The Contrarian's View is published 11 times per year on a mostly-irregular schedule, and the views expressed are those of the author and editor, Nick Chase. Because nobody can predict the future, results of past suggestions or recommendations are no guarantee of future results. Material in this publication may be freely quoted provided proper attribution is given to its source. Subscription rate: Free on the Internet through the World-Wide Web service at Assumption College. Using your favorite Web-browsing program, Open URL http://nick.assumption.edu. Mailed paper subscriptions, one year for $39 to The Contrarian's View, 132 Moreland Street, Worcester, Massachusetts 01609. There is a limit of 50 paid subscribers at one time; please check for availability before sending any money. Sorry, Visa and Mastercard are not available. Overseas subscription rate, U.S. $54. Unsolicited material sent to us by UPS or by courier other than the postal service is refused and returned to sender! Phone: (508) 757-2881
The first incident was in suburban St. Louis. Five male teenage inner-city thugs, fully armed with semiautomatic guns and a Molotov cocktail, and probably high on something, commandeered (that is, stole) a station wagon and drove it down a quiet side street, firing willy-nilly into the big plate-glass picture windows which faced toward the street. In most houses, where people rather quickly figured they were under some sort of attack, the lights were doused; in a few houses, the residents just headed for cover, and screw the lights. But in one house an 83-year-old woman, probably a little hard of hearing, went to her front door and opened it to see what was going on. A well-aimed pistol shot from one of the thugs quickly dispatched her. One of the houses on the street was dark because the people were away, which the thugs soon realized. They lit and tossed the Molotov cocktail through the remains of its plate glass window; shortly the entire house was in flames.
Though the thugs sped away nonchalantly after their spree of vandalism and murder, they were not unobserved. Two of the residents on the street (after darkening their lights) had unobtrusively videotaped almost all of the escapade on their camcorders, and the event was broadcast on the late-night news on TV stations nationwide.
Most frustrating for the residents was the attitude of the police, who indicated they couldn't do as much as they could for a housebreak (except for the murder of the 83-year-old woman). In a housebreak, the crooks are gone but they frequently leave fingerprints or other clues to their identity, and they can be tracked down when they fence the stolen goods. But in this case, there was no forced entry; nothing was stolen to be later traced (except the car, which would undoubtedly be found abandoned), there were no clues left in this act of terrorism.
The helplessness of the neighborhood, on display across the country, suddenly made "house-shootings" a very popular activity among the young, angry, hungry and bored males from the inner cities. In a week's time, nearly every city in the country had suffered at least one such terrorist attack, with major metropolitan areas such as Miami and Los Angeles having two or three dozen a night. Sometimes the vandals would sack and set fire to a house where obviously nobody was home, but for the most part the attacks were just acts of terror.
Local police forces were just overwhelmed. They plainly could not possibly patrol all of the neighborhoods, even though almost all of the police were put on 12-hour days. Nighttime curfews were imposed in the cities, enforced by the National Guard and pretty much killing off any after-hours activity, but to no avail in stemming the terrorist tide.
The homeowners in the besieged areas found that their insurance policies did not cover damage from "civil insurrection" or "acts of war". Small windows could have their panes of glass repaired inexpensively, but plate-glass picture windows, that was another matter. They could cost several hundred dollars to replace, and why bother if police protection was nonexistent? The vandals would only return and shoot them out again. So large windows adopted a plywood decor; some people defensively sheathed all of their street-facing windows in plywood, on the theory that vandals would not bother to shoot out plywood.
The shock of the country's vulnerability to domestic terrorism, and the constricting of economic activity due to the nighttime curfews, Guard roadblocks and lost work hours of people whose homes were (or could have been) under attack, had done a job on the stock market. At the end of the month, the Dow was at 1484 and still headed south.
August 1998
"A well-regulated militia, being necessary to the security of a free state, the right of the people to keep and bear arms, shall not be infringed." - U.S. Constitution, Amendment II, 1789When the nation's founders framed the Bill of Rights, in Article II they undoubtedly had in mind protecting the means for citizens to resist foreign invasion and oppression, or possibly to rise up against a tyrannical state. It's unlikely they envisioned a situation where people would have to organize for their own safety because the government of the people was unable to offer that protection; but this is what happened for the remainder of the summer of 1998.
In the suburban neighborhoods, the terrorism had triggered abandonment and attracted squatters. Some people who had seen their equity in their over mortgaged homes vanish in the asset deflation, and who now felt their lives were threatened, simply packed up and moved away to a cheaper rental in a safer place, leaving a mess for the bank (or whoever owned the mortgage) to straighten out. But somehow, word would quickly spread to the people you'd rather not have living in your neighborhood that a house was available, and a few days later a group of them would move in, sometimes a family but more frequently an unrelated collection of drug users or prostitutes.
The first line of defense people adopted was that an abandoned house would "mysteriously" catch fire shortly after its abandonment, and people would "neglect" to call the fire department until the house was a total loss to the fire. But this didn't do much to improve the looks of the neighborhood, so stronger measures were needed.
And they came, all during the month of August, as people realized that the various well-meaning gun-control regulations had left them defenseless in the face of terror, while the crooks seemed to have no problem getting the guns they wanted at any time. In most states it is the gun owner, not the gun, that is licensed, so applications poured into local police departments en masse for permits to carry and use "hunting" rifles (for the most part) or handguns. In the cities, where the bureaucratic police departments were unwilling to admit the situation was out of control, it could take months for an application to be processed; but in the towns, where crime had been very low before the reign of terror and where the police chiefs knew they were hopelessly overwhelmed, the permits needed would be granted right away to anybody the police knew was a responsible person, without the required waiting period or background check.
