The Daily Reckoning - A Gentleman's Bet

verfasst von Firmian, 04.09.2003, 18:39

-->A Gentleman's Bet

The Daily Reckoning

Paris, France

Thursday, 4 September 2003

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

*** Dow, S&P put in 15-month highs..."Are we 180 degrees
wrong!?"... DR readers seek reassurance... and get it.

*** The 'recovery': Will small caps lead the way again?
(You can bet on it! below... )

*** Schwarzie and Wag... staving off the Chinese
bubble... fun with the French press... and more, more,
more... and more!

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

"Is it possible that those of us who fear doom and gloom in
the markets are one hundred and eighty degrees wrong?"

Daily Reckoning readers are beginning to wonder:

"Almost all the signs are that we are entering a new phase
of prosperity," continues one letter.

"Asia is starting to recover, China is booming, Japan
returning to life, even U.S. exports are up! Hardened
doomsters are capitulating (maybe this is a significant
contrary indicator in itself) and coming around to
accepting that the worst is not going to happen and that
growth has started again after 3 years of recession.

"Could it be that we have been facing the wrong way?
Instead of gloom, are we about to be overwhelmed by a new
growth phase across the world, with China as the new member
of the trading economy? Will it mean prosperity for all?
Can even the huge U.S. deficits be worked down under a huge
wave of new growth? Will house price booms in the U.S., the
U.K. and China be a harbinger of growth to come in the
wider economy, rather than an unsustainable anomaly facing
a massive correction?

"Reassure me please! I have spent the last two years
believing the world was going to change for the worse.
Could it be going to change for the better?"

We can almost hear them:

"Well, what do you think now, Misters Smartypants?"

They're talking to us.

We said the world was going to Hell in a handcart. Instead,
it seems to have risen to Heaven. What else could it be?
Where else could you get rich by lending money to people
who can't pay it back?

American consumers' ratio of debt to income is at its
highest level ever. Yet, they are expected to keep
borrowing and spending forever. Last year, Americans
borrowed $2.5 trillion in mortgage loans. This year,
they're expected to boost the total to $3.2 trillion - or
about $65 billion per week. With this borrowed lucre, they
not only get new houses... but they also get to walk into
auto dealerships and doughnut shops with money in their
pockets.

Krispy Kreme, for example, has seen its doughnut business
rise nearly 30% in the last 6 months, with earnings up too.
Investors seem to see no limit to the number of doughnuts
consumers can put away, nor to their ability to buy them.
The stock is priced at 50 times estimated earnings.

Alan Abelson notes in Barron's that Krispy Kreme is buying
up its franchises - paying between 3 and 10 times earnings
before interest, taxes, depreciation and amortization. That
is, it is willing to pay up to $10 for each dollar's worth
of earnings in the doughnut business. Why then do investors
pay two and a half times as much for Krispy Kreme stock, on
the same accounting basis? Is the company wrong about what
its franchises are worth? Or are investors wrong about what
Krispy Kreme is worth?

We have our opinion. The lumpen have theirs.

There are 3 kinds of money on Wall Street, dear reader.
There's the smart money, there's the dumb money... and
there's the money so brain-damaged that it practically begs
for euthanasia. For the moment, it's the dumb money that
has the upper hand. While smart insiders get out, the dumb
money buys... and prices rise, as they did again yesterday.

And today's press brings good news from all over the
planet; maybe the dumb money isn't so dumb, after all. The
U.S. consumer... that stalwart shopper upon whom the entire
world economy depends... is still digging himself deeper and
deeper into his hole of debt. As a result, in America, the
Fed gave an"upbeat assessment" of economic prospects in
its Beige Book, says the Financial Times. Germany seems to
be catching a break. Japan is finally on a upswing.

But what's this? Mortgage applications fell again last week
- the 4th in a row. People are still buying new houses - at
a record pace - but, with higher rates, they're not
refinancing the way they used to.

Could it be that everyone is looking at figures from the
recent past... instead of turning their faces to the future?

