This was a week to inspire the pessimists. The stock market kept sinking. Larry Kudlow and James Glassman, two super bulls on the stock market both had columns this week, trying to explain why the stock market is doing poorly when they keep telling us it will do great. Glassman, who in 1999 claimed that a fair value for the Dow Jones would be 36,000, had the nerve to quote himself as a source. Kudlow, who is an excellent economist, has been an unbridled optimist by nature, especially since recovering from his widely publicized cocaine addiction. Even he has to admit that things are not all hunky dory.
The Environmental Protection Agency endorsed a report blaming human development for global warming. President Bush ridiculed the report as coming from "the bureaucracy". He forgot to mention that he is in charge of that bureaucracy. The people who fight terror with color coded warnings are going to have their own enlarged bureaucracy. While its results remain to be seen, we can be assured it will spend lots of our money. More Israelis were massacred without much reaction. These massacres have become so common that they provoke little reaction. The Palestinian terrorists have tried twice, without success so far, to launch a mega terror attack that might kill thousands. Unfortunately, if given enough opportunities, they will probably have some success.
I am neither an optimist nor pessimist by nature. I believe that if people do the right things, good things will happen. The converse is also true. In some aspects of life, especially if courage is required people can often be counted on to do the wrong things. However, it is not preordained that good or bad times will occur at any specific time. A prudent person needs to prepare for both good and bad times. The Biblical Joseph might have been the first financial advisor, when he told the Pharaoh to store grains during the seven years of abundance in anticipation of seven years of poor crops. So what should we do now, how bad can things get?
I want to concentrate on financial issues here. I won't address the question of what happens if we fail in our war on terror and have to live under the shadow of nuclear blackmail by Saddam Hussein or Osama Bin Laden. I won't wonder about the future of public health as diseases such as HIV and the various brands of hepatitis work their way through an increasingly aging population. I will stick to issues of economics and finance here.
I tend to ignore apocalyptic predictions. They are usually made by people trying to get attention for their book or newsletter. Years ago I read an article in the San Francisco newspapers about how AIDS might spread. It told a story of straight suburban male teenagers going into San Francisco and acting as gay prostitutes for kicks. These guys may actually have existed, but I have trouble believing there are too many like them. The idea of the story was that these guys would contract AIDS in the city on Friday night and spread it to their girlfriends in suburbia on Saturday night. This was a writer looking to invent news. I want to concentrate on more likely scenarios.
A repeat of the depression of the 1930s seems most unlikely. We now have government backing of banks. We have unemployment insurance and many other things that would prevent a sudden collapse. So much of the financial system is backed by the credit worthiness of the Federal Government, which has unlimited ability to raise taxes and print currency. It would take a collapse of the government's financing abilities (such as happened in Argentina recently) to bring about a 1930s style depression. These safety nets might prevent a dramatic collapse of asset values and the economy, but they could also lengthen the duration of economic problems. By preventing free market adaptation to market forces, they delay the adjustments that are necessary to start the resumption of strong and stable economic growth. The result may be five fairly bad years instead of one or two calamitous years.
Inflation is certainly a possibility although it seems pretty far off. We have seen a declining dollar and an increase in gold prices. Financial markets view rising gold prices much as parents of teenage daughters view body piercing. Nothing good ever comes of it. While the price of gold has risen from $250 to $325 that is still 60% below its high set 22 years ago. Government spending is rising at an alarming rate. While the war on terror is one culprit, the dramatic spending increase has also hit the domestic area for both the federal and local governments. An alert eye should be kept on the prospects for inflation. However, it seems unlikely in the immediate future.
One model for our future could be Japan. In 1989 the Japanese Nikkei stock index stood at 39,000 yen. The Japanese had been extremely prosperous for over a decade until 1989. There were many economists who were convinced that the Japanese economy, which included "partnerships" between government and large industries, was the model for our future. Their model also included heavy doses of protectionism, government support for politically popular industries, and high levels of government control over the economy. Today the Nikkei stands at 11,400 yen. Japan has suffered three or four recessions in the past decade. The nation suffers from an extremely low birth rate, an aging population, declining real estate values, and a banking system that is probably as unhealthy as our savings and loan industry was 12 years ago.
There are many differences between Japan the USA. We are a much less rigid culture. We can accept immigrants to keep our work force from dwindling. We are more adaptable. However, our stock market is acting much like the Nikkei did in the early years of its bear market. In Japan interest rates were lowered to virtually zero yet the economy and stock market did not come back. Our Fed reduced its key interest rate to 1.75%. Our economy is showing signs of modest expansion but the stock market is still anemic at best.
If we have weak stock markets and anemic economic growth for a while longer, we might see the electorate demand more government spending and interference as a proposed solution. It never works but politicians always sell it and always find some buyers. Even with a supposedly Conservative Republican President we see Federal government spending and action expanding dramatically. We have seen steel tariffs, a huge farm bill, tremendous increases in federal spending on education (something that should not even exist on a small scale) and other large expansions of government. During the 1990s government officials got used to seeing large increases in tax revenues as a result of the expanding economy. They have continued to spend as if those tax revenues were still growing at a fast clip.
