-->No Place To Hide

The Daily Reckoning

Paris, France

Thursday, 29 January 2004

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*** Dow down... is this the start of something? Wouldn't
that be exciting?

*** The Fed's"semantic bombshell"... careless stewards and
uneventful events...

*** Miscalculations... why the stunning growth of Asia?
India... and more!

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The Dow dropped 141 points yesterday. Is it the beginning
of something big?

We don't know. But surely investors must wonder...

Yes, stocks have gone up."If you give me a trillion
dollars, I can show you a good time, too," said Warren
Buffett.

Investors have had a very good time ever since the rally
began in October 2002. Heavy partying has pushed the S&P
500 to trade at 28 times earnings.

But why does it make sense to buy at these prices?

"Because earnings are going up," comes the answer..."And if
earnings rise, so will share prices."

But even if earnings DO rise as much as forecast - 13.5% in
the year ahead - that leaves the average P/E still far
below the long-term average of 12 to 16. Getting down to
the average would require a 70% increase in earnings -
which, of course, is not going to happen. And that's merely
to get to the average. Typically, following a bubble, P/Es
fall to half the average. And they don't sink down because
the E's (earnings) rise... they drop because the P (price)
falls to a point where they are good buys again [don't miss
Dr. Steve Sjuggerud's comments on the direction of P/E's
across the globe, below... ].

The lumpeninvestoriat may not quite figure it out this way.
Still, they must have a little nervous residue from the
first leg down of the bear market, March 2000 to October
2002. They must remember that while they still believe in
'buy and hold for the long run,' those 18 months were a
good time to neither buy nor hold. And if they were to
sense a similar period coming up, they might well decide to
ride it out by being neither buyers nor holders, but
sellers of equities.

And whoa! Wouldn't that be exciting? We might even see a
day or two of utter panic selling on the Wall Street.
Sooner or later, they will come, dear reader.

You might also anticipate a panic in the currency and bond
markets. We don't know if it will happen. But we don't have
to know. What we DO know is that the odds of these things
coming to pass are almost certainly greater than most
people think (since most people put the odds at zero)... and
that you make money not by being right about the future but
by being right about how your fellow investors have
miscalculated in the present. A rout of the dollar?
Collapse of the bond market? A new, more terrible bear
market in stocks? Decline in house prices? Recession?

Recent surveys show neither economists, nor investment
professionals, nor the lumps themselves can imagine such
things. Which makes us think, not that they are necessarily
imminent, but that we want to bet on them anyway.

Herewith, more news from Eric:

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

Eric Fry from the Isle of Manhattan...

- Yesterday, the pathetic U.S. dollar struggled through yet
another trading day... until 2:15 Eastern Time. That's when
the Federal Reserve came to the dollar's rescue by deleting
two little words -"considerable period" - from the text of
its Federal Open Market Committee statement.

- What is a"considerable period," anyway?... Is it 15
minutes or 15 years? No one can say for certain. But
yesterday, every investor in America seemed to know
precisely what the ABSENCE of this phrase meant. Since
August, the FOMC's monthly statements have been promising
to hold interest rates low"for a considerable period." But
yesterday's statement replaced the longstanding phrase with
a pledge to be"patient" in holding down interest rates.
"With inflation quite low and resource use slack," the
statement read,"the committee believes that it can be
patient in removing its policy accommodation."

- Investors reacted swiftly and decisively to the semantic
bombshell: the dollar soared, while stocks and bonds
tumbled. (Gold, for its part, drifted lower). If the Fed
will no longer promise to hold interest rates low for a
considerable period, the lumpeninvestoriat reasoned, then
surely the Fed is preparing to raise rates, which is good
for the dollar but bad for stocks and bonds.

- By the end of the New York trading session, the dollar
had rocketed one and a half percent to $124.70 per euro,
while stocks FELL about one and a half percent. The Dow
dropped 142 points to 10,468 and the Nasdaq stumbled nearly
2% to 2,077. Treasury prices also fell, pushing the yield
on the 10-year note to 4.19% from 4.06% on Tuesday. Thus,
the January stock market rally, which began amidst such
fanfare and promise, is fading quickly as month end
approaches. The Nasdaq still boasts a respectable 3.7% gain
for the month, but the Dow is up a meager 15 points.

- The slumping stock market is irksome, but the drooping
dollar is of far more concern. Despite the dollar's one-day
reprieve, the decrepit currency still faces the same
daunting obstacles it faced before the Fed reworded its
monthly statement. Like a potted palm on a Park Avenue
terrace, the dollar battles each and every day to maintain
its health.

- Never does our precious palm enjoy the warming sunshine
of favorable macroeconomic trends. Instead, it finds itself
in the frost of a widening current account deficit and a
gaping federal deficit... The harsh U.S. macroeconomic
environment is simply no place for a currency to thrive.

- Nevertheless, despite the adverse fundamental trends
threatening the dollar, the hometown currency could still
hold its value for a while, or even appreciate, as long as
our foreign creditors maintain their hefty dollar
purchases.

