The Last Analysis (Richebächer) / The Daily Reckoning

verfasst von - Elli -, 10.07.2003, 21:46

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The Daily Reckoning

Paris, France

Thursday, 10 July 2003

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*** Trash is tops! But who buys this stuff? Bless their
hearts, whoever they are...

*** Long rates up, refinancings down...gold down too...but
the Nasdaq is still in the black...

*** Ants and grasshoppers...how dumb people are...and more!

How do you make money in this market?

"Well, for the past few months," explained colleague Dan
Denning,"you buy the worst stuff on the market. In our
trading portfolio, for example, we've been buying tech
stocks...goofy tech stocks...and we've been making a lot of
money."

Yesterday, the Dow fell 66 points. But the tech stocks have
been leading this rally; the Nasdaq ended yesterday's
session in the black.

The smart money, and the insiders who have it, have been
taking advantage of the situation; they've been getting
out. Of course, for every seller there has to be a buyer.
Who are these buyers? Whom should the insiders thank for
taking the world's trashiest stocks off their hands?

The lumpeninvestoriat! The moms and pops in mutual
funds...the little guys...investors without a clue or a
prayer.

Bless their hearts...

Addison and his wife, Jennifer, are enjoying their new 2nd
son this morning. Though born in July, they have named him
August. Eric is still enjoying the beach with his children.

And your editor is enjoying the spectacle around him.
Yesterday evening, he went to his second Tango lesson.
Entering the room, he found women in various stages of
deshabille, including one who was nearly stark naked. But
this is Paris, and what a wonderful place to spend the
summer.

Besides, his wife has gone to the country for the summer,
leaving him alone in the city...like Jack Lemmon in"The
Seven Year Itch," waiting for a flowerpot to fall on his
head.

And what is more entertaining than watching investment
markets in the Late Dollar Standard period? Did not the
U.S. pump in trillions of dollars worth of new 'money' into
the world's money system? Didn't this new cash and credit
bulge out the Japanese stock market until it looked like a
sumo wrestler...and then bubble up the U.S. stock market
too? And hasn't it ballooned America's trade deficit...and
brought a industrial boom to China...and caused the average
American to go a little light-headed, loading himself up
with more debt than at any time in history?

Despite the highest unemployment numbers in 9 years,
consumers added another $7.34 billion of debt in May - not
including mortgage debt. This comes after an increase of
$7.83 billion in April, bringing the total to $1.76
trillion.

We gawk at the whole spectacle and wonder what will happen
next.

Further evidence for what kind of rally this is comes from
a little Reuters dispatch:

"Bonds with the weakest credit ratings are making up a
bigger part of new junk issuance this year...companies with
the lowest ratings, CCC or below, have sold more than $5
billion of bonds, up from just $463 million in the first
half of 2002."

"Your best predictor of how something performed this year,"
Reuters quotes a high-yield specialist,"would have been
basically how risky it was. The higher the expected default
rate, the better a bond has done."

Bless their hearts again. Not only do the lumps bail rich
investors out of their bad stocks, they also provide
financing for their scammy, hopeless companies.

And the poor schmucks have no idea. The Harris pollsters
discovered that while 57% of investors think interest rates
will rise in the next two years, 65% were"unaware that
rising rates generally have a negative impact on the value
of bond investments."

"It is amazing how stupid people are," said my friend
Michel at lunch.

We had just told him about another little spectacle that
took place in the street outside our office. A group
calling itself the"Grasshoppers" set up a cozy
demonstration on the sidewalk. They rolled out green
carpets...and set up tables, parasols and lounge chairs. On
the tables was laid out a collation, served to whomever
came up to ask for it.

In the middle of this pleasant scene, a young woman in a
black t-shirt stood up to a microphone and began a harangue
worthy of a sweaty Bolshevik or a cool Bush.

"We, the Grasshoppers, are ready for the fight. We will
take on the ants. We will battle against them...we will
beat them...we will vanquish them..."

She did not say that they would rape the ants' horses and
ride off on their women, but she was thinking it.

Who were these strange people? What were they up to?

"Probably some group with a government grant...some kind of
street theatre," offered Michel."Wasting taxpayers'
money...

