-- Posted Thursday, 12 February 2004 | Digg This Article
The Daily Reckoning
London, England
Thursday, 12 February 2004
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*** Quagmire overseas...fiscal quicksand at home...feeding the fantasy...
*** World-famous cartoon character sparks a rally...frosting on the world's financial cupcake...
*** Who will pay their debts?...A fascinating quandry for Juniper...gratuitous politics...and more! More! More!
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Where was John Forbes Kerry?
We only ask the question to be provocative. We know the answer. He was in Vietnam; trying to kill the locals before they killed him. We just don't know why. More about that below.
For the moment, we return to our regular beat - the dreary world of finance, investment, and economics.
What brings the worlds of politics and money together - like a gigolo who pretends to be in love with a woman who pretends to be rich - is fraud. Both are so soaked in it, if you ever dried them out, there would be nothing left.
"It's time to put an end to the fantasies and the deceit," comments Bob Hebert in the New York Times, "which have landed America in a quagmire overseas and the equivalent of fiscal quicksand at home."
Each day that goes by, the federal government sinks about $1.5 billion deeper into the hole. George W. Bush never met a boondoggle he didn't like, and has yet to see a single pork-barrel spending bill he didn't want to sign. But others have become so alarmed that even the democrats are taking it up as a campaign issue.
The other source of alarm is the current account deficit. It is mud of a different sort...still, the U.S. sinks at about the same rate - down about $1.5 billion every day.
The great fantasy in which Americans put their faith is that these mires are nothing to worry about. "Deficits don't matter," said Dick Cheney...speaking of the federal kind. Most people think the other type matters even less. By some special dispensation from God himself, they seem to think that they never have to pay their debts.
In this detail, they may be right: Americans may never pay their debts. Even in the present 'recovery,' the means of repayment slip away. A nation cannot repay overseas debtors by polishing each others' shoes. It must make something it can sell to the foreigners. Yet, in America, the factories close down while shoe polish flies off the shelves. Industrial production, typically up by about 18% at this stage of a recovery, is still down 5% from 2000. Employment in the manufacturing sector should be booming, too. Instead, nearly 2.5 million jobs have been lost since the recession began in 2001.
"From its peak five years ago in 1998," explains Dr. Kurt Richebächer, "manufacturing employment has plunged 2.1 million, or about 18.3%. This is the single greatest percentage decline in the labor force in almost seven decades since the Great Depression of the 1930s. What has been happening to American manufacturing can only be described with the word 'depression.'"
[See Dr. Richebächer's article: The New Growth Euphoria http://www.dailyreckoning.com/body_headline.cfm?id=3755 ]
With nothing to sell, how will Americans settle their debts? They may not pay them, but the costs of settling up cannot be escaped.
If the bond issuers do not pay, perhaps the bond holders will. Eventually, someone pays...and the fantasy ends.
And here we pause to thank the kindness of strangers. Without the illusions of the Japanese...who think they can make money by lending to people who can't pay back...the fantasy would have ended long ago.
The division of labor in the world grows clearer. China produces. The U.S. consumes. Japan finances. The Bank of Japan has spent $250 billion - $2,000 per Japanese citizen - to hold the dollar up, and U.S. interest rates down, over the last 13 months.
When they will give up...we don't know.
But while we are waiting, here's Eric with more news:
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Eric Fry in Manhattan...
- Alan Greenspan and Mickey Mouse led the stock market to new highs yesterday. The world-famous cartoon character deserves most of the credit for the rally...but Mickey Mouse also played an important role.
- Shares of Walt Disney jumped 14% yesterday, leading the Dow to a fresh 32-month high, after Comcast bid $66 billion for the giant entertainment company. Meanwhile, over in Fantasyland, Chairman Greenspan presented a soothing assessment of our national economic condition to the House Financial Services Committee.
- "Looking forward, the odds of sustained robust growth are good," the Fed chairman beamed. "In all likelihood, employment will begin to grow more quickly before long as output continues to expand."
