The Daily Reckoning - The Scariest Scenario Imaginable (Steve Sjuggerud)

verfasst von Firmian, 08.10.2003, 09:18

-->The Scariest Scenario Imaginable

The Daily Reckoning

Rancho Santana, Nicaragua

Tuesday, 7 October 2003

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*** Tomorrow in the news - West Coast homeowners beware!
Madness and reason... advice to Arnie...

*** Stocks up, dollar down... tumult in the what's-my-
monthly-payment nation...

*** Our own private Eden... invaded! Cost-cutting
imbeciles... so is it a best-seller, or not?!? And more...

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

Well, it's 4 A.M., time to get to work.

Living in Europe has its advantages; the early bird doesn't
have to get up so early.

But here we are in sunny Nicaragua... trying to keep up with
the news.

And what's this...? Why, it must be tomorrow's news. From
the Seattle Times comes a headline that is bound to be
popular in the years ahead:

"More homeowners selling houses for less than they owe."

What went wrong? We don't know, but we have a feeling that
the headline will soon make its way down the coast. For,
elsewhere, we read that the California Association of
Realtors is projecting a 13% increase in house prices this
year in the Base Metal State. That will bring the median
house to $414,000, compared with $168,000 in saner parts of
the nation.

There you have it, dear reader: a business opportunity. Buy
up houses in Missouri and ship them to California. If you
can put them down on a lot for less than $246,000, you will
make a profit.

It is madness, of course. But it is madness with plenty of
reasons behind it. The California economy is almost the
same size as France... and run on the more or less on the
same principles.

"California governor faces a big mess," CNBC tells us.
(Advice to Arnie: if you win the popular vote... demand a
recount.)

One part of the mess, however, is not of the governor's
making... and not within his power to fix. It is the mess we
keep mentioning. California operates on dollars. France
does business and keeps its money in euros. The euro went
up again yesterday, after the head of the European Central
Bank noted that dollar was doomed."The U.S. has a huge
current account deficit," explained the silver-maned
banker,"so sooner or later there will have to be an
adjustment of its currency."

The day will not be a happy one for homeowners on the West
Coast. The median owner checked his 'home equity' account
last year and saw that his 'wealth' had gone up by $40,000
or so. Many were they who could not help themselves; they
took the money out.

And many will regret it, we predict, when a falling dollar
forces up interest rates and brings down house prices.
They'll find themselves with less equity than they
thought... while their mortgages are still every bit as big
as they remembered.

But that is all in the future. Like the Seattle headline.

Over to you, Eric:

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

Eric Fry, checking in from lower Manhattan:

- Move over Reggie Jackson! Meet the new Mr. October!... The
stock market chalked up its fourth straight winning session
of the new month - a perfect 4 for 4. The Dow added 23
points to 9,595 and the Nasdaq gained 0.7% to 1,893.

- The gold market also attracted a few buyers, as the price
of the yellow metal rebounded slightly from Friday's $13.70
drubbing - recouping $3.30 to $373.30 an ounce. But the
U.S. dollar tumbled again, falling 1.1% against the euro to
$1.17.

- How is it possible that stocks continue their winning
ways, even while the dollar continues its losing ways?
These two inimical trends are strange bedfellows indeed.
Imagine Rush Limbaugh as Halle Berry's new love interest
and you will begin to understand the freakish and unlikely
pairing of a rising stock market and a falling dollar.

- What makes this pairing particularly bizarre is the fact
that our nation relies so heavily upon the enthusiasm of
foreign investors for U.S. assets. In some way, shape or
form, foreigners lend our consumption-crazed nation almost
$1 trillion every year. We Americans, in turn, use the
money they send our way to buy SUVs, plasma TVs and costly
military campaigns in distant lands. However, we do not
forget to repay our creditors with ever-cheaper dollars.
Some day - timing uncertain - foreigners may lose interest
in subsidizing our consumption. They would have lost
interest already, except for the fact that we are consuming
the goods that they are producing.

- Exactly how unrewarding is it to exchange foreign
currencies for U.S. assets? Consider that the Nasdaq
Composite has jumped almost 5% since the end of August... in
U.S. dollar terms. But euro-based buyers of the Nasdaq
Composite have lost 2% over the same time frame.

- Foreign bondholders are faring no better... Foreign
central-bank holdings of Treasury and agency securities
total nearly $1 trillion. So, roughly speaking, the
dollar's drop over the last five weeks has impoverished our
foreign creditors by about $85 billion. That's real money.

- And yet, the brain trusts at the Federal Reserve and
Treasury and White House all want the dollar to fall even
more. It's good for our exporting industries, the
politicians say. That's true, but it's very bad for U.S.
consumers and savers and almost everyone else living in a
U.S. zip code. A feeble dollar gums up the consumption
engine that powers most of the U.S. economy... and a large
portion of the global economy.