"But if you ask people where the money comes from for this
sort of thing, they say it comes 'from the government.'
They have no idea that it comes out of their own pockets. I
have to explain to my employees that the money we pay to
the government in 'social charges' - 40% of the salary in
France - is really a cost to them. It could otherwise go to
them. But they think it comes from the employer...or the
government...or from the rich...like manna from heaven."

Readers who have stuck with us this far are probably
wondering where we're headed. This does not sound like the
Daily Reckoning market commentary you're used to, does it?

But it's summertime. Addison and Eric are not looking over
our shoulder. And we're warming up to something...exactly
what, we don't know yet...but watch this space, tomorrow.

In the meantime, we note that refinancing activity fell off
- down 21% - last week. The Fed is caught in its own
oxymoronic lie. On the one hand, it assures the nation that
inflation is as sure as California sun. And on the other,
it seems to take offense when investors put on a little
sunscreen. Long rates are rising, despite the Fed's latest
cut in short rates. Higher long rates mean more expensive
mortgages. More expensive mortgages mean fewer
refinancings...and less consumer spending...and, unless
business spending suddenly springs to life, more
slump...which means the Fed becomes even more frantic in
its effort to avoid deflation!

"The steep fall in global bond markets in recent weeks is
threatening to slow global economic recovery through higher
mortgage and corporate lending rates," the Financial Times
clarifies.

Spot gold dropped 70 cents yesterday, while gold for August
delivery lost 5. Why would gold go down if inflation were
really guaranteed by the Fed? Perhaps it is warning us;
deflation won't be so easy to beat, after all.

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

The Daily Reckoning PRESENTS: The recent Investors
Intelligence survey appraised bullish sentiment at 59%, with
bearish at 16%. Has the U.S. economy justified such a surge
in confidence? The good doctor reports, below...


THE LAST ANALYSIS
by Kurt Richebächer

Mr. Greenspan has been hailing the wonderment of the U.S.
economy's new resilience, both to the bursting of the stock
market bubble and to the various shocks from terrorists and
the Iraq war.

But the cause is obvious. What, for the time being, has
prevented a deeper and longer recession in the United
States is more and more of the very same consumer-
borrowing-and-spending bubble, which has been propelling
U.S. economic growth over the past several years.

Yet two things have changed. The first one is the
collateral behind the consumer borrowing and spending
binge. Rising stock prices have been replaced by rising
house prices. The second is that it needs more and more
rampant credit and debt creation to master just marginal
GDP growth.

Our highly critical assessment of the U.S. economy's
performance during the past two to three years, in fact,
finds its major justification in the atrocious discrepancy
that has developed between extremely promiscuous monetary
and fiscal stimuli and their extremely poor economic
effects.

Between 2000 and 2002, the federal budget has swung from a
surplus of $295 billion into a deficit of $257 billion,
heading for a $400-500 billion deficit in 2003. During the
same two years, total nonfinancial credit zoomed $2,520
billion and financial credit by another $1,879 billion,
both adding up to $4.4 trillion.

What was the effect of this credit and debt deluge on the
economy? GDP during these two years grew in real terms by
$248 billion and in nominal terms by $621 billion. To us,
this is an outright policy disaster.

Yet, American consensus economists are definitely
consistent in their approach. Undeterred by data that
overwhelmingly point to the enduring weakness of the
economy, they stick to the same forecast of the U.S.
economy's imminent, strong recovery. Though there is no
trace of the generally predicted postwar snapback, optimism
about the U.S. economy and its imminent, strong recovery
remain the order of the day.

Betting on the government's third tax cut, further Federal
Reserve easing, a weaker currency, and still more mortgage
refinancing, the consensus expects economic growth to
accelerate to 3-4% in the second half of this year,
compared to the dismal sub-2% in the first half.

In striking contrast, Mr. Greenspan and the Fed have become
distinctly more cautious in their utterances about the
economy's prospects. The Fed's latest Beige Book admits
that economic activity remains sluggish. Although"the
unwinding of war-related concerns appears to have provided
some lift to business and consumer confidence," the report
said,"the effect has not been dramatic."