- Concerning interest rates, the Fed chairman delighted his listeners - and millions of investors - by declaring, "With inflation very low and substantial slack in the economy, the Federal Reserve can be patient in removing its current policy accommodation." In others words, the Federal Reserve will not be raising interest rates any time soon.
- The Chairman also reassured the congressional committee that the plunging dollar is no problem, nor should we be overly concerned about the nation's gaping federal and current account deficits. Greenspan neglected to conclude his remarks by saying, "...and they lived happily ever after." Probably just an oversight by his speechwriter.
- Investors adored the chairman's remarks, and wasted little time responding. The Dow jumped 124 points to 10,738 - just shy of the 10,748 intra-day high set on January 27 - while the Nasdaq Composite Index added 14 points to 2,090, their highest closes since June 2001. Bond traders also responded rapturously to Greenspan's comments. Treasury bonds rallied, driving the yield on the 10-year note to 4.02 percent from 4.10 percent.
- But alas, dollar holders were not so enthralled to hear the chairman brush aside concerns about inflation and the current account deficit. The dollar tumbled more than 1% against the euro to $1.2811. Gold responded to the dollar's steep decline by rallying $3.70 to $410.70 an ounce.
- So, on balance, everyone but dollar holders found something to like in Greenspan's testimony...But wait a minute...aren't U.S. stocks, Treasury bonds and gold all priced in dollars? So if the dollar fell more than 1% yesterday, didn't all investors actually lose money?...But what do we know; we just try to keep our financial heads above water by owning the one asset - gold - that is likely to rise about as much as the dollar falls.
- While listening to Greenspan drone on and on yesterday, the phrase "divorced from reality" came to mind. The rallying stock and bond markets are celebrating the "reality" that Greenspan portrays: a buoyant economy with only the slightest of flaws.
- Perhaps his portrayal is accurate. But it seems to downplay one very inconvenient fact: Our prosperous nation relies heavily upon the kindness of foreigners. We enjoy a kind of contingent prosperity, which flourishes as long as our foreigner creditors don't neglect to stuff a bottle in our mouths at feeding time.
- Foreigners produce, so that we may consume. Foreigners save, so that we may borrow and spend. In effect, we Americans get to lick the frosting off the world's financial cupcake. How delightful it is to be an American in February 2004!
- Borrowing and spending has been sustaining the U.S. economy for so long that the phenomenon seems utterly unremarkable to most investors, and not worth mentioning to Chairman Greenspan. But our paltry national savings rate is indeed a remarkable phenomenon.
- "In 2002 the U.S. national net saving rate (gross saving less the nominal depreciation of the capital stock) was a post-World War II low of 2.4%," observes Northern Trust economist Paul Kasriel. "In fact, 2002's rate was the lowest net saving rate since the Great Depression! Though fourth-quarter data are not yet available, it appears that the net saving rate fell even more in 2003, averaging just 1.2% in the first three quarters of the year."
- Not to worry, foreigners are doing our saving for us..."The Fed's flow-of-funds data show that net foreign claims on U.S. assets already are $2.3 trillion, or about 21% of nominal GDP. That total is being added to at a current rate of about $550 billion a year," says Kasriel. "My suspicion is that over the next 20 years or so, the dollar will fall a lot more, U.S. interest rates will rise a lot...and baby boomers will be fighting each other for the greeters' positions at Wal-Mart."
- Last week, your Paris editors remarked, "Americans cannot save a dime...yet, they set out to save the entire world."
- Our advice: Let's try saving dimes first.
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Bill Bonner, back in London...
*** Who will pay their debts? Not homeowners...not in Philadelphia.
"With a record number of Philadelphia homeowners unable to pay their mortgages," begins a report from the City of Brotherly Love, "city officials, the sheriff and advocacy groups are trying to convince a judge to suspend the city's foreclosure auctions."
"This is the worst time for foreclosures basically since the Great Depression," said John Dodds, director of the Philadelphia Unemployment Project, the group leading the moratorium drive.
