The World's Best Businesses
The Daily Reckoning Australia
Buenos Aires, Argentina - Melbourne, Australia
Wednesday, 29 October 2008
From Dan Denning at the Old Hat Factory:
--Around noon yesterday here at the Old Hat Factory, a little daemon whispered in your editor's ear, "The bottom is in for the year of the ASX."
--"Huh?" We looked around to try and spot the little green devil. He's been in our ear before. But he was nowhere to be found. We could still hear his voice.
--"Think about you fool. It is now safe to be dogmatically bearish on the front page of the newspapers. The hedge funds have been forced to liquidate. The mob followed on the fund industry's heels, sold everything, and headed for the hills. The hills are full! Can't you see what this means?"
--"The selling has exhausted itself for the year you moron! Roubini recommends a $400 million stimulus package. It's a sign. The liquidation of the long commodities/short dollar and yen trades has got to be nearly over. The moves in the currency markets have been massive. It can't go on. And if it does...well if it does then this is the second Great Depression and you'll have other things to worry about."
--But what if you're wrong?
--"Then I'm wrong. If you're going to be in the equity markets at all for the next year, you should own the world's best businesses. You're not going to see them this cheap again for awhile. If you don't want to own theses businesses, why bother being in the market at all?"
--God may not whisper in everyone's ear. But we find daemons more than willing to have a chat, usually when our judgement is most in doubt. Still, we couldn't help following through the thoughts of our little green devil to their logical conclusion. And in his own way, he makes perfect sense.
--Bob Prechter and the Elliott Wave theorists (if we're not mistaken) believe that 'social mood' is what determines the direction of the stock market. And the market then leads the economy. But what leads the social mood?
--Well, that's a tough one. At the Border's on Chapel Street this weekend, we noticed that Bill Bonner and Lila Rajiva's book, Mobs, Messiahs, and Markets had moved up to number seven on the hardback best seller list. People are trying to understand why investors act like a flock of birds or a school of fish, all seeming to move in the same direction at once, without cause or explanation.
--People are wacky. The great mistake of market analysts (and most socialists) is to assume that people are rational and make economic decisions after calm, rational calculation. This is a figment of the rational imagination.
--People often take leave of their senses. And these days, it's hard to say just why some people are selling and no one is buying. As we've said here, we think it's the massive unwinding in leverage that's forcing stocks to be sold. There are simply not enough buyers to sop up all the selling (at least not until last night in New York, when some of that cash got back in the game).
--It doesn't help that you have a slowing global economy and a credit crunch. When you combine all that, the social mood turns decidedly sour. The beer goes flat. The smoke, rather than being a pleasant cloud in the lungs and making everyone look sophisticated and cool, just burns the eyes.
--What our little daemon told us yesterday, we think, is that the social mood couldn't possibly get any more sour. "Consumer confidence drops to record low," reports Bloomberg this morning. There was dust and tumbleweeds blowing through the markets this week. It was fast becoming a barren wasteland.
--But yesterday in New York, the first intrepid investors popped their head out from above their fallout shelters. Squinting in the sun, they found that perfectly healthy world-class businesses were lying around in the street for the taking. They were taken. The Dow was up double digits.
--Don't get us wrong. This still feels like the beginning of the 50% rally the Dow experienced in late 1929 and early 1930. But a man can take only so much depression in one quarter.
--It is not hard to see a simultaneous round of global interest rate cuts, a massive stimulus package in the U.S., and the election of Obama in the States (did somebody say Messiahs?) as just the things to turn the social mood around. And that's what makes for a rally.
--An improvement in the social mood won't do much to improve the structural causes of the mess we're in. FedEx CEO Fred Smith was recently interviewed in the Wall Street Journal. He made some fantastic points about why we are where we are...and how to get out of it.
--"Things became so flipped upside down," in the financial economy. "The assets at these banks became the liabilities and the liabilities became the assets. These people were making these fantastic returns -- at places like Fannie Mae and Freddie Mac -- but in reality they weren't adding a lot of value. I have said time and again that there is a fundamental tendency in good times in the financial sector to over-leverage. Our national policies actively encouraged all this debt."
--Smith points out that Anglo-Saxon capitalism favours speculation over actual capital accumulation and production. It does this through a tax policy and monetary policy. The corporate tax rate in the U.S. is 38%, compared to 25% in Germany. When you throw in loose monetary policy-money available at cheap rates to borrow and speculate with-you see how a company like GE went from being a company that made things to a company that made loans.
--If the regulators failed to restrict the amount of leveraging possible in the financial system, then corporate boards and CEOs equally failed. They took the easy way up, banking quick financial profits with borrowed money. They did not realise-or more likely ignored the fact-that leveraging financial returns with borrowed money is not a long-term business strategy. Leverage is the root of all our cotemporary financial evil.
--The last two months have seen the collapse of leverage and the deflating of the credit bubble as money drains from the global financial system (faster than the Feds can pump it back in). The hedge funds are delivering. The banks, despite infusions of new capital, probably still have too much leverage. What's Paulson going to do about that? Hmmn.
