- Lighter Than Air / The Daily Reckoning - - Elli -, 03.07.2003, 16:20
Lighter Than Air / The Daily Reckoning
-->Lighter Than Air
The Daily Reckoning
Paris, France
Thursday, 3 July 2003
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*** Tech Stocks - go, go, go! Insiders sell, sell, sell!
*** Not a textbook deflation...not a textbook inflation,
either. What do you do?"Gold is the no-brainer of our
lifetimes."
*** Starbucks +6%! California is broke. Tax cuts begin.
Dollar falls against Argentine peso...Shanghai stocks...and
the Glorious Fourth!
---------------------
Another great day on Wall Street...
That is, if you were an insider selling your shares at
prices they did not deserve; the little guys came into the
market to buy them from you.
Yet another calculation, this one by Vickers Weekly
Insider, shows the 8-week moving average of sales compared
to purchases running at 4.11 to 1. The last time the ratio
was over 4 was in May of last year - just before the Dow
fell from 10,353 to 7,286.
The lumps are coming into the market like tourists at the
Port Authority bus terminal, ready to have their pockets
picked. The American Association of Individual Investors
reports that it members are 7l.4% bullish while only 8.6%
are bearish. The bullish percentage is almost as high as
the all-time peak, which was reached on January 6 of 2000 -
- just before the worst bear market since the 1930s.
But what do we care about these yahoos? Isn't this the way
it is supposed to work? The sun rises in the East and sets
in the West. Jelly sandwiches fall face down. Lots of poor
investors make a few rich ones. And when you're worried
about the world going to hell in a handcart, you buy gold
to protect yourself.
Sometimes inflation threatens the world's paper money
system. Sometimes deflation menaces it. It is theoretically
impossible for both of them to pose a threat at the same
time. But here at the Daily Reckoning, we're too na simpleminded to worry about the contradiction; we see a
danger from both inflation and deflation.
"In a textbook deflation," my old friend Rick Ackerman
helps to explain this dizzy situation,"cash supposedly is
king. This implies that, to survive deflation, you must
stay mainly in cash or near-cash until a bottom is reached.
But this is not a textbook deflation; rather, it is like no
other deflation that has occurred before in human history,
since it will be the first to emerge atop a global currency
system that has been hollowed to the core."
All over the world, central banks are lowering interest
rates, printing money, and buying bonds. It is"inflate or
die," as Richard Russell puts it. We suspect it will be
both. Creating money out of thin air won't stop the
deflation in financial assets or reverse a worldwide
economic slump. But it will eventually destroy the paper
currencies in which this magic money is calibrated. Real
money, by contrast, will be more appreciated than ever
before.
"Gold is the no-brainer investment of our lifetime," Rick
continues."Moreover, it offers an opportunity to leverage
the destructive force of a millennial deflation that is
certain to devastate the net worth of millions of
investors, as well as to ravage valuations across a broad
swath of asset classes. Let me go on record as having
begged you to move immediately into gold, perhaps with 10-
20% of your investment capital.
"As far as I can recall, it is unprecedented that the
escape route from a severe economic downturn should be so
cheap, so obvious, and so essentially risk-less."
Eric? Your thoughts please...
---------------
Eric Fry writing from Wall Street...
- Hmmnn...brand new quarter, same old result. In fact, the
result seemed so old as to be utterly 'retro.' The stock
market's months-long rally powered ahead yesterday. Tech
stocks rallied like it was 1999. Names like Cisco Systems
and Juniper Networks led the Nasdaq to a 2.4 percent gain
to 1,679 - a new 13-month high for the technology-charged
index. The Dow surged 102 points to 9,143.
- Outside the tech sector, Nasdaq icon Starbucks jumped 6
percent to reach a 52-week high after reporting that it
sold about 10% more lattes, frappuccinos, espressos and
"double-grande-half-caf-soy-vanilla cappuccinos" than they
did last year.
- The rising stock market, like a potent narcotic, dulls
investors' sensitivity to adverse economic trends. But
rising share prices can't make the painful economic data go
away. No matter how high Starbuck's stock soars, for
example, consumers continue to choke on debt and businesses
continue to resist hiring workers.
-"Wait and see" has become the prevailing philosophy of
the land, or at least the prevailing philosophy of the
private sector. Over in the public sector, the all-weather
"tax and spend" philosophy still pertains. However, the
state and local governments have been doing more taxing
than spending these days. Thirty states have raised
cigarette taxes since the beginning of last year.
Meanwhile, spending cuts are all the rage.
-"There will be a little less 'rockets' red glare' across
the United States this Fourth of July," Reuters reports,
"as some fireworks displays have been cancelled or scaled
back due to local government budget troubles. With the
national economic slowdown eating into state and local tax
revenues, governments have less money to spend on the
traditional displays, which can typically cost $1,000 to
$2,500 a minute."