Some newly-licensed people bought guns at stores, typically sporting-goods stores; but a recession was underway, after all, so by far the cheapest and most popular way for people to arm themselves was at the weekend flea markets, where guns both new and used, and plenty of ammo, could be bought anony mously. This also was the means by which relatives and friends of the city and suburban dwellers who lived in the towns or countryside could get arms into the besieged areas. Now, BATF agents normally check out these flea markets for illegal buying and selling of guns, but they were nowhere in evidence this month. Either they had their hands full elsewhere, like dealing with the riots, or it was a policy of benign neglect.... one could not be sure which, but their absence was definitely taken advantage of.
By mid-month, neighborhood groups were striking back at the vandals. One person, often a Vietnam or Gulf War vet with combat experience, typically was put in charge to train these homegrown militias and to coordinate them in the event of attack. (If the neighborhood had no vets, one could be "borrowed" from another area, or sometimes from a vets' homeless shelter.) To repel an attack required an armed person (preferably with rifle and long-distance sight) in nearly every house, cellular phone communication between the houses and with other groups in nearby neighborhoods, and one person with a camcorder to record the event for showing on the late-night TV news.
The video of one very successful defense in the Detroit area was broadcast nationally. It opened by showing four young males approaching the neighborhood (a dead-end side street off a busy thoroughfare) in a light-colored pickup truck with no lights. The vandals first shot out all of the street lights within firing range to darken the area; then they drove down the side street to the second house on the left, which had a single light on in the living room, making it appear that nobody was home. Apparently the thugs were in a sacking mood, as after they had shot out the big window, three of them got out of the truck and scrambled toward the house to gain entry.
On a prearranged signal by cell phone, suddenly, the people in every house in the neighborhood flicked on their floodlights (driveway and yard lights), bathing the thugs in light and making them sitting ducks. In the next instant a hail of bullets cut them down; they crumpled to the ground. The driver of the truck, apparently dazed by what was going on, climbed out with a Molotov cocktail in hand, and lit it; but before he could throw it, he too was felled by a shot. The Molotov cocktail fell to the ground, broke, and erupted in a sheet of flame, engulfing both driver and truck.
Then two hefty, darkly-dressed figures emerged from the shadows and, one by one, carried the three remaining (dead) thugs to the truck, which had become a funeral pyre, and tossed them into the back. The figures beat a hasty retreat just before the flames reached the truck's gas tank, triggering a fierce secondary explosion and fire.
With the nightly showing of videos, like this one, of successful armed resistance to the house-shootings, and with the onset of cooler weather in the northern states, they began to die out, and by the end of the month there were only occasional attacks, mostly on isolated houses. However, the burden of keeping neighborhoods under constant surveillance took its toll on the economy in lost time at work, and the tourism industry nearly died, as people were afraid to leave home and instead devoted their vacation time to militia duty.
(To be continued next issue.)
I doubt that the government could do another "New Deal" today without turning the country into a police state. Roosevelt had the advantage that the Federal government was in pretty good financial condition while businesses and individuals were not, so he could confiscate gold and devalue the dollar, then try to money-print his way out on the government's good faith and credit. Today, the government is the biggest bankrupt of them all; a more likely outcome of a credit collapse, I think, would be something similar to contemporary Russia, where the underground economy becomes the economy (with a heavy criminal element) and people increasingly regard the government as irrelevant and impotent, unless they make a politically unwise move and are persecuted as a result.
I am privileged to accept the Union League of Philadelphia's Abraham Lincoln award. This is the first time I have been at the Union League in nearly four decades, but I am gratified to learn that your organization remains as vital and active as it was in the 1950s when I visited friends here with some frequency.
Today I would like to address an issue that almost certainly will be at the forefront of American concerns over the next decade: our largest federal entitlement program, social security.
It is becoming conventional wisdom that the social security system, as currently constructed, will not be fully viable after the so-called baby boom generation starts to retire in about fifteen years. The most recent report by the social security trustees projected that the trust funds of the system will grow over approximately the next fifteen years. However, beginning in the year 2012, the annual expected costs of social security are projected to exceed annual earmarked tax receipts, and the consequent deficits are projected to deplete the trust funds by the year 2029.
While such evaluations are based on an uncertain future, the benefit per current retiree under existing law, adjusted for inflation, can be forecast with some precision over the next thirty years. Somewhat less precision is possible for future retirees. The price escalation of benefits, of course, is even more difficult to pin down. But since price inflation has an equal effect on wages subject to social security taxation, for all practical purposes, the degree of inflation does not have a large direct effect on the net funding of the system over the long run. However, the rate of inflation, because it affects the overall economy, presumably does affect the real wage base from which social security taxes and future benefits are derived.
The projection of inflation-adjusted taxes, which are subject to a wider degree of uncertainty than total benefits, is largely driven by real wage growth -- that is, wage growth adjusted for inflation -- which, in turn, is primarily determined by the growth of productivity. Projecting productivity in line with the pattern of the last quarter century suggests a trend of revenue falling far short of the levels required to finance the benefits of the large baby-boomer bulge in retirees anticipated to start at about 2010. I should state, parenthetically, that if recent productivity trends are underestimated, as I suspect they are, for much the same reasons are the projected trends of both real benefits and payroll taxes. The real future funding shortfall, therefore, would not be materially affected. Our social security problem is, thus, not merely statistical; it is the consequence of a projected shortfall in real resources dedicated to social security. In money terms, the current social security trust fund of a half trillion dollars falls far short of the levels required to fund the current obligations to pay promised benefits to those already retired and those who will retire in the years ahead.
