10-K Season / The Daily Reckoning

verfasst von - Elli -, 23.03.2003, 20:14

-->10-K Season

The Daily Reckoning

Paris, France

Friday, 21 March 2003

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

***"I hate those bastards..." Demonstrators...McDonald's
gets smashed.

*** Dollar up...gold down...stocks up...bonds down - great
news for the economy. A new trend? Or a false one?

*** Freedom in America...oil...jobs...Argentina...and more!

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

"Damn Americans, I hate those bastards..."

Osama bin Laden? Saddam Hussein? Jacques Chirac?

No, Carolyn Parrish, a Canadian member of parliament,
speaking in front of a microphone she thought had been
turned off.

Even America's closest neighbors and dearest friends are
getting a little irritated. Here in Paris, demonstrators
filled the Place de la Concorde. The U.S. Embassy closed. A
plate-glass window was smashed at a McDonald's franchise on
the rue de Rennes.

"Bush is a terrorist!""No blood for oil!" said the signs.

"No War!" said the demonstrators.

Hey, wait a minute. These demonstrators were speaking
English...they're Americans! French television showed
groups of Americans who were protesting the war.

"I'm embarrassed to be an American," said one young woman
to the TV."I'm all for getting rid of Saddam," said an
older man,"but this is not the way to do it."

Isn't it interesting, dear reader, the way people tend to
take up whatever sentiment surrounds them? Americans in
America back the war. Those overseas oppose it, along with
87% of the French population and similar majorities in
other countries.

People believe they come to their opinions by thinking
about things. But what would cause them to think so
differently on one side of the Atlantic from the other?
Opinions do not seem to be derived from independent thought
at all...but from contagious infection...like hoof and
mouth disease or genital herpes. Usually, the absurd
opinions held by masses of people do them no harm. But
occasionally, the infection produces a fever...and they go
a little mad.

Here at the Daily Reckoning, we have no opinion on the war.
We are neither for it nor against it...we merely try to
avoid getting sick...

It is a war for"Iraqi Freedom," says the administration.
Most Americans believe the war has something to do with
protecting their own freedom. Of course, people who x-ray
their grandmothers' shoes are ready to believe anything...

We love freedom too, here at the Daily Reckoning. Not from
an ideological or theoretical point of view, though; we
just don't like anyone telling us what to do.
Which is why we're a little suspicious of changing a
foreign country's government without being asked. Who
knows; it just seems like the kind of good deed that might
not get you a sincere 'thank you'. If you fail, you look
like a foolish meddler. And if you succeed, your neighbors
begin to get nervous or jealous. Maybe what you're doing is
a good thing...still, when you throw your weight around
like that, others are bound to resent it. Even your friends
begin to hope you get taken down a peg.

America's major war aim must be to make the world safer
from terrorism. But after it's over, will the frogs, the
krauts and the canooks - to say nothing of the ruskies or
pakis - cooperate even more to suppress terrorists? Or
mightn't they turn their backs...and say,"damned yanks had
it coming..."

But in the Homeland at least, Americans are sure it's a
heroic war rather than a sordid one...and pretty sure it
marks the end of a long, annoying bear market.

Here in Paris, we're not sure on either point. So, we
content ourselves to guess about the latter and make
disagreeable reflections on the former.

Our guess is that if Saddam goes down hard and fast, the
thud may be enough to bounce U.S. stock prices for
weeks...months...who knows...even years. But what really
will have changed? Oil may be cheaper...but it would have
to fall 50% to get back to January '02 prices - which was
not an especially good time for the U.S. economy. Growth
rates are still below 2%, or near what Stephen Roach calls
"stall speed". Jobs are still disappearing. Corporations
are reluctant to invest...not because of the war, but
because they can't figure out how to make a profit. Without
jobs - and debts at record levels - consumers can't very
well increase spending. They need more money to do so.
Where could they get it? From stocks? Nope. From bonds?
Nope. From their homes - ah ha! They're refinancing their
homes at record rates in order to uphold a standard of
living that they cannot really afford. How will the end of
the war for Iraqi Freedom change things?

