Ouzilly, France / The Daily Reckoning

verfasst von - Elli -, 28.07.2003, 16:30

-->Ouzilly, France / The Daily Reckoning

Monday, 28 July 2003

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*** All eyes on Mr. Market... look at that monkey run! Bonds
take a beating...

*** Is Wall Street really a fraud? Mortgage rates up...

*** Alan Greenspan..."highly accommodative"... is the U.S.
economy unsinkable? Is this a great country, or what?

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

Look at Mr. Market run!

All eyes were on Wall Street last week. Most people think
the economy is improving; the long-awaited recovery is here
at last, they say.

New home sales hit a record 1.16 million in June. And
prices are still rising. The average house in Massachusetts
sells for $414,517. On the other coast, in San Diego,
ordinary digs will cost you $419,320.

Unemployment numbers looked better last week. And durable
goods sales - such as cars and washing machines - rose 2.1%
last month.

No wonder the Dow rose more than 170 points on Friday
alone. Who says you can't get rich by buying stocks?

Well... we did, last week. But we get away with nothing here
at the Daily Reckoning. Several readers wrote with a
challenge:

"You say the stock market is a fraud..." began the polite
version,"but aren't you the same ones who are promising
that we'll make 10,000% profit from this newsletter or a
million dollars from that trading service? What gives?"

Here we give an answer. But first, we stand still, turn our
eyes away from the stock market and once again, we admire
the polished irony of it all; we have to cover our eyes, so
brightly does it shine.

Our senses alert, we turn our heads slightly and think we
hear a million voices of the dead:

"It's not that simple..." they whisper.

The swindle of the stock market is the idea that Wall
Street is there to make you rich, no matter what you buy or
when you buy it. Every shopper tries to get the most for
his money, when he buys clothes, food, or anything else.
But when he shops on Wall Street, the poor man man's brain
starts backing up; instead of looking for bargains, he
looks for the most expensive merchandise he can find.

The brokerage houses, the media, Lou Rukeyeser, Abby Cohen
- they all tell him not to worry; all he has to do is to be
'in the market' and he'll get rich along with everyone
else. Nothing is as safe or as sure as long-term stock
market investing, they say. If only it were that simple and
that easy! And here's the lovely irony of it: the more he
believes them, the more he and other investors will lose.

There is, of course, a way to make a lot of money by
investing. But it can only be done by a few people, not by
many... and only by doing what the many do not do. There is
a time to buy stocks and a time to sell them. The time to
buy them is when other investors are least interested in
buying them and Wall Street is least interested in selling
them. The time to sell them is... we think... now.

And when all investors' eyes are on stocks, it is time to
recognize the humbug of Wall Street and look elsewhere. The
important spectacle is being played out, we believe, not on
Wall Street, but in the world's currency markets and gold
exchanges.

And here, the sparkle of irony is almost blinding. When the
Dollar Standard system emerged, Americans thought they had
been handed the keys to a liquor warehouse on the night
watchman's day off. The keys got them in... but there will
be hell to pay getting out. More on this - how America has
been cursed with good fortune - as the summer continues...

But now, Eric Fry with the latest news:

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

Presenting our?man-on-the-scene? in New York, Mr. Eric Fry
(haraaahh!!!):

- Mr. Market continues to behave like a well-mannered
dinner guest? perfectly innocuous. He is impeccably
inoffensive to bulls and bears alike. So fastidiously does
he avoid offending that he also fails to excite.

- The S&P 500 added half a percent last week to 998, but
still did not deviate outside the perfectly agreeable
trading range between 962 and 1,015 that has contained it
for the last seven weeks. The similarly inoffensive Dow
Jones Industrials rose 96 points last week to 9,288, while
the Nasdaq added 1.3% to 1,730.

- The bond market has not been nearly as polite. Unlike the
equity market, the bond market has become as alarmingly
raucous as a co-ed on spring break. Suddenly this
delightful girl-next-door of the financial markets is doing
?body shots? with those ill-mannered bond bears. No one
knows what she might do next!