"You can't keep letting hundreds and hundreds of people lose their home every week.
"Philadelphia Sheriff John Green said he would participate in a lawsuit to suspend the auctions, which this week saw a record 1,120 homes up for bid."
*** What's this...? Addison tells me the French version of our book suddenly leaped to #1 on Amazon's list in France yesterday. Ahead of Harry Potter even. We don't know what to make of it...
*** And here, colleague Porter Stansberry with more madness in the Nasdaq:
"Out of the eight public corporations in the world whose market capitalization exceeds $10 billion and whose shares trade at more than 15 times earnings, Juniper Networks has the absolute worst gross margins.
"The others are all around 90%. But Juniper sells big, hard-to-make routers. It is, then, mostly a manufacturing company. And its gross margins are comparatively normal: 69%.
"Like most revered high-tech stocks, Juniper's business doesn't appear to benefit shareholders in any way. On a cumulative basis, the company's efforts since its founding in 1998 add up to a loss of $13 million dollars. Of course, this GAAP accounting doesn't include Juniper's biggest expense: stock options. Juniper's management thoughtfully passes this cost along to shareholders directly.
"This, of course, is de rigueur for tech companies. But Juniper's board of directors threw gas onto the fire by agreeing to re-price all of the outstanding employee stock options, near the bottom of the market in tech shares. Today Juniper has 75 million stock options outstanding with an average strike price of $10.71. With the stock doing so well lately, these outstanding, off-balance sheet obligations provide investors with a fascinating quandary.
"At current share prices, Juniper's employees' options have an intrinsic value of $1.296 billion dollars. Meanwhile, Juniper's total shareholder equity only equals $1.5 billion. Thus, at current prices, Juniper's outstanding option grants to its employees are worth ~ 80% of its equity.
"The more bullish investors bid up the price of this stock, the smaller their own claims to the company's equity becomes. This is the only time I can recall seeing a stock actually become worth less, the more someone offered to pay for it. I'm not quite sure what to make of it...
"Juniper's managers, however, are not so curious. They seem quite able to chart a proper course of action: they're selling - like there is no tomorrow. So far this year (2004) Juniper's CEO has dumped 500,000 shares, worth more than $14 million dollars. The company's CFO isn't far behind: he's dumped about $6 million worth of stock.
"Like lab monkeys on cocaine, these guys see no reason to stop hitting the feeder bar. If shareholders are going to reward them for diluting their stock and dumping new shares on the market, why stop with giving stock to Juniper's employees?"
[More from Porter on the frenzy for techs below...] *** And now for some gratuitous politics.
"Senator John Kerry, the Democratic front-runner, received an early discharge from military service," explains this week's Time magazine. But unlike George Bush, who got out early so he could go to Harvard Business School, after spending much of his service career hustling votes in Alabama, Kerry went home after winning "three Purple Hearts, a Bronze Star and a Silver Star during 11 months in Vietnam."
Yet, the war itself was - according to its primary promoter at the time, Defense Secretary Robert McNamara - a colossal blunder. And as we recall, almost every thinking person at the time - except the Secretary of Defense - knew it. Which is why we wonder about Yale graduate, John Kerry. Which is more hideous, dear reader? Going off on a fool's errand to kill people for no good reason...or pulling strings to avoid it?
Neither is anything to brag about.
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The Daily Reckoning PRESENTS: Porter Stansberry, taking advantage of temporary insanity in the markets...
SELL! By Porter Stansberry
John was 88 years old. He'd been active in the stock market his entire life.
But now he thought it was time to sell.
At first glance, there was nothing unusual about his desire. Most 88-year olds don't own too many stocks. And, at the time John decided to sell, in January 2000, stocks were obviously expensive and therefore risky for conservative investors.
Selling a few stocks was only prudent. But it wasn't prudence that motivated John. It was profit.
