The Debt Generation / The Daily Reckoning

verfasst von - ELLI -, 26.11.2002, 21:24

-->The Debt Generation

The Daily Reckoning

Paris, France

Tuesday, 26 November 2002

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*** Thanksgiving coming...how about the end of the rally?

*** Investors chasing the most speculative stocks...could
this tech rally be for real?

*** Doing the right thing; not necessarily the smart
thing...young models in New York...and more...

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We checked our calendar. Thursday is clearly indicated as
Thanksgiving. (Alas, here in the Paris office, we will be
at our posts, unable to tuck into our turkey and
cranberry-sauce substitute until the weekend, when the
children are out of school.)

And there, on December 7th is 'Pearl Harbor Day,' and so
on.

But even peeking ahead to the calendar for 2003, darned
if we can find a date marked"End of the Wall Street
Rally." It just isn't there.

Investor's Intelligence tells us that the professionals
are encouraged. Seeing no end in sight of the bear market
rally, twice as many advisors are bullish as bearish. And
evidence mounts that ordinary investors are getting back
into stocks, for the long run, of course.

What a pity if the end of the rally comes unannounced,
unscheduled, and unexpected!

Poor Alan Greenspan. The former gold bug libertarian
turned his back on his old friends and went over to the
other side, becoming not merely a central planner, but
THE central planner for the entire world economy and THE
manager of the world's most important managed currency.
He must be getting lonely...and a little desperate. He's
cut rates a dozen times. But where is the"Strong
Recovery" economists have been predicting for the last 18
months?

How he must suffer...as day by day his reputation wears
down a bit more. And he still has 2 more years until
retirement. Check the calendar; will the rate cuts have
restored the economy by then?

Yesterday's news brought more confusing and conflicting
data. Houses are selling better than expected...with
average increases of about 10% year to year - more than 4
times the inflation rate!

On the other hand, bankruptcies hit a record high in the
third quarter. Personal debt passed the $8 trillion mark.
And the number of foreclosures is rising about 3 times as
fast as the inflation rate.

"Sometimes these companies throw the American dream in
your face," the NY Times quoted a homeowner in
Indianapolis whose appraisal was just reduced $20,000.
"You get a fast-talking lender. I can see why normally
level-headed people get sucked in."

Conseco is said to have 19,000 repossessed mobile homes
it would like to get rid of. And the NY Times reporter
found boarded up homes in many areas of Indianapolis.

Meanwhile, the National Association of Realtors estimates
that baby boomers will buy 1 million 2nd homes in the
next 10 years...and more than a few third homes, too. If
only they would buy their second homes in Indianapolis.
Or maybe a double-wide from Conseco.

But let's hear from Eric on the progress of this
wonderful bear trap...oops, we mean, bear market rally...

----------

Eric Fry in New York City...

- The"retro" market keeps powering ahead. Like a real-
time flashback to the bubble era, stocks seem to rise
every day, especially tech stocks...and speculative tech
stocks are rising most of all. Yesterday, the Dow picked
up 44 points to 8,849, while the Nasdaq gained nearly 1%
to 1482.

- It's hard to believe, but in less than two months,
investor psychology has shifted dramatically from fear to
greed. In early October, the bear market seemed to be a
permanent feature of the financial landscape, and no one
scoffed at projections of Dow 5,000. Now, however, the
angst of early October is a distant memory and optimism
is once again in full-bloom. In fact, some corners of the
stock market feel downright frothy.

- My friend, Michael Martin, a broker with R.F. Lafferty,
walked into my office yesterday with a piece of paper in
his hand and said,"Look at this!...Almost all of the
most active stocks on the NASDAQ are selling for less
than $10 a share...Buyers are going after the cheap
stuff, the speculative stuff."

- I looked at the list and, sure enough, a highly
speculative collection of bubble-euro flameouts topped
the list of most active issues. Names like JDS Uniphase,
Brocade, Ciena, Juniper Networks and Vitesse
Semiconductor headed up the list of most active issues,
as investors threw caution to the wind in hopes of making
a big score quickly. The great thing about lowly priced,
highly speculative stocks is that they can cover a lot of
ground in a hurry - both to the upside and to the
downside. But for now, it's all upside, and the"dumb
money" has never felt more brilliant.

- Yessiree, the speculative juices are flowing on Wall
Street once again, which tells us that this bear market
rally is probably just about over.

-"I know, I know, tech is rallying," writes Karim
Rahemtulla, the mind behind the Forward Profit Strategy
trading service."But is the tech rally real? Sure, tech
stocks are going up. But, are the shares worth the price
they are selling for? That's really the question that you
should be asking. And when you ask, here's the answer
you'll get. NO!

-"I don't buy into this rally because it has absolutely
no fundamental basis," Karim continues."It is a 'wish'
rally, and I am going to bet the wish will not come
true."