-"The United States long ago entered into an unholy
partnership with its Asian creditors," writes James Grant,
editor of Grant's Interest Rate Observer."They would
produce; we would consume. They would save; we would spend.
They would invest - in us - buying Treasuries and agencies
by the hundreds of billions of dollars worth. In effect [as
we wish we had been the first to say], the United States
and its lenders have entered into the biggest vendor-
financing scheme in the history of lending and borrowing."

- Then again, vendors expect to receive
payment... eventually. If payment is not forthcoming,
vendors withdraw financing and send the unpaid accounts
receivable to a collection agency. Presumably, no one will
ever threaten to break Uncle Sam's knees if he doesn't pay
up by next Tuesday. But Uncle Sam and his currency could
suffer a far worse fate if foreign central banks begin to
withdraw some of their financing. Any significant
retrenchment by our foreign creditors would be very bad
news for the dollar... if that still matters to anyone.
According to chairman Greenspan, the dollar's exchange rate
is no big deal, which is why the current account deficit is
no big deal.

-"To date," the increasingly wacky chairman said recently,
"the widening to record levels of the U.S. ratio of current
account deficit to GDP has been, with the exception of the
dollar's exchange rate, seemingly uneventful."

- Hmmm... we would suppose, therefore, that the current
account deficit will forever remain"uneventful," as
Greenspan would define,"eventful." Certainly, if one
ignores the dollar's exchange rate, the current account
deficit poses no problem whatsoever. In the same way,
Greenspan might consider death to be"seemingly
uneventful," if we may ignore the fact that the deceased is
no longer living.

- But we suspect that the dollar's slide is eventful,
especially when it is plummeting and the chairman of the
Federal Reserve doesn't care.

- Indeed, we think it is particularly eventful that the
chairman of the Federal Reserve, whose principal statutory
responsibility is to maintain the value of the dollar,
considers the dollar's steep slide to be"uneventful." If
the chairman of the Fed doesn't care about the dollar's
value, who will?... Buyer beware.

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

Bill Bonner, back in Paris...

*** More on the stunning growth of the Far East, from our
friend Martin Spring:"What are the factors which have
already delivered astonishing economic development and
suggest that there is much more to come?

* Liberalization of international trade and absence of
major wars have provided a benign global environment,
opening up the markets of the rest of the world to Asia's
new export industries.

* Asian governments and business leaders work closely
together. There has been single-minded focus on promotion
of production and wealth creation rather than on
consumption, state welfare and redistribution of wealth.

* Taxes have been kept low, capital cheap and channeled
into economic development. One of the secrets of China's
success is its creation of"export processing zones" where
employers are largely free to pay and use labor however
they wish. It's a model that India now intends to follow
with 20 such zones.

* Carefully managed mercantilism has provided cheap
currencies, export incentives and protection for"infant"
industries, but in combination with the controlled opening-
up of domestic markets to imported goods, services and
competition to spur continuous productivity improvement.

* Social attitudes favor the interests of the group
(nation, corporation, family) above those of the
individual.

* Quality mass education has been provided, with emphasis
on the sciences.

* Savings ratios are very high (up to 50 per cent of
incomes).

"The Far East has been the principal beneficiary of
globalization, the process that has brought capital and
technology to its enormous pool of inexpensive and highly
productive labor, while allowing much of the resulting
production to flow to the consumption-hungry nations of the
rest of the world.

"This process is accelerating. Multinationals protecting
their competitiveness and earnings are seeking to escape
the high costs, burdensome taxes and over-regulation of the
developed world by shifting their purchasing, production
and administrative processes to cheap and efficient
facilities in the developing economies, mainly in Asia."

*** How do you like that, dear reader? We flatter
ourselves, believing we have the freest, most dynamic
economy in the world. Meanwhile, our businesses move to
China and India - to get away from our high wage rates,
union meddling, government interference, and taxes!

*** We are continuing our serious research of all things
relating to what might be the world's next economic
superpower - India. Sitting across from us on the train
last night was a woman who looked as though she might from
India. We struck up a conversation.

It turned out that while her family was Indian by origin,
she had been born in Hong Kong and worked as a financial
analyst in London.

"It's very funny, you know, having this background,"
explained my lively and delightful traveling companion.
"For while I live in the West and work with economists,
brokers and analysts in the most sophisticated industry in
the world... I still have these attitudes and ideas that
come from my family background.

"We're very superstitious... when my sister got married, for
example, she had to clear it with the family priest back in
Madras. Otherwise, it would be very bad luck. We believe in
luck. If someone puts an 'evil eye' on you... you've got to
get a priest to take it off. You've got to find some good
karma to counteract the bad karma.

"India is booming. I know people who bought stock in some
of the high tech companies in India that are doing very
well..."

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The Daily Reckoning Presents: Against all odds,
international asset markets continue to climb higher. What
can you do with your money these days?"Take your pick,"
writes Dr. Steve Sjuggerud:"You can buy overpriced stocks,
overpriced bonds, or overpriced real estate..."


