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The Daily Reckoning Wednesday, January 20, 2010 Stocks rally while Citi admits creating accounting flaws worth millions, Japan's prospects after two lost decades and a barrage of bureaucracy, Plus, Bill Bonner on misguided market theorists and sex in Ireland... Joel Bowman, reporting from Taipei, Taiwan... It seems nothing can keep a bad market down. If this bounce goes much higher, we're going to have to review the laws of financial gravity. The Dow Jones Industrial Average rallied 115 points in yesterday's session, bucking Friday's loss of about the same amount. The S&P 500 and the NASDAQ were stronger still, ending the day up 1.25% and 1.4% respectively. "What was the good news catalyst for all this optimism?" readers wonder. Glad you asked... The surge in prices came as Citigroup Inc. - still "limping along" as The Wall Street Journal put it - posted a $7.6 billion net loss in the fourth quarter. "The bulk of the fourth-quarter net loss stemmed from accounting charges related to Citigroup's repayment of $20 billion of federal bailout funds late last year," the WSJ reported. "But excluding that hit, the results still were lackluster. Revenue of $5.4 billion was down about 4% compared with a year earlier." The beleaguered giant also 'fessed-up to a series of "accounting errors" involving the way it valued its debt. (Apparently someone forgot to tell Citi that loans are only worth something if they are repaid.) Such figure fiddling led the bank to report a $101 million profit in the third quarter of '09 when, actually, the company incurred a LOSS of $121 million. One hundred and forty two million seems like an awful lot of beans for a bean counter to misplace. But what's a few decimal places between friends? We're sure it was just an honest mistake. (Ahem... "cough"... "choke"...) One could be forgiven for assuming that such flagrantly erroneous accounting - at a bank, of all places! - might inspire at least a temporary bout of investor caution. Not so fast, Jack. Citi shares ended the day up 3.6%, buoyed by the rising tide of collective, myopic euphoria. Apparently uninterested by billions in bank losses, investors instead turned their attention the great state of Massachusetts, where the political circus sideshow was in full swing. We're happy to report that, in the state's race for senator, Republican Scott Brown took the seat previously held by that bloated "lion," (lower-case "L") Ted Kennedy. To be clear, we're not pro-Brown...or pro-Republicrat...or pro-anything related to the whole charade. As far as we're concerned, one thief is as bad as the other. That said, we're all for seeing politicians lock horns in battle. We like watching them gouge at one another's eyes, and we cheer extra loud for neck cranks, coat hangers and punches below the belt. Our hope is that, as long as they're beating each other up, they're less likely to meddle in the lives of honest, hardworking citizens. In many ways, most politicians are not unlike most household pets: they are entirely dependent on handouts and, if not properly vaccinated and spayed/neutered, they have a tendency to multiply like rabid mongrels. And, when all is said and done, it is we owners who are left to clean up the mess they leave all over the public's property. Pet owners are advised, therefore, to exercise control. Don't let your politicians get too long on the leash and never, under any circumstances, forget who is the master of whom. But we digress... Getting back to business, readers have written in requesting more information on Bill Bonner's Trade of the New Decade You will recall that Bill's trade for the last decade - buy gold, sell stocks - worked out fantastically well. This time around he's going long Japanese equities and short US Treasurys. Dan Amoss covered the short side of that trade in yesterday's issue. Today, Capital & Crisis editor, Chris Mayer, provides some insights on the long side of it. Details below... --- '09 Financial Darwin Awards Special Offer --- We're offering readers a chance to profit from companies that, through unbridled stupidity and an uncompromising dedication to fiscal inefficiency, have gone the way of the dinosaur! Get all the details here. --------------------------------------------------------------- The Daily Reckoning PRESENTS: After two lost decades and a generation of demoralizing, on-again, off-again recession, Japan is probably the last place most investors would look to park some cash. And that's just one reason to take a closer look. Chris Mayer does just that in today's guest essay. Please enjoy... Made in Japan: A New Bull Market By Chris Mayer Gaithersburg, Maryland Japan has now been through a 20-year bear market. Tokyo's Nikkei - think of it as Japan's Dow Jones Industrial Average - put in a new low last year. Even though it's rallied a bit since then, it's still down about 75% from its all-time high in 1989. That's a brutal bear market. After all