Social security, unlike fully funded private retirement programs, is largely an intergenerational transfer. Today's workers are essentially paying for today's retirees. Under the current system, the social security benefits paid to today's workers when they retire in the future will be primarily dependent upon the payroll taxes acquired from future workers. Accordingly, if the social security system is to survive in its current form, either real benefits must be curtailed, or real taxes increased. The latter can come from either higher tax rates or higher real wage growth -- in effect, higher productivity growth. However, as I will be explaining shortly, higher productivity is unlikely alone to do the trick. Moreover, increased social security tax rates, of course, are controversial in that many perceive them, myself included, to adversely affect employment.
A primary cause of social security's funding imbalance stems from the fact that, until very recently, the payments into the social security trust accounts by the average employee, plus employer contributions and interest earned, were inadequate, at retirement, to fund the total of retirement benefits. This has started to change. Under the most recent revisions to the law, and presumably conservative economic and demographic assumptions, today's younger workers will be paying social security taxes over their working years that appear sufficient to fund their benefits during retirement. However, the huge unfunded liability for current retirees, as well as for much of the work force closer to retirement, leaves the system, as a whole, badly underfunded.
As longevity improved far beyond that contemplated by the creators of the system, and productivity growth slowed after 1973, the original premise of the system of intergenerational balance began to fail. Today the official unfunded liability for the Old Age, Survivors, and Disability funds, which takes into account expected future tax payments and benefits out to the year 2070, has reached a staggering $3 trillion.
The social security trustees currently project taxes and benefits, under existing, and of necessity, quite tentative economic assumptions, that imply that fully funding social security for the next seventy-five years would require an immediate and permanent increase in social security taxes of about 2.2 percentage points of taxable payrolls on top of the current 12.4 percent tax rate, assuming that such an increase would not impede economic growth. Of course, benefit reductions of a similar magnitude, or a mix of tax hikes and benefit cuts, could also bring the system back into long-term actuarial balance, at least statistically. These types of program adjustments, which on the surface seem quite modest, might nonetheless be perceived as transforming what has until recently been a largely popular, subsidized, intergenerational transfer system into something quite contentious. Moreover, the longer action is deferred, the greater will be the necessary tax increases or, more likely, benefit adjustments required to achieve the goal of long-term actuarial balance.
Clearly, something has to give. The question is, what? We cannot hope to grow our way out of the problem. An immediate and sustained increase in annual productivity growth of about 2 percentage points apparently would be needed to close the long-run funding gap without an increase in taxes or a cut in benefits. The improvement in productivity growth must be this large because higher productivity raises future benefits as well as current and future tax receipts. However, given that we struggle to devise economic policies that might raise productivity growth by a few tenths of a percentage point per annum, a gain of 2 full points seems beyond the reach of credibility.
Nonetheless, this issue does underscore the critical elements in the forthcoming debate, since it focuses on the core of any retirement system, private or public. Simply put, unless social security taxes increase, or as I just indicated, more likely, benefits are adjusted, domestic savings must increase. Potential beneficiaries must further abstain from consuming all of their incomes. Enough must be set aside over a lifetime of work to fund the excess of consumption over any non-social security income a retiree may still enjoy. At the simplest level, one could envision households saving by actually storing goods purchased during their working years for consumption during retirement. Even better, the resources that would have otherwise gone into the stored goods could be diverted to the production of new capital assets, which would, cumulatively, over a working lifetime, produce an even greater quantity of retirement goods and services. In short, we would be getting more output per worker, our traditional measure of productivity, and a factor that is central in all calculations of long-term social security trust fund financing.
Hence, the bottom line in all retirement programs is physical resource availability. The finance of any system is merely to facilitate the underlying system of allocating real resources that fund retirement consumption of goods and services.
The basic premise of our current largely pay-as-you-go social security system is that future productivity growth will be adequate to supply promised retirement benefits for current workers. At existing rates of saving and investment this is becoming increasingly dubious. Accordingly, there are a number of initiatives, at a minimum, that will surely have to be addressed. As I argued at length in the Social Security Commission deliberations of 1983, with only marginal effect, some delaying of the age of eligibility for retirement benefits will become increasingly pressing. For example, adjusting the full-benefits retirement age to keep pace with increases in life expectancy would keep the ratio of retirement years to expected lifespan approximately constant and would help to significantly narrow the funding gap. Hopefully, other modifications to social security benefits also will be judged as necessary. Moreover, it is becoming increasingly recognized that the Consumer Price Index overstates increases in the cost of living, and thus indexing social security benefits to the CPI goes far beyond the intent of the Congress to insulate retirees from inflation. In that regard, the recently released report from the Boskin commission makes a valuable contribution to the emerging consensus on this issue.
But, unless future taxes and/or benefits are sufficiently adjusted, there is no substitute for increased domestic savings and investment currently. To be sure, for relatively short periods of time we can finance part of domestic investment in plant and equipment with foreign savings as we are doing today. History, however, tells us that there is a limit to how far that can go. We are also apparently increasing the productivity of our capital. It is possible that the maturing of emerging technologies, and further substantial deregulation of industry and finance, will, in themselves, improve the growth rate of productivity without large capital investment and savings. But, it would take implausible improvements in capital productivity from current rates to close very much of the social security funding gap from this source.
The necessary boost in domestic savings need not be derived from an improved social security system, but certainly a reduction in the social security funding gap would itself move in that direction. In a sense, it could create a virtuous cycle with higher savings engendering higher productivity growth which, in turn, would narrow the funding gap still further. Of course, additional saving can be achieved through a reduction in the overall federal government budget deficit, and intensified efforts to encourage private household and business savings.