The U.S. housing (and financing) industry was probably
responsible for at least half the world's economic growth
over the last 12 months. (The rest was military spending
and doughnuts... ) But what if the housing boom really were
over?

"The main force propelling residential real estate - the
lowest interest rates in 40 years - is suffering a brutal
reversal," FORTUNE points out."Since June the rate on 30-
year mortgages has gone from just under 5% to 6.1%. A new
$500,000 home loan now costs homeowners $2,540 a month in
interest, compared with $2,040 in June, an increase of 25%.
Suddenly the throngs who rushed to refinance their homes at
bargain rates are thinning. Weekly home-loan applications
have already shrunk 80% from their peak in May, and that's
no blip. The market scaled such outlandish peaks that a
nasty fall is all but inevitable."

We don't know, of course. Steve Sjuggerud argued in
Tuesday's episode of The Daily Reckoning that the housing
boom still has a long way to go. And maybe it does. But
smart money is wary money. It wouldn't buy Krispy Kreme at
these prices - even if they gave away the day-old doughnuts
free to shareholders.

And to our dear reader seeking reassurance, we offer it:
even though things seem to be getting better, for the
moment, they are actually getting worse. For the longer it
takes to correct the debt bubble, the worse it will be.
Housing may continue to inflate, or it may not. But it can
only inflate by sucking the air out of householders'
balance sheets... leaving them deeper in debt than ever
before.

Right, Eric?

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

Eric Fry, reporting from Wall Street:

- Well... for a second straight day, the stock market
thumbed its nose at the ghosts of Septembers past, as the
Dow Jones Industrial Average gained 45 points to 9,568 and
the Nasdaq rallied 11 points to 1,853.

- Cheery remarks from Cisco Systems emboldened investors to
continue buying overpriced tech stocks, including"CSCO."
Shares of the networking giant surged 3.3% to a fresh 52-
week high after CEO John Chambers declared that the
company's August orders were"better than expected."
Chambers neglected to mention what was"expected," and
investors did not seem to care about the specifics, as long
as whatever happened at Cisco in August was"better than"
whatever was supposed to have happened.

- Generally speaking, conditions in the tech industry have
improved very little. But conditions in the tech sector of
the stock market have improved substantially. The Nasdaq
100 Index of non-financial companies has soared nearly 70%
from the lows of last October, while the shares of Cisco
Systems have more than doubled... Either investors are
looking ahead - far, far ahead - to a period of substantial
earnings growth, or they're looking behind, pining for the
days when Cisco Systems was 'cheap' at 100 times earnings
and boasted the world's largest market value.

- Alas, the truth is sometimes hard to bear, but the
Internet mania that fueled a once-in-a-lifetime stock
market bubble is dead and gone. And when it died, a few
trillion dollars of shareholder wealth also perished, and a
few billion dollars of annual tax revenues vanished. Stocks
may be rebounding on Wall Street, the tax collection is
still mired in a deep bear market.

- As of late March, state governments faced collective
deficits of $94 billion... which isn't chump change. Just
imagine all the wonderful things that $94 billion could
buy. With that kind of money, the U.S. Army could occupy
Iraq for almost one entire year! Or the state of California
could plug its budget shortfall for more than two years!

-"From Maryland to Oregon, governors are firing state
workers or raising taxes - sometimes both - to meet
spending cuts," Bloomberg News reports."Maryland Governor
Robert Ehrlich Jr. said he'd fire 82 employees and pare
spending by $280 million from the current fiscal budget.
Oregon Governor Ted Kulongoski agreed to reduce spending by
$1 billion and raise taxes by $800 million in a two-year
budget that lawmakers approved in late August..."

- The cause of the tax revenue shortfall besetting the 50
states is hardly a mystery. For the last three years,
states have been facing a toxic combination of falling
employment and falling share prices. Meanwhile, the states'
expenses continue their inexorable rise.

