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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.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * *
A Death Struggle With Time
THE DAILY RECKONING
LONDON, ENGLAND
WEDNESDAY, 21 NOVEMBER 2001
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*** "A rebound in search of a reason"...Hold
on...reasons coming soon...
*** Is the rally over? Head fake? The momentum of
confidence continues...
*** Sticking to the essentials...Abby is bullish!...Tech
companies still wasting money...War Dividend...History
resumed...and more!
* * * * * * * * * * * * * * * * * * * * * * * * * * * *
"Your advice has cost me a lot of money in the
last few weeks," said an English Daily Reckoning reader
last night.
I had just given a speech to a group of readers at
the Caf� Royal in London, explaining why stocks were
more likely to go down than up. Not everyone was
convinced. "The rally may not last forever," my
interlocutor continued, "but then, they never do, do
they?"
No, they never do. Typically, Mr. Bear takes a
break after mauling a market. Prices almost always
recover somewhat - often rising to retrace half the
loss. That's about where the market closed on Monday
night.
After nearly two decades of rising stock prices,
there's a momentum of confidence that takes a long time
to reverse direction. Investors still believe the Fed's
lower rates will revive the economy - if not the first
10 cuts...perhaps the 11th! They still have faith that
long-term, buy-and-hold investing will pay off...if not
this year, surely the next!
And as stock prices rebound, investors quickly
regain their old confidence...believing the hard times
are over.
"Alas, for me, [the rally] still looks like a head
fake," writes Stephen Roach. "In a climate of rising
unemployment and declining personal income growth,
conditions are ripe for a classic consolidation of
discretionary consumption.
Financing and/or price incentives can only defer
the inevitable...the post-incentive fallback could be
even more severe. The same can be said for the impact of
home mortgage refinancing activity...By our estimates,
even with the October retail sales spike, real
consumption growth in 4Q01 should still come in around
"zero." Imagine what that number would have been without
refinancings and cut-rate financing of motor vehicles!
Or without the tax rebates! Or without the drop in
energy prices!"
"Demand is running on fumes," Roach concludes,
"...the 'V' shaped recovery remains a pipe dream..."
And yesterday, the rally may have come to an
end...Eric?
*****
Eric Fry in New York...
- News Flash! Abby Joseph Cohen is Bullish!...The stock
market fell anyway.
- The Dow dropped 75 points to 9,901, while the Nasdaq
tumbled nearly 3% to 1,880. Oh well, perhaps today will
be a better day to be bullish than yesterday.
- Bill and I take a slightly more matter-of-fact (read:
cautious) approach to this market of ours. "The
expensive stock could become less expensive," Bill
reasoned in yesterday's Daily Reckoning. "So, we stick
to the essentials...Buy low, sell high. No more
essential rule of investing has ever been formulated."
- Investors do well to remember this basic rule of
investing, especially when the stock market gets a
little nutty. When "Buy high...sell higher" is working
so well, it is easy to get confused.
- Many things succeed for a time: like jumping off a
bridge in order to fly; setting your couch on fire in
order to keep warm; or marrying several wives in order
to enjoy domestic bliss.
- At the current quote, the S&P 500 Index sells for more
than 30 times earnings and yields a fulsome 1.37%.
That's rich folks...no ifs, ands, or buts.
- Not to worry, says Goldman's Abby Joseph Cohen, stocks
will "continue to do well." The market's strong advance
since late September is "well-supported by intermediate-
term fundamentals," Cohen assures the faithful. What
exactly are these bullish "fundamentals?" Let's listen
in: "Fourth-quarter earnings will be exceptionally
ugly," Cohen says. "But it won't matter to stock prices.
That's because most investors expect improved earnings
in 2002."
- Can't argue with that unassailable logic. Cohen thinks
the Dow could easily reach the upper range of her "price
target" at 12,400. "Investors are no longer solely
focused on potential terror and risk," says Cohen, "[but
are] again making decisions balancing investment risks
against potential returns."
- But what about terrifying investment risks? Don't
those count for something? With all due respect to Ms.
Cohen, the stock market appears to be overreacting to
the prospect of economic recovery.
- James Stack, editor of InvesTech Research, offers a
more sobering assessment of the current market action.
"Bubble excesses take a long time to resolve," Stack
explains.
- "There are still many technology stocks that are
operating on a non-functional business plan. In other
words, they are still burning through cash faster than
they can earn it. So there are many [companies] - still
clinging to life - that are simply not going to survive
through the slow growth ahead."
- Furthermore, says Stack, "the popping of this bubble
has not taken valuations (i.e. overall P/E ratios) down
to acceptable norms...We think it could be years before
the NASDAQ index recovers to 3,000, let alone seizes the
old high of 5,048."
