-->Moving The Goal Posts

The Daily Reckoning

Baltimore, Maryland

Thursday, 29 May 2003

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

*** What would the old-timers think?

*** A 66% tax increase? Are you kidding?

*** Stocks up...bonds down. Gold down too. A tech revival...ha ha
ha...Atavistic Capital...and more!

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

The way to make money in stocks, said the old-timers, was to buy
solid companies that paid good dividends. You make money by
reinvesting the dividends, thus letting the new money breed with
the old. Over time, you'd get an expanding population of dollars.

The idea of buying stocks in hopes that they would go up in price
seemed reckless and absurd. Stocks were risky; they might just as
well go down in price as up. And the companies they represented
might go out of business. So stock investors wanted a 'risk
premium' -- a little extra dividend from stocks, as compared to
bonds, to make up for the risk of losing money.

But in the Great Boom of the last 25 years of the 20th century
changed attitudes. People began to think that the old fuddy
duddies were wrong; the new way to make money was faster and
easier. All you had to do, they said, was to buy stocks...and then
sell them later (when you needed the money for retirement) to some
Greater Fool who would come along at just the right moment, his
pockets bulging with lucre.

The Dow crested in 2000 at 11,722. It dropped as low as
7,286...and now seems to be on a modest rebound. Three years into
a Great Bust, people still believe in the promise of the boom.
They buy stocks at an average P/E that would have made the old-
timers gasp. Investors still believe that someone will come along
to buy them at higher prices. But where will the greater fools
come from?

Foreigners have taken huge losses from their dollar-based assets.
Europeans, for example, are down 25% since the beginning of the
year because of the dollar. And the pool of buyers in the U.S. is
threatened by two things: demography and economics.

The worldwide boom has turned into a worldwide slump. Incomes are
barely rising. And overseas manufacturers are undercutting prices.

Meanwhile, people in the developed countries are getting older. As
the years pass they become less willing to wait for the next fool
to come along, no matter how great he is; they need income.

Not only that, people facing retirement strain the entire boom-
time financing system. Instead of borrowing, spending and
investing, they turn to saving. Believe it or not, savings rates
are edging up -- even in America.

Before he joined the unemployed, Paul O'Neill, then U.S. Treasury
Secretary commissioned a study of how much it would cost for the
government to keep its promises to the baby boomers. Now
completed, the Financial Times, had this comment:

"The study's analysis of future deficits dwarfs previous estimates
of the financial challenge facing Washington. It is roughly
equivalent to 10 times the publicly held national debt, four years
of US economic output or more than 94 per cent of all US household
assets. Alan Greenspan, Federal Reserve chairman, last week
bemoaned what he called Washington's"deafening" silence about the
future crunch...."

The studiers concluded that an immediate tax increase of 66% is
needed.

The fuddy-duddies would be shocked again. How can you expect a man
to stomach a huge tax increase when he is already up to his neck
in debt and living paycheck to paycheck, he would want to know?

The baby boomers who are buying stocks might pause for a question
too. Where will the greater fools get the money to buy their
stocks? Why will they want to?

Eric?

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

Eric Fry writing from Wall Street...

- The stock market continued its bull-market-esque performance
yesterday - gaining ground for the fifth straight day. The Dow
added 12 points to 8,793, while the Nasdaq jumped about half a
percent, to 1,563. But even as the virile stock market continues
its advances, the economy hesitates like a coy virgin. Durable
goods orders dropped 2.4% in April, the fourth decline of the past
six months.

- Nevertheless, most financial market participants seem to believe
that the economy is all but certain to recover during the second
half of the year. Accordingly, government bonds fell for a second
straight day and the dollar rebounded a bit against the euro. The
30-year Treasury bond fell half a point, pushing its yield up to
4.42% from 4.39% on Tuesday.

- Despite the expectation that the economy will soon start flexing
its muscles, the long-dated treasury bonds seem to be priced for
recession or deflation, or both. As such, the mere suggestion that
consumer prices might rise more than 1% or 2% per year could send
shock waves through the bond market.

- The current macro-economic environment is nothing if not
conflicted. Deflationary phenomena seem to be just numerous as
inflationary phenomena. Therefore, while your New York editor is
satisfied that inflationary auguries abound, your Paris-based
editor observes numerous symptoms of deflation coursing through
the US economy...Like job losses, for example.

