-->Fat Cats / The Daily Reckoning
Ouzilly, France
Tuesday, 12 August 2003
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*** Sunrise, sunset... the way of the world
*** Bond market battered again... do the math on natural
gas...
*** Inflation or deflation? Yes! The Algerian War and other
lost causes...
Sunrise begets sunset.
Stability begets instability.
Birth begets death.
Boom begets bust.
Information begets ignorance.
Inflation begets deflation.
Longtime Daily Reckoning sufferers will recall that we have
our own philosophy. Essentialism, we call it.
It came to us neither as the result of logical inducement
nor sober reflection. Nor was it revealed to us as a divine
truth. Instead, we just took it up as a man takes up with a
pretty woman; we thought we might have some fun with it.
But now we find ourselves married to her - and happier for
it. After a few years, we find her as attractive as before,
and more serviceable than ever. She guides our steps and
keeps us from making a fool of ourselves.
Essentialism begins with the same insight as existentialism
- that the world is so complex and so full of baroque
exuberance that we will never be able to 'know' or
'understand' it fully.
But no sooner have we shaken hands with the existentialists
than we part company. We leave them to their folly. For the
poor bumblers then go forth, believing that even though
they can't understand how the world works they can
nevertheless figure out how to make it work better! Thus do
they want to control interest rates... economic
growth... foreign governments... ingestibles... you name it.
And thus do they throw away their dignity... and generally
make a mess of things.
In the '50s and '60s it was all very hip to be an
existentialist. It was avant garde.
But now almost everyone is an existentialist and almost
every one of them seems like a pathetic boob.
We essentialists may be pathetic too, but we hope to
maintain our dignity by observing the world rather than
sweating to improve it. We content ourselves to try to
fathom the essential principles, rules, and laws that keep
the old ball turning.
'You can't get something for nothing,' is a common example.
We were too late on the scene to claim we coined the
phrase, but when we found it we didn't waste a minute
putting it in our pocket, along with the other loose change
of the essentialist's fortune.
'Love thy neighbor,' is in there. So is 'the borrower is
slave to the lender.'
This last essential verity has been recently overlooked -
along with most of the rest. But it came to mind after a
news report explained that China had warned U.S. Treasury
Secretary John Snow to lay off criticism of China's policy
of pegging its currency to the dollar. Keep it up, said the
Chinese, and we'll stop lending you money by investing in
your damned bonds.
We're sure Snow must have shot back with something like:
'Oh yeah... well, we'll just stop buying your cheap crap... '
But Snow's comeback must have had a tinny sound to it, like
a bankrupt who threatens to take his bank business down the
street.
China's trade is booming - up at a 33% rate in the first 7
months of the year. The average Chinaman still lives in a
hovel, but it is a better hovel. They're building luxury
apartments in Shanghai and selling them as fast as they can
get them up. And foreigners are lining up to learn to speak
Mandarin, hoping to get an early edge on the Next Big
Thing.
Of course, the Chinese will have their own mad booms and
comic bust-ups. But the big boom of the last 200 years has
been in America. The U.S. is the great success story of the
last two centuries. Its thrifty, hard-working people built
the greatest economy the world has ever seen. Now they
enjoy the fruits of their labors; America has become the
land of the freest spenders on earth. And they will
continue to enjoy their good fortune... as long as the
Chinese are willing to lend them money.
Over to you, Eric...
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Eric Fry in Manhattan...
- The blue chips struggled for most of the trading session
yesterday, before clawing their way into the black by the
closing bell. The Dow gained 26 points to 9,217 and the
Nasdaq added 1.1% to 1,661. But the bond market tanked
again, as the 10-year Treasury yield jumped to 4.40%, close
to its one-year highs. In the currency markets, the U.S.
dollar slumped half a percent against the euro to $1.136,
while gold jumped $5.40 to $363.30 an ounce. Inspired by
the ancient currency's sparkling performance yesterday, the
Amex Gold Bugs Index jumped 1.7%.