Some have argued for a provision in law to require the social security trust funds to invest in higher-yielding private securities, especially equities, rather than in U.S. Treasuries only. A higher rate of return, it is alleged, would help solve the social security funding problem. That may in fact be the case, but if so, what would happen to private retirement programs?
If social security trust funds are shifted in part, or in whole, from U.S. Treasury securities to private debt and equity instruments, holders of those securities in the private sector must be induced to exchange them, net, for U.S. Treasuries. If, for example, social security funds were invested wholly in equities, presumably they would have to be purchased from the major holders of such equities. Private pension and insurance funds, among other holders of equities, presumably would have to swap equities for Treasuries. But, if the social security trust funds achieved a higher rate of return investing in equities than in lower yielding U.S. Treasuries, private sector incomes generated by their asset portfolios, including retirement funds, would fall by the same amount, potentially jeopardizing their financial condition. This zero-sum result occurs because of the assumption that no new productive saving and investment has been induced by this portfolio reallocation process.
Proceeding further, one must presume that in such a circumstance, in order to induce the private sector to exchange their equities for Treasuries, equity prices must rise and bond prices fall. But, this would create great market tension. Bonds and equities are merely the paper claims to income earning assets, and the value of the income stream is not determined by short-run changes in the supply and demand for securities. Rather, equity prices must, in the long run, reflect the underlying earnings of the corporations on which the equities are a claim, as well as society's need to be compensated for postponing consumption into the future and its perception and attitudes toward risk as a consequence of uncertainty about the future. Indeed, the total market value of debt plus equities, is, to a first approximation, likely to be unaffected by a shift in the balance of paper claims.
One might expect that this tension between the altered relative supply of equity and debt claims, on the one hand, and unaltered overall economic value of the nation's companies, on the other hand, would be resolved by an increase in the issuance of equity securities relative to bonds. This could reverse much, if not all, of the price shift in favor of equities. However, to complicate the issue still further, it is not clear as to whether, and to what extent, bond prices would rise as corporations cut back on debt issuance. Certainly with the social security trust funds no longer investing all of their surplus in U.S. Treasuries, the federal debt held by the public would rise, presumably placing downward pressure on bond prices. At best, the results of this restricted form of privatization are ambiguous.
Thus, the dilemma for the social security trust funds is that a shift to equity investments without an increase in domestic savings may not appreciably increase the rate of return of social security trust fund assets, and to whatever extent that it does, would likely be mirrored by a comparable decline in the incomes of private pension and retirement funds.
I should stress that this does not mean that at least a partial privatization of our social security system does not provide a potentially viable solution to current funding problems. There are a number of thoughtful initiatives that, through the process of privatization, could increase domestic saving rates. These are clearly worthy of intensive evaluation. Perhaps the strongest argument for privatization is that replacing the current unfunded system, which apparently discourages saving, with a fully funded system, is that such a change could boost domestic saving. But, in any event, we must remember it is because privatization plans might increase savings that makes them potentially viable, not their particular form of financing.
The types of changes that will be required to restore fiscal balance to our social security accounts, in the broader scheme of things, are significant but manageable. More important, most entail changes that are less unsettling if they are put into effect in the near term rather than waiting five or ten years or longer.
Minimizing the potential disruptions associated with the inevitable changes to social security is made all the more essential because of the pressing financial problems in the Medicare system, social security's companion program for retirees. Medicare currently is in an even more precarious position than social security. The financing of Medicare faces some of the same problems associated with demographics and productivity as social security but faces different, and currently greater, pressures owing to the behavior of medical costs and utilization rates. Reform of the Medicare system will require more immediate and potentially more dramatic changes than those necessary to reform social security.
We owe it to those who will retire after the turn of the century to be given sufficient advance notice to make what alterations in retirement planning may be required. The longer we wait to make what are surely inevitable adjustments, the more difficult they will become. If we procrastinate too long, the adjustments could be truly wrenching. Our citizens deserve better.
The stocks that contribute the lion's share to the S&P 500 are very popular these days because index funds that mimic the S&P 500 are very popular. Does any one remember that just a couple of years ago, the Fidelity Magellan fund was the most popular among investors? Well now, the most popular fund (at least the one that has been eating Fidelity's lunch recently) is the Vanguard Index 500 fund. A recent article in the San Jose Mercury News had some interesting tidbits:
Some novices have apparently mistaken the certainty that an index fund will match the market average for an assurance that it is an almost risk-free investment. In doing so, they have confused the diversification of their assets across a large number of stocks with the safer approach of spreading money among stocks, bonds and cash.The last paragraph is particularly interesting because it implies that collectively, 95% of the stocks in the S&P 500 have been in a bear market since 1993. Nick Chase (author of The Contrarian's View) pointed this situation out at least two years ago. It also creates a vicious (or virtuous, if you happen to own the right stocks) circle that sucks money away from the smaller stocks and pours it into the bigger cap stocks that have the greatest impact on the S&P 500. This type of investor behavior goes a long way in explaining why many of the big cap stocks are trading far above their historical valuations. It would also explain why the NASDAQ advance/decline line has been in a downtrend for the past few years as well.Over the last decade, the amount of mutual fund money invested in the most widely held stock index funds has risen more than a hundredfold, to $65 billion--a growth rate 18 times that of the rapidly expanding fund industry overall. And much of that money found its way to index funds in just the last two years.