NO PLACE TO HIDE
by Steve Sjuggerud

"Today we have substantially the worst prospects for long-
term global investment returns of my 35-year career when
all asset classes are considered, particularly for U.S.-
centric investors. The asset classes collectively are
simply the most overpriced they have been. There are no
large categories that are good hiding places..."

- Wall Street Legend Jeremy Grantham, in his most recent
report to his investors...


When it comes to investments today, there are very few
places to hide. Nobody wants to hear negativity. But I
don't see this as negativity... I see it as reality.

Back at the peak in 2000, there were still places to hide.
For instance, to readers of my newsletter, True Wealth, I
had recommended real estate and related stocks (REITs,
homebuilders, etc.). We all know what real estate has done
in the last four years. I'd also recommended several income
ideas, which were once-in-a-generation opportunities, and
they've performed even better than I could have imagined.

But now, in 2004, the pickin's are slim... so slim that the
most profitable investment approach now might simply be:

Ride the markets as long as they continue surging. But do
so like someone who understands that they are overvalued -
and that they will correct themselves.

Let me explain. We've got interest rates at multi-
generation lows, so you shouldn't leave your money in the
bank. Or should you? What else can you do with it? Take
your pick: You can buy overpriced stocks, overpriced bonds,
or overpriced real estate.

In times like these, Richard Russell (who's been writing an
investment newsletter for over 40 years) says,"He who
loses the least, wins."

In short, when you look around the world, there isn't much
value to be found in stocks. Let's look at the U.S., and
then we'll look at the Hong Kong market, as a proxy for
emerging markets and China.

The most basic valuation measure is the price-to-earnings
ratio. It's a rough gauge of how much you're paying for an
investment versus what you're getting back in return. In
simple terms, if you can earn $10,000 in rent on a house
each year (net), and the price of that house is $150,000,
then that house is selling for 15 times annual earnings. At
10 times earnings, or less, that house might be very cheap.
At 20 times earnings, it's probably very expensive.

The same is true for stocks. Throughout history, stocks
have traded for roughly 15 times earnings. A stock market
P/E ratio of 10 or less has proven to be cheap, and a great
buy. Meanwhile, a P/E of 20 or higher has been an early
warning sign of tough times ahead.

Let's consider the P/E ratios of U.S. stocks and Hong Kong
stocks in recent years:

U.S. Stocks

P/E Year

8 1982, a great time to have bought, in hindsight
22 1987, before The Crash, a good time to have
sold, in hindsight
14 1990
32 March of 2000, a good time to have sold, in
hindsight
28 Today

Hong Kong Stocks (notice how a similar picture to U.S.
stocks emerges)

P/E Year
6 1982, a great time to have bought
23 1987, before The Crash, a good time to have sold
10 1990
23 1993, China-related stocks crashed for 10 years
28 March of 2000, a good time to have sold
19 Today

As you can see above, the P/E in the U.S. is 28 - nearly
twice the historical average. That's expensive. The
downside risk may be greater than the upside potential over
the coming years. Hong Kong is less expensive than the
U.S., at a P/E of 18. But then again, emerging markets have
traditionally traded more cheaply than their U.S.
counterparts, as they are higher-risk investments.

It's not just the U.S. and Hong Kong that are expensive.
The entire world of stocks is expensive (with the exception
of Russia - but the risk is so high, it may be
appropriately priced. See for yourself at the end of this
essay, where I've included P/E ratios of the world's major
stock indexes).

So 35-year investment legend Jeremy Grantham is probably
right. Investments out there are expensive. This may indeed
be the toughest environment to invest in during his 35-year
career. There are few, if any, places to hide in stocks
worldwide... be careful in stocks for the next few years.

"Only the huge, politically driven stimulus gives cause for
hope, and that is for a short-term reprieve or rather a
'stay of execution,'" Grantham concludes. Translation:
Stocks, bonds and real estate could all push higher, as
people look for a place to put their money.

But the real question is... where to go from there?


Regards,

Steve Sjuggerud
for the Daily Reckoning

P.S. As promised, below are the P/E ratios of the major
stock market indexes around the world (keep in mind that a
P/E of 10 or less is considered a bargain)...

The Americas

28 S&P 500
126 Nasdaq
21 Canada
28 Brazil
16 Mexico

Europe

62 UK
21 France
61 Germany
44 Switzerland
27 Italy
19 Spain
20 Netherlands
32 Sweden
22 Finland

Emerging Europe / Africa

8 Russia
17 South Africa
21 Greece
31 Poland

Asia Pacific

111 Japan
20 Hong Kong
21 Australia
50 China (Shanghai)
41 China (Shenzhen)
44 Taiwan
18 India
23 Singapore
17 Malaysia
27 Thailand
17 Indonesia
23 New Zealand
24 Philippines

P.P.S. Fortunately, alternative investment opportunities
outside stocks, bonds and real estate do exist. A prime
example is gold - a classic 'safe haven' in times of
uncertainty, but also a bargain at its current price.