- As long as bonds are tumbling and gold is rallying,
equity investors will enjoy no serenity whatsoever... and
they might even lose a ton of money. After all, soaring
bond yields and soaring commodity prices are not known to
be the stock market's best friends.
- Nor is gold the only commodity that is kicking up dust
these days. Crude oil and natural gas are both dancing
higher as well. Crude oil traded to almost $33 last week,
the highest price since mid-March. Then yesterday, natural
gas for September delivery jumped nearly 2% to $5.13 per
million British thermal units.
-"Each and every week in these most-unsettled financial
markets is an adventure," remarks the Prudent Bear Fund's
Doug Noland. Looking out over the next few years, we wonder
whether the financial markets will provide a"Disneyland"
sort of adventure or a"Deliverance" sort of adventure. In
other words, will equity investors be squealing with
delight or terror, as their capital takes fright and
disappears?... We'd imagine that both bond investors and
stock investors will find the next few years far more
chilling than thrilling.
-"Elliot Wave Financial Forecast reports a most
interesting observation on the current stock market state
of mind," observes Jay Shartsis, a professional option
trader and friend of your New York editor."If the bear
market were over, advisors would be clinging to the fact
that a 30-day certificate of deposit has returned a solid
3% over the last three years, while the S&P 500 has lost an
average of 11.4% each year. Instead, low yields on CDs and
money market funds are cited as the No.1 reason to invest
in stocks and risky bonds.
-"In other words, at a major bear market bottom,
preservation of capital will be the dominant theme, not
Chinese Internet stocks. In August 1982, the last
generational low for stock prices, interest rates were sky-
high, but few thought that a 20+ year descent for interest
rates was starting along with a gigantic bull market for
stocks. We are probably now at the other side of the curve,
as interest rates have put in a generational low and stocks
are at a high point."
- If past is prologue, today's unsettled financial markets
will provide very fertile soil for commodities and resource
stocks. These hard-asset plays - like buckwheat - tend to
thrive in harsh conditions.
- Natural gas is a particularly promising commodity,
according to John Myers, editor of Outstanding Investments.
"I've been a fan of natural gas even longer than Alan
Greenspan," quips Myers, referring to the Fed Chairman's
recent bullish comments about natural gas."The
supply/demand fundamentals are excellent," Myers continues,
"yet natural gas stocks, as a group, are pretty cheap."
- Yesterday, the Energy Department reported that the
nation's natural gas supplies are only 2.1 trillion cubic
feet, which is a hefty 461 billion cubic feet below the
year-ago level and 234 billion cubic feet below the five-
year average. Exacerbating the supply shortage,"gas output
is expected to drop slightly in the U.S. this year,"
Barron's notes,"following a 4% decline in 2002, and
Canada, the nation's main foreign supplier, won't be able
to punch up exports for several years, until new pipelines
are completed."
-"Do the math," Myers concludes."The U.S. needs about 3
trillion cubic feet of natural gas in storage going into
the winter season, in order to keep a lid on gas prices.
Since we'll be well short of that number this year, rising
gas prices seems like a low-risk bet."
[Ed note: For details on the natural gas and crude oil
supply dilemma in the U.S. - and how it will affect their
prices - see John Myers' special report:
America's Next Crisis
http://www.agora-inc.com/reports/OST/RightOnWealth/ ]
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Bill Bonner, back in Ouzilly...
*** Inflation or deflation? The Fed has been inflating, off
and on, more and less, ever since it came into being... and
especially after the golden handcuffs were taken off in
1971. People grump and grouse when gasoline prices inflate,
but they smile in silence when inflation bubbles out the
prices of their houses or their stocks.
Everything that inflates, deflates too. At least, that is
our essentialist observation. While asset prices have been
going up... consumer price inflation has been falling. In
the last 18 months, the median CPI rate has fallen in half,
from 4% annually to 2%.
We are headed to Tokyo, we have thought, where CPI rates
have been negative for several years and the Bank of Japan
maintains short rates near zero.
But whoa-ho! Both Bloomberg and TheStreet.com think they
have spotted a change in the trend. Now there is talk of
the Fed raising rates, in light of an expanding economy.
