Traditional Values / The Daily Reckoning

verfasst von - Elli -, 12.06.2003, 18:41

-->Traditional Values

The Daily Reckoning

Waterford, Ireland

Thursday, 12 June 2003

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*** Mr. Market plays with his mice...

*** Stocks soar again...debt-cultivating, the newest
national pastime...federal deficit at $500 billion?

*** Get a mistress...and more!

The subject was bonds...

Yesterday, we offered a coward's guess...that people buying
up U.S. Treasury bonds at the highest prices since
Eisenhower was president would find them less safe than
they imagined.

We did not say when...

Today, we stick our necks out on the when question: not
yet. And we have more to say about why.

After a mighty exertion in WWII and Korea, the U.S. went
back to business in the 1950s. A creditor to the entire
world...with domestic savings rates near 10%, productivity
rising, a conservative administration in Washington and
young, new families spilling out of every Chevrolet and
Ford, America could rightly expect to pay little interest
when it borrowed money; there was no better credit risk in
the entire world. Even so, U.S. Treasury bonds proved poor
investments. After Eisenhower came Kennedy. And after low
yields came higher ones.

Even if you put a golf club in George W. Bush's hands, he
would hardly be mistaken for Dwight D. Eisenhower. Nor
would replaying old Hank Williams or Patsy Cline favorites
put us in the mood to buy the debt of the nation that has
become the world's greatest debtor. For in the space of
half a century, the U.S. has changed remarkably. Instead of
paying its debts, it adds to them. Instead of tending to
its own business, it minds everyone else's. Instead of
protecting its currency, its central bankers try to destroy
it.

While the U.S. economy barely moves, for example, its
debts, obligations, and money supply run wild. In the week
ended on May 28th, another $8.7 billion of new credits
screamed out of the Fed. The Fed's assets have been growing
about 6 times as fast as the nation's supply of goods and
services. And even if, despite the central bank's best
efforts, the U.S. dollar should ever manage to hold its
value, or - God forbid - go up in value, economists at the
Fed assure us that they have ways of bringing it back down.
If need be,"the Fed would pursue a targeted, substantial
depreciation of the U.S. dollar, by purchasing foreign
currency using newly minted dollars," say a pair of them in
Dallas. [Ed note: For more on where the dollar is headed,
see the following report from our friends in the research
wing of Everbank:"The Decline of the Dollar"
http://www.agora-inc.com/reports/rckn/everbank/ ]

Still, we do not predict an imminent collapse of bond
prices. We have a sneaky feeling that Eisuke Sakakibara is
right; that maintaining modest rates of inflation will be
harder for the Fed than it thinks. Mr. Market will play
with his mouse before killing it...

More tomorrow...

Our colleague, Eric Fry, from New York...

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Eric Fry on Wall Street...

- Stocks soared again yesterday as the Dow, Nasdaq and S&P
500 all hit fresh one-year highs. The Dow rose 128 points
to 9,183, while the Nasdaq gained 1.1% to 1,646. Lucky for
investors, the stock market requires no evidence of
economic recovery to continue soaring higher. Instead, it
relies upon the combustible mixture of hope and hype to
power its advance.

-"This Mini-Boom is Doomed to Fail," Comstock Partners
asserts."Almost every meaningful economic number has shown
continued weakness...Even so the stock market has climbed
significantly as investors, for the third straight year,
are placing their faith on the hopes of a strong economic
recovery on the basis of very little evidence...We believe
this 'mini bubble' will burst soon."

- Among the many goads that are lying in wait to puncture
the mini-bubble is the nation's large and growing debt
load. Debt-cultivating is the newest national pastime, and
everyone is joining in the fun, especially Uncle Sam.

-"The Congressional Budget Office now expects this year's
federal deficit to exceed $400 billion," the Associated
Press reports,"shattering the previous record even as
President Bush and lawmakers consider creating expensive
new prescription drug benefits for Medicare recipients.
Only a month ago, the budget office - which is Congress'
top nonpartisan fiscal analyst - said for the first time
that it believed this year's shortfall would exceed $300
billion...This year will mark the second consecutive one
with a budget deficit, following four straight annual
surpluses in the second term of the Clinton
administration."