- Already, her unspeakable improprieties include tossing
off?32nds? like so many articles of clothing. And now that
the 10-year bond price is flat on its back, its yield is
soaring. Over the last several weeks, 10-year bond yields
have jumped from 3.10% to 4.18%.

- The bond market?s behavior is not sitting well with all
the folks that had been expecting so much more of her. In
the last month, long-term government funds have tumbled
about 8%, which drops their year-to-date performance into
the red. So much for the safe haven of fixed income.

- Not surprisingly, Barron?s observes,?a growing number of
investors do appear to be losing their ardor for bond
funds. Flows into taxable bond funds, which hit a record
$45.3 billion in the first quarter of this year, have
slowed remarkably, according to Robert Adler, president of
AMG Data, a fund-tracking service based in Arcata,
California. The rate of inflows has dropped $2.1 billion
per week this month, down from a peak of $4.7 billion in
mid-March. Equity funds appear to be the beneficiaries of
this trend: Flows into equity funds climbed to nearly $20
billion in June from $1.2 billion in March, Adler says.?

- The bond market?s sidekick, mortgage rates are also out
of control. 30-year mortgage rates have spiked a stunning
73 basis points in only five weeks? from 5.21% to 5.94%.
These surging mortgage rates will be no friend to the
housing market.

-?The Mortgage Bankers Association says applications to
refinance mortgages fell 7% this week from a week earlier,?
USA Today reports.?But the real impact of rising rates on
the refinancing business won't be seen until later this
year, because many loans with locked-in lower rates are
still in the pipeline.?

- Financial bubbles, like rock stars, live fast and die
young. The bond bubble was no different... its hard-core
groupies may still be in denial. But the rest of us are
already mourning the loss of the economy?s best friend.

- During his testimony last week before the Senate
Committee on Banking, Housing, and Urban Affairs, Greenspan
opened with his familiar refrain:?The FOMC stands prepared
to maintain a highly accommodative stance of policy for as
long as needed to promote economic performance.?

- Professional bond market participants understood the
phrase to mean:?I will slash interest rates as low as
needed to produce a?little? inflation and to trigger
economic growth.? But in light of the ensuing bond market
collapse, it would appear that Greenspan's policies are
"accommodative" first and foremost to the bond market?s
small cadre of short sellers. When rates rise, almost no
one wins, neither corporations nor investors... well, maybe
some investors...

- A couple of weeks ago in the Daily Reckoning, we
mentioned Rydex Juno Fund and ProFund?s Rising Rates
Opportunity Fund - two mutual funds that take bearish bets
on the bond market by selling short long-term Treasury
bonds. We are happy to report that neither fund has
collapsed in price since we mentioned them. Instead, both
of them have advanced nicely.

- Likewise, John Myers? Resource Trader Alert has also been
busy profiting from the bond market?s collapse. Last week,
Myers urged his subscribers to ring up a 260% profit on the
bond put options he recommended in early June, when the
bond market was very close to it recent high.

[Ed note: for more from Myers, see:
http://www.agora-inc.com/reports/RTA/ProfitGalore/ ]

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

Bill Bonner back in... well, we're out in the countryside
for the rest of the summer...

*** An interesting letter from a dear reader:

"As I said in an email to Addison Wiggin the other day,
when I read your daily reckonings I nod my head knowingly
because I agree with you that, yes, the government is
broke, the currency declining and the economy is hollowing
out. The social programs of FDR and LBJ, dressed up with
all the additional bells and whistles added under the
administrations of HST, IKE, JFK, RMN, JRF, JEC, RWR, GHWB,
SLICK and now W, are leading us to the $44T (and growing)
shipwreck about which you have written. I think to myself,
?the water is washing over the decks of the Titanic,
and...? well, we all saw the movie, right? Remember that
line from Titanic? The shocked passenger says:?But, but,
but this ship is unsinkable.? The ship's architect replies:
?Madame, this ship is made of iron, and I assure you she
can sink.? And my heart sinks, because this was one hell of
a country before standards went out of favor and, more
specifically, the currency got all screwed up. Nothing that
you and your writers say about the future of the US Dollar,
and the US economy, makes me feel good.

