-->Caution Ahead

The Daily Reckoning

Paris, France

Thursday, 15 January 2004


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*** The mysteries of the 'voting machine' revealed!
Americans more confident than ever...

*** Aiming for Mars... Lap-dance of liquity... Salvation by
devaluation...

*** Oil... trouble in 'Credit Card Nation'... Rallyes... and
more!

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A question for you, dear reader:

What moves voters to cast their ballots one way or the
other?

Do they carefully study the arguments, the evidence, the
logic of the contestants' claims and promises? Or do they
give their vote to the man who shakes their hand... who says
the things they want to hear? Is it rational scrutiny or
sentiment that moves them?

You probably know our answer. A man may be a perfectly
decent brickmason or accountant. He drives down the road
day after day and does the right thing most of the time. He
poses no threat to his neighbors and can be counted on not
hijack commercial airliners. But put him in a voting booth
and he loses all his reliable points of reference. His
experience counts for nothing. He has no way of judging the
merits of the issues or arguments - 'national
security'... 'better health care for seniors'... 'fair tax
proposals'... 'peace in the mideast'... 'democracy in
Iraq'... they are all just hollow slogans and pet clichés.

All he has to guide him is the politician's smile... a
'feeling' that things are going well or badly... and a guess
about which humbug is likely to do the least damage.

In the short run, as Buffett points out, the stock market
is a giant"voting machine." Investors place their money as
recklessly as their ballots - based on nothing more than
vague sentiments and feelings. When they are feeling
bullish, they buy. When they are feeling bearish, they
sell.

In markets as in politics, the masses' sentiments are given
shape and focus by the mass media. Thus do millions of
people come to think just about the same thing at just
about the same time.

We can judge the mood of the public - or what Gustave Le
Bon called their"general belief" - by looking at the a few
broad measures. In 1974, the average investor would buy a
stock if, each year, it earned about 15% of what he paid
for it. A quarter of a century later, he was willing to buy
the same stock even though it only earned about 3% per year
of his purchase price.

Another way of measuring popular sentiment is to compare
the price of gold to the price of Dow stocks. There is no
particular reason why the average lumpenvoter should prefer
gold to stocks some times and not others... except that his
general sentiment has changed. Sometimes he is hopeful,
positive, optimistic, expansive, activist... and sometimes
he is not. When he is feeling good about the future... he
prefers stocks, for they represent growth, technology,
business, profits and all the good things he sees coming
his way. When he is feeling fearful, on the other hand, he
sells the stocks and buys gold."Just in case," he tells
himself. The stocks might be worth nothing tomorrow. The
gold will still be there.

According to Ian McAvity, the ratio of gold to the Dow has
been about 5 to one since 1900. That is, it took 5 ounces
of gold to buy the 30 Dow stocks. Gold trading was halted
in the U.S. by Franklin Roosevelt, but resumed in 1968.
Since then, the ratio has been about 8 to 1, says McAvity.
But today it is nearly 25 to 1.

Mass sentiment can also be calibrated in terms of debt.
When people feel expansive and positive, they are willing
to go into debt to realize their project, confident that
things will work out somehow. When they are feeling
pessimistic, they pay off their debts, trim expenses, and
wait until conditions improve.

How are Americans feeling today? The ratio of debt to GDP
averages - over the first 8 decades of the century - only
about 1.6 to 1. Currently, it is more than twice as
high... a new record.

Never before have Americans been so confident... so
optimistic... so expansive... so activist - so mad! They
borrow more than ever before and go bankrupt at the fastest
rate in history. They spend more... even as they earn less.
They buy stocks, hoping they will go up... even though they
have already gone up to levels that are about as high as
they ever get. And their president has given them the
biggest government deficits in history... and the most
ambitious foreign policy. Not content to plant the flag in
Babylon, today's paper tells us he is aiming for Mars! We
can hardly wait...

And now, over to Eric Fry... with more news:

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Eric Fry, observing the raucous ballet on Wall Street...

- A"lap dance of liquidity" is powering the stock market,
according to one female commentator on CNBC. Unfortunately,
we have no firsthand experience with lap dances, so we must
defer to her expertise on the subject and assume that the
metaphor is apt... A"lap dance of liquidity" seems as
plausible an explanation as any for the titillating trading
action on Wall Street and for the ecstatic squeals and
moans of delight issuing from satisfied - very satisfied -
investors.

- But is the liquidity provided by the Fed really the main
influence that's getting a rise out of the stock market
these days? Isn't it more likely that a"strip-tease of
speculation" is lifting share prices? Sadly, the strip-
tease of speculation is always followed shortly thereafter
by the frenetic"samba of selling."

