FreeRepublic , LLC
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Posted on 06/11/2002 12:51:40 PM PDT by Stand Watch Listen
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.
I guess that I am more pessimistic than this writer, having already sold my house and moved to a rental, and been out of the stock market since January 2000...
Personally I believe PE ratios will stabilize somewhat above the usual 14 or so, but well below where they are now. A few months more bleeding, then a few months of stagnation.
In theory it could, but I doubt that it will. Too much consumer and corporate debt, a new bubble in real estate, government spending accelerating and the dollar losing value equals many more months (if not years) of a mushy economy.
PE ratios have gotten worse over the last two years even as the markets have been dropping. Corporate profits are shrinking faster than any three years since the 1930's. In fact, the primary driver of profits for the past two years has been cost-cutting (layoffs and write downs of bad investments). Until those profits start increasing there will be no recovery.
I think that you meant 6,000, since the Dow was at 2,700 in 1988?
I've been predicting 6,500 for two years now. I think it will get there in the next 9 months...
Conservatives are pessimistic investors by nature. Because of that I never take investing advice I read on Free Republic. Pessimists are sometimes right about investing, but most of the time are wrong. You should only be pessimistic if the potential cost of loss is high, which I don't think is the case in the stock market right now. The real estate market though is overvalued. I see the economy slow down as a build up of postponed demand. If you guess the timing of the recovery right you can get very rich. A recovery is coming, it's just a question of when. If it's delayed, it will just be that much stronger, and have that much more profit potential.
Maybe because KUDLOW AND GLASSMAN ARE A COUPLE OF MAJOR LEAGUE IDIOTS?
Pessimism about stocks is not the same as pessimism in general.
"I see the economy slow down as a build up of postponed demand. If you guess the timing of the recovery right you can get very rich. A recovery is coming, it's just a question of when. If it's delayed, it will just be that much stronger, and have that much more profit potential."
You could just as easily and accurately say:
"I see the economy speed up as the release of pent-up demand. If you guess the timing of the recession right you can get very rich. A recession is coming, it's just a matter of when. If it's delayed, it will just be that much stronger, and have that much more profit potential."
However, in neither case would these platitudes and tautologies be of any use in assessing the future.
Wall Street insiders are shaken, stirred, and confused right now. They are no longer in charge of their own destiny.Not that they've stopped trying to control their own destiny, mind you, but it isn't there for them any longer. They're still out pimping for more players to take on more corporate debt, and they still think that they can convince new fools to buy at greater prices, but they are confused because their tired old spiel isn't working any longer.
And it isn't working because Joe Average no longer believes that tech miracle company "ABC" is going to keep growing and reporting increased revenues each year.
Joe Average no longer trusts that market analysts are giving good advice, and the man on the street is convinced that accounting firms have been lying for years about the true condition of corporate books.
Companies run by the same types of Ivy-League Lemmings are in big trouble. They have taken on too much debt. They haven't trimmed enough of their upper management bloat. They've expanded through acquisitions that no one had any business doing, and their books are even worse than the public fears.
The real confusion comes into play, however, when one factors in that technology is now permitting smaller companies to compete on a level playing field with larger firms. No one knows how large your company might be when they see its web page, for instance. Everyone can afford the same technical wizardry, too.
So where is the money going? Into real estate. Into smaller firms with histories of paying strong dividends (can't fake dividend payouts with crooked accounting, after all because cash payouts to stockholders can't be "massaged" on the accounting books). Into metals, and even kept in cash.
So Wall Street is in for a bloodbath (at least for the most popular "growth" stocks).
But our economy is fine. Our economy is benefiting from low interest rates, low inflation, low unemployment, easy money, and high productivity. Banks, those ultra conservative, staid, traditional businesses - are expanding. They wouldn't be expanding if small businesses weren't making up for the losses in large corporations.
But all of these facts fly in the face of the well-ordered world that Wall Street once thought it controlled, so the power players are confused. They talk about market "capitulation" and how the great recovery is just about to hit.
Well, the recovery hit our economy, but that doesn't mean that it will hit our stock market. There are decades of hype, excess, fluff, inefficiencies, and bad debt out there to be cleaned up, not to mention that corporate accounting will either have to be cleaned up or else every firm that wants to be fairly valued will have to go to paying quarterly dividends (which can't be faked with cooked accounting books) to their shareholders.
How bad can things get? If you own "growth" stocks (which don't pay dividends and do rely upon investors believing their corporate accounting books), then things can get quite a bit worse.
These tribulations on Wall Street will even contribute to large firms accellerating their layoff plans.
On the other hand, if you are invested in small companies which are taking over the business dropped by these large, troubled firms, then the future looks pretty bright.
If you get your news and analysis from the status quo Wall Street types, however, you're wondering just how low it can all go.
And for them, things will be going pretty darn low...
IMO small caps have already topped, or are very close to topping.
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