Vollständige Version anzeigen : Knocking at Deflation's Door
Knocking at Deflation's Door
Even the Pros have Trouble
Land of the Deflating Sun
Competitive Currency Devaluations
Dollar Devaluation Party
Absolute Returns
By John Mauldin
Today we are going to examine a war going on in the central banks of
the world. The central banks of the world continue to do what is
necessary to make their respective nation's products attractive to
the American consumer, doing the best they can to make their
currencies cheap. There are increasing calls for the US to let the
dollar fall as a weapon in the war against deflation. Both can't
happen at the same time. You don't want to let your investments get
caught in the crossfire. There will be casualties.
I am working later than usual on this letter, as thinking through
the implications of a number of reports I have read this week is
giving me some cause for concern. I am somewhat envious this evening
of Roman soothsayers. I think it would be easier to analyze sheep
entrails than the conflicting economic data coming out this week. At
least we would have lamb chops afterward.
However, difficult data has never prevented us from trying. I hope
today's letter will help you understand why interest rates and the
stock market keep going down, and will continue to do so.
Even the Pros have Trouble
The investment climate and the rules associated with them have
changed. If you are still investing under the old investment rules,
you are having trouble.
You can take some small comfort in that the professional management
world is having problems as well. I am not referring to buy and hold
managers, who don't even try to make money in bear markets, and for
the most part, don't have a clue. I am talking about active market
timers and hedge fund managers. These are professionals who are
really attempting to make money in this market.
I remember writing in 1999 that this next decade would be the decade
of the market timer, as bear markets have been in the past. I was
wrong. While this bear market has not been as bad for market timers
as it has been for traditional money managers, it could not be
called good for them.
I called my friend Roger Schreiner today. He tracks 639 market
timing programs. I asked him how many were up for the year. I knew
the number would be bad when he started counting through his list by
hand. Only 56 market timing programs showed positive returns, or
less than 9%. The median program was down 6%. This is certainly an
improvement over the actual markets, but down is still down.
I really confess amazement at that number. Given the number of bears
in the market timing crowd, I would have thought significantly
better than 9% would be profitable.
Equity hedge funds are only doing slightly better. These are
managers that can go both long and short. The average long-short
hedge fund is down a few points, and only a few are anywhere close
to their historic averages.
I believe this is because the many of the fundamental market
relationships upon which trading systems are based have changed. To
get an insight into the changes, let's first go to Japan. I will
need to quickly review the scene for new readers, but we will get to
the point shortly.
Land of the Deflating Sun
Japan is in a decades long recession/depression and is currently in
a deflationary spiral. Excess capacity means lower prices means less
profits means fewer jobs means less consumption which leads to lower
prices because of excess capacity and so on. It is a vicious
spiral. Japanese exports to the US fell again this month, and any
thoughts of a recovery are only in the dreams of politicians.
Japan is in a liquidity trap. That is a condition when interest
rates are as low as they can go, but since deflation is even lower,
the real cost of money is high. It leaves a central bank powerless,
as they cannot lower rates to stimulate spending.
It has been well known for some time that Japanese banks are
essentially bankrupt. Their bad loans far exceed their capital. In
my opinion, the principal reason for the Japanese economic crisis is
their refusal to force banks to deal with bad loans. They simply
would not force much of their elite to "take their medicine" and
thus the average Japanese citizen has been badly hurt.
I have stated many times that the Japanese central bank, along with
the government, is the only management team which could make Xerox
management look competent. They do a dance that Greg Weldon calls
"the Ostrich," as they continually stick their head in the sand to
avoid facing reality. Only now, reality is beginning to really get
scary.
At the recent Jackson Hole Federal Reserve conference where Alan
Greenspan gave the speech declaring the bubble was not his fault,
there was another academic paper presented. This one seriously
suggested a "fool-proof" method for the Japanese to escape from the
current deflationary liquidity trap in which it finds itself. It
called for setting price levels, depreciating the currency below any
conceivable equilibrium level, and then setting a fixed exchange
rate to guarantee the lower level. This should boost economic
activity and prices, and once things were moving along, the central
bank could abandon the price targets and once again target
inflation.
BCA Research tells us the representative from the Bank of Japan did
not endorse this, but admitted that extraordinary measures were
needed, such as the direct buying of real estate or stocks.
Let me translate the above economic language. The presenter
seriously suggested that Japan consciously destroy its currency and
its buying power, create enough inflation to insure a period of
sustained rising prices, and then induce a recession to control the
inflation. There are several important things to note from this.
First, this was presented in the context of a Federal Reserve
sponsored forum. It makes one wonder whether the Fed was sending yet
another message. Second, this was not some minor adjustment that was
suggested. It is major economic medicine, and if you are an average
Japanese citizen is not what you want to hear. If there was a
message, it was that Japan is in serious trouble and that only
drastic medicine can save it. Think chemotherapy. The patient may
live, but it is certainly anything but pleasant. Doctors, and
central banks, do not suggest such measures unless the patient is
otherwise terminal.
Japan is the world's second largest economy. It is the chief source
of deflation in the world, and the Fed is telling them they need to
do something before they drag the world down with them.
Then this week the Bank of Japan, after 10 years of sitting on its
hands, says it will start buying stocks directly from banks. Think
about that for a moment. If Greenspan were to announce the Fed was
going to buy stocks in order to shore up the economy, there would be
a huge outcry. It would be a mistake of the largest magnitude for
the Federal Reserve to buy stocks.
Let's look at what the Bank of Japan will likely do. Japanese banks
do not mark the stocks in their portfolios to market price. They are
kept on the books at the value at which they are bought. Since the
Japanese stock market is down 75% from its high (not counting actual
bankruptcies and mergers), many of the stocks in the portfolios of
banks are carried at losses. The banks have also many stocks they
have held for decades which are still showing a profit. But if they
started to do any serious selling, they would drive the stock market
down much further.
The banks desperately need cash to be able to write off bad loans. I
have seen serious estimates that banks will need at least four years
worth of earnings to be able to handle their bad loan portfolios.
But to go for four years showing no profits would depress and
further weaken an already devastated banking sector.
There is evidently no appetite in Japan for the government to do as
we did in the Savings and Loan crisis -- simply taking over banks,
letting the taxpayer foot the bill and selling the profitable
portions to solvent banks. That hurts shareholders, of course, but
it puts the banks in the hands of new management.
Japan will do what it must to make sure the elite save face and also
save their personal bank accounts. The Bank of Japan will do what it
can to save the current management and the large shareholders.
Here's what they will do. They will first buy stocks in which the
banks have a profit. This will allow the banks to sell stocks in
which they have a loss to the public. The profits and losses match,
showing no loss to the bank. They then have cash to write off bad
loans. This also has the "advantage" of injecting significant
liquidity into the economy. While not as direct as the Fed paper
suggestions, if aggressively applied, it will achieve the same
outcome.
It is not the correct thing to do. But Dennis Gartman cogently
argues that given the Japanese unwillingness to do the right thing,
it is better than nothing. From the standpoint of an American (or
for that matter, anyone but a Japanese citizen), and given my stake
in seeing the world economy avoid a deflationary implosion because
of Japanese intransigence, I would have to reluctantly agree.
However, it is indefensible to allow those responsible for the
problems to not only escape responsibility, but to profit from them.
If I were a Japanese voter, I would be in the streets, manning the
barricades. I guess that's just the 60's Flower Child coming out in
me.
However, this is not the troubling aspect of the issue. I am firmly
persuaded the Japanese care not one whit what the Federal Reserve or
any other government or central bank thinks. The "solution" proposed
by Fed academic clearly shows the serious level of concern at the
highest levels of our government. This concern is shared in many
quarters, both liberal and conservative, and in many countries.
That the Japanese are actually planning to do something shows that
the concern is not misplaced. If they have come to the point where
things are getting so bad they will be forced to do something, then
it is serious.
One last important point, which we will re-visit later, is that the
means suggested by the Fed and evidently agreed with by the Bank of
Japan is that to combat a deflationary spiral you need to devalue
you currency. Factor in that the Prime Minister of Japan also wants
to see the currency drop against the dollar, as do the major
exporting businesses, and it seems clear the direction of the yen is
headed down. Then why has the yen gotten stronger of late? We will
come back to this question, as it holds one of the keys to the new
investment rules.
Competitive Currency Devaluations
Stephen Roach of Morgan Stanley points out that the US consumer was
responsible for 64% of the growth in the world's economy from 1995-
2001, roughly twice what our share of world output was during the
same period. The world economy is dependent upon the US consumer. As
the US economy has slowed down, the world is slowing even more.
The problem is that there is no other engine for growth. I have
chronicled Japan's crisis. Germany, the third largest economy, is on
the brink of a recession and is close to deflation. Europe may slip
into recession before we do. South America is in shambles. China and
India are working hard to stimulate a consumer economy, but both are
years away from being a major force for growth in the world economy
Like a drug addict who needs his fix, it seems most countries want
to keep the value of their currencies low so they can continue to
sell products to the American consumer. Rather than going cold
turkey and trying to boost their own consumption and letting their
currencies rise, they keep returning to the "fix" of devaluation --
anything to keep the American consumer spending dollars.
During the 90's, the entire world, and especially Asia, spent huge
amounts on factories to build products for America. There is now too
much production capacity for current demand. The businesses of each
country hope to keep their factories producing, and sell their
products at ever cheaper prices. But rather than lower their prices
in terms of their local currency, they urge their governments to
lower the price of the currency. That way they can continue to pay
their workers in a depreciated currency, passing their problems to
the employees. Of course, the local currency buys less on the world
markets, but the factories are busy. This is a "last man standing"
business plan, and has its own set of problems, which are not the
concern of this letter today.
The point is, as one country after another, especially in Asia, lets
their currency drop, other countries feel forced to lower the value
of their currency to stay competitive. This is of course price
deflationary in terms of the US economy. It also means our competing
companies cannot raise prices, and hurts profits.
The US is now at a trade deficit of 5%. At our current "progress,"
the world will soon be lending us $2 billion per day to finance our
spending. There has never been a currency that did not drop when
trade deficit levels have risen to the heights that the US trade
deficit is currently approaching. But the dollar, after dropping
for the first part of the year, is now down only 3% against a basket
of world currencies. This is hardly the stuff of a serious currency
correction.
Knock, Knock, Knocking at Deflation's Door
And now we come to the heart of the matter. I have been writing and
warning about deflation for four years. There weren't many of us in
1998. Now it is standard fare.
I have maintained in this column that while I think we will
experience deflation, the most likely scenario is that it will be
mild. The Fed has clearly let the world know they will expand the
money supply as much as necessary to keep deflation from becoming
serious. The dollar (because of the huge trade deficit) should drop
in concert with this policy, thus letting us avoid the worst aspects
of deflation.
The important word in that last sentence is "should." There are some
reasons to be concerned that this might not be the case.
Martin Barnes of BCA Research is one of the most highly respected
economists in the world. He is read everywhere. He is not noted for
overstatement or hyperbole, as he is aware of how serious his words
are taken. Thus it is with some disquiet I read his recent letter.
He makes the argument that deflation is now at our door, and he
expects that we will see mild deflation soon. His argument is that
because growth in the US is so low, and because inflation is already
so low, that deflation is inevitable, barring a growth recovery not
currently on the horizons.