- Yesterday, however, investors were too busy kicking up
their heels to worry about the repercussions that might
follow. A melodious combination of good news and hopeful
rumors set an upbeat tempo for the day's stock-buying.
First up, the U.S. trade deficit narrowed in November to
$38 billion, well below the trend of prior months."The gap
during November was the narrowest in 13 months," Bloomberg
reports,"and followed a shortfall of $41.6 billion a month
earlier... The trade deficit with China narrowed to $10.8
billion from $13.6 billion."

- The trade report's release yesterday morning produced a
simultaneous dollar rally and gold selloff, while also
setting a bullish tone for the stock market. The greenback
surged nearly 1% against the euro to $1.265. Gold swooned
as much as $6.00, then recovered gradually throughout the
day to finish the New York session down $2.00 at $422.00 an
ounce.

- Here on Wall Street, rumors were flying all day that the
upcoming earnings releases from Intel, Yahoo and Apple
would"beat the number." Alas, all three companies reported
merely respectable results after the close of yesterday's
trading. Investors had hoped for so much more from the
three tech bellwethers that all three stocks slumped in
after-hours trading. But enough about unrealized
expectations... During Wednesday's trading, investors seemed
to enjoy the fulfillment of each and every expectation. The
Dow jumped 111 points to 10,538, while the Nasdaq Composite
added 15 points to 2,111.13.

- The surprising drop in the trade deficit seemed to
validate - momentarily - Greenspan's gospel of"salvation
by devaluation." For two years, Greenspan and his
pinstriped minions have been coaxing the dollar lower,
while threatening to print limitless amounts of greenbacks
if the currency refused to decline. And for two years, the
chairman has assured us that devaluing the dollar would
boost the economy and narrow the trade deficit.
Unfortunately, for most of the last two years the economy
languished and the trade deficit ballooned. And the trade
deficit seemed destined to expand forever... until
yesterday.

- The deficit finally narrowed, thanks to an improving
balance of trade with every major trading partner. The
deficit with the European Union, the second-largest trading
partner of the U.S. last year, narrowed to $7.4 billion in
November from $8.7 billion, while the deficits with Canada,
Mexico, China and Japan all contracted as well.

- But the Fed did not allow itself even one brief moment to
relish its achievement. Instead, it continued tirelessly
preaching the gospel of"salvation by devaluation." One day
after Greenspan amazed a Berlin audience with his audacious
disregard for the dollar's swoon, Ben Bernanke wowed
another gathering of European bankers in Geneva with a
similar message.

- Tuesday, you will recall, Greenspan strolled into a
meeting with the German Bundesbank and methodically annoyed
his European counterparts."Ich bin ein self-serving
American," seemed to be the main message of Greenspan's
Berlin address, as he praised the"productive" U.S. economy
growth path and shrugged off the dollar's steep decline.

- Bernanke picked up where Greenspan left off. A dollar
crisis is"extremely unlikely," said Bernanke."An
uncontrolled decline is unlikely to happen because it is
not in anybody's interest, including the Japanese."
Interesting theory... If we recall correctly, the 1929 stock
market crash was not in anyone's interest either, yet,
somehow, it still managed to occur.

- Greenspan's"salvation by devaluation" message has won
very few converts on the European continent. Numerous
European bankers and politicians have expressed their
dismay over the very same currency trends that Greenspan
dismisses as inconsequential. Monday, ECB President Jean-
Claude Trichet called the euro's steep ascent over the last
two years,"brutal." The following day, Bundesbank head
Ernst Welteke cautioned,"We fear that the appreciation of
the euro could put a brake on the recovery."

- Certainly, the Europeans have cause for concern. The
euro's swift ascent makes life miserable for the
Continent's export industries. If the dollar doesn't find
its footing soon, the European Union might begin dancing
the polka of protectionism.

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

Bill Bonner, back in the City of Light...

***"The good news," said Hugh Hendry, interviewed in
Barron's a couple weeks ago," is that the Dow is going to
be at 10,500 in 2020."

A comforting thought. Investors who are in for the long run
can watch their money waste away for the next 10 years or
more. Still, they might be made whole - eventually.

We turned back to the Hendry interview after realizing that
we were having dinner with him next week; we wanted to know
what he thought of things.

We found that Hendry, a hedge-fund manager, owns a company
called Kanaden, a Japanese electronics-component
manufacturer that must be about the cheapest publicly
traded stock we've ever seen. For just $30 million you
could buy the entire company... and get a billion dollars in
annual revenue. But watch out, profit margins are
slim... just 1.5% in earnings, before interest and taxes.