Last year, just the 25 largest stocks in the S&P 500, which account for one-third of the value of the index, rose 37 percent, accounting for more than the entire gain of 23 percent in the index. Over all, the other 475 stocks collectively dragged the index down. The same situation occurred in 1995 and 1994...And the S&P 500 itself represents only a fraction of the more than 9,000 regularly traded stocks.
What Fidelity needs to get back into the game against Vanguard is a fund that takes only the top 25 stocks in the S&P 500 and throws the others in a dung heap. Just imagine, the returns would be even greater than the S&P 500, and the lucky manager of the fund would be the envy of all of his peers who waste time trying to carefully select reasonably valued stocks.
The Big One - A recent article that made its way through the press yesterday [February 3] indicated that 54 percent of U.S. voters own mutual funds and 61 percent of them say that they would not sell if the US stock market took a dramatic drop. The poll of 1,008 registered voters found participation in the stock market widely spread among income, ethnic and demographic groups.
Asked what they would do if the market dropped dramatically, only four percent said they would sell their investments and get out of the market immediately, while 61 percent said they would retain their holdings as a long-term investment, 18 percent said they would keep some and sell some and 17 percent said they did not know what they would do.
I guess another question that could have been asked is if the respondents have actually experienced a dramatic drop in the stock market. With 80% of the money in mutual funds entering the market since 1990 (the last time anything close to a bear market occurred) I would bet that the answer for most would be no. Given this, it is very difficult to conclude what investors will do when actually faced with a scary sell-off.
I've lived in California all of my life and I have experienced numerous earthquakes (the first I remember was the San Fernando Valley quake of 1971). When the occasional large earthquake hits, native Californians typically shake it off while others who have never experienced such a thing sometimes panic. They would have known about earthquakes and that they occur from time to time, but when suddenly faced with (and I mean suddenly) everything rocking and rolling, panic and irrational fear sometimes take over common sense. If you would have asked these people before the quake if they would have panicked, many would have probably said no.
Many minor tremors that have hit the markets in the past few years have resulted in temporary outflows of funds by investors. Investors only jumped back in after it was obvious that the market has recovered and it was still a bit of time before they got really brave once again. Most investors have never really been tested by a dramatic drop in the markets or a prolonged bear market like the one that occurred between 1966 and 1982. However, it is my opinion that investors will finally get a chance to prove their mettle in the months ahead. So far, other than polls, I have seen no evidence that would lead me to believe that investors would remain calm in the event of a financial earthquake. Ironically, it will be the popular media outlets that will inspire investors to panic as they sensationalize every 100-point drop in the Dow.
...the Dow is now "allowed" to fall 350 points before the market is shut down for half an hour. After that, the Dow is allowed to fall an additional 200 points before the market is shut down for a full hour. When news that the Dow has "crashed" and is down 550 points with the market shut down, it is difficult to imagine a scenario other than outright panic.
The Bull versus the Fed - Minutes from the December FOMC meeting show that the Federal Reserve policy makers were unusually concerned about stock prices about two weeks after Greenspan uttered his now-famous "irrational exuberance" comments. The minutes stated that the decision to keep interest rates steady had been made more difficult by the long boom in stock prices to levels they called "extraordinary." The minutes further stated:
The behavior of the stock market injected an additional note of uncertainty into the forecast for consumer spending and the economy more generally. The rise over recent years had been extraordinary and had brought market valuations to fairly high levels relative to earnings and dividends.It would appear as if the Fed has finally admitted that it has noticed the runaway financial mania that it created. The fact that the Fed is now openly questioning the stock market's rise is a shot across the bow to the Bulls. Coupling this with the fact that the Fed continues to have a bias towards tightening is more evidence that the Bull will not only have to fight the Bear, but the Fed as well....members recognized the need to monitor with special care price movements in the stock market and asset markets more generally for their implications for consumer and other spending.
- Marc Sexton (Fiend SuperBear)
Live as you invest - There are two ways people organize their lives. One way is to live life for maximum gain. The other way is to live life for minimum loss.
Let me give you a sense of what I mean.
Most people in the U.S. are happily living their lives designed for maximum gain. They do not own their homes, they own typically less than 40%. The rest is mortgaged. They don't own their cars - only about 40%. They don't in fact own much at all: they have used the debt system to buy things with a promise to pay for them in the future.
By the way, this has extended itself into the investment world. It is not uncommon for people to take out a cash advance to "get started" in the stock market. You take a cash advance, put it into the market, and almost overnight (at least lately) you make enough money to pay back the card and put a few dollars in the bank.
When the Fed even talks about raising rates, this group of folks runs out and rings up still more debt because we learned in the 70s and 80s that we can pay things off with "cheaper money".
But the day of reckoning is indeed at hand. Not only has the stock bubble reached dangerous levels, but there's the underlying precipitous drop in real estate prices about to come at us.
The reason real estate will plunge is demographics: most people are now approaching the time in life when the kids are leaving home and the need for 2500 square feet and a three-car garage will all but disappear. As the baby boom generation comes to terms with the need for a smaller home, pressure on the stock market will cause more people to think about downsizing their living quarters. That will put more homes on the market and as everyone knows, when supply goes up, price goes down....
I observe that we are not only living in a greedy society, but an irrational one. Proof: We have literally thousands of mini-storage facilities in every city in America.
Think about the implications of this: Consumers are so busy with their consumer lifestyle that they are actually paying additional rent to store things they are not able to consume right now!
If you couple this fact with the world's growing capacity to produce, you see how the equation works - let's use televisions as an example.
The average home as 2 or 3 color televisions. No more are needed. There are 1-2 old color televisions in a storage unit. There's a huge supply of televisions at the electronics store in town. There are new television production facilities being built.