- Abby? Any rebuttal?
- "Buy low...sell high" is not only an essential
investment dictum, it is also a fairly obvious one. But
- like chastity - it is a principal that is easily
forgotten in the passion of the moment.
- It's a funny thing about investing that risky
practices sometimes masquerade as prudence. Almost any
strategy - however ridiculous it might actually be - can
work brilliantly for a while, and seem therefore like a
perfectly safe course of action.
- By contrast, even the most reasonable long-term
investment strategies can perform poorly over the short
run. But investors do well to remember that short-term
success is not the same thing as low-risk success.
- If your next-door neighbor leaned over the fence one
day and said, "You know, I figured out the perfect way
to shave 15 minutes off of my daily commute...I run
every red light."
- Would we thank our neighbor for divulging his
brilliant strategy? Or would we suggest to his spouse
that she start shopping for a casket?
- Yet, when someone we know boasts that they're making a
killing in the market by buying pricey stocks, we feel
like we're missing something. We feel like they must
really know something that we don't. Guess what? They
don't.
- The NASDAQ's gut-wrenching collapse over the last year
and one-half - a period which saw this go-go index lose
three-quarters of its value - tells you everything you
need to now about the durability of profits produced
through high-risk means.
- So many investors were running red lights in early
2000, that it seemed like no harm could ever come to
them. And then suddenly, everything started crashing.
- Running red lights is dangerous, even on Wall Street.
*****
Back in London...
*** "A rebound in search of a reason," wrote Gretchen
Morgensen of the current (recent?) rally. But if it goes
on long enough, imaginative bulls will find reasons
enough to justify it.
*** They're already re-inventing the myths of the
bubble...as reasons for a new bull market.
*** Remember the "Peace Dividend?" It was a collateral
benefit from what Francis Fukayama called "the end of
history." Democracy and capitalism were triumphant, we
were told. So there would be no more wars or revolutions
- history had run out of material. The fall of the
Berlin Wall was supposed to eliminate the need for big
defense budgets - releasing capital for other purposes.
But then, the WTC and the Pentagon were hit by
terrorists and history was, well, resumed. And now we
have the "war dividend," in which all the spending on
the war against terrorism is meant to stimulate the
economy.
*** Likewise, during the Bubble era, stocks were
supposed to go up because the Greenspan Fed would make
sure there would be no recession. No recession, no fall
in earnings. No fall in earnings, no need for stock
prices to go down. If stock prices never went down, they
must only go up...and therefore were good buys no matter
how expensive they were.
*** But then, the Fed failed. The entire world economy,
according to a yesterday's OECD report, is in recession.
And stocks lost about $4 trillion of value in America
alone. So, now we are told that that the Fed that was
not supposed to allow a recession is nevertheless able
to cure the one we have...and that the 11th or 12th rate
cut will do the work that the first 10 failed to do...
and that we should buy the stocks that could never go
down because they are cheaper now!
Whew!
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* * * * * * * * * * * * * * * * * * * * * * * * * *
The Daily Reckoning Presents: A guest essay in which the
author speculates on deflation, capitulation, and the
"silver generation" in...er, "J"...
A DEATH STRUGGLE WITH TIME
by Peter McKillop
Capitulation is that delicious moment when investor
sentiment is so bad that no one wants to catch the
proverbial falling knife even though it has landed on
the floor with a thump. It is that moment before dawn
when it is most dark. The Fat Lady has sung, the party's
over, and investors have thrown in the towel.
Capitulation is that moment when every negative cliche
has been used by newsletter writers.
Clearly that moment hasn't arrived in equity markets in
the United States or Europe. After selling-off quickly
following the tragic events of September 11, equity
optimists rushed back into the market to buy on what
they perceived as the mother of all dips.
There is, however, another economy, and another stock
market, far beyond the wailing sirens of lower
Manhattan, where the echoing call of "capitulation" can
be heard: Japan.
For 30 years, Japan was the national warrant for
investors eager for an Asian comeback play after the
Second World War. Today, Japan is the world's most
celebrated economic basket case. This once-mighty, just-
in-time export engine has fallen so hard, and for so
long, that even the most die-hard bulls are giving up.
The question before investors is whether Japan has
reached that stage of capitulation and whether it is now
time to get back into the market. I will argue that
never in modern history has investor sentiment been more
bearish about Japan.
Certainly, the signs of capitulation are everywhere.
Consider: at the height of the September 11 crisis, CNBC
analysts almost laughed when they reported on equity
markets in Japan. "The Nikkei down another 500 points,"
muttered one. "Yeah," said the other. "A real mess."
Capitulation.
"My patience has run out," Morgan Stanley's legendary
fund manager Barton Biggs recently told Asiaweek. "I'm
tired of waiting for a recovery." Capitulation.
