Weekday Commentary
from Jim Puplava
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Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
Week in Graphs 
Storm Watch 
Geopolitical News 
Energy 
Precious Metals 
Raw Materials
Wednesday, November 13, 2002
Separating Noise From Chatter
Sometimes it is important to separate the noise from all of the chatter. Today the markets rose after a Bloomberg piece hit the airwaves that Iraq accepted U.N. resolutions setting the stage for arms inspections. Given the fact that if they didn’t accept the resolution by Friday war would begin immediately. The markets interpreted this news to mean the war is off the table. That, I believe, is wishful thinking on part of the markets. Intelligence reports continue to signal that the US is moving significant military assets into the region. Furthermore, as of yesterday’s release of a tape by bin Laden, congratulating terrorists for the deaths in Bali, Yemen, and in Moscow, terrorism is back on the front pages. The rally in stocks was short lived. Stocks rose and then sold off as a more serious problem was developing in the bond market. Bond prices were crashing and this became the focus of the financial markets.
On Capitol Hill Mr. Greenspan was pointing out everything that was wrong with the economy: “The lengthy adjustment of capital spending, the fallout from the revelations of corporate malfeasance, the further decline in equity values, and heightened geopolitical risks.” This has impacted consumer and business spending. The chairman also pointed to the fact that credit spreads have widened between investment grade and non-investment grade debt. In addition to US problems, Mr. Greenspan pointed out the current mess in Japan. Despite the numerous difficulties and the multiple bubbles in the economy (housing, mortgage refi’s, consumption, & financial assets), the US was on the right track. In the chairman’s own words, “…the economy has hit a soft patch.” For these reasons it was necessary to lower interest rates half a point.
On a more positive note he went on to laud the bubble in housing and cash out mortgage financing as a big plus for the economy, saying, “These data and some preliminary econometric results suggest that a dollar of equity extracted from housing has a more powerful effect on consumer spending than a dollar change in the value of common stocks.” In other words, what happens to the bond market is more important than what happens to stocks. Therefore, the Fed will do all that is possible to maintain the mortgage-refi-housing-consumption bubbles.
While stocks were rallying earlier in today’s trading session the bond market was tumbling. It became necessary to focus attention on the bond market. Lower interest rates and an expanding trade and current account deficit make US-denominated Treasury debt less attractive to foreign buying. In fact, recent weakness in the bond market has been attributed to foreign selling. As I pointed out yesterday, what happens to the bond market and the currency market is much more important than what happens to equities. Mr. Greenspan reaffirmed these thoughts in his testimony today.
Looking at the market since October, this rally has lacked leadership and momentum. No group outside of gold seems to be emerging as a leader in this rally. The volume hasn’t been there; the number of new highs versus lows is still tilted towards losses. We have no leadership in a market that gyrates on a daily, if not hourly basis. This is a market that is looking for direction and can’t seem to find it. The rallies appear to be nothing more than trading rallies made up of group rotation as fund managers play musical chairs with fewer chairs to sit on.
The Impoverished Millionaire
Regarding Mr. Greenspan’s comments as to the positive effect of lower interest rates, I would have to disagree. Lower rates threaten pension returns, which lower profits, and lower rates will put greater pressure on the dollar and long-term rates as the dollar falls. As to the effects on consumers, lower rates have been devastating to the savers in this country. This point can be demonstrated by the following true-life example this writer experienced last week. A couple in their mid-60s came in to see me with major concerns, not only about their portfolio, but also about their retirement plans. Last year after losing over 40% of their portfolio from its peak in 2000, the couple cashed out of all their mutual funds. They placed the money ($1,000,000) in bank certificates of deposit and money market funds not knowing what to do. All they did know was that they didn’t want any more losses for this couple depended on their investment income to supplement their $18,000 a year in combined social security benefits. The husband had been a high level manager with a defense contractor that chose to role over his pension and 401(k) plan into an IRA when he retired. His living expenses were roughly $5,000 a month of which $1,500 came from the government in the form of a social security check.
The portfolio had been close to $1.7 million at its peak. Generating $3,500 a month from capital appreciation, dividends, and interest had never been a problem. In fact, since retiring in 1996 he had seen his income and net worth go up each year. That all changed in 2000. At first he believed what his brokerage firm and cable TV told him about the downturn in stocks being nothing more than a correction. He lost money in 2000. By the fall of 2001 his portfolio was hemorrhaging. He liquidated his portfolio during the rally that followed the tragic events of 9-11. The terrorist attacks of last September had unnerved him. The money came out of stocks, preferred stocks, corporate bonds, and equity mutual funds. It went into CD’s averaging between 3.5 to 4 percent. On a million dollars that would produce his needed $40,000 in income to supplement his social security. He had laddered his CD’s at various financial institutions. He felt comfortable with that decision, especially as the major averages plunged double digits going into July. That is when his CD’s started to mature.
He was in for a big shock. Rates had fallen almost in half from where they were last winter. Today he would have to go out ten years or more to get a rate of return that was less than what he received last year. He told me with all of the financial problems at some of the financial institutions he thought of Treasuries, but was leery of going out 10 to 30 years to receive the same rate of return. He felt more comfortable going short-term, especially with all of today’s uncertainty. That is when I gave him another shock. I told him that the best he could get on a 1-year t-bill was a little over 1.25%.
| U.S. Treasury Market | |
| 3-Month | 1.20% |
| 6-Month | 1.24% |
| 1-Year | 1.32% |
| 2-Year | 1.72% |
| 3-Year | 2.15% |
| 5-Year | 2.82% |
| 10-Year | 3.83% |
| 30-Year | 4.79% |
The returns on 2-year notes were less than 1.75% and 5-year notes were less than 3%. It was hard for him to believe that on $1,000,000 of capital he would receive less than $20,000 a year in income.