Now with all this supply, what do you expect the price of television stocks to do as clearly there's way too much supply? The scenario repeats with cars, where people drive one and park two, and with an increasing number of big-ticket consumer items.
If you want an eye opener, go to a storage unit at one of the mini-storage places and see what people have too much of. It's amazing....
What's about to happen to the world is pretty shocking: The baby boomers are about the divest from big-square-footage real estate. The productive engines of manufacturing are about to back up because of excessive supply of most consumer goods. The growth industries which drove prosperity from 1940s-50s (autos) though the 60s-80s (airlines) are at saturation levels (with the possible exception of a few small commuter airlines which will reach route saturation by 2005)....
What it all boils down to is that to avoid personal financial and lifestyle disaster, it may be timely to look at constructing your own downsized lifestyle while you can still do so voluntarily.
- George Ure
[And I thought I was pessimistic! - /Nick]
[We] began with the assumption that what we needed most was a machine that worked. Whether it was rugged Individualism, Fascism, Communism, Socialism, or what-not, made not the slightest bit of difference.... ....only if it had to.... the Government of the United States, forgetting all about the Constitution.... [would] ....commandeer everything and everyone.... - National Recovery Program planner Prof. Berle, writing in The New York Times Magazine of October 29, 1933, as related in The Future Comes - A Study of the New Deal (1933), by Beard and Smith. Provided by an Internet reader.
Despite today's low inflation, cash is a catastrophe as an investment. ....whoever said "it takes money to make money" oversimplified the concept. It takes money to buy stocks, and stocks are what make money. In a sense, a stock plan and a retirement plan are synonymous. - Janet Vega
I don't see any kind of blowup event that's going to cause the market to crash. The market does need a bit of digestion time before it goes up sharply again, but the only real risk I see is that some kind of speculation froth re-emerges. - Neil Hokanson
While stock prices appear expensive to some, prices are justified by the likelihood of continued growth in corporate earnings. Inflation fears are muted, bond yields have fallen back from their midsummer highs, and there is less likelihood of recession. - Abby Joseph Cohen
Just to reassure myself that I am not a raving lunatic, I sat down, pulled out my trusty financial calculator, and did a little math. In the past two years, roughly $200 billion per year of "new" money (that is, from novice investors, probably saving for retirement) has poured into mutual funds. That's equivalent to 20 million people putting $10,000 per year into the stock market. Now, the number of people and the amount of cash they're throwing at stocks varies widely, but the math does not change appreciably when I make this "average" assumption. Further, I assumed that this average "boomer" had just turned 40, and expects to retire on his or her accumulated wealth at age 67.
The average boomer appears to have high hopes for mutual-fund investments.... no more than a 10% correction in a market that's propelled forever higher, and about a 14%-per-year (compounded) annual rate of return, roughly the same as that returned by the S&P 500 over the past ten years. My trusty calculator tells me that, in 2024 when the boomer retires, he or she will have accumulated an additional $2,718,892 in his or her (tax-deferred) mutual-fund portfolio. In total, the amount of paper profits accumulated by the boomers over the 27 years would be more than 54 trillion dollars.
Of course, the economy grows, too. I extrapolated the current rates.... 2-1/2% annual growth, 3% inflation, for a total of 5.5%. In 27 years, the annual GDP would be about $30 trillion, up from the present (approximately) $7.1 trillion. Thus, the accumulations of the boomers alone would be almost twice the nation's Gross Domestic Product in 2024!
Naturally, the boomers' accumulations would not increase in a vacuum; the rest of the stock market, now grossly overpriced at a value more than 90% of GDP, would keep pace. Using $6.3 trillion as the current stock-market value, in 2024 and excluding the boomers' additional contributions, these stocks would be worth $217 trillion. Adding in the boomers' wealth, the total value of the stock market would be $271 trillion, or nine times the GDP in the year 2027.
No way is this going to happen. My recollection is that the Japanese stock market's value was just shy of twice Japan's GDP at the peak in 1989, and I doubt that we will outdo the Japanese in overvaluation. As I've pointed out before, over the long term stocks have kept pace with the overall growth of the economy while spitting out a reasonable dividend yield. An economy growing at 3% per year (more than currently, but not unreasonable from a historical point of view), with 3% inflation and a 4% dividend yield, adds up to a return of 10% per year, which jibes with history.
What could change to satisfy the boomers' expectations? Well, dividends could suddenly be increased from 2% to 8% per year. Unlikely. Or, economic growth could suddenly pick up to 8-1/2% per year for the foreseeable future. Has never happened yet, likely never will. Or inflation could pick up to 9% per year.... which has happened, but this would not be the outcome the boomers hope for.
Then I did the math in reverse. In 2024, if the stock market is more reasonably valued at about 60% of GDP, the compound rate of return from the stock market's capital appreciation would be about 3-1/2%, well below the historical norm even if the economy should continue to creep along unmolested, and only 1/2% greater than the rate of inflation. T-bills at 5-1/2% would be as profitable, and much safer.
My calculator does not lie. It tells me that many investors are about to have their expectations adjusted to fit reality. A large number of boomers will suffer "regression to the mean" to the max.
All of you younger bullish investors who have been giving me a hard time about my bearishness: With a little good luck I may still be alive in 2024, and I fully expect to see all of you comfortably retired, or about to retire, on your almost-$3 million stock portfolios. If you don't make it, I will have won the argument.
