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On the days that I don't publish, like today, you receive
Bill Bonner's DAILY RECKONING. This will help you to keep
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Black and Blue
The Daily Reckoning
Paris, France
Friday, 4 October 2002
-------------
*** Are we there yet? Apparently not...stocks keep
falling...
*** Debt up, bankruptcies up..."time to get your house
in order..."
*** We're shocked! Wall Street gave special favors to
big customers? Nah...can't be... Deflation is a "bad
bet," and other guesswork!
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The Wilshire 5000, the broadest measure of stocks in
America, is down nearly 50% from its peak. $8 trillion
has been wiped out.
Isn't that enough?
Apparently not. Stocks fell again yesterday.
"We're about halfway through the bear market in terms of
time," Robert Prechter told Newsweek, "but less than
halfway through in terms of price."
For Prechter's Comments see: Conquer The Crash
http://www.elliottwave.com/a.asp?url=conquer&cn=dailyr
No one knows, of course, but Prechter thinks we'll find
the bottom of this downtrend somewhere below 3550 on the
Dow. Bill Gross of PIMCO says it will be around 5,000.
Here at the Daily Reckoning, we take the same approach
as the Supreme Court to pornography: we'll know it when
we see it. Or, we won't.
But we think it will be a long time coming. The dream of
getting rich by buying stocks rocked so many people to
sleep for so long...it will take more than a few years
of losses and a few trillion dollars to wake them up.
Besides, nearly every broker and money manager still
reassures his clients - and maybe even believes himself
- that he is in it "for the long haul." America has the
most dynamic and resilient economy on the planet, he
reminds them; over the long run nothing beats a
portfolio of well-chosen U.S. stocks.
As time goes by, however, more and more stockholders
will give up: "I don't care about the long run," they'll
tell him. "Just take me out; I need the money."
Consumer debt rose $500 billion in the last 5 years. The
average family has $7,000 in credit card debt alone.
Federal Reserve figures show U.S. consumer debt reached
145% of GDP last quarter.
Bankruptcies are rising too - there were 1.5 million of
them in the last 12 months.
"Now is the time to get your house in order," says an
article at TheStreet.com. "Somebody who has a 15% debt
to income ratio has a problem," the article explains. By
our back-of-the-envelope calculations, the whole nation
has a problem. More below... including a startling
little number the financial press seems to have missed.
But first, Eric's report:
--------------
Eric Fry, from the city of New York...
- Another day, another failed rally attempt. The Dow
jumped more than 150 points in the early going
yesterday, immediately after the Institute for Supply
Management reported a higher-than-expected reading for
its non-manufacturing index. But the gains quickly
evaporated. A few subsequent rally attempts also failed
to take hold. By the end of trading, the Dow was off 37
points to 7,717 and the Nasdaq Composite had dropped
nearly 2% to 1,166.
- The brokerage stocks suffered a particularly severe
beating. The XBD Brokerage Stock Index tumbled another
5%, led lower by the newest bad boy on the block,
Goldman Sachs. It seems that the heretofore unsullied
Wall Street firm stands accused - by Congress no less -
of lavishing "hot IPOs" upon several of its investment
banking clients. (Remember when initial public offerings
used to be "hot?" Stocks like Etoys and Yahoo jumped
more than 250% on their very first day of trading!)
- Anyway, in a classic case of I'll-scratch-your-back-
and-you-scratch-mine, Goldman liberally dispensed stock
in hot IPOs to many of the very same folks who brought
them investment banking business. A coincidence?
Unlikely. Altruism? Even less likely. According to
Bloomberg News, "Kenneth Lay, Enron's former chairman,
Dennis Kozlowski, Tyco International Ltd.'s former chief
executive and Ebay CEO Margaret Whitman, a Goldman board
member, were among the executives to get IPO shares."
- We at the Daily Reckoning are shocked...shocked that
Goldman Sachs would load up the personal accounts of its
investment banking clients with hot IPOs. Who would do
such a thing, simply to attract tens of millions of
dollars of investment banking business?
- Since the early 1990s, this sort of preferential
treatment was one of the biggest open secrets on Wall
Street. I don't know any hedge fund manager, for
example, who DIDN'T know that this sort of thing was
happening. I always felt that the overtly unfair manner
in which brokerage firms allocated hot IPOs was scummy,
but that's because I never received any large IPO
allocations. If I had, I might have thought this was a
pretty nifty way to do business.
- We now return to the topic that has been captivating
Daily Reckoning readers all week: Whither the bond
market?...Will the 10-year Treasury yield continue
sliding in response to an unshakeable deflationary
malaise? Or, alternatively, might a renewed inflationary
cycle cause rates to rise? None of us has the exact
answer, of course, but we are not shy about hazarding a
guess - after all, we will either be right or wrong.