***"Oil is $34.31," begins the King Report."A
Bubblevision [CNBC] expert and his guest blamed OPEC and
the China boom. James May, CEO of the Air Transport
Association, warned that the declining dollar is a factor.
Long-time readers know we regularly state that historically
a cascading dollar produces sharply higher oil prices. U.S.
citizens and Wall Street shills might venerate the wonders
of currency debasement, but the receivers of U.S. dollars,
particularly OPEC, are not as gullible and detest payment
in debased lucre.

"Please recall that early in 2003, with the dollar in
spirited descent, Russia and Saddam Hussein advocated
changing the terms of oil contracts so that the euro, not
the dollar was the medium of exchange."

***"Consumers face rising energy costs," says one of
yesterday's headlines."Core" inflation is going down, says
the Fed, but consumers are getting it hard on a couple of
fronts. In addition to the pumps, they face rising housing
costs as the bubble in housing continues. The news from
L.A. yesterday was that houses had appreciated in that fair
land by 23% over the last 12 months. Wages, you'll recall,
are flat or falling.

*** The King Report also had this to say about the latest
employment report:

"The details of the report are more troubling than the
headline numbers. Temp workers (+30k for month; 166 for
2003), education & healthcare (21k, 301k for 2003) and
other low-paying gigs are the main job generators.

"Manufacturing lost 516,000 jobs in 2003 and has shed 2.8
million jobs since July 2000... The average workweek for
production or nonsupervisory workers on private nonfarm
payrolls decreased by 0.2 hour in December to 33.7 hours,
seasonally adjusted. The manufacturing workweek declined by
0.1 hour to 40.7 hours, and manufacturing overtime edged up
by 0.1 hour to 4.6 hours. The index of aggregate weekly
hours of production or nonsupervisory workers on private
nonfarm payrolls fell by 0.6 percent to 98.8 in December."

*** Colleague Karim Rahemtullah asked us to pass on the
following note:

"The Supper Club began four years ago. Your editor [he
refers to ourselves, dear reader] dreamed up an
organization that could take advantage of the private deals
that float around back rooms, front offices, and in the
minds of entrepreneurs. After all, who in their right mind
does not want the opportunity to get into the next
Microsoft?

But for every Microsoft, you have to endure a slew of
Enrons and Worldcoms. The point is to make sure that the
one Microsoft returns so much money to your coffers, that
the Enrons and Worldcoms are just welcome tax losses.

The Club has uncovered numerhous high-return opportunities
since its inception. Less than a year ago, for example,
Supper Club members invested in Phoenix Matachewan, a
junior mining company. As you know, the price of gold has
taken off, and so have the shares of Phoenix. This
investment is up more than 100% for our members AND trading
in the public market.

This year we expect several of our prospects to have
significant liquidity events... that means they are getting
ready to make our members some serious money."

Karim writes that the Club is looking at another 15 to 20
new ventures this year. If you have the stomach for these
sorts of opportunities, we could not think of a better
place to look for them...

*** The French are a funny race. The longer we live among
them and learn their ways... the funnier they are. Last
night, Elizabeth went to a meeting to plan a"rallye." A
rallye is a rather formal, structured attempt to control
teenagers' social lives. They are a bit like the
"cotillions" in the U.S. which your editor dodged, thanks
to his low social standing.

Elizabeth's report:

"It was strange. There must have been about 30
mothers... and one father... there. It was out at a house in
Boulogne. You know, the house was fairly small, but it was
packed with family heirlooms... so packed that you couldn't
even turn around. The meeting was in the basement, of all
places... even there, there were ancestral portraits staring
at us.

"The whole idea is to give the kids some social graces and
keep them from falling in with the wrong crowd. With a
little luck, they'll even meet someone from a good family
that they can marry and then their children can participate
in rallyes, too. Henry will fit right in. He's so
competitive... and so French.

"It is whole series of events. One mother is taking a group
of 60 teenagers on a bike ride through the parc de St.
Cloud. Can you imagine? She must be out of her mind.
Another is taking them bowling. I'm working with a woman I
already knew to hold a party in which we teach them to
dance."

"You mean, like le French rock?" came your editor's
question.

"Yes."

"But you don't know how to do the French rock."

"No, silly, we're not teaching the dancing ourselves.
That's done by the company that organizes these things. The
whole business is so complicated and difficult that private
companies act as consultants. They're the ones that teach
the kids to dance. We're just responsible for having the
party."