- Should we be surprised if the deficit soars to more than
$500 billion before the year is out? For perspective, the
largest budget gap ever was the $290 billion in red ink
produced in 1992...We cannot say for certain that the
swelling government deficit is bearish, but we would guess
that it is not bullish.

- The nettlesome corporate pension plan crisis is another
item that we'd put in the"not bullish" category. According
to a new study by FTI Consulting, the S&P 500 companies
will have to kick in about $36 billion to their pension
plans over the next 16 months...and that's just the base
amount needed to top off the plans to their minimum funding
levels...Out of 354 S&P 500 corporations offering defined-
benefit pensions, 215 will likely need to make added
contributions in the next 16 months, predicts FTI.

- 19 of the S&P 500 companies are in particularly bad
shape, pension-wise, in that they must devote more than 30%
of their most recent fiscal year's free-cash flow to
shoring up their pension plans...It ain't easy growing
earnings when retirees are skimming 30 cents off of each
and every dollar of profit.

-"Where will the companies get the cash?" the Associate
Press wonders."Not from current resources or operations,
since the study singled out companies that don't have
them...The companies...might need to divert funds from
reinvestments or shareholder distributions, or draw on bank
lines of credit."

- Think 'underfunded pension' and it is difficult NOT to
think of General Motors, the pension-underfunding poster
child. Tuesday, the struggling automaker admitted that
falling bond rates had added $6bn-$8bn to its retirement
liabilities, just as we predicted in this column a few
weeks back.

-"The expanding hole in the U.S. carmaker's pension fund,
which reached $25bn at the end of last year, increases the
problems for the company as it struggles with a fierce
domestic price war," the Financial Times notes. Yet,
miraculously, GM shares have been climbing higher
lately...Hope blended with hype is a powerful fuel for the
stock market.

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

Meanwhile, back in Waterford, Ireland...

***"What? Your wife didn't feed you..."

Taking a cab to the airport, we found ourselves in the
company of driver who liked to talk. Cabbies must all have
time to think, but few share their thoughts so readily.

"You know, a woman who doesn't cook is only half a woman.
Here's what to do: get a mistress. Then, your wife will
take care of you properly. They need the competition..."

"Wouldn't it be a lot simpler to go out to a restaurant?"
your editor asked.

"Well, maybe, but not as much fun. Besides, if you take the
easy way out, your wife will never learn to be a good
wife..."

He had a point. A man should think of what is good for his
wife, not necessarily what is good for him.

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

The Daily Reckoning PRESENTS: A Daily Reckoning Classique
written but a year ago...on June 11th, 2002.


TRADITIONAL VALUES
by Bill Bonner

Professor Joseph Lawrence of Princeton University earnestly
declared:"The consensus of the millions of people whose
judgments decide the price levels in the stock market tells
us that these stocks are not overpriced."

When he continued, the professor seemed to have the Daily
Reckoning in his sights:"Who then are these men with such
a universal wisdom that it gives them the right to veto the
judgment of this intelligent multitude?"

There is little doubt what the intelligent multitude thinks
today. Stocks must be worth 41 times earnings [or 31, a
year later] - or else investors wouldn't buy them. Who are
we to question the judgment of so many?

Doubting the wisdom of the masses - whether they are voting
with their money...or with their ballots - is a regular
feature of this space. It is not, we hasten to point out,
that we think people are necessarily dumbbells. For we are
human, too - and prey to all the weaknesses to which flesh
is normally heir, and to a few more of our own invention...

But in large groups of people, complex and even elegant
ideas get mushed down into a fermenting syrup of empty
jingles, slogans, and campaign folderol. From time to time,
now and again, but according to no published time-
schedule, Mr. John Q. Public takes up the brew and quaffs
it like a dipsomaniac with an empty stomach. In practically
no time at all, it has gone to his head. Professor Lawrence
gave us his opinion. Writing in the summer of 1929, his
timing was unfortunate...He was right about what the
multitudes thought at the time. But a few months later, the
multitudes had changed their minds.