Anecdotal evidence that the party is about to end continues to increase, as you can see from the following e-mail exchange I had with an obviously perceptive Internet reader:
I just got an unsolicited call from an unfamiliar brokerage firm in New York. Amazingly enough, they wanted me to buy stock. I told the salesman I no longer held any positions. He incredulously told me that this was crazy in the biggest bull market of all time, and that some analysts had been predicting the end since 1995 after which stocks had doubled (dramatic license). I told him I did not say that the bull market ended in 1995, and continued that I had closed out all our positions in the summer of 1996, and that I deemed the current ratio of risk to reward unacceptable, and that it is close to being all over.
He asked me, more aggressively now, if I analyze stocks. I replied that I did, naturally. He said, "You are no analyst. Stick to your job." He slammed the phone down. Of course he has no idea what my job is; moreover, he claimed to have called several months earlier, but that was untrue.
I inferred a couple of things. Firstly, he seemed to be both in terror of the end of the bull market, which could mean unemployment, as well as in denial. Secondly it was clear that he had no hesitation in behaving rudely and impertinently to me, a potential customer, suggesting that his firm has no difficulty picking up fresh suckers, and that I was dispensable. I have no doubt that this arrogance is reserved for the latter stages of a bull market.
I replied: Your story about the broker pest reminds me of a call I got at work in the early 1980s from a commodities broker peddling silver contracts. After he had extolled the "you can't lose" virtues of his offer, I think I said something like, "If it's such a great deal, why don't you put your own money into it?" The conversation went rapidly downhill from there. In this case, the call came well after the peak in silver; if past is prologue, after the meltdown people will still be pestered by cold calls from brokers urging them to "buy the dips" and "dollar cost average for the long term". Who knows, people may fall for it if they have any money left.
From the reader: ....a call I got from yet another persistent broker yesterday. (These unsolicited calls used to come at the rate of about one per month until recently, since when there are two or three a week). He was touting an IPO, and I told him I really wasn't interested right now. He said "That's what my wife said last night, but I flipped her over and..." Well, I won't give you the salacious particulars, which he began to divulge in crude detail.
Untypically, I had the presence of mind to respond adequately, and not think of a brilliant riposte twenty minutes later. I interrupted and said even were he able to guarantee me a profit of a million dollars on the trade I wouldn't sully my hands by dealing with him, and that he might as well hang up right now, because that was what I was about to do. Am I right to infer that this hooligan approach (his, not mine) only appears close to the end?
Short answer to the reader's question: Yes.
Longer answer: People see what they want to see of the evidence around them to support their point of view, and ignore the evidence that doesn't fit. When everybody is of the same opinion.... the herd is charging for the cliff.... the intolerance toward those who differ is intense, and one must conform or suffer (possibly by losing one's job).
I offer as evidence Elaine Garzarelli's experience. She turned bearish last July in that selloff. Last fall she had mailed out on her behalf a promotional piece touting her indicators, which had never failed to signal a bear market and get investors out shortly before or after the top. I got two of these pieces myself; I'm pretty sure I saved one to add to my "you should've kept your mouth shut" collection.
At any rate, after missing the 30%-plus rise in the Dow since last July, she recently turned bullish and went back and "tweaked" her indicators so they would have kept followers in the market if they'd had the benefit of the revised indicator last July. And people pay good money for this stuff?
My internet reader offered his own experiences on this subject: I subscribed to her [Garzarelli's] newsletter for a couple of issues, because I thought I might learn something. Not only was it of no educational value, it was dull and repetitive, so I got a refund several months ago.
However, I must have told them my phone number, which they had not discarded, because on January 23, around midday, I got a prerecorded message from them, stating that her indicators now suggested that it was "safe to enter" the market again. At the time the Dow was up about 40; perversely, it reversed and closed down about 95.
Robert Prechter was the golden boy of the 1980s but has fallen so much out of favor that few even bother to abuse him any longer. It looks as though Ms. G has donned the mantle of "investment jackass of the decade".
Re unsolicited mailings, I have an expander file for them. One of my favorites came from Hong Kong about twelve months ago, from a middle-aged lady, an expat American and retired math professor who was using astrology boldly to forecast unequivocally a gigantic crash within the next six months. I'm still waiting.
Another regular is the bearish Mr. Guarino, alleged by his publisher to be a genius of sorts. This appears last year to have taken the form of advising his subscribers to short the S&P 500 futures without a stop loss. They are now doubtless running all the way to the bank ...ruptcy court. A recent mailing from the same source offered his forecasts for T-Bonds for a measly $5000, with the proviso - get this - of a maximum of five thousand subscribers. As he dreams of twenty five million dollars of revenue, I suspect that he won't garner enough to buy a cup of coffee.
One of my favorite pastimes is picking up "prediction" books after their predictions have failed (for the most part) and they have hit the discount bins. Howard Ruff, Doug Casey, Tom Holt, Ravi Batra, Harry Figgie, Harry Browne.... they're all in my collection, which has grown quite large. Considering the dismal record of forecasters, plainly in print for all to see, it's amazing that people still try.
Any idiot can extrapolate present trends into the future; that's what's wrong with the current stock market, as people are implicitly extrapolating to Dow 99,000 in 2025. These people are bad analysts, not good analysts; there are always plenty of them at market peaks, whether silver in 1980 or stocks today. A good analyst will, at a minimum, recognize the cyclical nature of markets.... stemming from the ebb and flow of human emotion, "herd instinct" or whatever you want to call it.... and from there, compare with prior cycles to judge when extremes have been reached. This does not always pinpoint a peak, as my own experience demonstrates, but it does give you the perspective you need on how much risk you, personally, are willing to take to chase what could well turn out to be phantom profits.