-"Other countries share in the deep commitment to keep
U.S. consumers laying out their cash," observes CNN/Money's
Justin Lahart."Big exporters - Japan and China in
particular - have strived to keep their currencies low
against the dollar, allowing Americans, in effect, to buy
more of their stuff. U.S. consumer spending accounts for
around 20 percent of world gross domestic product.

-"So the world economy is leveraged to the U.S. consumer.
And the U.S. consumer is leveraged to the hilt... At some
point the U.S. consumer's creditors - which is to say the
rest of the world - may have second thoughts about how
their money is being used."

- This nightmare scenario features a buyer's strike by
foreign investors that causes the dollar to slide and U.S.
interest rates to rise... What then would become of the
American consumer?

-"We're a what's-my-monthly-payment nation," says Northern
Trust chief U.S. economist Paul Kasriel."The idea is to
have my monthly payments as high as I can take. If you cut
interest rates, I'll get a bigger car."

- If the dollar keeps sliding, America's what's-my-monthly-
payment consumers will be making much higher monthly
payments. But very few stock market investors are worrying
about such things. Stocks are rising and that's all that
really matters.

- Didn't investors learn anything from the 1990's?... $7
trillion of shareholder wealth disappeared between February
2000 and October 2002. Somebody somewhere must have lost
some of that money. Nevertheless, greed is much more
evident than fear.

-"You would think that seeing such a massive amount of
wealth wiped off their books would have made investors
cautious about the market - deeply mistrustful, even - but
that hardly seems to have been the case," notes CNN/Money.
"Flows into the mutual funds are steady, online trading has
picked up and casual conversation is turning back to what
stock did what. Even more distressingly, the stocks that
have been doing the best are the sorts of highfliers that
got investors into so much trouble last time around."

- The stock market bulls are back, their ranks are
swelling, and they are fearless. Most sentiment indicators
are showing levels of bullishness that exceed that of both
2000 and 1987. [More from Steve Sjuggerud, below... ]

-"There is a whiff of 1987," says the New York Times'
Floyd Norris,"and not just in the buoyant sentiment
indicators. Then, as now, there was international economic
discord. The dollar was weak, and the Treasury secretary
was criticizing policies of others for harming the world
economy."

- But that was then... History could not possibly repeat
itself, could it?

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

Bill Bonner, back in Rancho Santana...

***"Corporate profits will continue to go up," opined a
fellow on the TV the other day,"because companies are
getting so good at cutting costs."

Aha, we thought, what an imbecile...

A single corporation can improve profits by cutting costs.
But one man's cost cuts are another's income. A business
can fire an employee, for example. But then the employee
will buy fewer products. Or, it can force suppliers to
reduce prices; but then, the suppliers must cut costs too.
Taken all together, an economy cannot get richer by cutting
costs (though individuals may... ).

***"We have our own little bubble, right here," observed a
partner yesterday.

Five years ago, your editor invested in a daring venture.
He and some friends bought a large parcel of land on the
Pacific Coast of Latin America. It seemed almost mad at the
time. Nicaragua had passed through the Sandinista period,
but was still politically unsure. And the land itself was
only reachable by a dirt road that washed out in the rainy
season. But it was beautiful land. And very cheap. Even if
it doesn't work out as a business project, your editor was
able to say to himself, it will be great to own and enjoy
alone. He half wished the development would flop... for he
could imagine himself in his own private Eden, free from
the Internet.

Alas, it has sold so well there is almost nothing left. A
lot that sold for only $17,000 is now on the market for
nearly $70,000. And now there is an office with three
computer terminals and a satellite dish. So, your editor
shuts himself off from the morning songbirds, lowers the
blinds against dawn... and at 4 A.M. sits down to his
computer screen to enjoy the fruits of progress.

*** In other news... Financial Reckoning Day, the fruit of
our labor, made it to the NYTimes Best-seller list
yesterday - but only on-line. Apparently, they publish the
top #15 spots on-line and only the top 5 in the actual
printed newspaper. Guess where we are?

Who cares about the darn print edition anyway!

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

The Daily Reckoning PRESENTS: Newsletter writers, as a
group, are now as bullish as they've been since 1987. When
optimism reaches extremes as it has right now, warns Steve
Sjuggerud, there is nobody left to buy... which can pose a
problem.


THE SCARIEST SCENARIO IMAGINABLE
By Steve Sjuggerud

I never thought we'd see the day... the day when wild
speculation actually exceeded the excesses of the late
1990s. And I really didn't think it would just take four
years to get there. But here we are...

Investors are actually borrowing money to buy Nasdaq
stocks. In fact, more people are borrowing more money to
buy stocks today than at any time in history, including the
"Great Bubble" of early 2000.

The result? Just like in the days of the Great Bubble, the
'garbage' stocks have soared, while sounder stocks have
struggled. A $10,000 investment a year ago in AskJeeves.com
(do you know anyone on the planet that actually uses
AskJeeves.com?) would be worth $220,000 today. Or how about
NetEase.com? $10,000 invested a year ago would be worth
even more than AskJeeves...