Let me quote: "The Fed will not back away from an easy monetary
stance for the foreseeable future. This argues against a major sell-
off in bonds, and warns that the dollar is vulnerable on the
downside. With regard to the latter, the saving grace is that the
rest of the world is also on shaky economic ground and the dollar is
still regarded as a safe haven. However, if the U.S. edges closer to
a liquidity trap, the authorities will not hesitate to push the
dollar lower."
He makes a second point, "While the mixture of deflation and high
debt levels poses a threat for the U.S., disaster will be avoided if
the real estate market does not suffer a meltdown."
Part of his prescription is for the "authorities" to allow, or
encourage, the dollar to drop. This is echoed by Stephen Roach and
numerous other thoughtful economists.
Dollar Devaluation Party
OK, let's review. We are getting ready to enter a period of outright
deflation. The Federal Reserve recently published a paper outlining
what policies could be enacted to prevent serious deflation.
Basically it involves allowing the dollar to drop, more fiscal
stimulus in the form of budget deficits and tax cuts and expanding
the money supply. If this seems like a prescription for inflation,
that is because it is.
As I have argued in the past, the Fed has made it plain they intend
to keep us out of serious deflation. The logic seems to be that it
is better to have the devil of inflation with which we (the Fed)
know how to deal, than a devil we can't do anything about. It seems
to be a choice between the stagflation of the 70's or the
deflationary depression of the 30's.
Now, of course, the Fed and other leaders think they can induce only
mild inflation and engineer a new growth economy. I sincerely wish
them all the best. I like a growing economy.
But what if they throw a dollar devaluation party and no one comes?
Let me explain it this way: if every consumer in America decided it
was in his best interest to start saving an extra 5%, the US economy
would tilt into recession quite quickly. What would be a good policy
for each individual would have negative collective consequences for
the economy.
The same applies on an international level. If the drug addicts of
the world do not stop the competitive devaluation of their
currencies in an effort to keep the American consumer buying their
products, then it will be difficult for the "authorities" to lower
the value of the US dollar in the fight against deflation.
It will take away one of the major deflation fighting tools in the
hand of the Fed, just at the time when it will be most needed.
The problem is that everyone cannot lower their currency at the same
time. This means that if deflation becomes an issue, it may be
"necessary" for more aggressive easing and monetary expansion in
order to stem the deflationary tide. This will create more
imbalances that will have to be worked through. Ultimately,
aggressive monetary expansion will mean inflation that will not be
mild.
Now, before you start heading for the storm shelter, let me point
out that none of this is going to happen in the next quarter or
probably even begin next year. These things take time to work out.
It is quite possible we will continue to Muddle Through for quite
some time.
But some of the Fed governors are clearly concerned, or we would not
be seeing two governors not vote with Greenspan. The recent economic
papers coming from the Fed tells us there is concern about
deflation.
The bond market is telling us deflation is coming. Slow growth and a
dollar that stays too high in a low inflation environment tell us
deflation is coming. Richard Russell stated it well recently when he
said his head told him bonds are too high, but his pocketbook made
him buy some more municipal bonds.
It is tough to want to buy bonds when every historical indicator is
saying they are way overbought. Gartman makes the analogy that when
the temperature approaches absolute zero, the laws of physics
change. As we approach the absolute zero of outright deflation, the
normal historical relationships in the investment world are changing
as well. If you are using investment models based upon an
inflationary world, you are not going to succeed.
What does this mean in the near future? The Fed is going to cut
rates again and again. It will not be to stimulate the economy.
Cutting rates for that purpose is pointless at the low levels we see
today. The Fed will be looking to combat deflation and help lower
the dollar. They should have cut at this week's meeting. They will
at the next post-election meeting.
If mortgage rates were to go back up, the US housing market would be
seriously hurt, and that is the one thing with which the world
cannot cope. Fortunately, it appears likely that mortgage rates are
going lower. I rashly predicted a 5% 30-year mortgage in 1998. Now
it does not look so rash. It may happen by next spring. If someone
is willing to lend me money for 30 years at 5%, I shall oblige them
to the fullest extent possible.
Deflation also means that corporations will have no pricing power,
and thus earnings are not going to rebound at anywhere near the rate
analysts predict. That means more stock market upheaval; more bear
market rallies and more ultimate disappointment.
But we will get tax cuts, deficits, lower rates and easy money. All
this stimulus means we will likely continue to Muddle Through for
the year, albeit at a slow pace. Will it eventually catch up with
us? Will we have a Year of Reckoning? In the long run, of course we
will. But it could be a very long run. And let me remind you that
the world does not come to an end in recessions or even with
deflation. The vast majority of us will still have jobs and business
will go on as usual. Europe seems to be stumbling along with 9%
unemployment and no one is in a bread line.
Absolute Returns
I am not expecting a repeat of the 30's. I do expect that assets
will be re-valued, and that we will have to adjust. That is why
absolute return investment strategies are so important.
I am writing a book called Absolute Returns. You can see the chapter
explaining a secular bear market by going to www.johnmauldin.com and
clicking on Absolute Returns. If you are an accredited investor, I
also have a free letter on hedge funds you can find on that site as
well.
I finished this letter at 2 am Saturday morning. If there are more
typos than normal, it is not the fault of my proof-readers and
editors, who are properly in bed.
I will be speaking at the Fund of Hedge Funds Forum in New York in
two weeks. I still have a spot for meeting with clients or potential
clients on the afternoon of October 10.
I will be meeting with one of my oldest and dearest friends this
weekend, Bob Mumford. He has been instrumental in the development of
my understanding of the nature of relationships which we have with
both God and each other. Thinking of this serves to remind me that
part of our true wealth is in family and friends. It is comforting
to know there is something I have which a central bank cannot
devalue.
And finally, I promised my bride months ago I would take her to hear
Olivia Newton-John this weekend at the Bass Hall for her birthday.
Now that will be a trip down memory lane.
Your "Hopelessly Devoted to You" analyst,
John Mauldin
Quelle:
http://www.2000wave.com/
Und hier das neuste von John Mauldin
Text version is below. To view in color or printer friendly .pdf
please visit our website at www.2000wave.com
Dollar Devaluation Party
History versus the Fed, Part Two
Will the Trade Deficit Please Go to Work?
Coffee Cans in the Back Yard
A World of Hurt
Employment Improvement?
One More Year, and Counting
By John Mauldin
Today we are going to try and help you understand the strange action
in the stock and bond markets. We are going to look into the future,
and see if we can get a feel for what's around the curve in the
road. Is it smooth driving, or are there some rocks in the road we
need to avoid?
Last week I asked, "What if they gave a Dollar Devaluation Party and
no one came?" After a quick review, I am going to follow up on the
implications of this theme, as I believe this is going to have a big
impact upon the economy and your investments.
1. Japan is at the epicenter of the deflationary forces that are
sweeping the world. The Fed told (or suggested to) Japan at their
Jackson Hole meeting that they could get out of their deflationary
spiral by printing money and dramatically dropping the value of the
yen. The Bank of Japan could care less what the Fed thinks. However,
they have finally come to the end of their ability to do nothing,
and being faced with a true crisis, will go about destroying their
currency on the backs of the average consumer by reducing the
overall standard of living for the little guy, all the while
striving to save face. Given the massive incompetence demonstrated
heretofore by Japanese banking authorities, there are those who
question whether they can succeed in actually dropping the yen, but
central banks can destroy value when they put their mind to it.
2. The Federal Reserve recently published a paper noting that the US
could avoid Japanese style deflation by among other things, allowing
the dollar to drop and providing a very easy money policy.
3. The rest of the world is addicted to the drug of American
consumption. With the exception of Europe and a few smaller
countries, they are engaged in "Competitive Currency Devalution." By
that we mean they try and make their currency cheap against the
dollar and against their neighbors so American consumers will find
their products cheap and continue to buy.
4. Martin Barnes (of bcaresearch.com), Stephen Roach of Morgan
Stanley, Bill Gross of Pimco and other major economic luminaries are
openly telling us that deflation in the near future is a real
concern. Even Andrew Kashdan of Apogee Research seems to grudgingly
admit that deflation might be a problem in the short term before
inflation comes roaring back. They all seem to think (or hope) the
Fed can keep us out of a destructive deflation. A common theme is
that as long as the housing market holds up, we should be able to
avoid serious problems or "disaster" as normally sanguine Martin
Barnes so states. This may prove to be a thin thread holding us back
from the abyss.
5. One of the big bullets in the Federal Reserve gun to fight
deflation is the currency bullet: the Fed can help the dollar drop
in value. This is not supposed to be too hard, as the current
account or trade deficit is approaching 6% of GDP. In every other
historical instance of such a huge gap, the currency of the
offending country has dropped, bringing things back into a balance.
A drop in the value of the dollar would be inflationary, and is
supposed to be able to offset the deflationary forces in the
country. It also means we spend less on foreign goods, and helps
bring the trade deficit back in line.
History versus the Fed, Part Two
Long time readers know I am a big fan of History. Central bankers,
businessmen and investors continually try to beat History to a pulp,
and often win a few early rounds. Like Mohammed Ali and his Rope-A-
Dope strategy, History lets his opponents wear themselves out
throwing ineffective jab after futile blow. In the end, my man
History always wins in the final rounds. Betting against History can
look good for the first few rounds, as History looks drugged, but
the end is always the same.
History told us there would be a recession in the fall of 2001
because of the inverted yield curve in the fall of 2000, which I
wrote about in August of 2000. An inverted yield curve is always
followed a year later by recession. Greenspan and the Fed fought
back by aggressively lowering rates. They lost. Hopefully they can
do better fighting deflation.
I note the casual observation that the longer History allows his
opponents to pummel away, the more vengeful his wakening. Putting
off the Day of Reckoning is a natural human passion, often pursued
with great gusto. History has a way of bringing things back to the
mean, forcing us to reap what we sow.
Last week, I noted that every country cannot devalue their currency
at the same time. If the United States decided to pursue a policy of
weakening the dollar, it would not work if every country decided to
pursue the same policy, in an effort to remain attractive to the
American consumer. Everyone can't drop the value of their currency
at the same time.
The Invisible Hand of Adam Smith suggests that the economy is driven
as we each pursue our own best interests. That does not mean that
what is in the best interests of the individual will result in the
short term betterment of the economy. If everyone in the US decided
to start saving 10% of their income, we would quickly go into
recession. Long term, if this trend were to continue, the economy
would be better off. However, we all pay our bills in the short-
term.
The same is true for countries. Just as President Bush argues that
the security interest of the United States is our responsibility and
inherent right, and not subject to foreign approval, each country
argues that its economic sovereignty and future is also within its
sole prerogative.
If the United States were to go into a deflationary recession, the
rest of the world would quickly lurch into a far worse recession.
Just as the US has been responsible for 64% of the world's growth in
the last decade (Morgan Stanley), we would have a similar negative
effect on a world slowdown.
If the rest of the world does not allow the dollar to drop in value,
it would likely contribute to our going into deflation (or another
outcome I address later). But just as each individual when saying to
himself, "I need to save more money for retirement" is a reasonable
thing, the collective outcome would be recession; the same holds
true for countries.
The head of every central bank in the world would agree that it
would be a terrible thing for the US to slip into real long-term
deflation. But in the next breath they will do what they think is in
the best interests of their country, or at least the best interests
of the leadership and large businesses of their country.