There has been a"U-turn in rate expectations," said one
analyst."No one expects a cut any more."
We're not so sure. We don't think Greenspan has the stomach
for it. Besides, sooner or later, the inflation of the last
great credit boom will deflate... no matter what the Fed
does. Either prices will fall, or the dollar will. When?
How? All the gypsy fortune-tellers in the Bronx couldn't
tell you. But we will find out.
***"It reminds me more and more of Algeria," said a friend
who spent two years in the Algerian war, in the early '60s.
"Those years were hell. And a total waste. Of course, the
political situation was very different from your position
in Iraq. Algeria was a part of France. We didn't attack the
country, we were just trying to hold onto it. And we
couldn't believe that we wouldn't win. So the war went on
for 9 years... with 20,000 people killed on our side. God
knows how many were killed on the other side - more than
100,000, I think.
"But from a military point of view, it seems so similar. We
would walk down the street and someone would take a shot at
us... or throw a bomb.
"And you couldn't trust them. In the daylight, they would
pretend to be your friends, but come around at night and
slit your throat.
"You don't know what happened if they took you prisoner. I
saw one of my best friends laid out in the middle of the
street. His throat had been cut... and his body had been
mutilated.
"When you see something like that, you just want to kill
somebody. So, we'd go on the rampage... the officers
couldn't stop us... I don't think they wanted to stop us.
Nobody talks much about it. And even the history books
don't tell the real story. It was horrible.
"And eventually, we just couldn't stand it anymore. If the
population turns against you, and if they're determined to
kick you out... even if they aren't in the majority... you
have to leave. Otherwise, you become as bad as they
are... and you end up having to leave anyway."
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The Daily Reckoning PRESENTS: Excessive salaries for
mediocre performance... sound like any CEO's you know?
FAT CATS
by Lynn Carpenter
In the Railroad Age, the robber barons of business were
fatsos. Diamond Jim Brady weighed over 300 pounds. J.P.
Morgan and cronies were barely sleeker. Fat cats.
Today the barons of the business world call themselves
CEOs. They are slim and fit. But as a class, they'd make
Jesse James look good. Jesse meant to steal and advertised
it truthfully.
You already know about the high-profile crooks - Bernie
Ebbers led away in handcuffs, Ken Lay pretending he didn't
know a thing about Enron. They're only the sharp edge of a
huge problem. Most CEOs are not crooks, but many are
incompetent and misguided about their jobs.
There are two problems we investors suffer at CEOs' hands
today: excessive salaries for mediocre performance... and the
real booby trap, the golden parachute payoffs failing CEOs
get when they leave.
The job of today's CEO, as demanded by boards and
shortsighted shareholders, is to increase stock price. Now.
Every quarter. Period. And they will do what they can to make
the price go up... even if it means burying employee options
in the footnotes, taking serial reorganization charges,
selling off assets, delaying expenses and using pension
funds to pad the bottom line.
But when you look at the important numbers, things look
different. For the S&P 500 companies, sales have risen only
3% on average over the last year... but the companies have
reported a miraculous 19% leap in net profits. That's not
brilliance; it's bookkeeping at its smarmiest.
The return on equity for the S&P 500 looks fairly good at
14% on average. But that's way overstated, too. If profits
had risen only twice as much as revenues - which would be a
feat in itself and much closer to the truth without
accounting gimmicks - the S&P's ROE would be closer to 5!
All in all, the performance is dismal at the business
level, as opposed to the stock-price level. But this hasn't
hurt CEOs much, despite some news here and there of pay cuts
and firings for underperformance.
Burson-Marstellar has done an extensive study of CEO
salaries. Their conclusion: Average total compensation for
a CEO is $16.5 million. Average worth of a CEO to the
company is only $3 million.
Much of this compensation is hard to spot. You have to go
to the proxy statements, which too few people do, to
uncover CEO salaries, bonuses, and stock options and awards.
Even then, other costs like contributions to their
retirement, the retirement formula, perks and severance
benefits may be missing. Especially retirement benefits.