NetEase.com is valued in the stock market for over $2
billion (with a"b") dollars. Yet sales... yes, sales... over
the last 12 months were only $27 million (with an"m")
dollars. Who's buying this garbage at these prices? It
appears to be individual investors at online brokers...

Trading activity at online brokers in the most recent
quarter is up 40% from the same quarter last year. And this
is clearly 'hot' money... speculative money... At online
broker E-Trade, the level of margin debt in the latest
quarter (ended June 30, 2003) among E-Trade customers rose
by 31% over the previous quarter (ended March 31, 2003).

It's rampant speculation at its finest.

By contrast, look what corporate insiders - the 'smart
money' - are up to. Obviously corporate insiders know more
about their businesses than anyone else. Insiders are
generally right, but a little early in their selling.
Recently, they've been selling at a rate not seen since
1986. They were early back then... but they got out ahead of
the Crash of 1987, when stocks fell 22.6% in one day.

Looking at the latest data, corporate insiders set a dollar
record for the last decade... insiders sold $44.53 dollars
of stock for every dollar of stock they bought. That is
unbelievable.

"Insiders, of course, know much more than the general
public about their own stocks," Professor Henry Hu of the
University of Texas said in a news story on the subject.
"Ordinary investors are terribly naive - all they pick up
is what they hear from the their friends the financial
media. And, unfortunately, investors today still have this
pathological fear of being left behind if the market goes
up." (Some folks wrongly dismiss this figure, saying that
"Bill Gates regularly sells a ton of shares." What these
folks don't know is that these figures actually EXCLUDE
insider trades over $50 million - so the Bill Gateses of
the world are NOT included in this figure.)

It gets even worse when you look at tech stocks alone.
Kevin Schwenger, the insider data research analyst at
Thomson Financial, who puts out these numbers, told the
story in the Wall Street Journal... In August, $644 dollars
of stock were sold for every dollar of stock bought by
insiders at semiconductor companies. As a frame of
reference, $20 sold for every dollar bought is considered
bearish...

Yikes...

While the 'smart money' sells tech stocks in record
amounts... the 'dumb money' is taking on debt to buy these
stocks on margin. By my studies, the 'dumb money' is at an
extreme of optimism not seen since, well, right before the
1987 crash... In the last few months, individual investors
have become more bullish than at any time in history (as
measured by the American Association of Individual
Investors sentiment poll), except in 1987.

And the same is true of newsletter writers. The folks who
write investment advisory letters (like me), as a group,
are now as bullish as they've been since 1987 (as measured
by Investor's Intelligence, who has been monitoring these
things since the 1960s).

When optimism reaches extremes, as it has right now, quite
frankly, there is nobody left to buy... Individual
investors have been buying... newsletter writers and
analysts have been buying... and the pros have been buying.
There is no 'greater fool' left to buy and hope for a
higher price. There is nobody left to buy.

We're extremely close to the scariest scenario imaginable,
at least from my perspective.

There are three major ways to size up the markets to get
some clues on where it might be headed: fundamental
analysis, technical analysis, and analyzing the market
sentiment. All three reveal a gruesome spectacle.

We've already made the case about market sentiment - the
dumb money is at a record level of optimism, while the
smart money is at a record of pessimism. Which crowd do you
want to be with?

In the case of fundamentals, stocks are still more
expensive than they've been at any time in history. We are
still at 30 times earnings and three times book value in
the case of the S&P 500 Index of the big, boring stocks.
And of the tech stocks, oh my... by my calculation, the
companies of the Nasdaq 100 are trading at a price-to-
earnings ratio of 49. To explain this in plain English, if
you were buying a stock with a P/E ratio of 49 as a
business, it would take you 49 years to break even on your
investment. Why would anybody in their right mind borrow
money to invest in that?

The Nasdaq 100 Index is trading at 8 times sales. If you
were buying this business, that means if you paid yourself
every penny of sales for the next eight years, you'd break
even. Of course, you can't pay yourself every penny of
sales. Rent needs to be paid, salaries need to be paid, and
of course it will cost you money to make your product. In
other words, getting your money back in eight years is a
total pipe dream. The basic point is, fundamentals in tech
stocks are horrific.

All that's left is the technical analysis - the major
trend. The trend has not broken down yet... but in the face
of horrific fundamentals in the tech-heavy Nasdaq 100, and
the truly scary insider selling in the tech stocks, it is
time for us to place our chips on the table that the Nasdaq
100 will be lower a year from now than it is today.

When the market breaks down, you can't say you weren't
warned...


Regards,

Steve Sjuggerud
for the Daily Reckoning

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• The Daily Reckoning - The Scariest Scenario Imaginable (Steve Sjuggerud) - Firmian, 08.10.2003, 09:18