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* * * * * * * * * * * * REMINDER * * * * * * * * * * * * *
On the days that I don't publish, like today, you receive
Bill Bonner's DAILY RECKONING. This will help you to keep
pace with the changes in the markets. Bonner and I agree
on most things in the field of economics, so the two letters
reinforce each other.
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The Next Enron?
THE DAILY RECKONING
PARIS, FRANCE
TUESDAY, 5 MARCH 2002
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*** It's a BULL MARKET!!! Everybody says so...
*** Keeping the powder dry...waiting for the dollar to
fall... and paying tribute to sunny optimism...
*** The Lady 'Buffette' wins big... broken spirits,
hunched shoulders... and so much more it will make your
head spin!
"I'm getting murdered," a friend said to me at dinner on
Saturday night.
Guillaume imports lawn care products from America and
sells them in France. The products are good, he says.
But the dollar is so high he can't sell them. This is a
big part of the reason why U.S. corporations have just
suffered their biggest drop in earnings since WWII...
and why manufacturing output has fallen for more
consecutive months than at any time since the Great
Depression.
"I'm just waiting for the dollar to go down," Guillaume
continued. "It has to go down sooner or later, doesn't
it? Or America will go out of business!"
It is remarkable how little the world has changed in the
last two weeks. We are still on the edge of our seats...
waiting for things that have not happened yet.
Stocks are still priced as though we were at the top of
a bubble market. The dollar is still regarded as though
it would last forever. And Americans still spend money
as if they had some.
The world shuddered when the World Trade center towers
came down. But according to the latest statistics, it
soon returned to business more-or-less as usual. And
recession? Forget it. It never happened. The airlines
are full. Bars are crowded. Reservations are once-again
advised for good restaurants.
A new bull market has begun on Wall Street. At least,
everybody says so.
Right Eric?
*****
Eric Fry in New York...
- Stocks are soaring...everywhere! Across every time
zone, the financial markets are smiling on the bulls.
Japan's Nikkei 225 Index led the Asian markets with a
sparkling 6% rally - its biggest one-day gain in almost
a year. Heading east, Russian stocks jumped 4.4%,
bringing their considerable gains in 2002 to more than
25%.
- The stock-buying wave continued rolling east (somehow
making its way past the Maginot Line), buoying share
prices as it swept across the European bourses, before
finally splashing up on the shores of lower Manhattan,
home to the NYSE.
- Here in New York, where we put the "bull" in
bullishness, the Dow gained 217 points to 10,586. The
Nasdaq soared more than 3% to 1,859.
- This latest stock market rally in the States has all
the classic signs of a short-squeeze: the move is
abrupt, ferocious and led by stocks better known for
their recent problems than for their considerable
virtues.
- For example, the beleaguered banking giant, J.P.
Morgan Chase, led the blue chips with a 10% gain.
Similarly, Cisco and Tyco - two companies beset by
accounting concerns - both surged about 10%. Even truly
marginal companies like Providian Financial managed to
tack on 12%.
- "When the market rallies violently, as it has the past
several days, the stocks of troubled companies sometimes
climb more than good companies," explains C.A. Green,
Investment Director of The Oxford Club. "The reason,
ironically, is short covering... When the market starts
to really gather steam, short sellers often panic and
buy to cover their positions. The higher prices then
cause other short sellers to cover as well, adding fuel
to the fire."
- Green is "keeping his powder dry" while awaiting for
this rally to exhaust itself.
- "Last weekend," Green continues, "I spent over an hour
on the phone with Jim Rogers, the former partner of
legendary hedge fund manager George Soros. Jim believes,
as I do, that many of the best opportunities in the
month ahead will be on the short side. He said
individual investors are going to have to learn to sell
short if they want to make money in the volatile
financial markets we're experiencing."
- Not all investors, however, possess the mutant gene
that predisposes a person to short-selling. For the vast
majority of investors - the kind of folks who invest
hoping stocks will go up, not down - the recent rally on
Wall Street is welcome relief.