that, there is still no shortage of bad news on Japan. There are plenty of problems, including a ballooning pile of government debt. Some think a debt crisis is inevitable. Yet even the most ferocious of bear markets eventually ends. So naturally, the question is: Is now - finally - the time to buy Japanese stocks? I've come across lots of interesting bits on Japan of late that got me thinking that answer is yes. There is James Montier's new book, Value Investing, which is really just a compilation of stuff he's written before. Nonetheless, there is enough entertaining and thoughtful research to make it worthwhile. In rereading some of these pieces, I came across Montier's piece on Ben Graham's net-nets. Graham was an important investment thinker in the history of our craft. He created the idea of a net-net, which is a company that sells for less than its net working capital - current assets minus current liabilities - alone. Meaning, you pay nothing for the company's fixed assets. It's a kind of bedrock of value, a figure so low and ridiculous that no one would sell a business for that price. Turns out these are often good investments. The problem with net-nets, though, is that they are a kind of financial snow leopard - often sought, seldom seen. But in a September 2008 piece, Montier set out to find today's net-nets. He found more than half of them in Japan. As he writes, "This clearly suggests Japanese small caps are one of the best sources of bottom-up ideas available." In March 2009, Montier updated his findings and found more net-nets than ever. Again, more than half were in Japan. He called Japanese small caps among "the cheapest assets on earth." Then, too, I remember going to the Grant's Spring 2009 Investment Conference and listening to Jean-Marie Eveillard give a presentation. Eveillard, if you don't know, is a revered figure among investors. He is most known as the pilot of the First Eagle funds, for which he began managing money in 1979. The French-born Eveillard, born in 1940, is an old-school value investor. Graham's legacy inspires Eveillard, as he often mentions him. When managing money, Eveillard was known for holding onto quite a bit of cash when he couldn't find compelling investment ideas - unusual in the mutual fund world, where managers are usually fully invested. And he also invested in gold long before it was popular. In Eveillard's presentation last Spring, he too talked about how cheap Japan's stock market was. He pointed out that book value was "very hard" in Japan, since many of the assets were in cash. "To say the Japanese stock market trades below book value is to say quite a bit," Eveillard said. Right now, the Nikkei trades for a price-to-book ratio of about one-to-one. Eveillard ran through some examples of companies he liked - Fanuc, SMC, Astellas Pharma and Shimano. These are dominant businesses. Several of these had cash in excess of 50% of their market caps. They traded for only slight premiums to book at a time when the S&P 500 traded for four times book. In a November interview with Steve Forbes, Eveillard was still talking about Japan. He said investors were "thoroughly disgusted" with Japan's market, an environment that creates cheap stocks. He also talked about how Japan's companies have tons of cash. "Americans used to make fun of them," he said. "Those idiots are sitting on tons of cash that yield nothing." Now - after the trials of 2007-08 - many American companies wish they had held onto some cash. But Japan's companies hold too much cash. In general, Eveillard is forgiving of this excessive conservatism and sees it as a potential strength in today's environment. "Nothing is perfect," he says, "and that's a sin which I have been willing to forgive - excess conservatism, as opposed to excess aggressiveness. Today to have a very sound balance sheet is a tremendous advantage. It is one of the strengths that will allow some companies to gain at the expense of other companies burdened with debt." Over the last few years, he has been one of the lonely voices talking about investing in Japan. In fact, I talked to a good friend of mine - of the contrarian bent - who advises pensions and endowments on investing. I asked him if he had any favorites as far as getting exposure to Japan's stock market. "There really isn't much out there," he told me. "It's not like investors are clamoring to get into Japan." Then there is Bill Bonner, my publisher and editor of The Daily Reckoning. His famous Trade of Decade in 2000 was to buy gold and sell the dollar, a trade that worked out brilliantly. In the early days of 2010, Bonner put on a new Trade of the Decade: Sell US Treasuries and buy Japanese stocks. Finally, there is some historical precedent for surprise. Over the holidays, I read Keyes Beech's book Not Without the Americans. Beech was the dean of Far East correspondents, having worked the beat for over 50 years. His book came out in 1971 and he's been dead since 1990, but his book gives