business...right?

The worst options accounting abuse, however, goes on at
Yahoo! It's a shame, because this company has a great brand
and the potential to become the first important media
company of the Internet. Last year Yahoo! had a net income
of $42 million. But it spent more than ten times that
amount on stock-based compensation: $482 million. The year
before, $890 million was given to employees at
shareholders' expense. And the year before that, $1.3
billion in stock was doled out. Since 1998, Yahoo! has lost
over $3 billion on operations - when you include stock-
based compensation. Officially, the company reports earning
$55 million in the period.

There are many other examples I could cite...but the all
point to the same conclusion: the best businesses of an
entire generation aren't producing long-term wealth.
Instead, they're merely producing compensation and
consumption.

Baby Boomers are approaching retirement with nothing in
their saving accounts. Their equity portfolios have been
demolished, and their pension funds are wiped out. But the
most dangerous sign of all is that even now, the companies
headed by their contemporaries can't produce real profits
or real dividends for shareholders.

Without a revolution in the boardroom, the baby boomers
will never retire. There simply aren't any profits where
there should be in the companies created by this generation
in the 1980s and 1990s. Meanwhile, old-line blue-chip firms
with good earnings and sensible accounting policies are
crippled by the pension obligations they currently owe to
an older generation.

The baby boomers are heading into retirement with no
savings and no productive companies to support them in old
age. Generation debt is a ticking time bomb...with about
ten years left on the clock.


Regards,

Porter Stansberry,
for the Daily Reckoning