--In the meantime, you can be sure that there will be more corporate dirty laundry aired in the coming months. Unwinding that bank leverage may involve more selling of assets, perhaps to the government at an artificially high price (or to sovereign wealth funds and private equity if market prices prevail). The credit crisis, though improved, is not entirely over. More bad debts from mortgages loom on the horizon. And Europe faces trouble from emerging market debt.
--But for now, the social mood seems to have lightened. How long will it last? We'll ask our green devil if he shows up again. We'll see if we can get him to tell us what he's buying, between drinks of champagne.
And now over to Bill Bonner in Buenos Aires, Argentina:
The masks are coming off. It's the end of the party, now we get to see what people really look like.
And it's not a pretty sight.
You'll recall that one of the fairest of the Bubble Era's revelers was the idea that, over the long run, you would make money in stocks. All you had to do was 'buy and hold.' Who didn't like her? She seemed so easy...so willing...so fetching and attractive.
Yesterday, the Dow lost another 203 points. Investors are down 44% so far this year. Worldwide, they've lost $10 trillion this month - far worse than the crash of '29.
The most successful economy of the 20th century was the United States of America. The second was probably Japan. It rose from the bombed-out ruins of WWII to become a worldwide export powerhouse, dominating the auto and electronic equipment industries.
But yesterday, stock prices in Japan fell to more than a quarter-century low. Investors in Japanese stocks - including your editor (who is better at giving advice than taking it) - have made nothing in 26 years.
Here's the press report:
"Tokyo's Nikkei 225 index closed down 6.4 percent to 7,162.90 - the lowest since October 1982 - with exporters like Toyota Motor Corp. and Sony Corp hit hard. The losses came despite a report that the government was considering massive capital injection into struggling banks in a bid to calm jittery financial markets."
"Decades of pain and still no relief," adds the Financial Times, noting that investors in Japan have been waiting for a recovery for the last 18 years.
With the mask off, stocks in Japan are giving investors a Halloween fright.
But what other masks are coming off?
How about the sweet mask worn by housing? 'Housing always goes up.' And, 'you can't lose money in property.' Remember those beauties? Those masks hit the floor a year ago. Since then, the whole world has looked at the property market and gasped in horror. How could houses be so ugly, homeowners have wondered; they look like they just woke up.
Oh and there's oil...down to $63 yesterday. Oil was supposed to go up forever. At least, that was one of the favorite masks of the late Bubble Era.
But there are still a few Bubble Era masks that have not yet come off. In fact, the belle of the ball is the mask on 'progress.' People still believe that the world grows and improves - if not steadily, at least episodically. It's certainly true that long periods of history show what appears to be economic progress. Things get better. But occasionally, something terrible happens - plagues, wars, revolutions, Great Depressions and Dark Ages. Then, the world turns backward. The bull market in progress turns into a bear market of progress turns into a bear market of backsliding.
Today, people are losing faith in stocks and housing...but they still have faith in progress. Just a few months ago, they thought capitalism would make them rich. But wicked capitalism has disappointed them badly; it didn't guarantee rising asset prices after all. So, now they turn their sad eyes to the feds. 'Oh ye all-knowing, all-seeing, all-powerful ones...hear us. Save us - from capitalism!
They figure the feds will do the trick... And sure enough, all over the world the federales are playing along. The G7, the IMF, the central banks, the finance ministers and Treasury Secretaries - all have put on their own masks...strutting around, pretending to know what they are talking about. Curiously, France's president Nicholas Sarkozy is a leading strutter. He's trying to organize a New World Financial Order...based on something other than the dollar.
These poseurs don't look too bad - as long as they leave the masks on. Take them off, of course, and you will see the same silly clowns who CAUSED the crisis in the first place.
That is what is so amusing about this stage in the collapse of Western Civilization. You see, most of the world's financial press has come around; they see things much the way we do. They see, for example, that the U.S. Fed erred - big time - by fixing the price of credit too low for far too long.
Of course, there's nothing in the Manual of Capitalism that allows the feds to fix the price of credit or support the housing market. This was the government at work, not the market. With the misleading signal coming from the credit markets, the capitalists just did what they always do - they overdid it.
Still, the world's press, pundits and politicians have convinced themselves that the fault lies not in themselves...but in capitalism. And now, they expect the feds to do something about it.
But that's just the way it works...one hallucination gives way to another. One delusion on the way up; another on the way down.
*** Even star mutual fund managers are getting walloped by this market. Chris Mayer offers us a few examples:
"Managers with great track records are faring poorly, and it may help you feel better about how you are doing. Jean-Marie Eveillard, for example, has been running money for 50 years. He's beaten the market handily for a long time. He is a cautious type. He likes gold stocks. He likes Japan. He's down 27% this year. Robert Rodriguez, another cautious money manager who holds a lot of cash and runs FPA Capital, is down 29%. These are among the best of the best, as the market is down more than 40% this year. William Fries at Thornburg is down 43%. David Winters at Wintergreen is down 37%. Wally Weitz at Weitz Value is down 39%. The list goes on and on...