- For them, the "cause" of a rally is about as important
as the color of a free Ferrari. Gains in the market are
no less valuable for having been produced by short-
covering. But it's helpful to remember that short-
covering rallies tend to be short and swift - often
reversing their moves very quickly. And since stocks are
still expensive, in fact more so than three days ago,
and since corporate CFOs are no more (or less) honest
than they were last week, the latest rally might be a
gift worth accepting.
- One thing is for sure, the stock market's rip-snorting
advance over the last few days is reminiscent of the
good old days of 2000, when the only thing needed for a
stock market rally was an opening bell. Back in those
Halcyon days, stocks seemed to soar every day, IPOs
soared the highest of all and the Red Herring magazine
was a must-read of the venture capital crowd.
- "The September 200 issue of Red Herring," writes the
New York Times, "weighed in at 552 ad-stuffed pages -
more than two pounds of hubris that would kill a small
cat if it fell off a table."
- The issue paid tribute to "a style of business
pioneered in Silicon Valley, but now practiced
everywhere: sunny, optimistic and endlessly creative."
- Unfortunately, the ink had scarcely dried on the
September 2000 issue before storm clouds gathered over
the Internet economy's sunny business-scape. The
endlessly creative Silicon Valley business practices
quickly become endlessly expensive, as one venture
capital deal after another imploded in a heap of na‹ve
optimism.
- Fast-forward 18 months: The post-bubble Red Herring
has undergone a little journalistic liposuction. "The
March 2002 issue," according to the Times, "all 6.5
ounces of it, runs a scant 100 pages, and includes
public service ads for the Girl Scouts and the United
Way, along with six pages of the magazine advertising
itself.
- "The spate of magazines living off the Internet boom
have turned into a journalistic rust belt," The Times
observes. "The fizzy vocabulary that had become part of
the genre is now of little use in the telling of stories
of Cisco's inventory debacle, the evaporation of
investment and the unwillingness of traditional
businesses to hire dot-com veterans. There is really no
enjoyable way to talk about a trip to the gallows, after
all."
- Interestingly, despite the demise of the Internet
economy, its spirit of sunny optimism and endless
creativity lives on...in the pages of Wall Street
research.
******
Back in Paris...
*** Has Warren Buffett been reading my old friend, Lynn
Carpenter's Fleet Street Letter reports?
*** It sure looks that way. Last year Lynn released her
special report... "The Three Best Midcaps for 2001"
right here in Daily Reckoning.
*** Did you buy these stocks? You should have. A value
investor with her own proprietary system, Lynn's been
beating Warren Buffett to the goodies. Since we gave you
a chance to peek into Lynn's style for free with her
special midcap report last year, Warren Buffett took
stakes in all three companies she recommended.
*** He bought, then sold Jones New York. He still owns H&R
Block (up 170% so far and still rising) and he just
announced that he's begun buying Outback Steakhouse.
Outback's up 37.6% in this past year, but now that the
market knows Buffett's in, it's sure to keep on rising...
just as Office Depot did. Office Depot is another stock
that Lynn recommended before Warren Buffett got in that
took off after the Buffett news came out. That's why we
call her our "Warren Buffette."
*** Lynn's own proprietary TUFF value investing system has
beaten the market and given investors double-digit returns
for the past three years. For more see:
http://www.agora-inc.com/reports/FST/FindMoney
*** Normally, I use frequent flier miles to cadge a seat in
business class. Coming back to France from Nicaragua,
however, in a gesture of solidarity, I sat in economy with
the rest of the family. Uggh. The seats on American
Airlines seem to have been designed by a sadist. Or,
perhaps it is a government plot? Before a new immigrant
ever touches the ground, his shoulders are already hunched
over and his spirit is already broken.
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THE NEXT ENRON?
by Bill Bonner
"Give him enough credit and even a dumbbell will find a
way to blow himself up."
Bill Bonner
The newspapers and TV stations are turning the Enron
story into a the sort of tale they can handle.
"Witnesses clash" heralds the NY TIMES account of Enron
officials' testimony before the Senate Commerce
Committee.
"I never duped Ken Lay," Jeffrey Skilling told the pols.
Soon, they will be looking for a 'deep throat' or a
stained blue dress.