- Bill is partial to the notion of a deflation that
slowly billows through every nook and cranny of our
economy log fog through downtown San Francisco. I, on
the other hand, consider inflation the betting man's
wager. As money manager Edwin Levy said recently in an
interview with James Grant, "[T]he idea of America
falling into deflation is a bad bet. I am not saying I
am short [Treasury] bonds...I am saying that this is a
lousy bet."
- But the nice thing about the great deflation vs.
inflation debate is that both sides are bound to be
correct at some point in the future. Anticipating this
possibility, PIMCO's legendary bond-fund manager Bill
Gross predicts BOTH deflation AND inflation.
"Deflationary fears are all the rage these days," he
observes, adding that in his own five-year forecast,
"deflation might rule the early years while reflation
might command years four and five plus."
- What if Mr. Bonner is right? What if rates are more
likely to fall than to rise? Wouldn't that be a good
thing? Well, maybe not, as Jim Grant explains:
- "What is implied by [today's] yields and prices is
that Treasury securities are just as safe today as
equities were in March 2000. They are safe because they
are going up...The risks to the downside are familiar to
anyone who keeps up with Japan. Ultra-low yields damage
the sponsors of underfunded pension plans. They hurt
life insurance companies with obligations to deliver
streams of relatively high-yielding annuity income. They
tempt investors into the old conjuring trick of trying
to coax a 6% return from a yield curve unable to give
that much."
- Not to worry, a couple of hot IPOs from Goldman Sachs
could make up the difference.
--------------
Back in Paris...
*** A message from my friend, Dan Ferris: "Hey, Bill...
I'm in Hawaii researching that company, Alexander &
Baldwin. I'm going over to Maui and maybe Kauai (I'm on
Oahu, yuck!) to check out their sugar and coffee
plantations, watershed land, residential developments,
as well as to visit the Maui County Real Property
Assessment Division office.
"Not many beautiful women here. I'm a little stumped
about that.
"I told my dad that ALEX owned 90,000 acres of Hawaiian
land, about half of it carried on the books for $150 an
acre. I think he bought some. The carrying value of all
the company's land is a measly $104 million. Its entire
real estate business lists assets of $476 million.
"The fair value of its 1246 acres of urban land and
buildings is about $1.5 million per acre...not including
the buildings. That's like $1.5 billion, about 50% more
than you can buy the whole company for today. Another
1710 acres is at least one step along the way toward
that process. Another 11,000 or so will go into that
pipeline in the next decade or so.
"Who cares about its relatively flat cash flow (10
years: -2%)? Who cares about modest earnings growth
(5%)? I just wanna own a piece of all that land...(and
make 4% in dividends, too)."
Ferris, I believe, is on a mission for the
Pirateinvestor.com crew. You can learn more about their
moneymaking exploits at this link:
"True Wealth"
http://www.agora-inc.com/reports/TRW/WTRWC911/
*** "The situation is pretty simple," said Jean Charles,
a bureau chief for the French daily, Le Monde, over
drinks last night. Your editor's wife had invited her
horse friends over; one was married to the newsman.
Neither of us had much interest in the central topic -
four-legged animals with disagreeable temperaments - so
we turned to the subject of world affairs.
"I remember back to the '70s. Then, the U.S. had Jimmy
Carter and double-digit inflation and French shopkeepers
were reluctant to take dollars. Europe was on its high
horse back then...and it seemed like Europe would lead
the world into a new era of peace and prosperity.
"Instead, Europe contracted some form of sclerosis...
costs rose...unemployment went up and nothing seemed to
work as it was supposed to. Instead, the Japanese
economy took the leadership role.
"But by the '90s, the U.S. had sorted itself out. It
dominated the key industry - software - and nobody could
compete with it. Plus, unlike the Japanese or the
Europeans, the U.S. is also a military superpower.
"That is the big difference. The U.S. has severe
economic problems - with all the debt that consumers
carry - but it also has a lot of military muscle to
throw around. We wait now to find out how long it will
be before it destroys itself...it could be 5 months...
or, like Rome, it could take 5 centuries."
*** "We get along fine with the English," a French
businessman said to me last week. "We detest each other
equally. What we don't understand is the Americans. We
detest them, of course...but they seem to like us
anyway."
"Don't worry," your editor reassured him, "there are
plenty of Americans who detest the French."
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---------------------
BLACK AND BLUE
by Bill Bonner
Investors are getting beaten, whacked about the head and
hindquarters by stock prices that won't stop falling.