"So you see, nothing is really working well in this market right now - at least not for investors in stocks. However, there are a lot of cheap stocks out there, bargains I haven't seen in a long time. Unless the world comes to an end, which it has a habit of not doing, future investors will be a happy lot. Count me a cautious buyer of stocks."
Caution is the name of the game here...
And the bargain hunters were abound this morning, setting up a rally worldwide in the markets.
Also boosting the markets is the anticipation of the Fed's two-day meeting, that begins today. It is widely believed that the Fed will cut rates...but it remains to be seen what, if any, lasting effect it will have on the markets.
Lurking behind this rally is this unsurprising tidbit: consumer confidence in the United States hit an all-time low in October. The Conference Board reported that expectations have turned "significantly pessimistic with the percentage of consumers expecting business condition to worsen over the next 6 months rising to 36.6% from 21% and those expecting fewer jobs rising to 41.5% from 26.9%"
*** Perhaps the biggest delusion of the financial world now is that the dollar...and dollar-based Treasury obligations...are a safe refuge. In a sense, of course, they are. The U.S. government is in no danger of defaulting on its loans. In an emergency, it can always just print up the money. But that's the problem. An emergency is coming. More on this when we get a chance to think about it...
*** "I'll be all right down here," said our old friend Doug Casey. Doug has bought a place in Cafayate, a town that reminds us of Santa Fe or Aspen, before they were ruined by rich people. He's building a world-class resort - complete with golf course, riding trails, tennis, health spa, library...everything he wants.
Cafayate also has several things going for it that Aspen and Santa Fe did not. First, it is prettier and the weather is better. It is always sunny, with pleasant temperatures. Wherever you look, you see beautiful mountains. What's more, it produces some of the world's best wine.
Doug's place is right in the middle of a vineyard. In fact, he's got it set up so that revenue from the vines pays much of the operating costs of running a golf course and so forth.
"Another big plus," says Doug, "is that this place isn't going to suffer too much from the credit crisis. Nobody down here had any credit."
*** Doug is not completely right about Argentina's credit situation. Believe it or not, there were lenders - mostly big banks - who were foolish enough to extend the nation credit. Naturally, the Argentine government treats these angels like taxi drivers in Buenos Aires treat other foreigners.
Almost every time we go to the airport, the taxi driver tries to pull a fast one. "My meter is broken," said one, "the standard fare is 200 pesos." (It is really about 70 pesos.) "We crossed into another zone," said another, "so I have to add another 50 pesos." "It's night time," came another invention, "after dark you have to pay a surcharge."
It's all good fun. The taxi drivers are merely establishing the going rate. The price for a run to the airport is much higher for naive foreigners, but why shouldn't it be?
So is the price for lending to the Argentine government.
This from MoneyWeek:
"In December 2001 [Argentina] reneged on its $95bn of sovereign debt.
"At the time, that was the biggest default in world history, though these days such a number looks like chicken feed compared with what the world's bankers have recently managed to mislay. Only in 2005 did Argentina sort the final details, with a 'take-it-or-leave-it' 70% 'haircut' on face value, again the largest sovereign debt markdown ever.
"Three years later, it's back to square one. Inflation is rocketing (some estimates put it at 20% annualized) and the government is once again running out of cash. Argentina's borrowing needs will swell to as much as $14bn next year from $7bn in 2008, says RBC Capital Markets. And any confidence that the country will be able to repay what it owes is fast flying out of the window.
"Argentina's 8.28% government bonds are due to be redeemed in 2033. Fat chance of that, the way things are looking right now. Now priced at 22 cents on the dollar, they currently yield 31%, as against 'just' 12% a month ago. And still no one wants them.
"What's more, the price of credit default swaps - market insurance that investors can buy to protect themselves against default (Read: All you need to know about credit default swaps for more) - covering the country's sovereign debt has more than quadrupled over the past month. These CDS now stand at more than three times the Icelandic level, and suggest there's almost a 2:1 chance that Argentina will go bust this year."
Does this worry your editor - who has substantial (for him) investments in Argentina? Not at all. As a dear reader pointed out, the average Buenos Aires taxi driver knows more about financial crises than Bernanke, Paulson and Greenspan put together. The Argentines know how to get through a crisis, in other words, and still put steak on the table and wine in their glasses.
We're going to learn from them.
*** Finally, another dear reader sends a news item explaining why there was a bagpiper in front of our neighborhood church last Sunday.
It was the "kirking of the tartans," said the headline. Turns out, the local Scottish Argentine society does this every year...a kind of blessing of the clans, performed by the local priest. "Kirk" in Scottish means church.
[Editor's Note: Bill Bonner & Lila Rajiva's new book, Mobs, Messiahs and Markets, is now available in Australia from The Educated Investor. Order here for a 15% discount.]