-"All this time, we thought that Ebitda stood for
earnings before interest, taxes, depreciation and
amortization," Alan Abelson jokes in this week's
Barron's."Comes now an old friend to inform us that all
these years we were wrong. What Ebitda really stands for,
he contends, is earnings before investigation,
termination, deposition and arrest."...Now we know.

- We'll end on a sad note: Citing"difficult business
challenges," America Online is canceling holiday parties
for its 18,000 employees. Apparently life inside the
former dot.com darling is not as festive as it used to
be. How ironic. AOL was one of the most visible party-
animals during that raucous two-year romp known as the
"dot.com bubble." Oh well, you can't party like a 21-
year-old forever. Instead of an"elaborate holiday
party," division head Jonathan Miller said that AOL will
offer some rather sober-sounding"special employee
socials." Hey, that sounds like a pretty wild
time!...Will there be a quilting bee?

-----------

Back in Paris...

*** Stocks continue to rise. Gold goes nowhere. Which
would you rather own? Most investors will take the
stocks. Heck, they're already up more than 20% since the
bottom.

But here at the Daily Reckoning...and here we warn new
readers...we try not to care too much about money. Like
laying bricks or courting women, it's best not to pay too
much attention. Otherwise, you're likely to make a mess
of it.

We aim to do the right thing, not necessarily the smart
thing. With no calendar indicating important future tops
and bottoms, all we can do is to follow the essential
principles. We don't know what the smart thing is; so we
do the right thing and hope it pays off. If it doesn't,
well...it ought to.

So we buy gold and sell stocks. Because the right thing
for an investor to do is always to buy low and sell high.
Stocks are high. Gold, by comparison, is low. And if gold
goes nowhere...well, nowhere is okay with us.

Most often and eventually, we have observed, things go
back to where they usually are. At the end of the Carter
Administration, an ounce of gold traded for about the
same price as the entire list of Dow stocks. That was an
aberration, to be sure. But no more of an aberration than
what happened at the end of the Clinton years - when it
took 38 ounces of gold to by the Dow. Currently, an ounce
of gold will buy only 1/28th of the Dow...with probably a
lot further to go before things have reached normal.

*** Paris was especially beautiful last night. The big
department store, Samaritaine, was lit up in pink for
Christmas. Trees and lights of the holiday season have
begun to appear. And everywhere, the wet streets bent the
light back up towards us, skewed by decaying leaves and
cobblestones.

Maria, 16, took her father's arm as the two of us walked
down the Rue Jacob.

"Daddy, my agent says I should relocate to New York. He
says that this is my big chance...

"Uh huh..."

"Models don't get many chances. You have to take it when
you have it. I'm a little young, I know, but Véronique
told me too that this is the perfect time. I've made the
rounds in New York already. They're starting to know me.
I have to be there when they ask for me."

"Uh huh..."

"I don't really want to leave home, though...It just
feels like all of a sudden I can't be a little girl
anymore. That makes me a little sad...like I won't be
part of the family anymore, except on holidays..."

"Uh huh..."

"But a lot of the girls are like that, even those who are
younger than me: I know a couple who are only 15. They're
from Russia, I think. They've been on their own for more
than a year. They only see their families once a year.
And their parents can't afford to come visit them.

"Still, they seem to do okay. I mean, they seem happy...

"One of them got to be really successful. She made a lot
of money, got a nice apartment and sent her mother a
ticket to come to visit her...

"But most of them just sort of get by...it's kind of
sad..."

Later that evening, after dinner, Elizabeth asked:

"Well, what do you think? Do think Maria is ready to move
to New York...?

"She seems ready..." your editor replied, wondering
whether he was ready.


THE DEBT GENERATION
by Porter Stansberry

Throughout history, even the most important and self-
evident trends are often completely ignored because the
changes they foreshadow are simply unthinkable...

Examples of big, problematic trends that the"elite"
missed are too numerous to list here with any authority.
But consider: did the massive inflation of the 1970s come
without significant warning early in the decade? No one
said much when Nixon untied the dollar from its gold peg
in 1971. There wasn't a huge outcry in the mass media
against his price controls in 1972. And the rapid
escalation of social spending coming from Johnson's"War
on Poverty" went without critical analysis until the mid-
1980s. Why did so few people see clearly what were huge
and obvious warning signs of an enormous inflation?

Not all trends are bad, of course. But many still go
unnoticed. Take the bull market of the 1990s, for
example. The Netscape IPO that launched the mania
occurred in the spring of 1995...five years before the
market's peak. Few people understood what was likely to
happen. In his 1994 book, The Road Ahead, about the
future of computer technologies, Bill Gates, doesn't even
mention the word"Internet."