- The parlous condition of state and municipal finances,
epitomized by California's $38 billion shortfall, has
caused investors to shy away from municipal bonds,
especially those issued by the not-so-Golden State."A
California general obligation bond that matures in 2022 was
priced Friday at $96.59 with a yield of 5.29 percent," says
Bloomberg."That's 44 basis points higher than Bloomberg's
index for comparable AAA rated general obligation debt,
which had a 4.85 percent yield Friday."

- In other words, bond investors are a little bit wary
about lending money to states that might not repay their
debts. But they are only a LITTLE bit wary...

-"Municipal bond volume appears to be on track for another
record year of issuance," Dow Jones News reports."With
state budgets expected to continue confronting deficits,
and with the flow of funds from the states to local
governments severely pinched, candies, cities, towns in
villages across the country will continue to have little
choice but to borrow to meet essential project needs, even
if they do cut back on other spending." Muni bond issuance
could top $400 billion this year, which would easily top of
the record of $357.1 billion that was just sat last year.

-"The federal government will also set a new borrowing
record this year," observes Doug Noland of the Prudent Bear
Fund."Corporate debt issuance, although remaining
considerably below late '90s bubble levels, is picking up
meaningfully. We are on pace for record junk and
convertible debt issuance. In total, we are in the midst of
record system credit growth."

- Bravo for Mr. Greenspan!... The chairman's bubble-
reinflation campaign is progressing very nicely.

[If you'd like strong insights into the mind behind the
reflation strategy, read John Mauldin's dissection of Easy
Al's Jackson Hole speech given last Friday, here:

The Greenspan Uncertainty Principle
http://www.dailyreckoning.com/body_headline.cfm?id=3407 ]

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

Mr. Bonner, back in Paris...

*** And what's this? China increased its reserve
requirements for commercial banks from 6% to 7%. Why would
we care? It's just that China is the latest bubble economy
- puffed up by the Dollar Standard. Chinese officials have
watched what happened in Latin America, Japan, Malaysia,
Thailand and the U.S. - as a tidal wave of dollars made its
way around the globe. Have they learned anything? Are they
trying to let the air out of the bubble before it gets too
big? Will they be able to do what Greenspan couldn't - spot
a bubble and prick it? More on this and other things
(including investment opportunities in China)...
tomorrow...

*** The front page of yesterday's Le Monde tells us more
about the man who may be California's next governor.

"In 1966, this couple (Wag and Dianne Bennett) dominated
the London body-building scene. Wag was one of the judges
for the Mr. Universe competition, in which a young 19-year-
old Austrian - a good-looking kid with only rudimentary
English - participated.

"Instinctively, Wag realized that he was looking at a star.
'Schwarzie' went to live in their house on Romford Road
where the Bennetts lived with their six children. 'Arnold
had all the attributes to become a champion. His
perseverance at training was incredible,' recalls Diane
Bennett.

"For two years, this native of Graz slept on the Bennett's
couch. He rarely went out, avoided the pubs, and courted
the young girls who worked out in the gym. Dianne made his
shirts and his pants. Each morning, she prepared his
breakfast, an omelet of 8 eggs and an enormous steak.

"In 1968, following the Bennett's advice, Arnold emigrated
to the U.S..."

*** We often check the foreign press, just to see what they
think of us. Also on the front page of Le Monde, Patrick
Jarreau wonders about Americans' technical abilities:"No
one dares doubt Americans' technical mastery and
professionalism," he begins. Still, for the last three
years, everything that could go wrong, technically, seems
to be going wrong. First, he notes, even counting votes in
Florida proved a challenge that had to be resolved by the
Supreme Court. A year later, terrorists with box cutters
revealed an extraordinary weakness in the nation's security
systems. Then, in February 2003 the space shuttle
disintegrated. And finally, he says, it's bad enough that
they can't get the electrical system working in Iraq, but
they were even unable to keep the lights on at home.

*** The French press is still sweating the heat wave. Each
week, it seems as though the tally of the dead rises.

"A warning should have been issued earlier," says an
article in the Figaro. We wonder what the warning might
have said:

"Attention, it's hot! Keep cool or you may die!"