For years we have heard about our favorable demographics. We have a mature work force that is at its height of productivity and investing for retirement. That cannot and will not last forever. Baby boomers will begin retiring in the next five to ten years. They will stop putting money into retirement accounts and begin to withdraw that money to live on. The ever expanding pool of investment capital would begin to shrink. They will stop contributing to the social security pool (no Al there is no lock box) and eventually start receiving social security benefits. This will cause a need for higher social security taxes, lower benefits, or a change in the minimum retirement age. Needless to say, the effect will be more dramatic on the Medicare system, especially with the new prescription drugs benefit.
Our stock market has seen incredible carnage in some sectors, mainly technology. Remember companies such as CMGI, WorldCom, JDS Uniphase, and Sun Microsystems. They still exist but few people talk about them. Their stock price has declined anywhere from 80 to 99%. Of course there are many others besides these four. The S&P 500 still trades at historically high levels. The real estate market is still incredibly strong. Consumer spending is still strong. However, there are cracks in the armor of all these areas. Despite our enormous prosperity of the last decade, we still have 1 million bankruptcies per year. I had lunch with a partner of an Accounting firm in San Francisco, who mentioned that two years ago rents in their building were being set at $100 per square foot. Today he is turning down an offer to stay at $40 per square foot. Can the consumers, many of whom spend themselves into bankruptcy, decide to cool it? Can the S&P 500 trade at historical norms or below? Can the weakness in some areas of the real estate market spread?
All of these things have a reasonable probability of occurring. It would not be catastrophic. In Japan today, people are not begging on the streets as a result of their economic problems. Shanty towns are not springing up. Life continues to go on. However, those of us hoping to retire in the next five years may need to spread out our time horizon. We may have to keep our old cars another few years. We may have to give up on plans to buy more expensive homes or to take expensive vacations.
Then again, maybe none of these negative scenarios will prevail. Maybe the stock market is hitting a bottom as I write this. Maybe this stock market bubble is no worse than the 1962 "nifty fifty" bubble which was not that big of a deal. Maybe consumers will continue to spend, as the economy shows signs of turning up. Maybe real estate will continue to shine as the supply of homes continues to be low.
I think we need to be ready for both positive and negative outcomes. I am keeping a larger than usual supply of liquid assets (short term debt instruments) on hand. I am avoiding any unusually bold financial moves. On the other hand, I am not selling my home and moving into a rental nor am I selling my core stock holdings. I am trying to maintain a balance between optimism and pessimism. Maybe next week will be better.
In principle I agree. The problem though, from a macro perspective, is that there are too few of those to go around.
What good is a stock anyhow? To me it doesn't seem any different than betting on football. A company may raise cash by issuing the darn things but from then on it is pure gambling. Nobody can take the stock back to the company and demand something for it.
That is a good point. There are many times when the average worker has done much better under a declining market. There are MANY non-market related factors in the economy. The major gains in the market in the last 10 years have come about because of "right-sizing". The only real control over the bottom line within a company are labor costs. However, when those cuts are so severe that a new round of hiring is required just to remain in business, the stock price may well drop but the public gains in new jobs.
"What good is a stock anyhow? To me it doesn't seem any different than betting on football. A company may raise cash by issuing the darn things but from then on it is pure gambling. Nobody can take the stock back to the company and demand something for it."
Heaven's no.
A stock gives you a voting right in a company's business. It gives you ownership rights and a stake in the profits, while protecting your own personal assets from the company's losses.
Many stocks pay dividends, too. CLP, a favorite Alabama REIT, pays more than 7% per year in dividends. That's much better money than you could earn in a bank CD, and CLP is backed by physical real estate and long-term tenant contracts. Banking paper AXM pays more than 13% per year in dividends. PVX is another high-payer (oil company).
But people aren't told about dividend stocks. They're told about the pump and dump "growth" stocks that pay little or no dividends (and may not even be profitable as a corporation).
Is it any wonder that those stocks without dividends are getting clobbered now that accounting scandals are being revealed?!
Is it any wonder that those of us invested in dividend stocks are seeing our economy as being rosy?! With tax deductible margin leverage, 13% dividends become more than 20% annual returns in pure cash flow, with no buying or selling "at the right time" required for such fire-and-forget income.
Let the professionals and the suckers try to guess at the right "growth" stocks, as well as the right time to buy and sell them.
The easy money isn't there. It's just not in "growth," but it is in dividends (too bad they get taxed twice).
That's nice to get dividends like that. It actually makes the stock mean something. But what is the average or median dividend? Voting rights?... color me skeptical, because the vote recommended by the officers is almost never successfully overridden by the stockholders.