The biggest trend we see in place right now can easily be
captured in one word: debt. Since 1992, there's been an
ominous shift in debt from the public to the private
sector. Federal borrowing rates have declined, while
private borrowing has grown at a rate never seen before
in America.

In 1992, the government borrowed around $300 billion;
private industry borrowed $200 billion. Since then,
private borrowing has increased every year except 2000
and now tallies over $1 trillion per year. Federal
borrowing, as you know, declined until mid-2000 and was
actually negative for a few years (indicating a Federal
surplus). But, overall net debts - private and Federal
combined - increased during the whole period, moving from
around $500 billion per year in new debt to over $1
trillion per year in net debt addition.

A high rate of debt growth, by itself, is not necessarily
a problem. If these funds are invested wisely, if they
spur new economic opportunities, then, as a percentage of
our national balance sheet, these debts could remain
sanguine. But that's not what has happened. Instead,
since the 1960s, each new dollar of debt has added less
than a dollar to economic growth. This indicates our
economy is suffering from systematic declining returns.
Today, each new dollar of debt adds about $0.54 to
economic growth (that's assuming the U.S. economy is
growing at 2.5% a year - which it may not be).

The vast majority of the debts we added in the 1990s were
used to fuel massive financial speculation in
corporations and home mortgages. As these financial
assets begin to deflate, the debt remains, causing the
debt to loom higher and higher as a percentage of
assets. Total debt, as a percentage of GDP, has grown
from around 150% in 1982 to nearly 300% today.

Unfortunately, not even this high debt load tells the
whole story of our future obligations.

As the bear market has ravaged the stock market, the
assets of U.S. pension funds were annihilated. State and
local pension funds - whose figures are a matter of
public record - have fallen in value from $80 billion in
2000 to $25 billion today...a 70% decline. Although I
don't have complete figures for U.S. corporate pension
funds, those numbers won't look much different from the
state and local government accounts (which often use the
same pension fund managers).

Meanwhile, news of enormous future charges to earnings
based on the mandatory contributions to their sagging
pension funds are filling the pages of the financial
media. For example, SBC announced this week it would take
a $2 billion charge against earnings next year to begin
repairing its pension plan. Raytheon says it must pay
$500 million towards its pension fund over the next two
years. Right now, Wall Street estimates that 10% of the
S&P 500's earnings next year will go towards underfunded
pensions.

There is, of course, an even bigger underfunded pension
plan out there - Social Security. But describing the
future impact of these costs requires more detail than I
can even begin to cover in a few paragraphs.

Suffice it to say, there are two components to private
debts - corporate debts and personal debts. The rise of
personal debt isn't hard to figure out: who doesn't like
to live beyond his means? On the other hand,
understanding why companies have abandoned all fiscal
responsibility isn't that easy.

Corporate managers have leveraged their balance sheets
and used debt to manipulate earnings in order to increase
profits, 'grow' earnings and augment the value of their
stock in the short term. Stock option compensation gives
managers an incentive to take big risks. If the risks
work, the managers receive windfall profits. If they
don't, managers can walk away unscathed.

The worst abusers of shareholder trust aren't hard to
find. Just look at America's biggest and most respected
companies. IBM bought back $9 billion worth of stock
while issuing $20 billion in new debt during Lou
Gerstner's reign as CEO from 1993-2000. Why would you
issue debt that costs you 8-12% in interest when your
stock only pays a 1% dividend? The only reason you'd do
this is to juice earnings in the short term. In the long
term, you're only adding risk and shrinking your future
profit margins.

But what did Lou care? He received 500 million stock
options (all of which he sold when he retired in 2000).
There's no doubt that Lou Gerstner leveraged IBM's
balance sheet to increase its operating margin. That's
not against the law...but it's not the way great
companies are built. It's the way great companies are
devoured. Since Gerstner's departure, IBM also admitted
to booking asset sales as operating revenue - a common
accounting trick to hit earnings forecasts. Selling
assets is also another way to leverage your balance
sheet. Within one year of Lou's retirement, his
replacement had taken huge billion-dollar charges, sold
off major underperforming businesses (hard drives) and
closed non-performing (but long held) businesses like
PCs.

Unbelievably, Gerstner wrote a self-congratulatory book
about his tenure at IBM. It's being published.

Or how about GE, perhaps the most respected company of
all time? Since 1992, GE has been a net borrower. How
could America's best company be a net borrower for ten
years? Well, look at what the company is doing to make
money, and it's easy to figure out.

About 50% of the company's total debt is in the form of
short-term paper - the 90-day commercial paper market it
can access thanks to an AAA rating by Moody's. The
company uses this debt, which carries a low interest
rate, to finance credit cards, which carry a high
interest rate. If you walk into J.C. Penney or Macy's and
take out a credit card, chances are pretty good that
you're on the hook to GE. In total, GE Capital has spent
$43 billion on buying such receivables in the last three
years alone.