-"America's biggest export is jobs," your Paris-based
correspondent observed last week at the gathering on Amelia
Island. It's true, the US manufacturing sector has suffered
mightily during the last three years. More than two million
manufacturing jobs have disappeared over that timeframe -- and
most of those jobs have disappeared for good...or else they will
be reincarnated as low-paying jobs working the deep-fryer at
Kentucky Fried Chicken...The GM welder who loses his job this
month, may have little choice but to become a Starbucks barrista
next month.

- However, while"smokestack America" struggles, the erstwhile New
Economy seems to be reviving...ever so slightly."Yesterday's
technology bust has purged much of the capital spending excess of
the bubble," says Morgan Stanley's Richerd Berner,"and today a
tech revival is the main island of strength in an otherwise dreary
manufacturing outlook.

-"While the tech revival is healthy," Berner continues,"so far
it's really just about 'maintenance and repair.'...The evidence
for revival: Nominal bookings for information technology gear
jumped 25.3% at an annual rate in the first quarter, the strongest
pace in three years. Accordingly, output for computers,
communication equipment, and semiconductors accelerated to a 15.3%
annual clip in the three months ending in April."

- The lumpeninvestoriat has acknowledged the molehill-sized
recovery in the tech sector with a mountain-sized Nasdaq rally.
The tech-powered index has soared a remarkable 40% since last
October.

- Are the financial markets as conflicted as the economy?
Bridgewater Associates points out that stocks rarely rally while
bond yields and the dollar are both tumbling. And yet, that's
exactly what's been happening for the last couple of months.
Typically, rising share prices signal economic expansion, which
typically coincides with rising bond yields and a strong dollar.
What do the current divergences imply? Which market is correct?
Are any of them correct? If forced to hazard some guesses, we'd
say that the bond market is delusional, the stock market is over-
anxious and the dollar market is right as rain...But we're just
guessing.

-"Listening to the incredible comments being made by U.S.
policymakers these days," observes Stephanie Pomboy of
MacroMavens,"one can't help but feel trapped in a bizarre dream
where the most bedrock of principles bend under the weight of
abstraction like the watches in a Salvatore Dali painting...Things
first took a turn for the surreal last November when Ben Bernanke
made his now famous speech [about printing dollars for almost no
cost]...Bernanke's speech deserves a prominent place in the annals
of dollar history. With it he ushered in a new phase for the
dollar...one in which its weakness is exploited as a means to buoy
exports and restore domestic pricing power. But will it work?"

- Well, we suspect the endeavor to create a feeble dollar will
succeed. But as for the"buoyed exports" and"restored pricing
power" part of the plan, we have our doubts.

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

Bill Bonner back in Baltimore...

*** When stocks get this high, Richard Bernstein recently figured,
the likelihood is that they will lose a third of their value over
the next 10 years.

*** The trade deficit gets worse. West Coast ports at Long Beach
and Los Angeles report that in-bound cargo traffic is up 7% over
last year. Outbound, traffic is down 3%. And 29% of outbound
containers are empty...a number that is more than half those
coming in.

*** Amazon.com is at a 52-week high. We repeat our comment from
yesterday: ha ha ha ha ha....

*** There is a record number of unsold homes in the Denver area.
House prices in the UK are falling.

*** The money supply (M3) is increasing at a 7.2% annual rate. It
rose by $10 billion last week. But the Fed is stepping up its
purchases of treasury bonds at an 11% annual rate. Normally, this
would be seen as a sign of impending inflation. But bond investors
are unconcerned. TIPS, the 10-year inflation adjusted treasury
notes, are priced to yield just 1.78%. A regular 10-year note
yields 3.47%. The difference -- a rough measure of what bond
buyers expect from inflation -- is only 1.69%.

*** We were down in Amelia Island, Florida, last week at a private
conference for investment analysts, gurus and financial advisors.
We have been meaning to report to you some of the best investment
suggestions that were presented at the conference, but have not
gotten around to it. Nor will we mention any today.

Instead, we pass along this anecdote.

On their way to a restaurant, a group of us boarded a bus, which
stopped to pick up other Amelia Island vacationers. An attractive,
bejeweled older woman sat down next to your editor and struck up a
conversation.

"What brings you gentlemen down here?"