- As the states' budget surpluses go up in smoke, one-by-
one, $25,000 fireworks shows begin to seem more
ostentatious than patriotic. So maybe the government bean-
counters are right to cut back on fireworks. But it just
doesn't seem right. And besides, we suspect that most
taxpayers would rather pay for a bad fireworks display than
a good congressman.
- Struggling state finances are simply one of the hallmarks
of the post-bubble environment. Bear-market rallies are
another."Even bear markets bounce," David Tice reminds us.
David is both a friend of your New York editor and the
manager of the Prudent Bear mutual fund.
-"Here we are in the season of summer reruns," says Tice,
"and sure enough, we've seen this stock market before. The
S&P 500 and Nasdaq are deep into the black year-to-date,
and up 22 percent and 26 percent from their March
lows...This doesn't remind me so much of the U.S. in 1999
as it does Japan in 1993. Although down some 60 percent
from its bubble peak, the Nikkei rallied 25 percent from
early March to early June of '93...The April '93 issue of
Business Week described the bullish mood this way:
'Analysts now think the Nikkei will head toward 21,000
before long. That would bring the market's average price-
earnings ratio back to a lofty 70, compared with 35 at its
bottom last year. Yet stock-pickers seem unworried by that
prospect.'
-"Sound familiar?" Tice continues."Today's investors in
U.S. stocks aren't sweating much over valuation either. By
virtually any measure, stock valuations have more in common
with bull market tops than bottoms...Such bullish
enthusiasm has Yahoo! selling for three times the 2002
revenues of the entire online advertising industry - a
valuation truly worthy of an exclamation point."
- Tice says the bear market rally is almost over...but the
bear market itself is far from over. The bear market will
not end, says Tice,"until either (1) prices come down
substantially, or (2) stocks meander long enough for
earnings growth to make valuations compelling...It looks to
me like this U.S. bear has a long way to run."
---------------
Meanwhile, Bill Bonner back in Paris...
*** California is broke. In Connecticut, the governor
called out troops to force lawmakers to come up with a
budget.
*** This week, thanks to the Bush tax cuts, a single guy
making $50,000 per year will take home another $8. We never
met a tax cut we didn't like. But we can't help but wonder
where the $8 comes from. Did the Feds make the troops in
Afghanistan or Iraq skip lunch? Did George W. Bush take a
taxi over to the Pentagon? Did the universities decide they
really didn't need another copy of"Hidden Lesbianism in
the Writings of St. Thomas Aquinas" for the campus Gender
Studies library?
"No," we are told."They borrowed the money from the
Japanese."
"How will we pay it back?" we ask.
"Silly fools," comes the reply,"we will never pay it back.
Because the Japanese admire our dynamic economy so much
they will continue to lend, more and more, forever.
Besides, if they don't lend us money, we won't buy their
Toyotas or their sushi."
*** The Australian dollar is at a 5-year high against the
U.S. brand. The NZ and Canadian dollars are also at multi-
year highs. Is there any currency that isn't rising against
the dollar? Even the Argentine Peso is going up; it's
gained nearly 30% in the last 12 months.
***"Asia or Bust" begins a Barron's headline."U.S. Tech
firms increasingly move jobs overseas." Small wonder. An
engineer in Shanghai earns only about one one-seventh as
much as one in Silicon Valley. So, Asia booms...while the
developed world slugs along.
*** How to take advantage of it? Buy a company in Shanghai,
suggests Shu Yin Lee in Barron's. Despite the growth,
property prices in Shanghai are about 30% of those in New
York, and the companies are cheap, too. China Overseas Land
sells for 8.9 times earnings. Hopson Development Holdings
has a P/E of only 8. And Shanghai Real Estate's P/E is only
7.6.
Warren Buffet likes Petrochina - a large oil company with a
P/E of about 9 and a dividend yield of 5%. For more, see:
The China Strategy Report
http://www.agora-inc.com/reports/CSR/WCSRD711/
*** Tomorrow is the 4th of July, when America celebrates
its independence. The Revolutionary War was won - and here
we remind readers of one of those natty little details of
history they might prefer to forget - by the courage of the
French, whose fleet blocked the entrance to the Chesapeake
Bay, stranding British troops at Yorktown, Virginia.
More on the Land of the Free and the Home of the Brave...
tomorrow.
----------------------
The Daily Reckoning PRESENTS: Eric Fry sniffs out the
latest frothy issuance of America's great bubble-blower...
and turns his head with a wince.
LIGHTER THAN AIR
By Eric J. Fry
It's official: The bond market is a bubble. GM's brand-new
$17.6 billion offering is positive proof.
Investors are so desperate for yield - any yield - that
they will make a risky loan - any risky loan - to get it.
Along comes cash-light, debt-heavy GM, offering up a great
big bundle of near-junk paper that promises to pay
investors 4% more per year than a Treasury bond. Enticed by
the plump,"American-sized" yield, investors lined up to
buy the deal, turning a blind eye to the automaker's
parlous financial health.