Right now, the majority of the world's central bankers seem to think
that means keeping their currency low against the dollar. Until
their respective country's addiction to the American consumer is
cured, that seems likely to be their future opinion. The market
will cure their addiction if they do not. However, I can guarantee
you no one will like the market's concept of drug withdrawal. Marine
drill sergeants have more compassion than the market.
Long-term, we would all be better off saving more money. Long-term,
they would all be better off building up their own consumer base.
But we all live in the pressures of the short-term. It is the same
for individuals and sovereign states.
Will the Trade Deficit Please Go to Work?
The US trade deficit is supposed to be the main mechanism by which
the dollar is brought under pressure. Earlier this year, I wrote
about the deficit, and suggested the dollar was at its top. Shortly
thereafter, it began to drop.
Part of the reason I suggested the dollar would fall was that
foreign buying of US companies was rapidly slowing down. This was a
major contributor to the flow of dollars into the US for the past
decade. "What could pick up the slack"? I asked, and thus predicted
a drop in the dollar. The dollar did drop, especially against the
euro and its associated currencies. But elsewhere, it has held its
own fairly well. Why?
Our trade deficit is now at its largest ever. If the dollar is not
dropping, it is because there are large inflows of dollars into the
US. It is no longer European companies buying US businesses, or
Japanese building US factories. Where is the money coming from? And
why, seeing how weak the stock market is, hasn't the dollar dropped
further? Surely the world sees we are a bad investment?
Well, not exactly. The rest of the world's stock markets are doing
as bad as or worse than ours. The carnage world-wide is astounding.
As an example, the German exchange opened the Neuer market, its
answer to the NASDAQ just five years ago. There was much acclaim, as
the market soared. At the time it was hailed as the engine for
future European technology growth. It became the mechanism for
corruption, fraud and large investment losses. Last week, they
simply shut the new exchange down after losses of over 90%, and
little action on the exchange.
If you were in Argentina or Brazil, the S&P 500 would look like a
good investment. On a relative basis, the US markets are not that
bad. So, US investors are fleeing foreign stock markets, and foreign
investors are looking for safe havens.
"Due to large inflows as well as large net selling of foreign
securities by US investors (roughly $20 billion in July alone), net
aggregate portfolio inflows totaled $71 billion in July, the second-
highest total on record. Keep in mind that foreign investors are not
the only ones exporting cash to the US -- so too are US investors as
they bail out of foreign markets." (Morgan Stanley)
Japanese investors have sent $40 billion to the US in just the first
seven months of this year. They recognize that eventually the Bank
of Japan is going to have to destroy their yen in order to save the
country. (It calls to mind the old line, "The operation was a
success, but the patient died anyway.") The smart money is leaving.
Coffee Cans in the Back Yard
If you are in Korea, it increasingly looks like they are in for a
hard landing (recession). Plus, the central bank is determined to
maintain a competitive posture for its currency. Latin America? The
rest of Asia? Diversification seems like a good idea in most of the
world.
Many of you write and ask, "Won't foreigners flee the dollar and go
into the euro, thus driving the euro up and the dollar down?"
Maybe, but not as much as you might think.
If you held a gun to my head and asked me which one fund should you
put your money into, if I thought you might pull the trigger, I
would give you one name. But in the absence of physical coercion, I
would strongly tell you that you need to diversify. And 99.9% of you
would agree. For some of you, diversification means two coffee cans
in the back yard, but at least you understand the principle.
Why would foreign investors be any different? Why put everything
into a euro basket, especially when Europe may be slipping into
recession? Having traveled in 40 countries, I can tell you that
Americans are one of the few peoples who are comfortable with all
their eggs in one currency basket.
It is in the short term, and by short term I mean NOW, that the Fed
must begin to fight inflation. It is not altogether clear to me that
the Fed can count on the normal market mechanism of a large trade
deficit to ratchet down the dollar within a short-term time frame.
It should happen. I think it will. But the appetite of the rest of
the world for dollars is still strong. Currencies are a relative
value game. You put your money into another currency because you
think that when you bring it back into your local currency, you will
have improved your buying power over simply leaving it in your local
currency.
If the rest of the world perceives that competitive currency
devaluation is going to prop up the dollar in terms of their local
currency, and their goal is to maintain value in their local
currency, it could be harder to drive the dollar down than one might
think. If central banks are intent upon keeping their currencies
low, it could become very hard.
A little deflation is not the end of the world, if the Fed can
"reflate" the economy. Prolonged, systemic deflation will not be
good, however. It will lead to lower home values, which will hurt
the housing market, which will hurt jobs, which will hurt
consumption and trigger a serious recession.
The Fed increasingly understands this. Dallas Fed Research Director
Harvey Rosenebluem notes that "there is a distinct possibility
inflation could morph into deflation. GregWeldon notes a recent
strange comment by the Richmond Fed president, "The Fed knows what
to do, if the Feds fund rate has been pushed to zero, and prices
were falling." As Weldon points out, that must mean that at least a
few people in the Fed system think this is a distinct possibility.
There is a huge discussion on this issue going on inside the walls
of the Fed. At least some of the leadership understands the
problem. They need to act NOW. If Greenspan lets deflation get away
from him, the next sword at his neck will not be the Queen knighting
him.
If the Fed has to forestall deflation by printing even more money,
we are clearly told it will do so. But eventually, History will
weigh in. Inflation will come back much stronger than it would have
if the dollar could be one of the main mechanisms to fight
deflation. This is the true implication of the problem with
devaluing the dollar, as when inflation does come back, the Fed will
raise rates to stop it, and thus bring on a serious recession. Think
Volker and 1980. We are between the proverbial rock and the hard
place.
A World of Hurt
Bill Gross may be the most influential and astute man in the country
when it comes to bonds. His recent article and that of his associate
Paul McCulley, are absolute must-read, in my opinion.
(www.pimco.com) I wish I had the time and space to address them in
depth this week.
This is what he says: "Well, here's what those same astute observers
whisper, but are afraid to believe will happen. If the American
[mortgage] refinancing boom ends before a new investment boom
begins, we are in a world of hurt. Consumption withers, investment
rejuvenation will not have begun, and the U.S. global economic
locomotive, such as it is, will grind to a halt. How long do we
have? Twelve months at the most, even if Greenspan drives rates
toward zero."
The list of problem "bubbles" is long: a consumer debt bubble, a
dollar bubble, a bond bubble, a trade deficit bubble, the boomer
retirement bubble, housing bubble and so on. Each of these will
eventually come back to trend. The forces of Economic History will
see to that.
What we would hope is that not all of these bubbles burst at the
same time. It would be even nicer if they would deflate slowly. We
have seen the stock market bubble burst as well as the bubble in
capital spending. While this caused a recession, it has been very
mild as recessions go.
There are those who rightly maintain the US had a significant
recession in the 80's. But it was a rolling recession. Each region
went into its own recession, while the rest of the country was
strong. I can assure you, we had a recession in Texas. Each of you
can remember a downturn in your own area. But collectively, we did
ok.
The hope seems to be in upper economic circles that we can have a
gentle and rolling bursting of the various bubbles.
But to get this period of sequential bursting bubbles, the housing
and mortgage refinancing boom must not go before the rest of them
do. If the housing market goes flat, as Gross says, we are in a
world of hurt. Barnes calls it a disaster. I would call it a
serious recession, at a minimum.
The Fed has no choice. They will lower Fed rates. They must keep
interest rates low to spur the refinance market. Lower mortgage
rates act like a tax cut. It makes more money available each month
for spending and saving. They hope this will stimulate the economy
and thus create more investment.
Lower interest rates will also act to push the dollar down, without
actually announcing a "weak dollar" policy.
It is for this reason -- massive stimulation by the Fed and lower
rates-- that I maintain my view we will remain in a Muddle Through
Economy for the next few quarters, at least. We might even continue
the slow growth dance for a year or more.
We will find that the third quarter was an improvement over the
second quarter, but that the 4th quarter will be weaker. Overall,
growth will be slow. It is precisely when you are in a slow growth
environment, with very low inflation, that deflation can creep in.
The Fed, which is being urged from numerous quarters to act
preemptively, will soon do so. Stimulus can have an effect for a
short time. As foreigners continue to buy our bonds, rates will
continue to drop. I wrote about 5% mortgages in 1998. Thus, I still
think mortgages have a small way to go, but I agree with Gross, that
much below 5% is very unlikely.
But until there is some evidence that deflation is in check,
interest rates will continue to fall. Dennis Gartman recently noted
the eerie comparison between the charts of the Japanese bond market
and the US ten year note.
Can the Fed reflate the economy, lower mortgage rates and ratchet
down the dollar in the next 12 months? Can we slowly let one bubble
burst before we have to deal with another? Will the market be so
kind?
Maybe. Maybe Not. History is on the side of Maybe Not. History says
one or more of these bubbles run into a pin at the same time, and
then we get a recession. Only this time, the Fed cannot cut rates
475 basis points.
This is why secular bear markets take years to fully run their
course. It takes more than one recession to convince investors that
stocks are too risky, and to look for more stable climes. It often
takes three or four.
However, just because I think History will probably win, doesn't
mean the Fed won't try like Hades to last just one more round.
Maybe, the thinking goes, with a little more of the right
stimulation, this time things will be different. Avoiding pain is
great motivator. I personally would like to put off any real pain
for another 5 decades or so.
Because of the stimulation we will be getting, we could see a bear
market rally. But the stimulus will not overcome History, in my
opinion, and sooner or later we get another recession and a
resumption of the bear market. I just hope the next recession is as
mild as the last.
On a side note, I agree with Gross, Kashdan et al that eventually we
will see inflation again. I am just not so sure we will see it in 3
years.
There are just too many things that can happen on the way to the
Dollar Devaluation Party. We will have to watch the developments in
the world currency and bond markets with a close eye. I will be
writing frequently about these markets in future letters.
I must admit, I find myself late at night succumbing to the all too
human thoughts of the common pursuit of mankind: hoping we can put
off the Day of Reckoning just a little longer while we get our house
in order. Maybe the Fed will be successful. Unlike some of the more
stoic analysts, I hope we can avoid "the world of hurt."
Employment Improvement?
Greg Weldon did a detailed analysis of today's employment figures.
What he came away with was that the numbers just don't add up.
According to the Household survey, the economy created 1.14 million
jobs in the last two months, over 700,000 in September. Yet, in the
non-farm survey 70% of various sectors reported job losses. Only
government and real estate have posted consistent growth. Yet we are
told the economy created 1.14 million jobs even as total hours
worked and overtime hours both fell. This just does not add up.
Retail sales are quite soft. Housing starts are slowing down. 1.5
million people have been out of work longer than 27 weeks, and 27%
of unemployed have been out of work for longer than 27 weeks, both
cycle highs. Nothing in any economic indicator shows a boom in labor
that could suggest the creation of 1,000,000+ jobs. Something is
wrong with some of these Labor Department numbers.
Part of the answer to this conundrum lies in the fact that the
1,000,000 jobs statistic comes from a survey. This is not any
different than political opinion polls. Being a little simplistic,
they call households and ask if they are working. If the sample gets
skewed, or the wrong assumptions are made, the numbers can come out
very wrong, just like political polls.