"We're financial writers and analysts."

"Oh...I put all my money with a guy in Miami. Do you know him? His
name is Feldman, with Atavistic Capital...or something like that.
I just found him. A friend of a friend introduced him."

"What kinds of investments does he look for," we asked.

"Well...I was in stocks. And then I lost a lot of money...I guess
everybody did. Now, he's putting me in bonds. That seems to be
what everybody is doing, isn't it?"

The woman got off at the next stop. Our group looked at each
other. Without a word, we all began to laugh.

---------------------
The Daily Reckoning PRESENTS: Comforting delusions in the pension
world seem to be colliding head-on with a very different reality.


MOVING THE GOALPOSTS
By Eric J. Fry

Americans will do almost anything to avoid saving money. They hate
it like a five-year-old hates broccoli. And just like that five-
year-old, they will grimace, whine, kvetch, and, yes, even lie to
avoid doing what is good for them.

They will tell themselves that stocks always go up in the long run
.. or that their home equity is all the"savings" they will ever
need. But such comforting delusions seem to be colliding head-on
with a very different reality. America is"savings-lite" -- a
condition that is likely to weigh on corporate profits and stunt
economic growth for years to come.

Most Americans don't save enough money in a year's time to buy a
week's worth of groceries. And what's true at the individual level
is also true collectively. Our government is borrowing about half
a trillion dollars a year, just to make sure that the barrels
never run low on pork. At the same time, America's pension plans -
- both in the private and public sectors -- are woefully
underfunded.

"For the past three years," Business Week observes,"the damage
from corporate pension-plan losses has been piling up like a slow-
motion train wreck. As stock prices stayed low and interest rates
declined, on average, plan assets have lost 15% of their value,
while their liabilities have soared 59%, according to money
manager and researcher Ryan Labs. The squeeze has vaporized
surplus assets in nearly all funds. Pension plans of companies in
the Standard & Poor's 100 index were showing a 16% deficit to
liabilities at yearend, down sharply from a 30% surplus two years
before."

Meanwhile, the accounts of the Pension Benefit Guaranty Corp.
(PBGC), the federal government-sponsored insurer of most pensions,
have swung from a surplus of $7.7 billion last year to a deficit
of $5.4 billion in the past 18 months.

Out in the public sector, a record 79% of U.S. public pension
plans are underfunded, according to Wilshire Associates of Santa
Monica, Calif."The phrase 'unfunded pension liability' has
returned to public officials' vocabularies," writes Bloomberg's
municipal bond guru, Joe Mysak."And to the vocabulary of bankers.
States and municipalities are thinking about selling more than $20
billion in pension obligation bonds." Is it not American ingenuity
at its finest, this idea of selling bonds to plug the gap created
by non-saving? Somehow, an apparently dysfunctional American
system seems to work, over and over again.

But maybe, the age of easy accommodation has about run its course.
Maybe the slumping dollar is signaling a change in the wind. Maybe
our savings-lite nation will not be able to borrow money as
effortlessly as it has in the past.

The bear market of the last three years has exposed America's
savings deficiency like a low tide exposes skinny-dippers. We've
been"swimming naked" for years, hidden from public view by a bull
market in stocks that kept us all chest-deep in capital gains. But
now, as the stock market ebbs, pension plan liabilities flow. The
PBGC estimates that the U.S. private pension system alone is
underwater by over $300 billion.

It's hardly surprising, therefore, that CFOs are scared to death
about the pension plan underfinding crisis."Global outsourcing
and consulting firm Hewitt Associates found that pension
shortfalls, pension regulations, and pension accounting are high
on CFOs' lists of concerns these days," CFO Magazine reports.
"More than half of the CFOs and treasurers at the 174 midsize to
large companies in the survey said they will need to fund a
pension liability this year.... More than 60% of the respondents
believe that pension cost volatility is either a major problem or
a serious concern."

Not only do the mounting corporate pension liabilities threaten to
divert cash flow away from productive uses like investing in R&D,
but also from unproductive uses like boosting corporate executive
compensation packages - including the packages CFOs receive. These
high-priced accountants thus have a very personal vested interest
in re-jiggering the pension accounting assumptions, rather than
taking legitimate measures to shore up the financial integrity of
the plans under their stewardship. Re-jiggering rather than
repairing is precisely the tack that Congress seems to be taking.