*** Finally, a happy note. Our model daughter, Maria, turns
18 today. As though a birthday present, yesterday, the girl
got a contract to pose for Lancel handbags. If all goes as
planned, we will soon see her picture all over Europe.

"Daddy," said she on the eve of her birthday."I know I get
in a bad mood a lot... but I just wanted to tell you how
much I appreciate you."

Your editor rose off the ground... and has yet to touch the
floor.

Stay tuned.

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The Daily Reckoning PRESENTS: Our friend John Mauldin
heralds 2004 as a year investors may possibly enjoy... but
warns that the rest of the decade will not be full of
roses.


CAUTION AHEAD
By John Mauldin

The most recent economic data tells us that the U.S.
economy grew in the third quarter of 2003 by 8.2%. 4th
quarter projections for the same year show another 4% plus.
That is hardly middling growth - that is Red Hot. Further,
it is highly likely that 2004 will turn out to be a good
year, barring some shock.

How, then, can I continue to urge caution? Why won't things
simply continue to improve? First, let me be clear that I
am talking about a much longer period than just 2004.
Second, as we will see below, even in lengthy sluggish
decades, there are always (thankfully!) some powerful
interludes of growth.

I do not see a continual below-trend state of growth ahead
of us. Then again, we have yet to do the difficult work of
re-balancing the economic scales which were decidedly
tilted in the last boom. Until we have adjusted these
imbalances, we will be fighting an uphill battle for
growth. It can and will be done, but it will not be easy.
It may take the rest of this decade.

I believe the annual GDP growth of this decade will be
somewhat below average or less than 3% at the end of the
period. There will be some very good periods when the bulls
will proclaim the return of the high-growth economy of the
90's, and some years we would like to avoid, in which the
bears will declare the Day of Reckoning is at hand. In my
view, neither will be right, at least this decade.

Not many remember the period of the 70's as good economic
times. Between 1970 and 1982, the average annual GDP growth
was 2.5% and for the period was a total of 37.5%.

Yet there were years when the GDP was very high. The years
1976-79 saw back to back growth in real GDP of 5.6%, 4.6%.
5.5% and 3.2%. The average for the four years is almost 5%.
(Of course, inflation for that period was over 7%
annually.) Yes, the 70's had its moments. But on the whole,
it was by no means a stellar growth performance.

In my opinion, the secular bear market really started in
the third quarter of 2000. The market collapse in March of
2000 was the collapse of Nasdaq-related stocks. In a true
sense, the resulting tumble was far more than a bear
market. That was a bubble bursting.

The burst of the Nasdaq bubble did not have that much of an
effect on other stocks until a few months later. The
broader-based NYSE almost reached new highs in the third
quarter of that year before starting into its own bear
market. The non-Nasdaq component of the S&P 500 was not in
bad shape until then, and value and small-cap stocks were
on a run. Then came the beginning of the economic slowdown
and the true beginning of the secular bear cycle.

The third quarter of 2000 was the slowest growth quarter
since 1993 and the 2001 recession followed hard on its
heels. In fact, the recession may have begun in 2000. The
Bureau of Economic Analysis told us in December that they
made a small mistake back in 2000... and gave us revised GDP
numbers all the way back to 1929. According to the new
figures, Q3 of 2000 had negative GDP of 0.5% instead of the
reported +0.6%. The BEA are evidently removing the effects
of hedonic pricing of computers [so often descried in these
pages by the good Dr. Richebächer] as they now believe they
might"distort" actual GDP numbers. No kidding. In his
report at the time, Bill King sarcastically (and
appropriately) wondered what effect an accurate
announcement that we were in recession would have had on
the presidential election? There wouldn't be any home team
bias in government figure, would there? Surely not.

Since that third quarter, the economy will have
approximately grown at an annual rate of less than 2.1%,
even given the explosive growth of the last half of 2003.

If the economy were to grow in 2004 and 2005 at the
blistering pace of 4% as it did in the late 90's, the
average growth since 2000 would still not be 3% at the end
of the period, which is less than the long-term trend of
3%. If the economy were to grow at 4% for the next three
years before a historically mild recession (repeat - mild)
the economic growth for almost 7 years would be back down
to 2.5%.

A decade in which there are two recessions is almost by
definition going to grow less than 3% on average. And the
chances of the U.S. economy getting through the rest of
this decade without a recession are not good. Congress and
the Fed can create all the stimulus they like. Imbalances
will only worsen as a result - and remain a drag on the
U.S. economy.


Regards,

John Mauldin
for the Daily Reckoning