"Asset quality is worse than even we had believed,"
Goldman Sachs banking analyst David Atkinson's recently
wrote in a report entitled "Totally Rethinking Japanese
Asset Quality". The report concludes that a "bottoms-up"
analysis suggests total bad debts of 237 trillion yen.
Please don't adjust your reading glasses. This isn't a
typo. Goldman Sachs thinks Japan's listed companies are
sitting on more than $2 trillion in bad debt.
Capitulation.
"The Japanese economy is a mess," Kiichi Miyazawa,
Japan's finance minister until last year, grimly
admitted, and "I really do not know how to get out of
the current situation." Miyazawa's public service
stretches back so far that he was part of the Japanese
delegation that signed the U.S.-Japan peace treaty in
San Francisco in 1952. He was the man who, as prime
minister, offered a helping lap to then President George
H.W. Bush when he had an adverse reaction to Japanese
food in 1990.
When one of the most powerful ministers and politicians
of the postwar era of Japan admits he has run out of
ideas, that is a classic sign of complete capitulation.
Why are things so bad in Japan?
Probably the most asked question by any visitor to Japan
is why, if the economy is so bad, does everyone in Tokyo
seem so prosperous? It's true, the new Ginza Hermes
store is doing a terrific job selling handbags and ties
to free-spending young professional women. Families are
flocking to the new Universal and Disney theme parks in
Osaka and Tokyo. Until just recently, Porsche, Ferrari,
and Mercedes were enjoying robust sales.
And yet the daily economic news out of Japan is
unrelentingly grim. Property prices have collapsed. The
Nikkei is at an 18-year low. It recently made history
falling below the Dow! There once was a time when the
Dow was at 2,000 and the Nikkei at more than 30,000.
With the market in full swoon, so is business and
consumer sentiment. The Tankan Business Condition survey
is bouncing like a dead cat. At the same time, deflation
and unemployment are accelerating at a record pace. The
Bank of Japan is feverishly printing money to weaken the
Yen and trigger inflation. Government debt to prop up
the economy is at more than 130% of GDP.
Entire forests have been cut down as analysts and
economists try to figure out what is wrong with Japan.
[Not to mention more than a few gigabytes of bandwidth
used up by your editors at The Daily Reckoning...]
"The lever that Japan ought to be able to use to ensure
its survival and leadership in the new economy is, of
course, its financial capital," offers Bart Broadman,
chairman of J.P. Morgan in Japan. "Certainly, it has a
lot of it. This is a nation flooded with Yen savings."
The problem in Japan, however, isn't the availability of
capital, but rather how it is used.
"How can the nation compete long-term in a dynamic
global economy, when it is hobbled by troubled financial
intermediaries and is compulsively risk averse? Capital
that is not being recycled from yesterday's losers to
tomorrow's winners. There is none of the creative
destruction process that we have learned is so critical
to long-term economic success," says Broadman.
This may also answer the question of why Japan seems so
prosperous in such lean times. The post office now holds
$2 trillion in savings. Japanese government bonds,
representing the safest investment available, are at
record low yield levels. A two-year bond yields 1/8 of
1%. The massive imbalance of capital allocation means
there is a lot of money out there to be spent on Chanel
scarves and trips to Tuscany, but almost no capital
available to fund new entrepreneurs and their business
ideas.
Excessive risk aversion is killing any entrepreneurial
spirit in Japan. Ironically, Japanese entrepreneurs have
to look to imported capital, while living among vast
pools of risk-averse domestic capital. John Lipsky,
Chief global economist for J.P. Morgan, pins all of
Japan's problems on another issue: consumer sentiment. I
would agree.
Recently, I was having a chat with one of our most
senior Japanese bankers. Yes, I told him, I understand
all the economic concerns. Now, please, tell me the real
problem.
"It's a generational war," he said. "The old have the
money, the young want it, but the old are not about to
give it up." The problem is getting worse by the day as
the nation ages faster than any other country on earth.
With the so-called silver generation controlling most of
the nation's assets, be it land, Yen, or gold, the risk
appetite in Japan has never been more conservative.
Adding complexity to the issue is that this generation
is also the most politically active. They are the
primary beneficiaries of a gerrymandered political
system that essentially freezes out Japan's largest
cities - and the young people who live there - from the
political process.
This silver generation, which worked so hard to rebuild
the nation from the radioactive rubble of the Second
World War, not only controls the "gold", but the
political fate of the nation. And this generation has no
intention of embracing the "no pain, no gain" economic
reforms suggested by Prime Minister Junichiro Koizumi.
The risk-averse nature of this generation shouldn't come
as any surprise to anyone whose parents came of age in
the Great Depression of the 1930s. Take my mother. She
doesn't realize how much she shares in common with her
silver peers in Japan.