John believed he could make as much money on the way down as other, more foolish investors had made on the way up. Of course, unlike the bullish speculators, if John was right, he'd walk away with his gains in cash instead of watching them disappear on an electronic quote screen.
It's one thing to have an idea about where the market ought to be heading. It's another thing altogether to bet an entire $180 million fortune on your hypothesis. But, that's exactly what John did, beginning in January 2000. John sold short 84 different Nasdaq stocks, putting an even amount of his fortune against each position - roughly $2.2 million on each stock.
He told his brokers: "This is the only time in my 88 years I've seen technology stocks go to 100 times earnings; or, when there were no earnings, 20 times sales. It is insane, and I am going to take advantage of the temporary insanity."
By "shorting" these stocks, John borrowed shares of stock from brokers who held large inventories of shares on behalf of their clients. These shares were then sold in the market. The money from each sale was put into John's margin account. John was now on the hook for the shares that he'd borrowed and sold. If the shares rose in price, he'd lose money - perhaps all of his money - because he'd have to buy the stock back at a higher price to repay the brokers from whom he'd originally borrowed the stock. On the other hand, if the shares fell in price...John would never have to repay the full value of his loans, earning him a profit.
He told his brokers to sell short every new technology IPO that came to the market in 2000 - every single one. He told them to establish his position 11 days before the stock's IPO lock-up expired, which was typically six months after the IPO took place. In this way, John was selling just before all the company's insiders were allowed to dump their shares.
In about half of these positions, the stocks fell 95% or more before he "covered" his short position, repaying only about 5% of the value he'd borrowed. In other stocks, he covered when share prices retreated to more reasonable multiples of earnings (30 times earnings). On average, he made over $1 million per position, increasing his fortune by 50% in just a few months.
Even for Sir John Templeton - the "John" in our story - this stock market operation was the trade of a lifetime. As you probably know, Sir Templeton is one of the world's all- time best investors. He is famous - and was knighted in 1987 - because he made fortunes for long-term holders of his emerging market mutual funds, which profited by investing in dirt cheap foreign growth markets, like Japan in the 1970s and Peru in the 1980s.
Sir Templeton grew up in rural Tennessee. He attended Yale, but was only a mediocre student until the crash of '29. The crash wiped out his father, who could no longer pay for Sir Templeton's education. To stay in school he had to earn a scholarship. Only the top students were awarded such grants...so he became the top student in his class and, in addition to his Yale tuition, was awarded a Rhodes scholarship to study economics at Oxford.
Today Sir John Templeton is a British citizen and lives on Lyford Cay, in the Bahamas. He's still - even at 91 - active in the markets. He granted an interview to Forbes magazine earlier this year. He offered a warning to investors, telling them it's difficult to find reasonably priced stocks anywhere in the world. "You can always find bargains somewhere but it's difficult now. My advice is to own government bonds." He's not recommending U.S. bonds, but bonds from countries that don't have huge fiscal and trade deficits - like Hong Kong, Singapore and South Korea.
I found Sir Templeton's recent remarks significant because, for the first time since January 2000, when he began his now famous short selling operation, you will find Nasdaq 100 stocks trading at the same kind of absurd valuations as they did at the top of the bubble.
Personally, I think the craziness started back in September of last year. That was the month when Prudential, which is the only major Wall Street brokerage that doesn't also conduct investment banking operations, altered its rating system. Instead of having its analysts decide objectively if a stock offered good value, Prudential instructed its analysts to offer only "relative" valuations. In other words, nobody was willing to tell investors that things were getting out of hand. Instead, as long as all stocks were getting equally overvalued, Prudential could still find something to recommend to you. Great.
And so today The Wall Street Journal is once again reporting on the lives of 20-something financial whiz kids who have been mistaken for geniuses in the midst of a raging bull market.