As for indicators of market tops, once we are into the downside it will, with hindsight, be clear what worked and what didn't. Beforehand, I don't think that one can make a statement that such-and-such will work this time because it has always worked in the past. The stock market is a constantly-changing creature; and the accuracy of indicators waxes and wanes with these changes. In 1968, odd-lot short sales were a very good indicator for signalling the market top; today, they're useless. The peak reached in "letter stock" issuance was another good clue; today, courtesy the SEC, letter stock is no more.
Conversely, I suspect that after this market's peak a number of derivatives-related indicators will be seen to have accurately warned of the top, but nobody knows what they are now because they have no track record. Even when looking at extremes of valuation, which I consider the most reliable of indicators for keeping one out of bear markets, it's easy to be fooled. My own conservatism toward the 1995-97 blowoff was based on my never expecting in my lifetime to see a market mania greater than that of 1929, and in this I was clearly wrong.
People are expecting advisers to do the impossible - to chase the market's upward momentum to the very peak, then issue a "sell" signal before getting caught in the collapse. It can't be done. Advisers who try, like me, predicate their soothsaying on what's happened in the past. But when a mania takes hold.... and remember, this one makes 1929 look like a piker.... I think most of the traditional measures that people use to pick off market tops fail. Only when the peak is past can one make estimates of when the deluge will come, and even then, unfolding events may make a liar out of history.
The point is to be in stocks when they are cheap or fairly valued, and to be in something else when they are ridiculously overpriced and vulnerable to a crash. Statistically, there will always be a few people who get out at the exact top, but most will crash and burn in the deluge. By definition, it must be so.
In last month's issue I indicated that, using history as a guide, the stock market (as measured by the popular averages) would likely peak in March.... which I would now further refine to early-to-mid March.... with the meltdown arriving in May. Even the timing of the peak is tricky to judge (translation: I've been wrong before, and might be again), and these manic events give us no clue as to the level stocks will reach before they collapse. Dow 7300 (as in my tale of fiction)? 7800? 8200? Nobody knows.
I can tell you that I have seen and lived through this before, as the "Nifty Fifty" craze of 1972-73. Back then, the theory was that the large "growth" corporations had essentially a monopoly position in the economy, and one needed to make only one decision.... when to buy.... for one would never need to sell these wonder stocks. The "Nifty Fifty" soared to levels of extreme overvaluation comparable to today's large-cap holdings before the 1973-74 bear market blew them away. I can recall getting frustrated, watching the blue chips soar while the stocks in my own portfolio (I held various high-tech stocks at the time) barely budged. In fact, the broad market never had fully recovered from the 1970 bear before the collapse of the "Nifty Fifty" pulled it down again in that granddaddy-sized bear market.
Today's equivalent, the urge to index, is a consequence of retirement plans, derivatives and computerized trading, but the effect is the same.... too much money chasing after too few stocks. Consider: If you remove from the NASDAQ indexes those companies included in the S&P 500, the remaining NASDAQ and over-the-counter stocks have been in a bear market since May 1996. If you remove from the NYSE and AMEX indexes those stocks included in the S&P 500, the remaining stocks have been neutral at best. Even in the S&P 500, as Marc Sexton reminds us above, a few stocks are pulling most of the weight. Perhaps we should name this mania the "Alive 25". If you find, as I did in 1972, that your own portfolio is lagging the popular averages, then you should be in index funds, you fool! Join the lemmings!
The 1973-74 bear market reminded us that the bigger they are, the harder they fall. In a bear, one expects the little IPOs, launched with a hope and a prayer when the feeding frenzy is at its peak, to disappear altogether; but the shock was the depths to which the "Nifty Fifty" fell.... declines of 80%, 85% or more. I continue to estimate "fair value" for stocks.... where I think the stock market "should" be.... which is currently in the range Dow 3200-3300. To reach fair value, which generally marks the bottom of the mildest bear markets, the "Alive 25" would have to decline by 53%. For dividend yields to return to 3%, which is the level for most bull-market tops, the "Alive 25" would have to decline by 37% (to about Dow 4430). If the next bear market takes us to severe undervalue, with an infinite price-to-earnings ratio (because there are no earnings) for the Dow and with dividend yields pushing 6%, as in 1974 and 1982, then the "Alive 25" would have to decline by 69%, to about Dow 2200. Even the more-grossly-inflated Japanese Nikkei index declined by only 64% in their bear market (so far).
In the late 1960s, as the "gunslingers" were racking up tenuous profits with letter stock, and again in the early 1970s as the "Nifty Fifty" soared, foundation and pension managers were criticized for being "too conservative" with their investments, and for missing out on the superior long-term return that stocks offered. So the managers jumped in, only to get slaughtered by the bear. Today's equivalent would seem to be the push to privatize Social Security. It appears that nobody but Alan Greenspan has pointed out that this is a zero-sum game, unless the privatization stimulates net new saving. At or near major market tops, it seems there is always an enormous chunk of new money just over the horizon.... Social Security today, Japanese investors in 1987, institutional money in 1968, investment trusts in 1929.... which people believe will keep the good times rolling; but it fails to materialize.
Readers have reminded me that there is a strong demographic bias toward increased investment. I agree wholeheartedly; but there is no rule anywhere that all of that money had to go into stocks. It has gone into the stock market because of stocks' superior returns since 1982, and their flawless returns for the past five years, the period highlighted in mutual funds' sales literature. Had it been the real-estate market, or the bond market, or commodities or precious metals that had been the "hot" market for the past few years, the mania would have occurred there instead. Yet as it occurs, it is fed by the pimps and shills of the industry and of the press and TV (so I'm told, as I don't watch TV), who make money whether you win or lose, while only a few of us hardy souls dare point out the extreme folly of the enterprise.