"But you convinced me to buy Gold, and to take delivery. I
did exactly that. I do feel good about it. And I appreciate
your time and efforts.?

Best wishes... BWK

*** And here's another letter that made us wistful for the
Clinton years...

"It doesn't get any better (worse?) than this.

"Jessie Jackson has added former Chicago democratic
congressman Mel Reynolds to Rainbow/PUSH Coalition's
payroll. Reynolds was among the 176 criminals excused in
President Clinton's last-minute forgiveness spree.

"Reynolds received a commutation of his six-and-a-half-year
federal sentence for 15 convictions of wire fraud, bank
fraud and lies to the Federal Election Commission. He is
more notorious, however, for concurrently serving five
years for sleeping with an underage campaign volunteer.
This is a first in American politics: an ex-congressman who
had sex with a subordinate... won clemency from a president
who had sex with a subordinate... then was hired by a
clergyman who had sex with a subordinate.

"His new job?

"Youth counselor!!!

"IS THIS A GREAT COUNTRY OR WHAT?"

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

The Daily Reckoning PRESENTS: John Mauldin, freshly
returned from Europe, with a few reflections on what you
should do with your money over the next decade.


GREENSCAM
by John Mauldin

Last Tuesday evening I spent one of the more stimulating
(and enjoyable) evenings I have had in a long time in the
home of one Francis Stobart of SODITIC in Geneva. He had
assembled a small, but eclectic, group of Swiss private
bankers and asset managers for dinner to discuss whatever
small insights into finance and economics I might be able
to dispense. I was expected to sing for my exceptional
supper and superb wines, but I believe I walked away with
far more insight than I was able to impart.

While the size of the firms represented ranged from huge to
small and the range of services was quite diverse, we all
had one common connection: our clients expect us to come up
with investment strategies that make sense in today's
world. The problem is the future seems particularly risky
as of late, with the world of investment ideas a less and
less friendly place.

Where does one safely put assets, whether it is billions
for institutions or smaller personal accounts for retirees?
One very large and rather bearish manager is now suggesting
his rather substantial clients allocate 15% to physical
gold. While not all participants were quite so bearish, the
outlook was more somber than I would have expected.

[Reading an advance copy of Bill Bonner's new book,
Financial Reckoning Day (on my computer - it will soon be
out in print) on the ten-hour return flight did not relieve
that note of concern. But it did give me some food for
thought as I reflected upon the conversation. A few of
those thoughts gleaned from that evening might be of
interest.]

As might be expected, there were more than a few questions
for a Republican from Texas. Not only at this dinner but
throughout the week, I was posed some hard, but polite,
questions. The night before, I had dined in Paris
with a friend of Chirac's, who also had questions. Jean-
Michel noted that it was not the strategy in Iraq that was
the concern, but the execution.

I have been a staunch defender, and still am, of the
President. But I will tell you that it is disconcerting to
talk with sophisticated men of considerable experience in
the world who so clearly did not understand the President's
view or America's concerns. It was not a case of these men
not listening (I did not have an opportunity to discuss
events with any ladies). It was not always a case of
disagreement. We have clearly not communicated well to the
public at large, and that must be corrected or it will come
back to haunt us.

But the subject of the evening was primarily economics, so
that is where we will return. There was almost universal
unease with the U.S. economy. There was a recognition that
the U.S. was the economic engine for the world, and a
concern the engine was running out of steam. There was an
intense discussion on Greenspan's latest policy statements,
which none (including me, of course) in the room could
understand.