We will see...

Over to our man in the Homeland...Eric Fry in New York
City:

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

Eric Fry, checking in from the Big Apple...

- Well, George W. launched his big, beefy, Texas-style
invasion yesterday, and the nation's unemployed colonels
and generals couldn't be happier. Suddenly, no TV news
anchorman dares to go on the air without a couple of
retired military personnel flanking him like a fighter
escort. The TV anchors and their decorated guests take
turns spewing inane speculations about each and every rat-
tat-tat that issues from the night sky over Baghdad. We
hope the war ends soon, so that all these retired stiff-
jaws can return home to Boca and resume boring their wives
and burdening their friends with their tedious opinions.

- Meanwhile, here on Wall Street, we seem to be reaching
the point of diminishing returns...the deployment of 100
Tomahawk cruise missiles yielded fewer than 21 Dow points.
That's less than a quarter of a point per missile! But stay
tuned; tomorrow's bombings may produce a more satisfying
result. Apparently, investors are having difficulty
identifying attractive"targets of opportunity" in the
stock market. The Dow finished the day at 8,287, while the
Nasdaq added half a percent to 1,403.

- The U.S. military's apparent initial success in Iraq
sucked a little more of the"war premium" out of bonds,
gold and oil. The 10-year Treasury note fell about half a
point, pushing the yield up to 4.00% from 3.98% in the
previous session. Gold also slumped, falling $3.90 to
$332.30, while crude oil fell $1.11 to $28.25. Investors'
fleeting fling with caution is yielding to a rekindled
passion for risk.

- Are the retreating prices of oil, gold and many other
commodities creating targets of opportunity in the resource
sector? Selectively, yes, says Greg Weldon, the newly
minted editor of Outstanding Investments and Resource
Trader Alert. In particular, Weldon suspects that the
recent sell-off in the energy sector presents a buying
opportunity - or at least a trading opportunity.

- Weldon is no perma-bull on commodities, however. Last month,
his Resource Trader Alert (RTA) initiated a well-timed bearish
trade on heating oil. As heating oil prices collapsed this
week, Weldon urged RTA members to exit the trade with their
300% gains. RTA also deployed a bearish trade on gold a few
weeks back. But Weldon now sees opportunity on the long side
of several commodity markets and in selected resource stocks.
Specifically, Resource Trader has issued a couple of brand new
trades to capitalize on rallies in crude oil and natural gas.
[Editor's note: For more information, see: Resource Trader
Alert: http://www.agora-inc.com/reports/RTA/ClickHereNow/ ]

- How rugged has the U.S. job market become? Consider the
following anecdote from Grant's Interest Rate Observer:"A
four-line ad for an administrative assistant in the March 2
New York Times said the following: 'Expanding company seeks
smart, self-motivated person. Must have excellent computer
skills, be good with details and have patient, friendly
phone manner. Growth opportunity. Fax resume...'"

- The advertisement, placed by a friend of Grant's,
elicited an overwhelming response. The first fax arrived
early Saturday evening, as the Sunday paper hit the
streets, and as Grant's friend explained,"[the fax]
basically did not stop through Wednesday, and it slowed
down somewhat on Thursday and Friday...I think I fed over
3, 000 pages into the fax machine...and I was just
constantly refilling it. And when it would run out, it
would build up in memory and then it would go for three
hours straight. And I went through two ink cartridges."

- Despite the stunning volume of responses, Grant's friend
said,"I didn't get a bad resume, and most of them had a
nice cover letter...It just dawned on me after reading
these things that, you know, this is the bubble unwinding."

- The job market is awful, no question about it. But at
least the television networks are still hiring unskilled
labor.

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

Back in Paris...