Here at the Daily Reckoning we will try a different
approach. We take it for granted that even a
Presbyterian or moron will find a way to lie, cheat and
steal - if it pays well enough. And any fool will allow
himself to be duped or hypnotized... if not for money,
for love or glory.
While the rest of the press and the politicians look for
a tragic character flaw or lamentable regulatory gap,
here at the Daily Reckoning we continue to search for
the comic absurdity. Not that it provides any better
explanation or any more entertaining reflections... but
we hope it helps us anticipate other Enron-like farces.
What's more, it allows us to come to the end of our
story without having to sort out who told what to whom
when. For it was not a shortage of character strength
that gave rise to the Enron debacle, we reckon, but a
surplus of easy credit. Too much credit leads to
financial chicanery as surely as a fat wallet left on a
car seat in a bad neighborhood leads to a smashed
window.
In that light, we can anticipate a lot more glass on the
nation's streets. Because the amount of financial
leverage in America has gone up - since '29...since the
bull market began in '82... since the collapse of Long-
Term Capital Management in 1998... and even throughout
the recent recession that never happened.
In September 1998, the Fed panicked when LTCM faced
extinction. The 'systemic risk' was so great, feared the
central bankers, that they had to do something. They
brought the bankers together to bail out Long-Term, and
not coincidentally, loosened credit worldwide.
But LTCM was peanuts compared to what lay ahead. The
hedge fund raised only about $2.5 billion - still, the
most successful launch ever. By 1998 the fund was out of
business... but John Meriwether and the other partners
were back in the game in a matter of months. And, thanks
to the easy credit, the number of new hedge funds
ballooned. By 2001, the amount of money in the funds had
grown to $500 billion... with $86 billion of new cash
raised in 2001 alone.
In September 2001, the Fed again feared 'systemic risk'
- after the WTC towers were destroyed by terrorists.
Again, they loosened credit worldwide.
In fact, throughout the entire post-WWII period, central
bankers have maintained a bias towards looser credit...
putting so many extra dollars in circulation that the
purchasing power of the greenback is down at least 75%.
A glimpse at a single company shows how the culture of
credit has expanded since the Great Depression.
In '29, General Electric was a very healthy company,
almost debt free. "At its peak," writes Jim Grant, "it
covered fixed charges out of cash flow (that's EBIT, not
EBITDA, an invention of the 1980s) 109.6 times over. In
1932, at the bottom, it covered by 11.5 times. In 1929,
GE generated a return on equity of 18.8%. In 2001, a
thoroughly up-to-date GE produced an ROE of 26.3% while
employing vastly more debt (it had, of course, long
before entered the financial services line)."
How much debt? While the company had debt of only one
half of one percent in '29... by 2001 GE's debt reached
60% of its capitalization.
The biggest increase in debt has occurred in the recent
past. "To get a broad idea of the ravage imparted to
corporate balance sheets during these years," writes Dr.
Kurt Richebacher, "just compare the two following
figures covering 1995-2000: U.S. business net fixed
capital investment edged up $321 billion; indebtedness
ballooned by $2,472 billion. For each dollar added to
net new fixed investment, there were 7.7 dollars added
to indebtedness."
The stunning difference between the two figures
essentially reflects the fact that the debt orgy went
overwhelmingly into unproductive use, mainly stock
buybacks, mergers and acquisitions. Counterpart to the
soaring gap between debt growth and net investment
growth were bits of paper bearing the pretentious title
of 'goodwill.'
But the more debt U.S. corporations took on, the better
investors seem to like them.
"It is said that millions of investors are angry and
disillusioned about the financial community that has so
grossly defrauded them," adds Dr. Richebacher. "Looking
at sky-high P/E ratios, we have the impression that
complacency and hope still grossly outweighs worry."
"At the 1929 top," Grant continues, "the capitalization
of the U.S. equity markets amounted to just 81.4% of
U.S. GDP. By the March 2000 peak, the reading was 183%
of GDP."
While debt grew faster than an escapee from a fat
farm... profits and earnings slimmed down.
But that part of this story... and the exciting climax -
in which we reveal the biggest 'next Enron' of all -
will have to wait until Thursday.
Until then, adios...
Bill Bonner
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