The strong numbers caused the markets to surge this morning, and
long bonds to plummet. By the end of the day, as the numbers went
under the knife, and as more traders read the widely followed (by
insiders) Weldon analysis, they came to the same conclusion: the
numbers are bogus.
I do not doubt that there were new jobs added last month. I just do
not believe there were 1,000,000 jobs added. The numbers will be
revised, and revised downward.
One More Year, and Counting
Today is birthday number 53. Tonight I will spend it with family,
but today it is my pleasure to write this letter, and I hope you
enjoy my birthday gift to you.
The New Orleans Investment Conference is close to filling up. If you
are thinking about attending (and meeting me there) then you should
register quickly. The conference is November 7-10 and features
Richard Russell and John Templeton, along with a host of excellent
speakers. They allow yours truly to tag along. (See
www.neworleansconference.com)
In the next 10 days, I am in La Jolla, back to Fort Worth,
Pittsburgh, New York and Washington, DC. Too much travel, but all
for a good cause - finding investment opportunities for clients, and
maybe a little golf. (You can find out more about those investments
by going to www.johnmauldin.com) Fortunately, I have a saint of a wife
who lets me go so long and keeps everything working at home.
Your already wishing he was back home before he left analyst,
John Mauldin
John@2000wave.com
Copyright 2002 John Mauldin. All Rights Reserved
If you would like to reproduce any of John Mauldin's E-Letters you
must include the source of your quote and an email address
(John@2000wave.com)
Please write to Wave@2000wave.com and inform us of any reproductions.
Please include where and when the copy will be reproduced.
To subscribe to John Mauldin's E-Letter please click here:
http://www.2000wave.com/subscribe.asp
To change your email address please send a message with the changes to
wave@2000wave.com Please include your old and new email address and
specify if you would like the changes applied to the Accredited
Investor E- Letter as well as the regular weekly e-letter.
To unsubscribe please refer to the bottom of the email.
John Mauldin is president of Millennium Wave Advisors, LLC, a
registered investment advisor. All material presented herein is
believed to be reliable but we cannot attest to its accuracy.
Investment recommendations may change and readers are urged to check
with their investment counselors before making any investment
decisions. Opinions expressed in these reports may change without
prior notice. John Mauldin and/or the staff at Millennium Wave
Investments may or may not have investments in any funds cited above.
Mauldin can be reached at 800-829-7273.
History versus the Fed
October 4, 2002
Dollar Devaluation Party
History versus the Fed, Part Two
Will the Trade Deficit Please Go to Work?
Coffee Cans in the Back Yard
A World of Hurt
Employment Improvement?
One More Year, and Counting
Additional Options
Send to a Friend
Print Version
.pdf Format
Today we are going to try and help you understand the strange action in the stock and bond markets. We are going to look into the future, and see if we can get a feel for what's around the curve in the road. Is it smooth driving, or are there some rocks in the road we need to avoid?
Last week I asked, "What if they gave a Dollar Devaluation Party and no one came?" After a quick review, I am going to follow up on the implications of this theme, as I believe this is going to have a big impact upon the economy and your investments.
1. Japan is at the epicenter of the deflationary forces that are sweeping the world. The Fed told (or suggested to) Japan at their Jackson Hole meeting that they could get out of their deflationary spiral by printing money and dramatically dropping the value of the yen. The Bank of Japan could care less what the Fed thinks. However, they have finally come to the end of their ability to do nothing, and being faced with a true crisis, will go about destroying their currency on the backs of the average consumer by reducing the overall standard of living for the little guy, all the while striving to save face. Given the massive incompetence demonstrated heretofore by Japanese banking authorities, there are those who question whether they can succeed in actually dropping the yen, but central banks can destroy value when they put their mind to it.
2. The Federal Reserve recently published a paper noting that the US could avoid Japanese style deflation by among other things, allowing the dollar to drop and providing a very easy money policy.
3. The rest of the world is addicted to the drug of American consumption. With the exception of Europe and a few smaller countries, they are engaged in "Competitive Currency Devalution." By that we mean they try and make their currency cheap against the dollar and against their neighbors so American consumers will find their products cheap and continue to buy.
4. Martin Barnes (of bcaresearch.com), Stephen Roach of Morgan Stanley, Bill Gross of Pimco and other major economic luminaries are openly telling us that deflation in the near future is a real concern. Even Andrew Kashdan of Apogee Research seems to grudgingly admit that deflation might be a problem in the short term before inflation comes roaring back. They all seem to think (or hope) the Fed can keep us out of a destructive deflation. A common theme is that as long as the housing market holds up, we should be able to avoid serious problems or "disaster" as normally sanguine Martin Barnes so states. This may prove to be a thin thread holding us back from the abyss.
5. One of the big bullets in the Federal Reserve gun to fight deflation is the currency bullet: the Fed can help the dollar drop in value. This is not supposed to be too hard, as the current account or trade deficit is approaching 6% of GDP. In every other historical instance of such a huge gap, the currency of the offending country has dropped, bringing things back into a balance. A drop in the value of the dollar would be inflationary, and is supposed to be able to offset the deflationary forces in the country. It also means we spend less on foreign goods, and helps bring the trade deficit back in line.
History versus the Fed, Part Two
Long time readers know I am a big fan of History. Central bankers, businessmen and investors continually try to beat History to a pulp, and often win a few early rounds. Like Mohammed Ali and his Rope-A-Dope strategy, History lets his opponents wear themselves out throwing ineffective jab after futile blow. In the end, my man History always wins in the final rounds. Betting against History can look good for the first few rounds, as History looks drugged, but the end is always the same.
History told us there would be a recession in the fall of 2001 because of the inverted yield curve in the fall of 2000, which I wrote about in August of 2000. An inverted yield curve is always followed a year later by recession. Greenspan and the Fed fought back by aggressively lowering rates. They lost. Hopefully they can do better fighting deflation.
I note the casual observation that the longer History allows his opponents to pummel away, the more vengeful his wakening. Putting off the Day of Reckoning is a natural human passion, often pursued with great gusto. History has a way of bringing things back to the mean, forcing us to reap what we sow.
Last week, I noted that every country cannot devalue their currency at the same time. If the United States decided to pursue a policy of weakening the dollar, it would not work if every country decided to pursue the same policy, in an effort to remain attractive to the American consumer. Everyone can't drop the value of their currency at the same time.
The Invisible Hand of Adam Smith suggests that the economy is driven as we each pursue our own best interests. That does not mean that what is in the best interests of the individual will result in the short term betterment of the economy. If everyone in the US decided to start saving 10% of their income, we would quickly go into recession. Long term, if this trend were to continue, the economy would be better off. However, we all pay our bills in the short-term.
The same is true for countries. Just as President Bush argues that the security interest of the United States is our responsibility and inherent right, and not subject to foreign approval, each country argues that its economic sovereignty and future is also within its sole prerogative.
If the United States were to go into a deflationary recession, the rest of the world would quickly lurch into a far worse recession. Just as the US has been responsible for 64% of the world's growth in the last decade (Morgan Stanley), we would have a similar negative effect on a world slowdown.
If the rest of the world does not allow the dollar to drop in value, it would likely contribute to our going into deflation (or another outcome I address later). But just as each individual when saying to himself, "I need to save more money for retirement" is a reasonable thing, the collective outcome would be recession; the same holds true for countries.
The head of every central bank in the world would agree that it would be a terrible thing for the US to slip into real long-term deflation. But in the next breath they will do what they think is in the best interests of their country, or at least the best interests of the leadership and large businesses of their country.
Right now, the majority of the world's central bankers seem to think that means keeping their currency low against the dollar. Until their respective country's addiction to the American consumer is cured, that seems likely to be their future opinion. The market will cure their addiction if they do not. However, I can guarantee you no one will like the market's concept of drug withdrawal. Marine drill sergeants have more compassion than the market.
Long-term, we would all be better off saving more money. Long-term, they would all be better off building up their own consumer base. But we all live in the pressures of the short-term. It is the same for individuals and sovereign states.
Will the Trade Deficit Please Go to Work?
The US trade deficit is supposed to be the main mechanism by which the dollar is brought under pressure. Earlier this year, I wrote about the deficit, and suggested the dollar was at its top. Shortly thereafter, it began to drop.
Part of the reason I suggested the dollar would fall was that foreign buying of US companies was rapidly slowing down. This was a major contributor to the flow of dollars into the US for the past decade. "What could pick up the slack"? I asked, and thus predicted a drop in the dollar. The dollar did drop, especially against the euro and its associated currencies. But elsewhere, it has held its own fairly well. Why?
Our trade deficit is now at its largest ever. If the dollar is not dropping, it is because there are large inflows of dollars into the US. It is no longer European companies buying US businesses, or Japanese building US factories. Where is the money coming from? And why, seeing how weak the stock market is, hasn't the dollar dropped further? Surely the world sees we are a bad investment?
Well, not exactly. The rest of the world's stock markets are doing as bad as or worse than ours. The carnage world-wide is astounding. As an example, the German exchange opened the Neuer market, its answer to the NASDAQ just five years ago. There was much acclaim, as the market soared. At the time it was hailed as the engine for future European technology growth. It became the mechanism for corruption, fraud and large investment losses. Last week, they simply shut the new exchange down after losses of over 90%, and little action on the exchange.
If you were in Argentina or Brazil, the S&P 500 would look like a good investment. On a relative basis, the US markets are not that bad. So, US investors are fleeing foreign stock markets, and foreign investors are looking for safe havens.
"Due to large inflows as well as large net selling of foreign securities by US investors (roughly $20 billion in July alone), net aggregate portfolio inflows totaled $71 billion in July, the second-highest total on record. Keep in mind that foreign investors are not the only ones exporting cash to the US -- so too are US investors as they bail out of foreign markets." (Morgan Stanley)
Japanese investors have sent $40 billion to the US in just the first seven months of this year. They recognize that eventually the Bank of Japan is going to have to destroy their yen in order to save the country. (It calls to mind the old line, "The operation was a success, but the patient died anyway.") The smart money is leaving.
Coffee Cans in the Back Yard
If you are in Korea, it increasingly looks like they are in for a hard landing (recession). Plus, the central bank is determined to maintain a competitive posture for its currency. Latin America? The rest of Asia? Diversification seems like a good idea in most of the world.
Many of you write and ask, "Won't foreigners flee the dollar and go into the euro, thus driving the euro up and the dollar down?"
Maybe, but not as much as you might think.
If you held a gun to my head and asked me which one fund should you put your money into, if I thought you might pull the trigger, I would give you one name. But in the absence of physical coercion, I would strongly tell you that you need to diversify. And 99.9% of you would agree. For some of you, diversification means two coffee cans in the back yard, but at least you understand the principle.
Why would foreign investors be any different? Why put everything into a euro basket, especially when Europe may be slipping into recession? Having traveled in 40 countries, I can tell you that Americans are one of the few peoples who are comfortable with all their eggs in one currency basket.
It is in the short term, and by short term I mean NOW, that the Fed must begin to fight inflation. It is not altogether clear to me that the Fed can count on the normal market mechanism of a large trade deficit to ratchet down the dollar within a short-term time frame. It should happen. I think it will. But the appetite of the rest of the world for dollars is still strong. Currencies are a relative value game. You put your money into another currency because you think that when you bring it back into your local currency, you will have improved your buying power over simply leaving it in your local currency.