And here's the scary part. Fifteen times since 1997, the
company has sold a large batch of these securities (at a
loss?) less than three weeks before the end of a quarter.
That's how the company is able to match its earnings
forecasts so precisely.

Meanwhile, GE's debts have mounted. Today, its balance
sheet stands precariously at four times debt to equity.
Why take such risks? Because these debt-laden
acquisitions accounted for 40% of GE's revenue growth
from 1985 to 2000, according to Merrill Lynch analyst
Jeanne Terrile (who retired immediately after publishing
her study of GE's use of debt).

Again...these are America's best companies. As profit
margins slipped in the '80s and '90s, corporations
leveraged their balance sheets to make profits look
better. More sophisticated companies played more
sophisticated games. And the whole time, fundamentals
continued to deteriorate without any clearly discernible
warning.

Since 1975, capital expenditures have exceeded cash flow,
meaning that corporations have been raising debt or
equity faster than profits. This game catches up to you
as demand slowly declines. Eventually, capacity
utilization rates begin to fall on everything from
computers to credit cards, indicating a broad surplus of
goods and services in our economy. And that's what we see
was slowly happening, starting as early as 1985 and
accelerating with amazing rapidity over the last two
years.

Across the board in our economy, capacity utilization has
fallen from around 85-90% in 1985 to below 75% today,
according to the Board of Governors of the Federal
Reserve System. The data makes sense: areas of our
economy that had the biggest investment boom show the
biggest decline in capacity utilization today. Capacity
utilization in electronics, for example, has declined
from 90% in 1999 to under 65% today.

This rapid decline in capacity utilization is one of the
symptoms of a credit bubble bursting.

A healthy economy is driven by savings-fueled demand.
When savings and investment become badly maladjusted,
there will be problems. If you think of these problems in
the abstract, they're easier to understand. Imagine your
own family's balance sheet. What would happen if you
maxed out every available credit source over the next six
months? Your rate of consumption would soar, you'd place
great demands on the economy and, eventually, your needs
would slowly decline. You'd be left with few wants...and
a lot of debts. You'd stop buying anything for a long
time, until you were able to repair your family's balance
sheet.

That's essentially what has gone on in America over the
last ten years. The savings rate here declined from
around 5% (which is weak) all the way to a negative
figure in the late 1990s. People were spending more than
they made each year, mostly by tapping into home equity
loans. Now we've reached the point were most people (and
most corporations) are close to tapped out.

The amount of money people have borrowed against the
value of their homes is unprecedented. Since 1992,
quarterly adds to home mortgage debt have increased from
around $200 billion per quarter in 1992 to over $600
billion in the most recent quarter. This is an amazing
amount of debt...

Take a look at the data we have on consumer credit, which
includes auto leases and home equity loans. Back in 1992,
consumer credit as a percentage of disposable personal
income stood close to 16%. Today it's over 25%. And that
means an overwhelming majority of people's income today
is going towards taxes, interest and paying down debts.

Future demand is going to be weak...and could be for a
surprisingly long time.


Regards,

Porter Stansberry,
For the Daily Reckoning

P.S. 0n March 20, 2001, in response to the third Federal
Reserve rate cut of that year, I wrote a piece called
"Where Do Stocks Go From Here". Some analysts were
putting out research showing that in the past, after
three Federal Reserve rate cuts, stocks had always gone
up. But that's not what I concluded was likely to happen
this time around.

"The last time stocks were this overvalued," I wrote,
"and our economy was leveraged to this degree was the
Great Depression. The third rate cut by the Fed (in
February 1930) didn't do anything to halt the collapsing
stock market. Stocks fell another 41%. I continue to
recommend that you own high quality, short-maturity
corporate bonds. That's where 91% of my assets sit today.

"When bonds yield more than 1.5 times stocks' earnings
growth, bonds outperform stocks by more than 5% on
average...The most important thing for you to do is to
realize that the size and duration of this recession is
probably going to be bigger and longer than most people
think."

Eighteen months and NINE rate cutes later, the Prudential
Short Term Corporate Bond Fund (to use one example) has
gone from $11.16 to $11.34 while the S&P 500 has fallen
from 1160 to a low of 779. Today it trades at 932, a loss
of 20%.

Editor's note: Porter Stansberry is the founder of Pirate
Investor, publishers of high-quality investment research.

Thread gesperrt

 

gesamter Thread:

• The Debt Generation / The Daily Reckoning - - ELLI -, 26.11.2002, 21:24
  • Re: Danke fürs Reinstellen!! (owT) - So geht das mit Doppelnamen:-) Luigi, 26.11.2002, 21:32
  • Re: kenn ich schon lange diesen newsletter, ideal für super-long-shorties - Sterntaler, 27.11.2002, 10:55