Consumer spending was said to have"remained lackluster."
Labor markets were described as"weak" and manufacturing
activity as"mixed." In particular, one remark concerning
consumer spending shocked us:"Overall consumer spending
was soft in April and May. Retail sales picked up some
after subdued sales in March, but most reports indicated
that sales remained below the level of a year ago."

This weakness in consumer spending is ominous, considering
that new borrowing and mortgage refinancing are setting ever-
new records. Both new and existing home sales rose to record
highs last year, with mortgage origination totaling $2.5
trillion. According to estimates by the Mortgage Bankers
Association, mortgage origination this year is set to reach
even $3 trillion, with over $1.7 trillion of refinancings.

This mortgage-refinancing binge has had two effects. One is
the change in net new borrowing by the consumer, which rose
by a record amount of $768 billion during 2002. The other
effect is the amount 'saved' by private households through
the refinancing of existing mortgages on their interest
payments. Considering that 30-year fixed rates for
mortgages have plunged by more than two percentage points
over the past 12 months, from well over 7% to almost 5%,
these savings have played an important role in bolstering
disposable consumer incomes.

Pondering where all this money went, we took a look at the
pattern of consumer spending from 2002's first quarter to
2003's first quarter. What we found greatly surprised us.

Apart from a temporary, minor surge in the sale of motor
vehicles, expenditures on consumer durables were flat over
the year. Among nondurable goods, the major increases in
spending were on food, gasoline and fuel. Actually, 63% of
the higher consumer spending was on services, and mainly on
housing and medical care.

It was a discovery that has shocked us - because we learned
that the American consumer's heavy borrowing is largely
financing expenditures on essentials.

The other, equally important conclusion to be drawn from
these facts is that consumer spending, despite ever-new
records in borrowing, is not able to lead a sustained
recovery. So far, it has prevented a deepening recession,
but it is much too weak for more than that. The obvious
indispensable further condition for sustained, stronger
economic growth is higher business fixed investment. Mr.
Greenspan has certainly realized this, having said in a
recent speech,"the central question about the outlook
remains whether business firms will quicken the pace of
investment."

Scrutinizing the GDP numbers and also the necessary
conditions for a broad recovery in business fixed
investment, we see no chance for it to happen. But first a
clarification of facts:

Over the 12 months to the first quarter of 2003,
nonresidential fixed investment has declined in nominal
terms by $21.7 billion and in real terms by $17.6 billion.
The decline occurred across the board, but it was centered
in structures, that is, in nonresidential buildings.

Business investment on equipment and software, measured in
current dollars, increased slightly, by $10 billion, or
1.2%, implying virtual stagnation. Measured in real terms,
however, one item - computers and peripheral equipment -
showed a sharp increase by $56 billion, or 21%. For many
bulls, this is one ray of hope in the economy's overall
dismal picture. But we see nothing but hedonic pricing. In
current dollars, business spending on computers rose by
just $4.4 billion.

Pondering the possibility of a broad recovery in business
capital investment, we can only repeat what we have
stressed many times before. Profit prospects are the key
question in this respect. But scrutinizing the various
macroeconomic components that ultimately determine
aggregate profits, we note a preponderance of negative
influences. The greatest potential threat to profits is a
return of private households to higher savings, which is
sure to happen when the mortgage refinancing frenzy abates
and long-term interest rates stop falling.

Positive influences from the macro perspective during 2002
were the sharply widening federal budget deficit and rising
residential building. Major negative influences were the
continuous rise in the trade deficit and declining net
investment, mainly due to the continuous rise in
depreciations.

The fact is, there are no reasonable signs of an imminent
pickup in U.S. economic growth in general and of business
fixed investment in particular. In the last analysis, all
the prevailing optimistic forecasts are based on the
conviction that the Fed and government have the infallible
means to generate a recovery under any circumstances. The
chorus calling for the Fed to open its money spigots
further has become deafening.


Best regards,

Kurt Richebächer,
for the Daily Reckoning

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• The Last Analysis (Richebächer) / The Daily Reckoning - - Elli -, 10.07.2003, 21:46