Featured last week was Mr. Bret Grebow, the 28-year old manager of HMC International - a hedge fund. Bret is so confident that he'll be able to maintain the 40% annual gain his fund scored last year that he recently purchased a $160,000 Lamborghini Gallardo. Bret's big winnings allow him to keep a residence in Highland Beach, Florida and an office in New York City. He charters a $10,000 per flight jet for the round trip. In reference to the jet, Bret told Wall Street Journal reporter Gregory Zuckerman, "It's fantastic. They've got my favorite cereal, Cookie Crisp, waiting for me, and Jack Daniels on ice."
Another hedge fund manager rented Versailles for his wedding last summer.
And broker Grant Morgan, who says "We're comfortable the market won't take a new downturn," was confident enough in his future earnings to spend a week at the Breakers in Palm Beach...after buying a $150,000 Ferrari 360 and spending $600,000 to remodel his home.
Once, not too long ago, I was a part of the hotshot crowd, piling into growth stocks without a care. Well, at least in a small way. For a short time, I posted gaudy performance numbers. My picks were up 134% in 1999. And I heard people tell others that I was a "genius." I remember squiring my girlfriend around New York City, staying in hotels that cost more than a month's rent just for the night. As your editor, Bill Bonner, wrote of me, I was living as though God whispered in my ear.
But, having been a part of that once, I remember all too clearly how it ends.
In November of 2000, I hosted a lavish conference for high- tech, growth-stock investors at the Ritz-Carleton in Montego Bay, Jamaica. In the days leading up to the conference, my portfolio collapsed. As I hit my stops, I sold, sometimes at a loss.
One of the speakers at the conference was a director of VA Linux, a company that was attempting to compete directly against Microsoft by selling desktop computers with a version of the free Linux operating system installed on the hard drive, instead of Microsoft's Windows. In other words, its business plan was the Charge of the Light Brigade. On the day of his presentation in Jamaica, VA Linux's stock dropped 20%, reducing this director's net worth substantially - probably by more than a million dollars. He flew home the next day. VA Linux had become the largest loss ever recorded in my model portfolio.
The conference attendees - my best customers - were stunned when, in my closing presentation, I warned them about the impact of the Fed's interest rate tightening, which had produced an inverted yield curve, making it prohibitively expensive for speculative companies to get additional financing. I wrote the same message in my newsletter, to all my subscribers: get out, it's a bear market and it's going to last a while.
People were angry. In less than a year I'd gone from a genius to a fool. As the market began to spiral lower, I lost most of my subscribers, who had largely ignored their stop losses and my warnings of an impending bear market.
I lost my bull market girlfriend, too.
But I learned a very valuable lesson: what you put at risk in the market is far more important than what you might gain.
Given this background, the run-up of 2003 looks suspiciously like the party year of 1999 to me - and the risk of stock investing in 2004 akin to investing in the year 2000. As Templeton told Forbes, there are almost no cheap stocks, anywhere in the world. Within the S&P 500 there are only 10 stocks that have P/E ratios below 10. That's the lowest tally of cheap stocks ever, according to Barron's.
What should we do when all of the signs, not least the crumbling dollar, point to higher interest rates? What should we do when the world's best, most experienced investors issue public warnings about worldwide stock market prices? What should we do when there are literally no reasonably priced stocks trading in the entire U.S. market? What should we do when individual investors are wildly bullish, but insiders are selling at a record setting pace?
It's simple. We sell the market.
Regards,
Porter Stansberry, for The Daily Reckoning
Editor's note: Porter Stansberry is the founder of Pirate Investor LLC, a financial publishing group dedicated to providing high-quality research for high net-worth investors. The former editor of several well-known financial letters, including Latin American Index, China Business and Investment, and the U.S. edition of The Fleet Street Letter, Mr. Stansberry is regularly quoted in leading financial journals, such as Barron's and World Money Analyst.
Porter is also the publisher of Extreme Value, an investment letter that seeks to uncover solid shares selling on the cheap - even in an wildly overpriced market. Read on to discover the gems the Extreme Value team have recently laid bare in the real estate market:
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-- Posted Thursday, 12 February 2004 | Digg This Article