Unfortunately, in the case of bond yields, bigger is not
always better, especially when bigger isn't all that big.
But when markets are rising, investors tend to buy first
and ask questions later. In other words, bond buyers have
become very indiscriminate, and an indiscriminate buyer is
a stupid buyer. It follows that wherever many
indiscriminate buyers congregate - like in the bond market,
for example - many stupid purchases are certain to occur.
And when many stupid purchases occur in rapid succession,
prices rise to stupid levels.
Before you know it, you've got a full-blown bubble.
The stock market bubble of the 1990s (as everyone belatedly
calls it) was merely the first of the serial financial
bubbles of the Greenspan era. Financial excesses spewed
forth from Greenspan's monetary policies like bubbles from
a child's bubble-wand. The bond bubble is simply
Greenspan's latest frothy creation.
When - not if - the bond bubble bursts, the resulting
economic concussion could make the stock market's three-
year implosion seem like a mere tremor before the bond-
market Vesuvius. A burst bond bubble, for example, would
devastate stocks, particularly the stocks of homebuilders.
Some of the strongest evidence in support of the bond
bubble argument is the"sniff test." This thing just
doesn't smell right. Even an investor who knows nothing
about current economic conditions in the U.S., but a little
something about the history of government finance, should
be repulsed by the stench of 3% yields on a 10-year
government bond. Like a week-old tuna fish sandwich, it
just doesn't smell right.
The anecdotal evidence of irrational exuberance in the bond
market is also plentiful."The deflation alarms have caused
savers to climb stepladders to reach for yield in the upper
branches of barren trees," observes James Grant, editor of
Grant's Interest Rate Observer. GM's rotting balance sheet
may be one of the most barren trees on the fixed-income
landscape. The express purpose of the automaker's titanic
$17 billion bond offering - the largest ever by an American
corporation - is to shift liabilities from one corner of
its balance sheet to another corner.
Like a college kid borrowing money from Mom and Dad to pay
his credit card bills, GM is using the bond offering
proceeds to pay off other debts. Specifically, most of the
proceeds are earmarked for bolstering GM's badly
underfunded retirement plan...Of course,"issuing debt in
an amount equal to about half its equity-market
capitalization to finance future benefits is a stark
reminder of the extent to which GM's fate resides largely
with its unions and retirees," remarks Barron's Michael
Santoli.
"Although GM touted the debt issuance as 'an overall effort
to accelerate improvements in GM's balance sheet and
financial flexibility,' the truth is that GM is merely
substituting one debt, much of it off-balance sheet, for
another debt that remains on the balance sheet," observes a
very skeptical Apogee Research."Can anyone realistically
consider this outcome a positive indicator for GM's future
prospects?...This is nothing more than a red flag signaling
that escalating pension and 'other post-retirement employee
benefits' (OPEB) obligations are placing a menacing burden
on the interests of common shareholders.
"Simply put," Apogee continues,"the $17 billion of debt-
raised proceeds is not going toward R&D or product
development or improved manufacturing processes, any of
which might conceivably improve the fortunes of the common
shareholder. Instead, the proceeds will go to support the
growing needs of GM's substantial retiree base." All
together, GM's underfunded pension liabilities total a
staggering $75 billion. Even the largest-ever $17 billion
corporate bond sale, therefore, is literally a drop in the
bucket. But none of this troubling math seems to vex the
folks who are clamoring to lend GM billions of dollars.
Statistically speaking, the bond market is also looking
very bubblesque."The bond market surge in recent months
looked and felt much like the spike from 3,000 to 5000 in
Nasdaq in late-1999 to early 2000," observes Donald
Straszheim of Straszheim Global Advisors."Consider the
similarities - Treasuries and the Nasdaq. The Nasdaq rose
320% (April 1997 to March 2000), 1201 to 5048. In a shorter
span, it rose 260% (October 1998 to March 2000), 1419 to
5048.
"In Nasdaq, the 3000 to 4000 move took just 70 trading
days. If there ever was a mania, this qualified. In the 5-
year Treasury, the yield declined 70% (May 2000 to June
2003), from 6.83% to 2.08%. In a shorter span, it declined
by 57% (April 2002 to June 2003). This decline in yield
(price rally) is unprecedented in the postwar era....The
deflation story has been overdone," Straszheim winds up.
"Fashionable for a time, the Fed has plenty of capability
to flood the system with liquidity in the effort to avert
deflation....We don't expect an inflationary surge in
rates, but recent lows were far below sustainable."
What has been helping to sustain these"unsustainable"
yields, of course, is the massive flood of dollars into
bond mutual funds. In the 12 months ended April, $160
billion of new cash flowed into bond funds."The bond
market is over-bought, over-valued [and] over-leveraged,"
says Jim Bianco, president of Bianco Research in Chicago.
We wouldn't argue with him. So letting this bubble float on
by seems like the best way to stay out of harm's way.
Regards,
Eric Fry,
The Daily Reckoning
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