Perhaps the government should have organized squads of
volunteers to go around and visit old people - forcing them
to drink bottles of Perrier.

*** Speaking of warnings, the French have become even
madder than Americans when it comes to cigarettes. You can
still smoke in most places, but now packs of smokes must
carry a large warning: CIGARETTES KILL! Or SMOKING CAUSES
LONG AND PAINFUL DEATH! Or, SMOKING CIGARETTES MAKES MEN
IMPOTENT!

No one seems concerned that the warnings are fraudulent. As
far as we know, no one has ever shown that smoking a
cigarette every once in a while is harmful. Nor do the
warnings mention that smoking has some beneficial effects.
When you feel like killing someone, for example, sit down;
have a smoke. By the time the cigarette is finished, the
fatal instinct may have passed. Or, if you believe the
French warnings, you are dead anyway.

*** A reader's comment:

"We wallow in madness here in California. Vote for Larry
Flint! Vote for Arnold! Vote for Gary Coleman! Throw a dart
at the board and pick one of the 135 candidates! The sun
didn't show two days ago - it must be Gray Davis's fault! A
woman was killed last week by a Great White shark 10 miles
from my home - maybe Gray Davis put it there - he certainly
didn't protect us from it - recall him! Off with his head!"

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

The Daily Reckoning PRESENTS: With the Dow and S&P putting
in fresh new 15-month highs yesterday, even the staunchest
of bears are beginning to wonder: are we wrong? Small-cap
sleuth James Boric is willing to place a wager on it...


A GENTLEMAN'S BET
by James Boric

I'm not usually a betting man, but today I'm going to make
an exception. I've found a group of stocks that will likely
outperform every major index over the next 12 months - by
at least 15%. The reason I'm so sure: it's happened time
and time again dating back to the early 1920s. And it's
happening now.

I'll tell you about my winning stock idea in a second. But
first I want to remind you of an article I wrote almost one
year ago today for The Daily Reckoning.

On Sept. 24 of last year, I told you to prepare for a
recovery. I wasn't so bold as to say when. But I knew the
market would recover, soon. More importantly, I gave you a
plan of attack to make back ALL the money you lost from
2000 to 2002 - if you had stuck it out in the stock market
while it crashed.

At the time, it seemed like the financial world was going
to hell in a hand-basket. The Dow Jones was down 35% from
its all-time high in Jan. 2000. The S&P 500 was down 46%
from its high in March of 2000. And the Russell 2000, the
'small-cap index,' was taking a beating as well. It was
down 41% from its high in March 2000. Panic was in the air.

Despite the doom and gloom, I suggested last September,
based on historical precedent, it was time to invest in
fundamentally sound small-cap stocks. Why? One simple
reason: for the last 100 years, small-cap stocks have led
the way once the market turned from bear to bull.

Let's take a stroll down memory lane...

In the recovery years following the crash of 1929, small-
cap stocks outpaced large-cap stocks by about 20% a year -
for four years.

Following the crash of 1973, small-caps rose 349% from 1975
to 1980. Their large-cap counterparts managed only 59%
gains.

And after the downturn in 1982, small-cap stocks jumped up
almost 37% by 1983. Again, large-cap stocks lagged behind -
gaining only 21%.

The statistics are irrefutable. When the market turns from
bear to bull, small-cap stocks have historically been the
best class of stock to own - PERIOD.

Always have been? Perhaps, they always will be. Take this
most recent rally for example. On March 11, 2003, the Dow
was at its lowest point since October 2002 (just after the
Sept. 11 terrorist attacks). It was trading at 7,524. Since
then, it has rallied up to 9,523 - a gain of 27%.

Not too shabby. But the Russell 2000's turnaround has been
far more impressive.

The Russell 2000 is a small-cap index. It hit a low of 345
on March 12. Today, it trades at 507 - up 47%. Just like in
the 1940s, small-cap stocks are outpacing the blue chips by
about 20%. In the last six months, had you invested in
select small caps with sound fundamentals, you could have
made back everything you lost in the 2000 fallout - just
like I predicted.