If the rest of the world perceives that competitive currency devaluation is going to prop up the dollar in terms of their local currency, and their goal is to maintain value in their local currency, it could be harder to drive the dollar down than one might think. If central banks are intent upon keeping their currencies low, it could become very hard.
A little deflation is not the end of the world, if the Fed can "reflate" the economy. Prolonged, systemic deflation will not be good, however. It will lead to lower home values, which will hurt the housing market, which will hurt jobs, which will hurt consumption and trigger a serious recession.
The Fed increasingly understands this. Dallas Fed Research Director Harvey Rosenebluem notes that "there is a distinct possibility inflation could morph into deflation. GregWeldon notes a recent strange comment by the Richmond Fed president, "The Fed knows what to do, if the Feds fund rate has been pushed to zero, and prices were falling." As Weldon points out, that must mean that at least a few people in the Fed system think this is a distinct possibility.
There is a huge discussion on this issue going on inside the walls of the Fed. At least some of the leadership understands the problem. They need to act NOW. If Greenspan lets deflation get away from him, the next sword at his neck will not be the Queen knighting him.
If the Fed has to forestall deflation by printing even more money, we are clearly told it will do so. But eventually, History will weigh in. Inflation will come back much stronger than it would have if the dollar could be one of the main mechanisms to fight deflation. This is the true implication of the problem with devaluing the dollar, as when inflation does come back, the Fed will raise rates to stop it, and thus bring on a serious recession. Think Volker and 1980. We are between the proverbial rock and the hard place.
A World of Hurt
Bill Gross may be the most influential and astute man in the country when it comes to bonds. His recent article and that of his associate Paul McCulley, are absolute must-read, in my opinion. (www.pimco.com) I wish I had the time and space to address them in depth this week.
This is what he says: "Well, here's what those same astute observers whisper, but are afraid to believe will happen. If the American [mortgage] refinancing boom ends before a new investment boom begins, we are in a world of hurt. Consumption withers, investment rejuvenation will not have begun, and the U.S. global economic locomotive, such as it is, will grind to a halt. How long do we have? Twelve months at the most, even if Greenspan drives rates toward zero."
The list of problem "bubbles" is long: a consumer debt bubble, a dollar bubble, a bond bubble, a trade deficit bubble, the boomer retirement bubble, housing bubble and so on. Each of these will eventually come back to trend. The forces of Economic History will see to that.
What we would hope is that not all of these bubbles burst at the same time. It would be even nicer if they would deflate slowly. We have seen the stock market bubble burst as well as the bubble in capital spending. While this caused a recession, it has been very mild as recessions go.
There are those who rightly maintain the US had a significant recession in the 80's. But it was a rolling recession. Each region went into its own recession, while the rest of the country was strong. I can assure you, we had a recession in Texas. Each of you can remember a downturn in your own area. But collectively, we did ok.
The hope seems to be in upper economic circles that we can have a gentle and rolling bursting of the various bubbles.
But to get this period of sequential bursting bubbles, the housing and mortgage refinancing boom must not go before the rest of them do. If the housing market goes flat, as Gross says, we are in a world of hurt. Barnes calls it a disaster. I would call it a serious recession, at a minimum.
The Fed has no choice. They will lower Fed rates. They must keep interest rates low to spur the refinance market. Lower mortgage rates act like a tax cut. It makes more money available each month for spending and saving. They hope this will stimulate the economy and thus create more investment.
Lower interest rates will also act to push the dollar down, without actually announcing a "weak dollar" policy.
It is for this reason -- massive stimulation by the Fed and lower rates-- that I maintain my view we will remain in a Muddle Through Economy for the next few quarters, at least. We might even continue the slow growth dance for a year or more.
We will find that the third quarter was an improvement over the second quarter, but that the 4th quarter will be weaker. Overall, growth will be slow. It is precisely when you are in a slow growth environment, with very low inflation, that deflation can creep in.
The Fed, which is being urged from numerous quarters to act preemptively, will soon do so. Stimulus can have an effect for a short time. As foreigners continue to buy our bonds, rates will continue to drop. I wrote about 5% mortgages in 1998. Thus, I still think mortgages have a small way to go, but I agree with Gross, that much below 5% is very unlikely.
But until there is some evidence that deflation is in check, interest rates will continue to fall. Dennis Gartman recently noted the eerie comparison between the charts of the Japanese bond market and the US ten year note.
Can the Fed reflate the economy, lower mortgage rates and ratchet down the dollar in the next 12 months? Can we slowly let one bubble burst before we have to deal with another? Will the market be so kind?
Maybe. Maybe Not. History is on the side of Maybe Not. History says one or more of these bubbles run into a pin at the same time, and then we get a recession. Only this time, the Fed cannot cut rates 475 basis points.
This is why secular bear markets take years to fully run their course. It takes more than one recession to convince investors that stocks are too risky, and to look for more stable climes. It often takes three or four.
However, just because I think History will probably win, doesn't mean the Fed won't try like Hades to last just one more round. Maybe, the thinking goes, with a little more of the right stimulation, this time things will be different. Avoiding pain is great motivator. I personally would like to put off any real pain for another 5 decades or so.
Because of the stimulation we will be getting, we could see a bear market rally. But the stimulus will not overcome History, in my opinion, and sooner or later we get another recession and a resumption of the bear market. I just hope the next recession is as mild as the last.
On a side note, I agree with Gross, Kashdan et al that eventually we will see inflation again. I am just not so sure we will see it in 3 years.
There are just too many things that can happen on the way to the Dollar Devaluation Party. We will have to watch the developments in the world currency and bond markets with a close eye. I will be writing frequently about these markets in future letters.
I must admit, I find myself late at night succumbing to the all too human thoughts of the common pursuit of mankind: hoping we can put off the Day of Reckoning just a little longer while we get our house in order. Maybe the Fed will be successful. Unlike some of the more stoic analysts, I hope we can avoid "the world of hurt."
Employment Improvement?
Greg Weldon did a detailed analysis of today's employment figures. What he came away with was that the numbers just don't add up. According to the Household survey, the economy created 1.14 million jobs in the last two months, over 700,000 in September. Yet, in the non-farm survey 70% of various sectors reported job losses. Only government and real estate have posted consistent growth. Yet we are told the economy created 1.14 million jobs even as total hours worked and overtime hours both fell. This just does not add up.
Retail sales are quite soft. Housing starts are slowing down. 1.5 million people have been out of work longer than 27 weeks, and 27% of unemployed have been out of work for longer than 27 weeks, both cycle highs. Nothing in any economic indicator shows a boom in labor that could suggest the creation of 1,000,000+ jobs. Something is wrong with some of these Labor Department numbers.
Part of the answer to this conundrum lies in the fact that the 1,000,000 jobs statistic comes from a survey. This is not any different than political opinion polls. Being a little simplistic, they call households and ask if they are working. If the sample gets skewed, or the wrong assumptions are made, the numbers can come out very wrong, just like political polls.
The strong numbers caused the markets to surge this morning, and long bonds to plummet. By the end of the day, as the numbers went under the knife, and as more traders read the widely followed (by insiders) Weldon analysis, they came to the same conclusion: the numbers are bogus.
I do not doubt that there were new jobs added last month. I just do not believe there were 1,000,000 jobs added. The numbers will be revised, and revised downward.
One More Year, and Counting
Today is birthday number 53. Tonight I will spend it with family, but today it is my pleasure to write this letter, and I hope you enjoy my birthday gift to you.
The New Orleans Investment Conference is close to filling up. If you are thinking about attending (and meeting me there) then you should register quickly. The conference is November 7-10 and features Richard Russell and John Templeton, along with a host of excellent speakers. They allow yours truly to tag along. (See www.neworleansconference.com)
In the next 10 days, I am in La Jolla, back to Fort Worth, Pittsburgh, New York and Washington, DC. Too much travel, but all for a good cause - finding investment opportunities for clients, and maybe a little golf. (You can find out more about those investments by going to www.johnmauldin.com) Fortunately, I have a saint of a wife who lets me go so long and keeps everything working at home.
Your already wishing he was back home before he left analyst,
John Mauldin
John@2000wave.com
Copyright 2002 John Mauldin. All Rights Reserved
-> http://www.wave2000.com
Matze
http://www.stock-channel.net/stock-board/images/icons/icon14.gif
so ein schöner Beitrag,und bei der Länge suche ich verzweifelt nach einem Fazit
eine bemerkenswerte Eigenschaft von GERMA :)
man wirft heutzutage nur so mit ENGLISCH um sich :mad: :mad: :mad: :mad: selbst die Deutsche Telekom :mad:
und vergißt,daß wir hier in Deutschland leben und das :) unsere Sprache ist.
Jeder,der Englisch nur wenig....... :cry versteht,kann sich nicht sicher sein,das was da steht,für sich richtig zu übersetzen :(
und bitte verweist nicht auf die Übersetzungsprogramme....soviele HECKEN :cry :cry
wie es da gibt,wachsen nicht mal in Irland.
Ein kurzes Fazit,.... das wäre es....... für die DOOFEN :lach
danke
Nilrem
Einfach ein Fazit unter einen Beitrag in Englisch würde sicher vielen
Nicht schimpfen, weil es englisch ist bitte :rolleyes: Ich nehme einfach mal das "Amerika"-Forum als Entschuldigung dafür :rofl
2003 Forecast: Transition and Surprise
A World of Hurt
King Dollar and the Guillotine
Gold Has a Lot More Glitter to Come
The Muddle Through Economy, Part 2003
Deflation Hiding Behind the Trees and Bond Prices
Rallies in a Secular Bear Market
Summary: On the Gripping Hand
My Biggest Forecasting Mistake
By John Mauldin
We cover the globe, currencies, the US economy, bonds, stocks,
deflation, inflation, gold, oil and more!
For the last three years, making annual predictions has been
relatively easy, at least as compared to this year. You try to
discern the dominant theme for the year and then everything else
usually flows from there. In 2000, it was an over-valued stock
market. In August of 2000, the interest rate yield curve went
negative, and as I wrote at length at the time, Federal Reserve
studies (among others) showed that a recession always followed a
negative curve by about 12 months. I saw no reason for that not to
be the case this time. I suggested strongly to readers that the safe
move was to get out of the stock market entirely at that time.
Thus, coming to January of 2001, a second half recession was the
dominant theme of 2001, and the general slowdown throughout the
world provided a back-drop for a very bearish picture. I began to
write that year that we were beginning a probable decade long (at
least) secular bear market. Last year, the theme was the arrival of
deflation, a less than robust recovery and the development of my
view that we are in a Muddle Through Economy. (I should point out
that I first wrote about deflation in the fall of 1998 and strongly
suggested readers consider long term zero coupon Treasury bonds at
that time. That has been a very good trade. Later we will consider
whether it will be so in the future.) In March of 2002 I turned
bullish on gold and bearish on the dollar.
All in all, it has been a reasonably good track record, with of
course the usual bumps here and there. Long term bonds were not a
winner in 2001, although they did very well in 2000 and last year.
Stocks have had some tradable rallies, but the trend has been down.