The feelings expressed about Greenspan are best summed up
in a statement by Alex Bridport, of Bridport and Cie., in a
client letter he wrote the next morning. (Bridport is a
major firm, consulting with large European institutions on
their bond portfolios, which in the aggregate would be well
in excess of $100,000,000,000. They have bought over
$20,000,000,000 in bonds for their clients just since the
beginning of the year. In short, they have their fingers on
the pulse of European institutional investors.) This
caustic note from Sir Alex:

"When it comes to wealth destruction, the recent fall in
bond values must rival anything that happened to the stock
market when the bubble burst. For this contribution to
mankind, investors can thank Alan Greenspan for an
operation we might call the?Greenscam.? It involved him
allowing investors to believe that the overwhelming risk
was deflation and that all means would be used, including
the Fed buying long T-bonds, to keep long-term yields low
and support the?carry trade.? Then Greenspan pulled the
rug and investors all fell down, taking off the carry
trade.

"We admit to being as much a victim of the Greenscam as
anyone else. At least we all know whom never to trust
again. Beyond the half-truths, the inherent contradictions
and unproven optimism about the rolling?recovery in six
months,? our task is to weigh up the likely developments in
the U.S. economy as the starting point to what will happen
there and elsewhere.

?Until last week we had?swallowed? the Greenscam line that
the economy could only recover or deflate. Since recovery
with such a debt load looked impossible, we went along with
deflation being the more likely scenario, although, in
fairness to ourselves, we saw it as only a short-term
phenomenon, as a weakening dollar would offset deflationary
pressures in time (we overestimated the amount of time in
making a?wild guess? of one year).

"As of last week, because of a little-publicized report
that producer prices were rising at a 4.8% annual rate, we
began to think of the third possibility: stagflation. Given
our view that recovery is impossible until the U.S.
imbalances have been corrected (a view we hold despite
volatile stock market rallies), we see the debate as
deflation vs. stagflation. The latter is understood to mean
slow growth (only slightly above growth in working
population), increasing unemployment, and rising inflation
and interest rates.

"A major question for the outlook in this stagflation vs.
deflation competition is the future of the dollar.
Bridgewater [Associates] points out that, in past periods
of high twin deficits, the dollar fell but bonds did not.
They see the Fed producing?whatever liquidity is needed to
shift some of the downward pressure on bond and stock
markets to the US dollar? - hoping to attract foreign
capital because the dollar is cheap (presumably with a view
to its appreciating again). Up to that point we agree with
Bridgewater's analysis, but we have to part company with
them when they continue to see the deflation model and
falling yields as the most likely scenario.

"Our view is towards the stagflation model, because of the
force of argument from the indices and because the dollar
looks likely to fall again. Despite our now leaning towards
the stagflation model (yes, we changed our minds over the
last few weeks - but the facts changed, too!), it would be
inappropriate to recommend maturities other than those
close to the bond index. Yields overshot on the way down
and may well do on the way up. Besides, the Greenscam may
not have run its course. New cash should wait on the
sidelines or be used to buy instruments to counter a
further rise in yields and inflation."

I am attracted to this view, as it is similar to mine,
although I think the time-line is somewhat longer and more
stretched out. Reviewing quickly, I think we are in a slow-
growth Muddle Through Economy. The Fed has virtually
guaranteed that short-term rates will remain low for some
time, until either inflation appears or the economy is
soundly growing above trend.

Neither eventuality is my most likely scenario. At some
point, there will come a recession (there is always another
recession), without the Fed having the"ammunition" of
being able to lower short-term rates. In my opinion, if a
significant rise in rates, either long term or short term,
were to happen in the current slow growth economy, it would
indeed trigger a recession.

Since recessions are by nature deflationary, the Fed will
respond with the rest of its arsenal, as they view
deflation as the worst of all possible worlds. I believe
they will indeed stop deflation dead in its tracks.

However, I think that leads not to a comfortable reflation
and a return to the Roaring 90's, but to a slow-growth
inflationary period, similar to the stagflation of the
70's. It will become the Muddle Through Decade.


Regards,

John Mauldin,
for The Daily Reckoning

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• Ouzilly, France / The Daily Reckoning - - Elli -, 28.07.2003, 16:30