*** What America's supporters, friends, allies, and enemies
all have in common is dollars. Trillions of them. Friends
and foe alike may admire America's military machine...but,
after the war, they may still despise its currency. We can
hardly wait to see what happens...

*** Argentina...! We try to keep an eye on life south of
the Rio Plata...just to get a glimpse of what it might be
like in the U.S. when the dollar finally gets marked down
to where it belongs. Last year, the Argentine peso fell 70%
against the dollar. The economy dropped 10.9% - the"worst
performance in a century", said press reports. Sixty
percent of the population now lives in poverty - with
former government employees picking through trash bins to
try to find something to eat.

Buy gold.

***"Freedom" is the word that people use to describe what
America means to them. Freedom was the reason often given
by immigrants. Freedom was what the Bill of Rights and the
Constitution were meant to protect...and what elected and
appointed officials pledge to honor. It is also the word
now used to explain America's war against Iraq.

More than a year ago, we began wondering about freedom and
America. Are today's freedom fighters in the Bush
administration really pursuing the cause of freedom? Or are
they more like the Christian crusaders of the Middle Ages -
- killing Moors in the name of the Prince of Peace? Has
freedom itself become a sort of religious relic in America
- worshipped, rather than used in daily life?

These cogitations led to a book - The Idea of America - a
collection of writings on the subject. Back from the
printer this week, the book is sure to be a classic...or a
complete dud. Before that happens, however, we will give
you a chance to buy a copy. Watch this space.


The Daily Reckoning PRESENTS: As war with Iraq fills the
headlines, America's public companies are getting ready to
show investors what they've been up to all year. But as our
own Eric Fry points out, it's unlikely to be pleasant:
"Many corporate pension plans are racking up titanic
liabilities," making"even the varnished truth...unsightly
to investors..."


10-K SEASON
By Eric J. Fry

"10-K Season" has arrived on Wall Street...and this year's
10-K season promises to be more exciting than ever! This is
the time of year when most of America's largest public
companies release their 10-Ks, also known as annual
reports. Lending drama to the 2002 vintage of 10-Ks is the
fact that pension plan liabilities are skyrocketing to
become a very serious problem for many companies...and the
annual 10-K filing is the only public document in which
companies must fess up to these ugly truths.

Several well-known corporations, like General Electric and
Berkshire Hathaway, have already dispatched their 10-Ks.
But many more of these revealing annual filings are yet to
emerge. Traditionally, many of the most disturbing K's
arrive on, or immediately prior, to March 31st, the final
due date. While there is no automatic connection between
corporate shenanigans and a late-arriving 10-K, it's true
that"cooking the books" requires more time and creativity
than merely reporting the unvarnished truth.

This year, however, even the varnished truth may be
unsightly to investors. That's because many corporate
pension plans are racking up titanic liabilities.

Normally, pension plan health doesn't change very
materially over a 12-month span. But 2002 wasn't"normal" -
the stock market tumbled and health care costs soared,
which means that many pensions suffered a wicked double-
whammy.

Ron Ryan, president of a New York-based pension plan
consultancy, calls 2002"the worst year in pension
history". His firm, Ryan Labs Inc., estimates pension
assets dropped 11%, as pension liabilities soared 19%.
GE, as a case in point, divulged in its latest 10-K that
its pension plan's surplus declined a whopping $10 billion
last year. The industrial giant's surplus shriveled from
$14.5 billion at the end of 2001 to a mere $4.5 billion on
Dec. 31, 2002.

Thanks to the long-running bull market of the 1990s, GE
hasn't made contributions to its pension plan since 1987.
The company optimistically states that no future
contributions will be needed, as long as expected rates of
return are achieved. But that's a significant caveat. GE's
management expects its pension plan's investments to earn
about 8.5% per year.

We are skeptical. And so is Warren Buffett, who recently
cautioned companies to lower their annual pension income
estimates to 6.5%, as he did with his Berkshire Hathaway
Inc. Not surprisingly, his cautions have largely been
ignored.