One prudent response to pension underfunding might be to rein in
costs while simultaneously accelerating contributions. But that
two-pronged approach would be painful, and, besides, it would
severely constrain the"profit growth" of many American
corporations...which could severely constrain the desire of
investors to pay 35 times earnings for stocks. And if investors
won't pay 35 times earnings for stocks, share prices might fall.
And if share prices fall, the pension plan deficits would become
an even bigger problem.

So in order to keep the game alive, the powers that be must
prevent the grim reality of pension underfunding from encroaching
upon the delightful fantasy of a bull market at 35 times earnings.
The solution is obvious, move the goalposts. In other words,
change the underlying assumptions about future expenses or future
pension plan asset growth.

To illustrate, let's imagine a hypothetical family breadwinner who
earns $80,000 per year. Now imagine that the breadwinner's family
spends $100,000 per year. (Sadly, this scenario is all too easy
for many of us to"imagine.")

The breadwinner is in deficit to the tune of $20,000 per
year...unless he changes his assumptions to achieve a balanced
budget, pension-accounting style. Which means he could either
assume expenses of $80,000, even though they are actually
$100,000, or he could assume annual income of $100,000, even
though it is actually $80,000.

Eventually, of course, the real-world gap between income and
expenses would produce unavoidable insolvency. But in the
meantime, the breadwinner and his family could enjoy the happy
illusion of budgetary balance, without having to curtail their
outsized spending.

This"solution," self-evidently, would be nothing more than a
charade, a tragic farce. But it would make life much more
enjoyable for a while...and that, dear reader, seems to be the
spirit of the new Portman-Cardin bill that is currently snaking
its way through the House of Representatives.

For starters, the pension bill would let companies use a separate
mortality table for blue-collar workers."In essence," the Rocky
Mountain News notes,"companies would not be required to pay as
much into the pension plan because they could assume blue-collar
workers will die sooner than other employees."

Such actuarial sleight-of-hand would be welcome relief for
companies like General Motors Corp. and Deere & Co., two companies
with the ignominious distinction of having amassed pension plan
deficits that exceed their respective market capitalizations. Not
coincidentally, these two companies also share the distinction of
having been selected as promising short-sale candidates by Apogee
Research.

GM, which strains under the weight of a monstrous $25.4 billion
pension plan deficit, possesses a market capitalization of only
$19.67 billion.

Another of the bill's ingenious measures is to allow the companies
with the most severely"funding-challenged" plans to reduce their
insurance premium payments to the PBGC, the federal pension fund
insurer. In other words, the companies that are most likely to
require a government bailout would pay the least amount for
insurance.

The last innovation proposed in the House bill would reduce the
present value of future pension liabilities, simply by changing
the interest rate used in the calculation. Specifically, the bill
would replace the 30-year Treasury bond rate with a higher-
yielding corporate bond index, thereby reducing the present value
of future liabilities by an estimated 10% to 15%. All together,
the House bill could save a company like GM about $2 billion per
year...for a while. And that would be welcome and immediate relief
for the cash-strapped automaker.

Sadly, however, none of the maneuvers proposed by the Portman-
Cardin bill would fortify our nation's pension plans. To the
contrary, they would weaken them, and further jeopardize their
ability to meet future obligations. The"good news" is that
corporations with underfunded plans could continue to report
illusory earnings growth while retaining cash for other uses like
research and development, capital investment and executive
compensation.

We will not quarrel with the possible merit of deferring pension
plan contributions. But we will point out that deferring the Day
of Reckoning does not eliminate it.

The pension-plan funding crisis will likely weigh on corporate
earnings for years. Likewise, the national savings shortfall will
probably stunt economic growth for years to come."In order to get
out from under the 16-ton sledgehammer of debt, companies use cash
flow to build reserves or retire bonds -- they don't invest,"
observes Bill Gross, the legendary bond fund manager."Consumers
begin to put away money instead of spend.... And the combination
induces a negative spiral or vicious cycle of even more
conservative behavior including job layoffs, which leads to muted
growth in personal income.... As the U.S. private sector
retrenches to a more normal historic average level of total
savings, it necessarily acts as an economic drag."

The Day of Reckoning beckons...

Eric Fry,
The Daily Reckoning