Economists can hardly believe it. They admit they have
no words to describe this 'baffling economy.' But like
lookouts on the Titanic, they sit and stare, dumb,
mesmerized by the destruction they should have seen
coming.
In the spirit of constructive criticism, once again we
try to help.
You don't get something for nothing, goes the adage.
But you'd have hardly thought so in the last decade of
the 20th century. Companies with no earnings were
suddenly worth billions. People were getting rich with
nothing more than zeros on their income statements.
Without even casting a single crust upon the water,
Americans were reaping more loaves than they ever
imagined possible.
What was the source of this modern-day miracle? The Fed
was creating 'credit' out of thin air; after all, it is
in the business of printing money. Money was conjured
up...from nothing, credit far in excess of available
savings. And the more nothing the Fed brought to the
job, the more people began to like it. They felt they
had something...and wanted more.
Thus did Alan Greenspan's reputation, debt, and mass
fantasy all become extraordinarily popular as the
century came to a close. The economics profession had a
theory: that all a central bank had to do to promote
permanent prosperity was to control the price of credit
- making it easy to borrow most of the time and more
difficult occasionally when inflation needed to be
controlled. As long as consumers didn't see the price of
beer and cigarettes rise from week to week - the more
credit the better.
Throughout most of the '90s, credit expanded at a rate 2
to 3 times the increase in GDP. But by the end of the
period, credit was gushing into the U.S. economy at the
rate of $2 trillion per year...or 20% of the entire
gross domestic product.
As time went by it took more and more nothing to produce
the illusion of something that people wanted. As
reported in this space at least once before, during the
first 3 decades following WWII the ratio of debt-to-GDP
growth was fairly constant. For every extra dollar of
GDP, debt went up by $1.40. Recently, the ratio has gone
out of whack - with nearly $5 in debt for every extra
dollar in GDP.
There is a hint of desperation about these figures, we
think. People are borrowing not to invest in new and
better industries, but to keep up appearances. As
reported here yesterday, for example, Americans are
refinancing their homes just to get a $40 break on their
monthly payments.
Alas, the Fed's miracle money machine was almost too
wonderful. An email message found on Richard Russell's
website helps explain why:
This is different from previous downturns "PRIMARILY
because underlying economic activity can no longer be
stimulated by monetary or fiscal means at this point in
time. Markets have become saturated, and even if you
offer zero interest loans people cannot drive more than
one car at a time, and they still have to pay back the
capital value of the car loan. Even if you charge 0% on
housing mortgage rates, people still have to have the
income to pay back the capital value of the housing loan
(on a house price which has risen because the buyer
could afford to pay more)...
"What has been happening is that middle class people
have been TRADING UP because easy money and low interest
rates have facilitated the purchase of bigger and better
cars and houses (not more). This is what caused the
housing bubble. House "prices" have been rising, and
average car "prices" have been rising as middle class
people have shifted from compact cars to 4 wheel drives
(as an example)...
"It is different...because all the debt that was built
up to facilitate the "wild binge" in consumption of
fancy cars and upgrading of houses by ordinary people,
and purchase of new cars and houses by people who would
not have been able to afford to buy them if "normal"
credit assessment criteria had been applied - all this
debt now has to be repaid. THE 30 YEAR PARTY IS OVER,
AND THE HANGOVER NEEDS TO BE WORKED OFF.
"People, we need to understand that there is NO WAY that
the equity markets have reached bottom. Price/Earnings
ratios are still factoring in growth which...DOES NOT
HAVE A SNOWBALLS HOPE IN HELL of materializing.
Price/Earnings ratios WILL fall to bring the financial
world back to reality (and probably will also
overshoot)."
If we are right, rates will fall still further. Credit
will get cheaper (and bonds more expensive) simply
because people will stop asking for it.
The Fed's legerdemain requires buying and selling
treasury securities to force the cost of credit in the
direction it wants. It may be the biggest customer for
credit instruments, but it is not the only one. As other
customers for credit exit the market, it takes less
meddling from the Fed to keep rates low - simply because
there is less demand for them.
Jim Grant reports that since June, "the Fed has been
throttling back."
"Our guess," he continues, "is that the demand for funds
is falling, ergo the supply of funds needed to fix the
funds rate at 1�% is also falling."
Uh oh. Suddenly, people don't want to borrow the way
they used to. And here is another little item discovered
in yesterday's news: the latest figures show the savings
rate going up - to 4%. Despairing of nothing, people are
beginning to stock up on something.
Your editor,
Bill Bonner
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---------------------
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