Another fly in the ointment is that, even if GE achieves
its unrealistic investment-return bogey of 8.5%, health-
care costs are soaring out of control. That's a
particularly acute problem for a company like GE, where
nearly three quarters of pension plan participants are
retired personnel and therefore, more likely to require
medical care than current employees.

The bad news for corporate America, and by extension, the
stock market, is that GE's pension plan is fairly typical
of established U.S. companies in that the lion's share of
the plan's participants are retired, which makes any
retroactive benefit reduction nearly impossible. In other
words, there's no easy way to get rid of these nasty
liabilities! Net-net, GE may find itself functionally
working for its pensioners rather than its shareholders.

The good news is that GE's pension plan remains in
surplus...for now. Many other companies are not so
fortunate.

Apogee Research (a company from which I draw a paycheck)
has been prospecting for short-sale candidates among the
companies with large, and growing, pension liabilities.
Late last year, for example, Apogee identified a
metasticizing liability on the books of Deere Corp. The
tractor company's pension liabilities had soared more than
70%, from $3.2 billion to $5.5 billion."Put another way,"
said Apogee,"$5.5 billion is equivalent to almost 10 times
Deere's estimated earnings for all of 2003."

More recently, the gang at Apogee has been sniffing around
the financial statements of a few other American companies.
In fact, Apogee's latest short-sale recommendation is a
well-known American company that's saddled with a
spectacular $76 billion liability - a number four times
larger than the company's market capitalization! In other
words, every dollar an investor spends buying the stock
also buys about $4 worth of pension liability. Most folks
would not knowingly make such an investment, if they
thought about it in those terms.

It's true, of course, that pension plan liabilities are
"soft liabilities": they are based upon unknowable, long-
term assumptions, like rates of return on investment,
future benefit costs and discount rates. Even so, these
"soft liabilities" can create some very hard costs in the
here and now - costs that can take a huge bit out of the
shareholder's equity.

Deere, for example, reduced its shareholder equity by $1
billion to account for its pension losses in 2002. That
represents a sizeable hit to the company's $3.26 billion
book value. In and of itself, a large pension plan
liability does not make a given stock a great short-sale
candidate. But since massive pension liabilities can create
a substantial headwind to profitability, stocks like these
are likely good ones to avoid.

Unfortunately, an investor has to do some serious digging
to uncover the facts about a company's pension liability.
GE, for example, buried its pension plan disclosures in the
footnotes of its recent 10-K filing.

Furthermore, Financial Accounting Standards Board (FASB)
accounting rules help to obscure the truth. The full
magnitude of pension fund losses hasn't shown up on many
corporate financial statements, because FASB rules allow
companies to allocate estimated pension investment gains to
net income, rather than actual investment losses.

"Companies in the Standard & Poor's 500 Index lost more
than $200 billion in the past two years in pension
investments without clearly disclosing those losses in SEC
filings," Bloomberg News reports."12 companies, including
General Motors Corp. and International Business Machines
Corp., said they had reduced shareholder equity by $40
billion to account for pension deficits." This too, is real
money!

"IBM, for example, using an estimated rate of 10 percent,
reported assumed pension gains totaling $12.2 billion for
2000 and 2001 in its SEC filings, following FASB rules,"
Bloomberg continues."IBM's annual reports showed in
footnotes that the world's largest computer maker actually
lost $2.8 billion in its pension fund for those two years -
a disparity of $15 billion. On Dec. 31, IBM said it put
$3.95 billion in cash and stock into its U.S. pension fund
to make it fully funded."

Don't blame IBM; it's legal!

CFOs become addicted to booking illusory pension"gains" as
profits, says Ron Ryan, even when their plans produced
losses."Some [people] get addicted to heroin and cocaine.
They got addicted to pension earnings."

A prediction: De-tox will be a painful experience.


Regards,

Eric Fry,
The Daily Reckoning

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• 10-K Season / The Daily Reckoning - - Elli -, 23.03.2003, 20:14