Thanks to Jack Welch, former and famous head of GE, we have
entered the age of shareholder value and CEO as superstar.
Shareholder value, Jack's mantra, translates to 'make the
stock price go up, no matter how you do it.' And boy did
Jack do it.
Adjusted for splits, GE stock went from around $4 a share in
1980 to a high of $60 in 2000. But Jack's accomplishments
are hollow at the core, and that's the reason GE stock is
down 50% from its high today.
While GE supposedly grew its earnings per share at 14.4% a
year over the past 10 years, it did so with a lot of
accounting help and asset shifting. Some of the money that
fattened the bottom line came from the pension fund. Some
came from selling off assets.
Standard and Poors has calculated that if you back out the
extraordinary events, restructuring charges and such, GE
only achieved an 8.1% growth rate over the past 10 years,
not 14%.
And even if it were 14%, famous Jack's charisma sparked the
price. Remember, GE was an industrial conglomerate before
Jack made it an industrial and finance company
conglomerate. As such, it should have been selling for a
P/E ratio of 14-20. It sold for P/Es of 30-50 when Jack was
king.
Investors who bought GE at the top are now paying the price
Jack Welch wrought. That's a done story. But it will repeat
itself hundreds of times over in the next three or four
years, as one company after another reaches the same
impasse GE faced. You can only strip out shareholder value
for so long unless you actually build a better business.
But whether or not they manage to genuinely improve their
companies, CEOs are paid like so many kings. Today, even a
middle-of-the pack CEO makes 475 times as much as his
regular employees, and the top cats are off the charts.
That's an astonishing paycheck for a hired hand.
How did these wild salaries happen? Let me ask you a simple
question. If you hired a window washer and told him to name
his price, anything he wanted, do you think he'd say"eight
bucks an hour"? No sir, you'd have yourself a $50,000
window washer.
Human nature doesn't change as you go up the job ladder.
These days, CEOs are colluding in setting their own
salaries. All the folderol about independent boards and
compensation committees studying competing salaries is so
much sand in the eyes. Among the S&P 500 companies, 75% of
the CEOs also serve as chairmen of the board. Do you really
think the compensation is going to be stingy with the
chairman and CEO? They pack the compensation committee.
But getting fired is an even better deal these days... and
so is retiring.
At E*Trade, former CEO Christos Cotsakos invoked
shareholder fury over his $83,091,000 salary and bonus
package in 2001. The company's earnings were $291 million
in the hole at the time. In 2002, Cotsakos 'forgave' $20
million of his salary as the company continued to slide and
share prices dropped again. Finally, he retired under
strong suggestion, but he didn't go lightly. Cotsakos
walked with an immediate $4 million in severance pay and
another $5.1 million a year retirement. Guaranteed.
Meanwhile, regular employees didn't get guarantees. They
got a lot of E*Trade stock in their 401(k) accounts, which
fell from $30 in 2000 to under $4 earlier this year.
No matter what the next CEO makes, remember that if you buy
E*Trade shares, you will be paying Cotsakos $5 million a
year until he dies. He's only 50.
But the sneakiest deals don't show until the bill comes
due. Delta gave its CEO, Leo Mullin, credit for 25 years of
employment when calculating his retirement plan. He only
worked there for three years. Boeing CEO Philip Condit gets
two years credit for every year he works in his pension
formula. When he goes, his pension will be three times as
much as his base salary for working.
All this is not to say that I'm against hefty salaries
necessarily. Big pay for big performance is the American
way. Even Bill Gates' fortune is fine with me. He took the
risk, put his future on the line and babied and bullied
Microsoft to its market dominance. Without Bill Gates,
Microsoft would be another also-ran company. In his
lifetime, Bill Gates has taken a company from startup to
growth stock to blue-chip growth... and introduced it into
more parts of the world than McDonald's.
Anyone else who can take a company from startup to one of
the world's most important firms in 30 years can name his
price. The rest of you guys... $3 million a year if you're
good. Six if you're really, really good.
Regards,
Lynn Carpenter,
for the Daily Reckoning
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