At 79, she is a master of Depression economics. We were
all indoctrinated on its core fundamentals: never borrow
or lend; never get into debt - even with credit cards;
balance your check book; never speculate on real estate,
but own a mortgage-free home that you live in. Never,
ever live beyond your means. And if you must gamble,
dabble in the stock market; it's cheaper than horse
racing and more socially acceptable dinner conversation.
Sound advice from a cagey social doyenne from the cave-
dweller land of Washington, D.C. And today, anyone in
Japan who had followed my mother's advice would be way
ahead of those who invested in stocks. There are other
lessons from the Depression. My father was raised by two
old Victorian aunts in Boston during the Depression. He
used to say he never had it so good. Each month the
value of the coupons his auntie clipped grew in value as
deflation accelerated.
And over in England, my wife's Oxford-educated but
capital-starved BBC journalist parents came of age in
the grim days following the Second World War. For their
whole lives they have scrimped and saved in a manner
that would make even my family blush. Yet, on both sides
of the Atlantic, most of my family sits with modest
amounts of real estate, not a dollar of debt, and enough
cash on hand to keep life pleasant. And so too does much
of Japan.
Any family that ignored those pesky Nomura, Merrill, or
Daiwa salesmen and did absolutely nothing more with
their money than stuff it under a futon is looking
pretty good. Yen collected in kitchen jars or in the
government equivalent - the post savings system - has
achieved a far greater return than a long-term
investment in a basket of Japanese stocks.
Why? Deflation.
While deflation is a nightmare for government budgets,
businesses, and financial firms, it is a godsend for
most Japanese, particularly retired ones. Those
seemingly laughable returns from postal saving deposits
are now creating real returns of more than 2%.
Deflation investing has done the consumer well in Japan.
Pensions are worth more, as the price of everything from
apples to coffins has plunged in Japan. Real estate
prices have dropped, of course, but if there is no plan
to sell, who cares? There is something in the spirit of
postwar Japan that loves this kind of austerity.
While their daughters are buying Chanel, Mom is counting
the number of toilet sheets to be used, or sending Dad
off to work with a few hundred Yen in his pocket. This
is great for the family budget, but spells disaster for
the economy. Private consumption is 63% of GDP, which is
why our economic gurus at J.P. Morgan describe the
economic situation in Japan as "dire".
Japan, then, is in a death struggle with time. The
macroeconomic indicators keep getting worse. Foreign
pressure to reform is getting louder by the day. Yet,
each day more and more Japanese retire into a deflation
paradise where their hard-earned Yen gains value. Every
effort by Japan's Diet to reform the economy is met by a
wave of opposition from this conservative majority.
No doubt, the economic and financial problems Japan
faces are as difficult as any developed economy has ever
experienced. But don't mistake difficulty for adversity.
Japan isn't Indonesia, Argentina, or Turkey. To the
contrary: it owns most of the U.S. debt. There is no way
to really pressure Japan, particularly with tens of
thousands of U.S. troops living in Japan on the
invitation of the government. As Jesper Koll at Merrill
Lynch always likes to point out, Japan could survive for
years, perhaps decades, living off the fat of the money
it has saved.
All the experts agree there can be no economic recovery
until the bad loans are resolved. Getting rid of bad
loans really means doing radical surgery on the Japanese
economy. It means thousands of bankruptcies, soaring
unemployment, and a dismantling of the Japanese social
welfare system as we know it. However, being serious
about resolving the NPL issue will also trigger the kind
of generational reaction that has and will continue to
stop real reform for quite some time.
So, what does this all mean for investors in Japan? Hold
on to your wallet. Chartists will say that this may be a
historic opportunity to invest in Japan. They said that
when the Nikkei was at 20,000. And again at 16,000. And
yet again at 12,000. Now it's around 10,000. My guess.
When the Nikkei falls below 6,400 - calling Mr.
Greenspan - then I believe the country will truly be in
trouble.
Things are going to get a lot worse in Japan before they
get better, if ever. This writer has capitulated.
Peter McKillop,
for The Daily Reckoning
Peter McKillop is a former New York bureau chief for
Newsweek where he covered, among other things, the stock
market crash in 1987, and a foreign correspondent in
Hong Kong and Tokyo, where he covered the collapse of
the Japanese bubble in 1992. After nine years in Japan
he continues to write about the country for Time
magazine's website. He now works as a vice president in
charge of corporate communications for J.P. Morgan in
Japan.
A version of Mr. McKillop's essay first appeared in The
Gloom Boom and Doom Report, published by the Blue Team's
Dr. Marc Faber.
* * * * * * * * * * Advertisement * * * * * * * * *
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