I have been meditating for over a month what the main themes for
this year's forecast should be. The problem is that there are no
obvious over-riding themes, in my opinion, that control the rest of
the picture. As I have thought about it, this is the year of
Transition and Surprise. As we examine our portfolios and look to
what might unfold in 2003, we will want to keep these two words in
the front of our minds.
Please keep in mind these are predictions and not prophecies. I did
not receive them on stone tablets shoved under my office door. They
are my best take after reading hundreds of pages of economic
analysis form scores of services. They are my opinions, and are not
guaranteed. The one prediction I can confidently make is that I will
change my opinion on at least a few of these thoughts sometime in
the year. That being said, let's look at 2003: Transition and
Surprise.
On the Gripping Hand
To the usual economic essay that starts "On the one hand..." and
continues "On the other hand..," in my past annual forecasts I have
added a third possibility, "on the gripping hand." This comes from
Larry Niven & Jerry Pournelle's masterful 1993 science fiction novel
"The Gripping Hand" which involved a species of aliens with three
arms. Since economists are about as alien a species as we have on
earth, and because we are indeed trying to "get a grip" on our
finances, it seems appropriate. As we examine each economic arena
and market, we shall look at both sides of the issue and try to come
away with some idea (the gripping hand) of what might really happen.
(Because of the rather large range of topics we will be discussing,
I am not going to provide my usual lengthy analysis of each
individual market. I will cover in future letters those areas which
beg for more in-depth analysis.)
A World of Hurt
Before we look at the US economy, let's quickly review how the rest
of the world is doing. Europe is on the verge of a recession, if not
already there. Incredibly, even Chancellor Gerhard Schroeder's own
optimistic economists (called for some reason the "Five Wise Men")
openly bring into question his proposed tax increases, saying they
may prevent Germany's economy from growing at the anemic 1% rate
they forecast for this year. Italy is not well, France is doing
somewhat better, but it is only in relationship to Germany that you
would use the word better. (Bloomberg)
Incredibly, while deflationary forces sweep the world, the European
Central Bank is still fighting the last war. They are so afraid of
inflation they provided only one measly interest rate cut last year.
They seem to be waiting until the patient becomes comatose before
providing blood. My take is they will cut rates again this year, but
only grudgingly and not soon enough or deep enough to have any real
influence prior to a recession starting. Even though the dollar is
falling, Europe is not going to be a source of significant export
growth until it works through its current malaise.
I have lost count of how many final stimulus packages have been
proposed or enacted in Japan. Japan redefines the meaning of
futility. The country is mired in long term deflation and recession.
A large chorus of national leaders calls for the yen to drop to a
value of at least 130 against the dollar and some say the Bank of
Japan should target 150-160 from the current 118. This of course
would make Japanese exports cheaper and therefore more affordable to
US consumers, help Japanese exports rise and allow them to continue
to export their deflation to the US and the rest of the world.
There will be a new counterpart to Alan Greenspan at the Bank of
Japan this year. He will probably be from the school of thought
which says Japan should develop a specific inflation target. I agree
they should, but doubt very seriously whether they will be able to
do so without serious structural reform to their banking system. The
Bank of Japan in combination with the government is the only
management team which makes Wall Street analysts look competent.
Look for the yen to drop with the appointment of a new BOJ chairman,
as there will be lots of speeches calling for a drop in the yen
among government circles. Then as no action actually follows the
rhetoric, the yen will probably drift back up. You are pretty much a
failure as a central banker when you cannot destroy your own
currency. Maybe this year the leopard will change its spots, but I
am skeptical.
The rest of Asia, and especially China, continues to grow. The trade
surpluses of these countries continue to rise, especially with the
US. Latin America struggles as Argentina is a basket case and Brazil
has seen its currency drop 30% in the last year.
King Dollar and the Guillotine
The US trade deficit continues to rise. It is well over 5% of GDP
and going to 6%, and such levels normally mean a serious correction
in the value of a currency. While the dollar has dropped, especially
against the euro, it has not dropped as much as you might think on a
trade weighted basis. (I have done extensive analysis of this
problem in previous letters, under the theme "What if they gave a
dollar devaluation party and no on came?")
The dollar is doing better than it should because China has fixed
the currency to the dollar, and the rest of Asia is in a competitive
currency devaluation race (Greg Weldon's terminology) to see who can
make their currency lower in order to attract US consumers. The
world and especially Asia will continue to be addicted to the US
consumer. They sell us their products for electronic dollars, and
then buy our government paper and stock. The world either owns 35%
(BCA Research) or 42% (Morgan Stanley) of our Treasury debt. Morgan
Stanley also reports foreign investors own 18% of US long term
securities and stocks.
Why would foreign central banks continue to buy and hold large
positions of dollar denominated US assets when it is clear the
dollar is over-priced? Because they have a Hobson's choice. They can
take pain now or take it later. Politicians are the same all over
the world. They prefer to take their pain later, even if it will be
more severe.
If a country stops taking dollars and buying US assets, then their
currency will rise and make their products less attractive to our
consumers. In export driven economies, this is a disaster,
especially for the politicians, as it assures a recession at the
very least. Thus they continue to support our spending habit.
Canada, Mexico, China and Japan account for 47% of the trade
weighted currencies. The Canuck is flat for the year, the peso is
actually down 10% and the yen is down more than 10% for the year,
much to the consternation of the Bank of Japan, as noted above. The
Chinese currency is pegged to the dollar, so there has been no
movement. (These and other currency figures cited are from A. Gary
Shilling's INSIGHT newsletter)
Thus the drop in the euro is the single major reason the dollar has
dropped slightly on a trade weighted basis, when seen on multi-
decade chart.
Is there a limit to this? Of course. We can't sell more than 100% of
our assets, and we are now selling $500 billion a year. At this
rate, the rest of the world will own 100% of our government debt in
ten years, even as we grow the deficits. Clearly this is not
sustainable. When does the pain of taking over-valued dollars become
more than the pain of selling less to the US? I think it is when
China allows their currency to float. Asian countries do not
necessarily want an over-priced dollar; they simply want the price
of their currency to be favorable in relation to their neighbors.
The gorilla in this process is China, and when they allow the
renminbi to rise, that will be the real end of the dollar as the
rest of Asia will feel comfortable inletting their currencies rise
as well.
There is an increasing call from many corners of the world for the
Chinese to allow the renminbi to float. They have not responded to
the pressure, but as do all countries will act when they feel it is
in their own best interests. That will probably be when they think
their own consumer demand is growing and solid, and thus can sustain
a possible slowing of sales to the US. When that will be is anyone's
guess, so the dollar could be surprisingly strong even when by all
rights it should drop. But China could be the surprise move which
sets this set of dominoes in motion. This is one area we will watch
closely this year, as it will be a surprise and will be the
transition to a much lower dollar fairly quickly.
(Sidebar surprise question: which country has the third largest
trade surplus behind Japan and Germany? Answer a few paragraphs
below.)
By the way, this is not the end of the world, as some would have you
think. The dollar dropped by over 1/3 against all currencies in the
80's and early 90's, and the US seemed to move along just fine.
Inflation dropped during that time and the economy grew. A falling
dollar will help our exports, of course. I expect the Bush
administration to tacitly approve a weak dollar policy while
continuing to say the market should determine prices.
The one real exception is the euro, as the European Central Bank
seems quite content to let the dollar drop. Even with the weakness
in Europe, I think it is likely the dollar will continue to drop
against the euro. In 2002, I predicted the euro would rise to parity
by year end, and it has gone decisively past that point, to $1.05.
Those readers who opened euro denominated bank accounts at Everbank
are happy today. The "natural" target of the next 12-18 months, if
not sooner, is around $1.17, which is where the euro started about
four years ago. You can buy a euro denominated CD from Everbank by
calling Chuck Butler: 314-984-0892, ext 102. (Full disclosure:
Everbank has a business relationship with my publisher. I know of no
other US based bank from which you can buy CD's denominated in
foreign currencies. If you know of one, I will be glad to add them
to the list.)
I believe Europe will resist a drop much further than $1.17 until
China starts the dollar tumbling down the hill so they can stay
competitive as well. It is truly every country for themselves in the
currency markets.
(The answer to the question above is that bastion of capitalism:
Russia. Their trade surplus in 2002 was $44 billion. They also have
the lowest taxes of any major country. Khrushchev loses. Reagan
wins. And the biggest winners are the Russian people.)
This naturally brings us to that international currency: gold.
Gold Has a Lot More Glitter to Come
Gold has finally gotten off the floor, and has become the hot
investment of the year, up around 35% or more, depending upon which
day you look. I think it has more room on the upside.
First, gold finally broke through the $325 barrier. Dennis Gartman
tells us that the reason is that the Bank of Canada finally finished
selling all the gold it wanted to at that level. There now seems to
be someone major selling in the $355 area. When that supply is
worked through, the next level of resistance is $385 per one of my
favorite gold technicians Ian McAvity.
Central banks are not in some vast conspiracy to hold down the price
of gold. They simply want to sell what they have. They do not
understand the yellow stuff, and don't want to own it. As gold
rises, they will sell more. The prefer electrons to hard metal,
which in theory can earn interest. (The lease rates on the gold they
lend to banks and dealers are quite small, which is the way they
make something on their gold holdings.)
My long held belief is that gold acts like a currency, and if the
dollar drops another 10% against the euro, you could easily see
another 10% rise in gold. Because gold is so thin a market, it could
rise much further fairly quickly, if central banks decide to limit
their sales.
And as Paul McCulley of Pimco points out, gold needs to rise as a
sign that the world is dealing with its deflationary problems. For a
very fascinating and well written historical study of the
relationship of gold to inflation/deflation see his January essay at
www.pimco.com.
When the need of central bankers coincides with the direction of the
market, we should pay attention. Thus, I continue to be a long term
fan of gold and gold stocks (at least since March of 2001).
The Muddle Through Economy, Part 2003
Economists throughout the country are predicting that this year we
will see a resurge in capital spending, and this will be the trigger
for a return to the boom years with 4% growth. I think not.
First, let's look at my Three Amigo Economic Indicators: the ISM
numbers, capacity utilization and junk bonds. The ISM number is the
old NAPM (National Association of Purchasing Managers) and is a very
accurate independent measure of the level of purchasing and business
activity. It has recently turned modestly positive, which means
business is finally doing better, but not great. Capacity
utilization stinks. This is a measure of how much of your potential
production you are actually using. It now hovers around 76%, which
means that business has no pricing power, and if you can produce all
you can sell and then some, what reason is there to increase
capacity by spending money on more factories and production
capacity? Better to use the money to pare down debt.
As the level of business loans as a percentage of GDP is still
dropping, that suggests business is not borrowing to increase
capacity. That suggests the resurgence of capital spending mentioned
above is still beyond the horizon.
Finally, junk bonds have improved somewhat over the past few months,
but not a lot. When the economy starts to roll after a recession,
junk bonds ceased to be treated as nuclear waste and earn the
respectable title of high yield bonds. They show a real jump in
value. After the recession in 1991, we saw junk bond funds rise 70%
in the next three years. Interest rate returns and spreads over
treasury bonds are still very high, but sl-o-o-o-wly coming down.
This also suggests that the economy is improving, but still quite
soft.
There are three main components which normally lead a recovery in
the economy: consumer spending, housing and capital spending by
business. We saw weak consumer spending in the holiday season. While
overall it did not fall out of bed, the "growth" was anemic, and
moved down the food chain from upscale stores to Wal-Mart and
Target. Even so, they performed below earlier projections.