So why don't more investors forget about the slower-moving
large-cap stocks and dump their money in the small-cap
market?

Risk.

Most investors consider buying small-cap stocks 'gambling,'
'speculation' or very 'high-risk.' They are right to a
degree - albeit a very small one.

In the late 1990s, Sherman Hanna, a professor at Ohio State
University, and Peng Chen, an associate at Ibbotson
Associates in Chicago, did a study on small-cap stocks
versus large-cap stocks. They wanted to show how they
stacked up against each other in the short, medium and long
term.

Here's what they found...

Using data from 1926 to 1996, Hanna and Chen found that
small-cap stocks are riskier if you hold for shorter
periods of time. For instance, if you picked the absolute
worst five-year holding period between 1926 and 1996 to
invest in a basket of small-cap stocks, a $1 investment in
that basket would have been worth 26 cents at the end of
the five years. Scary.

But that's the worst-case scenario - the number doom and
gloomers will use to convince you to head to the hills and
never look back. It's not normal. So let's look at what is.

In an average year, small-cap stocks outperform large-cap
stocks 56% of the time. Bet you didn't know that! And the
longer you hold small-cap stocks, the more impressive the
numbers get.

If you hold for 10 years, small-cap stocks will beat their
large-cap counterparts 66% of the time. (Also, the 10-year
mark is where the risk associated with holding small-cap
stocks equals that of the large-caps. In other words, after
10 years, it's actually riskier to hold large-cap stocks!)

And if you hold for longer than 10 years, forget about it.
There's no comparison between small-and large-cap stocks.
During any 15-year holding period, small-cap stocks will
beat out large-caps 78% of the time. Over 20 years, they
win out 94%. And over 35 years, small-cap stocks have
always beaten out the blue chips. Always.

Let there be no doubt - if you are looking for a long-term
investment strategy, you would be foolish not to consider
small-cap stocks. But the question everyone wants an answer
to is: How can I make money now? I don't want to wait 20
years.

I'll tell you the same thing now I told you last September.
The secret is to look for fundamentally sound small-cap
stocks.

Right now, there are 8,880 active companies (large and
small) trading on the major U.S. exchanges. Of those, only
101 are fundamentally sound, growing enterprises. How many
do you think are large blue chips?

Go ahead, guess.

Twenty-five? Fifty? Seventy-five? Nope. Try 14!

There are only 14 large-cap stocks that trade for 25 times
earnings or less, 1.5 times sales or less, 1.5 times book
value or less AND are growing their sales 10% quarter-over-
quarter and their net incomes by at least 1% quarter-over-
quarter.

The remaining 87 fundamentally sound companies are all
small-caps - with a market cap of $1.5 billion or less.
These are your best investment opportunities over the next
year, five years and beyond. In fact, I'm so sure of
myself, I'll make you a bet - a gentlemen's bet.

Over the next 12 months, those 87 fundamentally sound
small-cap companies will outpace every single major U.S.
index by at least 15%. Not only that, they will
collectively beat the tar out of the 14 fundamentally sound
large-cap stocks - by at least 10%.

Am I nuts?

Maybe. But I have 80 years of history on my side that says
otherwise. I like my odds. And as long as the market
remains in recovery mode, which it is in right now, small-
cap stocks are the way to go. They will beat out every
other class of stock.


Sincerely,

James Boric
For The Daily Reckoning

P.S. This wouldn't be a fair bet if I didn't give you the
list of 14 large-cap stocks and 87 small-cap stocks to see
for yourself. If you are interested in the list, send me an
e-mail at psfortunes@agora-inc.com with"send me your list"
in the subject line. I'll send you a spreadsheet with all
the data.

Next September, I'll let you now how the 87 small-cap
stocks performed relative to the broad market and the 14
large-cap stocks.

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gesamter Thread:

• The Daily Reckoning - A Gentleman's Bet - Firmian, 04.09.2003, 18:39