"That enormous profits should have turned into still more
colossal losses," wrote Graham and Dodd in their review of
the '29 crash and the aftermath,"that new theories have
been developed and later discredited, that unlimited
optimism should have been succeeded by the deepest despair
are all in strict accord with age-old tradition."

There is nothing wrong with the judgment of the masses; but
the hot steel of public opinion needs to be hammered a few
times before it is of any use. People make progress in
technology, we are fond of pointing out...but in love,
politics and markets they go from one myth to the next,
pausing at reasonable points of view only long enough to
sneer at them.

When they are in a bullish frame of mind, reasonably priced
stocks are considered losers - left behind by the New
Thing, whatever it is. When they are bearish, reasonably
priced stocks seem like bait for fools...for investors are
sure that all stocks will go down.

Traditions do not arise in the course of a single
generation. What makes them valuable is that they develop
little by little, wrought by heat and cold, beaten into a
serviceable shape by countless pounding over many
generations, through many complete cycles.

In the early '20s, age-old tradition had told investors to
watch out for stocks; they were dangerous. In 1921, the
great mass of investors judged a dollar's worth of
corporate earnings to be worth only $5 of stock price. But
something happened in the late '20s that changed the stock-
buying public's view. It was a"New Era" in the '20s,
complete with a number of important new innovations - the
automobile, electrical appliances, radio broadcasting and
so on...Light-headed, by '29, investors were willing to pay
$33 for every dollar of earnings - and still considered it
a fair trade. Then, of course, came the crash.

By the end of the end of the year, investors asked
themselves:"What ever made me think GE was worth so much?"
Mr. John Q. Public never had a clue...then or now.
Herewith, we give him a hint:

In the summer of 1927, the world's central bankers got
together - much as they did in Montreal just last week.
"[Montagu] Norman [of the Bank of England] and [Benjamin]
Strong [of the U.S. Fed] summoned Schact of the Reichsbank
and Rist of the Banque de France to a conference at which
it was proposed that they all increase credit together..."
writes our U.K. correspondent, Sean Corrigan. Then, as now,
"the continentals demurred..." So, the Anglo-Saxons acted
on their own.

"Strong blithely told Rist," Corrigan continues,"that he
was going to administer a 'little coup de whiskey to the
stock market'...Adolph Miller of the FRB subsequently
testified to the Senate Banking Committee in 1931 that this
episode constituted 'the greatest and boldest operation
ever undertaken by the Federal Reserve System and, in my
judgment, resulted in one of the most costly errors
committed by it or any other banking system in the last 75
years.'"

"Now skip to autumn 1998," urges Corrigan,"when the world
economy, still racked by the problems of the Asian debt
bust over the preceding year, then had to cope with the
Russian default and implosion of the mighty Long-Term
Capital Management...Once again, a Fed chairman...flooded
the U.S. with money...

"The whole sorry history of the last six years is one of
building up huge new swathes of debt on the top of older
ones. All the while, we deluded ourselves that the
composition of growth stimulated by this and the
concomitant rise in asset prices were supportable."

Traditionally, credit bubbles don't last. Nor do the stock
prices they inspire.

At the beginning of the '80s, you could buy a dollar's
worth of corporate earnings for just $7. At the top,
according to Yale Professor Robert Shiller, investors paid
$44. Even now, three years into a bear market - the muddled
masses judge $41 [$31, a year later] as the right price.

Today, the judgment of the multitudes is that GE is a
decent deal at $30 and Microsoft, at $51 [a whopping $25
today], is fairly priced. Tomorrow, they may think
differently.

Your tradition-minded correspondent...


Bill Bonner

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• Traditional Values / The Daily Reckoning - - Elli -, 12.06.2003, 18:41