US household debt as a percentage of GDP has doubled since 1960 from
40% to 80%. As Martin Barnes of BCA Research points out, this is not
quite as bad as it might first look. A great deal of the rise is
from lower and middle income families finally being able to buy a
home as well as qualify for other types of credits. While this has
caused an increase in delinquency rates, it has also allowed home
ownership to become more universal which is a good thing.
Nonetheless, there are again limits, and it appears that consumers
are at least beginning to slow down the growth of their credit. The
practical limit is that at some point credit growth cannot outpace
income growth. My reading of the numbers is that the vast majority
of US consumers are not in trouble, but they do not appear anxious
to increase their debt. Since debt growth has clearly been the
engine for the growth of consumer spending, this suggests consumer
spending is not going to be the engine for a powerful recovery.
Paul Kasriel of Northern Trust points out that growth in consumer
spending and exports are a requirement for or pre-cursor to
significant increase in business capital spending. If this is true,
and I agree with him that it is, then that leaves housing as the
last possible stimulus for the long awaited "V" shaped recovery.
Housing is already at an all-time high and it is hard to see how it
can grow any more. The best we can hope for is continued low
mortgage rates and for the housing industry to simply remain at the
current levels. To expect any more is not realistic, given the
slowly rising unemployment.
Economists are projecting a rise in S&P 500 corporate profits in the
15% range. It will be closer to 5% than 15%, probably in the high
single digits. This could change for the positive if capacity
utilization increases, among other things, so we will watch this
closely. But right now I do not see a big jump in capacity
utilization in the near future. This is not the stuff of which 4%
economic growth is made of.
That being said, there are factors which would lead one to believe
that we will again Muddle Through. The proposed Bush tax cut and
government deficit spending is a decided boost to the economy. Low
rates are a stimulus. A falling dollar will help the deflation fight
and US exports.
While the economy is certainly not robust, the recovery has been
profitless and jobless and there seems to be no real area which will
lead to significant growth, there is nothing to suggest that we are
on a verge of a double dip recession. We Muddle Through.
I think the Bush administration is adding the stimulus plan to
provide some insurance that the economy will stay out of recession
through 2004. I think for 2003 it is likely to work, but my estimate
is that growth will be probably between 2% and 2.5%.
As an aside, I monitor the yield curve almost daily. There has not
been a recession in post-war America when short term rates have not
risen above 20 year Treasury rates for 90 days approximately 4
quarters prior to the onset of recession. This is called an
"inverted yield curve." A Federal Reserve study has shown that it is
the single best and most reliable indicator of future recessions. We
are a long way from that point. Can we see a recession without an
inverted yield curve? It is more than an academic question.
We can get an inverted yield curve by short terms rates rising or
long term rates falling or a combination. That is why I do not think
the Fed will raise rates this year. They cannot afford to raise
rates until the recovery is robust, unemployment is low and
consumers and business can handle the increased interest rate costs
without pain.
If there is any interest rate change this year, it will be another
cut. I hope not, because that will mean we are having problems,
probably an unpleasant surprise, and that Greenspan feels we need
the emotional stimulus of knowing the Fed is on the job and still
cares. Another 25 basis point cut will achieve little of actual
consequence within the economy, but it would be done in an effort to
shore up consumer and investor confidence.
As I wrote in 2001, Greenspan has raised interest rates for the last
time in his career. He retires in 2004. He will not raise rates in
2004, but will leave that task for his successor, who will not raise
rates prior to the second Tuesday in November.
It is primarily because of the yield curve that I think the
underlying economy will Muddle Through. Because rates are so low and
artificially distorted, we may not get a fully inverted curve prior
to the next recession. But we should see some kind of move where the
yield curve at least flattens. For those of you who want to see the
"curve," and for those who like to monitor interest rates, you can
click on http://www.bloomberg.com/markets/C13.html?sidenav=front.
What are the risks to the Muddle Through Economy? A surprise in
Iraq. Right now everyone thinks it will be short and successful.
Another major terrorist incident would be a significant issue. If
the President's stimulus package or some version thereof (see below)
does not pass that could turn the mood of the country negative and
crunch consumer spending.
And I must admit if the stimulus package gets passed quickly, if we
see a significant bear market rally, a drop in unemployment and a
short and successful war in Iraq, it is not hard to think GDP could
grow another 1% over the Muddle Through 2.5% range. But those are a
lot of ifs.
Deflation Hiding Behind the Trees and Bond Prices
My less-than-sainted Dad would often tell me after a moment of
youthful bragging something like, "Let not him that puts on his
sword boast like him who takes it off." His actual version was a tad
more colorful, but there are ladies who read this letter.
Greenspan, Bernanke and crew have bragged that they have the
"ammunition" (their word) to defeat the deflation bully. Much of the
world breathed a sigh of relief to know the Fed was on the job and
started worrying about the coming inflation. Call me a cynic, but I
am not prepared to abandon my deflationary views just yet.
As Stephen Roach of Morgan Stanley points out, "For the economy as a
whole, GDP-based inflation slowed to just +0.8% in 3Q02, the lowest
rate in nearly half a century. Another year of sub-par economic
growth in the 2% vicinity -- pretty much my personal prognosis --
could well find inflation moving even lower, possibly flirting with
the "zero" threshold of outright deflation. The authorities must do
everything in their power to avoid such an outcome."
Larger federal deficits, a falling dollar and increased growth in
the money supply should hold outright deflation at bay for this year
and maybe the next. The real test -- the moment when we see what the
Fed's ammunition is worth -- is during the next recession. At that
point, we will see whether they are pushing on a string and we
develop a Japanese liquidity trap, or they can actually move
mountains.
Are we headed for a Japanese style deflation? Right now, I think
not. That is because the Japanese consumer prefers cash to
consumption, and coupled with their insane banking system that is
what has created their liquidity trap and deflation. That is not the
picture of the US consumer or of our banking system, nor has it been
in our national character for some time. There is a difference, for
good or bad, between the two national personalities. (For
explanations of a liquidity trap, go to www.google.com and type in
liquidity trap.) But I could just as easily argue that an aging
boomer generation will want to increase savings dramatically and
thus become more like the Japanese. But that requires a change in
the character of my generation, and one I do not currently see.
That does not mean the Fed will have it easy. I think that at some
point the Fed is going to have to put its printing press where its
mouth is. I do not think that happens in any serious way until the
next recession.
In 1998, I became a big proponent of long term zero coupon
government bonds. It has been a very good 40% or so run in my
favorite bond fund, The American Century 2025 fund (BTTRX). Last
year we saw almost 20%. It is the most aggressive of the bond funds.
This is a volatile fund, and has lost almost 6% so far in the first
10 days of this year.
A recent survey of Schwab account holders revealed that 40% of them
did not understand that they could lose money in a bond fund. I am
sure none of my readers were in that group, as all of you are well
above average in investment savvy, but that is an appalling fact. If
interest rates rise, you WILL lose money in bond funds.
For reasons I will outline below, I think we could see a significant
rally in the stock market. This will not be good for bond funds.
Much of the market has put their deflation fears to rest. They are
now worried about inflation, which is not good for bonds.
While I do not think long term interest rates will be allowed to
rise too much without active intervention from the Fed, interest
rates will probably drift higher for some time.
Sidebar: if interest rates, and specifically 10 year treasuries move
a lot higher, then that will increase mortgage rates. Rising
mortgage rates will threaten to push the economy back into recession
if allowed to persist in a time of weak recovery. A strong and
growing economy can handle rising mortgage rates. I do not think
this one can.
Don Peters, who has one of the best track records I know of for
predicting interest rates and Gary Shilling both think interest
rates have much further to drop. They may be right, but I believe
interest rates are going to continue to be volatile. The problem is
that if they are right and you exit your long bonds now, you will
miss much of the move when rates begin to drop again (if and/or when
they do). These things happen quickly, as the last few days suggest.
If you believe deflation is still in the cards, hold at least some
of your bond positions. If you think inflation is on the way, sell
all the bonds you do not plan to hold to maturity. If you are not
sure, lighten up your bond position.
My current thinking is that long term bonds (other than those you
plan to hold to maturity) are now more of a trade than an
investment. If you hold a gun to my head, I think we see lower rates
in the future during the next recession. They could be
substantially lower if the Fed has not been able to induce
inflation, and there are no signs they have been able to do so as
yet.
But the period in between now and the next recession will be
volatile. If you are going to hold long bonds, you have to look over
the valley of volatility to the next recession. Both Peters and
Shilling think you will be well rewarded for your patience, and
their independent track record on bonds for the last two plus
decades speaks for itself.
What should income investors do? First, do not chase yield. If you
can't deal with volatility, do not buy long bond funds. If you need
income, I would suggest the traditional ladder of variable length
bonds and hold to maturity. You should look at medium term high
quality corporate bonds.
Also, consider TIPS - Treasury Inflation-protected Securities. They
rose 16% last year, and have excellent potential for capital gains
when inflation does come back, which it eventually will (again, in
my opinion).
As a type of "call option" on the economy, you might consider a
portion of your portfolio in a conservative high yield bond fund. If
the economy improves, then high yield bonds will rise. The capital
gains plus the yields could be quite nice. Go to Morningstar and
look for 4 and 5 star rated funds. Put a close stop on the fund.
This is a year of Transition and Surprise. Can the Fed and the world
deal with deflation? Right now, the market says yes. This is the
battle. We will either transition to inflation or slide further
toward deflation. It is in the balance.
Rallies In a Secular Bear Market
The primary trend of this market is down. We are in a secular bear
market. (For a detailed discussion of what a secular bear market is
go to www.absolutereturns.net and read the relevant chapters in my
book-in-progress called Absolute Returns.)
Secular bear markets usually do not end until P/E ratios are in the
single digits, which is far from where we are today. This primary
trend is likely to last for the remainder of this decade, at a
minimum. I do not have the space today, but will write in an
upcoming e-letter about the very well-reasoned analysis done by Gary
Anderson and separately by Ed Easterling. Anderson gets as much as
$60,000 a year for his newsletter on stocks and timing, depending on
the assets under management. He is quite sharp. Hedge fund managers
among my readership will want to pay attention and review his work.
He shows why we could see 4-5,000 on the Dow before this cycle is
over, even though he is somewhat bullish this moment.
Easterling, another hedge fund manager, takes a very different
approach. His work suggests that we could be in a sideways trading
range for at least another ten years, with some serious risk to the
downside as well.
But that is the future. What about this year? I read everywhere or
at least from the cheerleaders, that the odds are that we will see a
rise in the market, because there has only been one time in history
when the markets went down four years in a row. The odds are only
one in a hundred.
With all due respect (actually with no respect at all), that is the
worst statistical garbage I have read in quite some time. First of
all, there have only been three times when the market have even had
a chance to go negative four times in a row, and one of those times
the market was down less than .5% in year, so that hardly counts as
down three in a row. So if that type of statistic was valid, then
the odds would be either 1 in 4 or 1 in 3.
But it is meaningless. The conditions in any one given year are the
reason for the market to go up or down. I am going to discuss why
this market could significantly rise and/or significantly fall. It
has nothing to do with odds. If any broker tries to get you to buy
stock based upon this "statistic," hang up or fire him.