This is the dilemma facing the savings class. Thanks to taxes and inflation, their rate of return on savings was now negative. The rate of return on a 1-year t-bill, currently at 1.32%, was less than the official inflation rate in the US of 1.5%. Back out federal tax rates of 28% and state taxes of 9.2% and another third is lost to taxes, bringing his after-tax return to below 1%. Maybe this is what Mr. Greenspan had in mind when he extols the favorable rates on borrowing and extracting equity out of housing. There seems to be a general focus in Washington on rewarding debt and consumption, and penalizing savings and investment. Who would have thought that a millionaire would have a hard time making ends meet? This individual is not extravagant by any means. He has a nice middle-class house that is paid for, and his hobbies aren’t expensive: golf and bridge. Yet with falling markets and interest rates he has fallen on hard times. Fortunately for this individual we had options. However, I can’t help but think that many other retirees and savers in this country dependent on their investments are suffering similar anxieties. Lower interest rates and inflation benefit the debtor class at the expense of the savings class, which is bad for the country economically.
Today’s Markets
Looking at the markets today it was a tug-of-war between optimism and fear as geopolitical fears remain at the forefront of investors concerns. Yesterday a bin Laden tape raised the specter of another terrorist event becoming a distinct possibility. On Saturday Pakistani-American businessman Mansoor Ijaz appeared on the Fox News Channel with Rita Crosby. Mansoor was the same man who tried to help negotiate an extradition of Osama bin Laden with the Clinton Administration that turned him down. During the course of the interview he stated that Al-Qaeda is planning to launch major attacks on the US and two other countries by the end of the month. The most likely date given by the recent bin Laden tape is Thanksgiving. Osama referred to the American feast holiday as a time of retaliation. In his interview Ijaz said, “Within the next two or three weeks I think we’re going to be looking at something pretty tough. I’ve been told that there’s going to be three simultaneous attacks on three different continents.” Ijaz believes the two primary targets will be the U.S. and the United Kingdom.
Prime Ministers and intelligence officials seem to confirm Ijaz’s story. Interpol secretary-general Ronald Noble said, “All intelligence experts agree that Al-Qaeda is preparing a major terrorist operation simultaneously. Britain’s Prime Minister Tony Blair warned his country yesterday about pending attacks. The French Prime Minister addressed the French people on Sunday warning of coming attacks. The German GNB (intelligence agency) has confirmed attacks will occur in the US shortly. The British Air Force, the RAF, is now patrolling the air over London and snipers have been placed on the roof of Heathrow Airport. The state department has issued a worldwide alert of an attack against Americans. The Bush Administration seems to be in a hurry to attack Iraq. Word in the intelligence community is that Saddam may be slipping weapons of mass destruction to terrorists to be used against the US.
It is doubtful the US economy and the markets could withstand another 9-11 or an event equally or more devastating, given the fragile nature of business and consumers. It may be one reason why the markets are requiring propping up and have had difficulty staying above their 20-50 day moving averages. But interest rates aren’t the only tool at the Fed’s disposal. The Fed Chairman seemed to intimate he had other means when he said, “We do have the capability, if required to do so, to go well beyond activities related to short-term rates.” Last night an article appeared on CNN/MONEY titled “For the Fed’s next Trick.” The article listed a plethora of ideas from pushing rates to zero by monetizing the government’s debt, buying corporate bonds, lowering bank reserves, lowering margin requirements for investors, to virtually giving money away. Some economists are arguing that the Fed could induce spending by consumers and business by targeting a higher rate of inflation, which would make holding on to cash less beneficial. This is the kind of madness that is now taken as sound economic policy, and most in the investment community would go along with it. In fact, many are calling for even more money. You got to have gold. Madness and lunacy and political risks are everywhere.
The major averages, with the exception of the S&P 500, made it back into the black after going on a wild swing from gains to losses to squeaking by with a minor gain for the day. Investigations into Citigroup’s stock ratings and market practices at Merck and Schering-Plough renewed concerns over corporate malfeasance. Defense and energy shares sold off after Iraq said it would comply with UN resolutions. Traders believe that the threat of war and a disruption of oil supplies are less of a danger now. Despite minor gains for the averages, most stocks lost ground. Losing issues beat out advancing issues on the NYSE by a 10 to 9 margin. They were evenly matched on the Nasdaq. Volume fell to below the six-month daily average. The VIX rose .89 to 36.28 while thee VXN fell .79 to 54.46.
Overseas Markets
European stocks fell after Corus Group’s decision to call off a takeover and results from Cable & Wireless highlighted a slump in demand as the region's economy slows. The Dow Jones Stoxx 50 Index shed 0.6% to 2518.14, falling for a fifth day in six. The Stoxx 600 Index dropped 0.8% to 209.65 as Cable & Wireless slumped 36% and Corus tumbled 27%. Seven of eight major European markets were down during today’s trading.
Japan's Nikkei 225 Stock Average fell to a 19-year low after the government reduced its economic assessment for the first time this year. Mizuho Holdings Inc. and Seven-Eleven Japan Co. led the drop. The Nikkei 225 Stock Average slid 0.3% to 8438.52, its lowest since April 1983.
Copyright © Jim Puplava
November 13, 2002