First, how can I think the market might rise if I think we are in a
long term bear market? Let's look at a few reasons.
While the performance of the stock market in any one year is random
from a statistical standpoint, over a complete cycle, there is more
solid footing. There have been two 50% rallies in the Japanese
Nikkei while it has dropped over 75% in the last 12 years. There
have been at least a dozen 20% rallies. They were all hailed as the
end of the bear and the beginning of a new bull.
Ed Easterling has allowed me to reproduce a chart with some very
interesting statistics on bull and bear markets. What we find is
that in most long term secular bear cycles the market goes up 50% of
the time in any given year. In bull markets they go up 80% of the
time.
As noted above, bear markets have historically ended in single digit
P/E (Price to Earnings) ratios. If this market were to go directly
to that single digit P/E without a few years where the stock market
actually rises, it would be the first time in history in the US, and
I cannot think of or find an example in any major market anywhere
else. There seems to be something about the psychology of a bear
market that demands a respite. Bear markets do not end when there
are still bulls in the corral. These bear market cycles take years,
and typically longer than a decade, to shake out.
I should point out that for the market to go directly to about
single digit P/E ratios would require a drop of at least another 50-
60%. I do not need to discuss the kind of devastation that would
produce in the world.
You can go to this very interesting table at
http://www.2000wave.com/marketprofile.asp
What could spur a rise this year even as the markets are
historically way over-valued? I met with the manager of a major long
short hedge fund this week. Their approach is based on value. They
buy value long and sell bad companies short. They did quite well
last year, performing in the top 10% of long short equity funds.
Today they are close to 50% in cash. His problem is that he can't
find enough companies he feels comfortable about to invest.
There are not just enough stocks with low enough values to interest
him. This is not surprising. But the intriguing piece of information
was that he can't find anything to short. All the obvious stocks to
short have large short positions already from other hedge funds and
individual investors. To get in today is very dangerous.
That is because these hedge funds are very sensitive to their
relative standing to each other and to profits and losses. A long
short hedge fund is supposed to preserve capital. If a "short rally"
starts and a hedge fund holds its position it can quickly drop more
than their previous historical losses, making investors nervous.
Most long-short equity hedge funds did not have a particularly good
year last year, and do not want to have a second losing year, even
if it is small. Thus many managers are "scared money." If a short
position begins to deteriorate, they could bail very quickly,
creating a short rally. (You have to buy the stock long to cover
your short position, thus in theory driving the stock up even
further.)
In his opinion a significant short rally was possible. But what if
such a rally begins to create a market in which all stocks start to
move? Then momentum traders move in and create more buying. Many
hedge fund managers with significant cash will not have the
discipline to let the market run from them and will begin to chase
the market in an effort to at least stay near their S&P 500
benchmark. Hedge funds that are traders (and there are hundreds of
them) will smell blood and profits and help drive the feeding
frenzy. By the time the market has moved 20%, the cheerleaders are
proclaiming the end of the bear market, and the small investors pile
in, chasing the now hot mutual funds.
What could be the fuel to keep such a rally going? Trimtabs tells us
that companies are going to have to fund their pension plans by over
$100 billion over the next year. As an example, General Motors will
increase its pension contributions by $3 billion (cutting its
profits by 26% in the process) this year. That is just one company.
These companies have fixed positions for their pension funds. For
instance, their consultants may have them in 50% in stocks, 40%
bonds and 10% cash. Since they lost 20% on their stocks last year
and their bonds went up, they are now "underweight" on stocks, so
that means they will plow much of the new cash into the stock market
in an effort to get back to their target allocations.
Mix in large increases in the money supply and you have the
conditions for a bear market rally. In the table I mentioned above,
the average gain in positive years in bear market cycles was 24%!
Underlying all this is going to be the repeal of the dividend tax.
If this happens, it will put a new and higher floor on the eventual
bottom of the bear market. This makes dividend paying stocks worth
more. You can argue that dividends were much higher in previous bear
market cycles, and that did not keep the stocks from going much
lower, but I would point out the dividends were taxed in past bear
markets. This will not start a new bull cycle, but I do think it
changes the equation on the eventual bottom. While that may be cold
comfort when the Dow is at 6000, that level is a lot better than 4
or 5,000.
Let's be clear about one thing. Bush is not putting out this
dividend tax repeal as a ploy. He is dead serious. This is not a
negotiating position. I know from personal experience here in Texas
that when he stakes out a position, he argues and pushes for it
aggressively. He is not looking for a compromise.
He tried to change the tax structure in Texas in 1998.e is very hard
to say "no" toHeHe He did not have close to a majority of his own
party supporting him. He eventually lost that fight, but he did not
back down.
This time he will get most of his party (hopefully McCain will come
along) and a few dems and he should get his dividend tax repeal.
While I am generally in favor of all tax cuts, this one is important
in that it will change the corporate culture in America. Dividends
will rule, and dividends require actual profits and not stock
pumping to get your options cashed.
I believe the hope from the Bush team is that this will put new life
into the stock market, or at least a base for a few years at the
least. Whether it will remains to be seen, but it is a brilliant
political move and also a proper philosophical move as well. It may
well be the most important long term contribution from the Bush
presidency.
Let us make no mistake about this. Bush is putting his re-election
on the line. If this tax repeal fails, it could very well tank the
market and sour the mood of the country. That could tank his re-
election. He could argue it was those bad democrats, but it would
probably ring hollow to those whose retirement accounts are down.
This is an all-or-nothing, bare knuckles political brawl.
Son of Bubble
Now let's look at why the market is going to go down this year.
First and foremost is that valuations are WAY too high for a
significant bear market rally. Other than the last bubble, we are
near all-time highs for previous bull markets. How can you rally
from what is already high? How can a new bull start from the top
floor? Can we say Son of Bubble?
Earnings are going to disappoint investors. Not by as much as in
2002, but they will still be below current analysts' forecasts. It's
hard to see a sustainable rally coming from constantly lower
earnings estimates.
The list of problems is long: Iraq, terrorism, deflationary world
pressures, a Muddle Through Economy, a possible retreat by foreign
investors because of the dollar, etc.
So where will the stock market end up for the year? I don't know,
and that's the honest truth. Anything I said would be a guess, and I
do not want anyone investing hard money on my guess. I could guess
and be lucky as I do have a 50-50 chance to be right, but to then
tell you that my guess was anything but luck next year would be
dishonest.
I do think we could see a very serious rally this year. Whether it
will last the year is not clear, although it easily could. Could we
see a rally after Iraq is done, tax cuts are in place and a nation
breathes a sigh of relief? You bet, as the fuel for a rally is there
in the form of pension fund cash and a lot of cash in the hands of
investors. Will they be once bitten, twice shy? When this rally
fails, as it eventually will, they will be even more embittered and
the resulting drop will be worse than what would occur if we simply
maintain a trading range.
I think the next significant leg down in the stock market comes as a
result of the next recession, whenever that is. As I will discuss in
the next few weeks and make a longer case in my book, AT BEST the
trend is a sideways trading range for the rest of this decade.
History suggests we will not be so lucky. But this year, we may
dodge a 4th straight bullet. We will see.
In the meantime, it is best to follow the advice that Dennis Gartman
reminded me of: treat the stock market not as a stock market but as
a market of stocks. This is a stock picker's market. There are
always companies which will do well in any year. This is also a
period where market timers should do well. In a few weeks, I will
point you to some successful timing programs and managers. There are
not many, but there are some who have done well.
The Oil Patch
One wild card is the price of oil. If the war with Iraq is short,
and does not destroy their wells, we could see the price of oil come
down significantly. This would probably be as much or more real
stimulus than the tax cuts. On the other hand, a significant price
rise in oil from here could offset any tax cuts, especially when you
factor in the tax increases which are coming from states and cities.
Our new best friend, Vladimir Putin, will do his best to put as much
oil into the world markets as possible, but a serious rise in oil
prices could throw a world economy that is already wobbly into
recession. Let us hope that does not happen.
Summary: On the Gripping Hand
In summary, I think this year is another Muddle Through Year for the
US. The dollar should drop further against the euro. The economy
should grow much like last year, in fits and spurts. Profits will
disappoint, but will rise. Bonds and the stock market are in
transition, and we could see a significant rally, or sparked by a
negative surprise, another bear year. This is a year to be cautious.
Unless you are an astute trader, if you want to buy stocks to play a
rally, buy value and dividend stocks from companies who can grow
their dividends. Dividend stocks should do well this year, even if
the market is down slightly.
In my opinion, it should be a year where most hedge fund styles
should do well. Commodity traders and global macro funds should have
trends to follow and a second good year in a row, after a decade of
disappointment. If you are an accredited investor ($1,000,000 or
more net worth) and would like information on hedge funds and
private offerings, you can go to www.accreditedinvestor.ws and
subscribe to my free letter about these funds. Oh, one last
prediction: mutual funds and stock analysts will tell you now is the
time to buy. The market is a lock to go up. Cheerleaders of the
World, Unite.
My Biggest Forecasting Mistake
As a final note, let me take you through one optimistic point: if
the economy only grows at 2.5% year for the next ten years and
inflation is 2%, neither of which are unreasonable to assume, then
the GDP is 50% bigger in ten years than it is today. It will be 30%
larger in real terms. The economy grew 177% in real terms from 1966
to 1982, which most consider to be a secular bear period. The stock
market was flat for the 16 years.
There are going to be plenty of opportunities over the next decade
for astute investors and entrepreneurs. The main forecasting mistake
I have been guilty of over the past years is to underestimate the
ability of individuals and businesses in the free market to adjust
to uncertainty and problems.
I recognize we have significant problems in our economy. We are
going to have to deal with our huge national debt, over-extended
consumers, aging population, deflationary pressures or the inflation
which will come about from the Fed's pumping of the money supply to
fight deflation, an over-valued dollar foreign competition
pressures, trade accounts deficits, an over-valued stock markets,
not enough retirement savings. Federal government deficits, high
taxes, and the list goes on and on. All of these will have a
significant effect upon our economy and investments.
But the one thing that we need to remind ourselves of it that most
Americans are like you and me. When we are presented with a problem,
we deal with it. We take our lumps and get up and move on. We figure
out how to make next year better. We are an amazingly optimistic and
resilient people.
The new technologies and the new companies that will drive the next
bull market have probably not yet been invented or started.
What's in store for 2003 from Millennium Wave?
This next year, it is my intention to add a few features to the web
site. I will start posting 3-4 articles a week that I think are of
interest. I WILL get my book finished in the next few months.
If you are reading this letter for the first time, you can join
approximately 1,500,000 investors who get my free weekly e-letter,
where I deal with the topics above in a far more in-depth manner, by
going to www.2000wave.com and signing up for the letter. To find out
more about me you can go to www.johnmauldin.com. At that site you
can find links to chapters I have posted on my book called Absolute
Returns and my others free e-letter on hedge funds and private
offerings.
I look forward to serving you in 2003, and welcome your letters and
comments. Please know that I wish you the best year of your life in
2003.
Your betting 2003 will be a great year analyst,
(Whether or not my predictions come true.)
John Mauldin
John@2000wave.com
Copyright 2003 John Mauldin. All Rights Reserved
vBulletin v3.0.3, Copyright ©2000-2012, Jelsoft Enterprises Ltd.