valuable perspective on Asia's development. If you think things are bad in Japan now, you should take a minute to imagine what it was like in 1945. As Beech writes: The country was literally in ruins. Its major cities were leveled by American warplanes. Its industrial plant was either destroyed or obsolete. Its once great merchant fleet lay at the bottom of the sea. One expert at the time described Japan as "10 men in a boat with food for seven." It could hardly be bleaker. Yet within 20 years of its crushing defeat, Japan was the third largest economy in the world, behind only the US and Soviet Union. It was four times bigger than it was before the war. The Economist called it "the most successful sudden economic growth story of all time." Within two decades Japan had the highest growth rate in the world. It made half the world's ships, produced more steel than Britain and had the second largest auto industry in the world. All of which would have been unimaginable in 1945. And it did all this with nary any natural resources. I'm not saying Japan will repeat this miracle. I'm passing on more evidence that the consensus is often wrong and one should expect surprises. Bottom line: I wouldn't count Japan out. And bear markets do end. Twenty years is a long time. I like the new Trade of the Decade. To participate, you have several choices. You can invest in the Japanese Smaller Capitalization Fund, ticker JOF, which has lost a third of its value over the last decade. The iShares MSCI Japan Index Fund, ticker EWJ, has done even worse, but it is another fund that aims to capture the returns of the Japanese market...for better or worse. Regards, Chris Mayer for The Daily Reckoning And now over to Bill Bonner, who has today's reckoning from Waterford, Ireland... Does the stock market know something we don't? Yesterday, investors bid up prices on the Dow stocks to a new high. The index rose 115 points. According to theory, the markets know more than any single investor, analyst or economist. In theory, the markets know everything there is to know. In theory, the markets are always right. But what the heck? This is the same stock market that signaled clear sailing ahead ten years ago. Soon after, equities hit an iceberg. They sank for the next decade. Here at The Daily Reckoning, we had our own views. At the beginning of the '00s, we told readers to sell their stocks. We were right. The stock market was wrong. Heh heh. So, who ya gonna trust now? The stock market... Or, The Daily Reckoning? Who knows... Maybe we're wrong this time, but we see another 10 years of trouble coming. Two years ago, the credit cycle peaked out. After half a century of adding debt, the private sector had had enough. Borrowing turned down. Last November, it registered its 10th month in a row of declines, something that had never happened since they began keeping records after WWII. Consumer spending has held up surprisingly well. But with credit contracting and unemployment high and rising, it can't continue. Small businesses create jobs. But who wants to take the risk of funding a small business now? Not the banks. And the capital markets are closed off to small businesses. You have to have a big business - preferably one that is dying... Then, you can get all the money you want from Wall Street and the feds. Since the downturn began two years ago, 7.5 million jobs have been lost. There is no sign that they will be found anytime soon. Jobless people do not spend a lot of money. Ergo, you can't really expect an economic surge until people get jobs. When will that happen? Possibly years from now...maybe 2...maybe 5...maybe 10... Yes, dear reader, we are in a depression. It is a period of adjustment...of correction...of de-leveraging...of paying down debt. And there's not much the feds can do about it - except disguise it...delay it...and make it worse. The government can spend money. The government can inflate the currency. But it's neither government spending nor inflation of the currency that makes an economy healthy. If inflating the currency could make an economy prosper, where did Zimbabwe go wrong? And if government spending could boost an economy, what did Cuba do wrong? Or Venezuela? The two-bit, banana republic economies are almost all burdened by too much government stimulus. The feds tax too much, spend too much, borrow too much and inflate too much. Instead of doing their jobs - enforcing property rights, protecting people from crime, and staying out of the way - they meddle and spend. The president gets a fancy house and lots of security guards. And the economy rots. Of course, we could be wrong about what is happening in the US. But our guess is that the stock market is wrong instead. Stock market investors anticipate a return to 'normal.' But the normal they're looking at is a very unusual credit bubble that blew up and can't be mended. The real normal is what we're getting. And the real normal is a world where bad stuff happens. Investors make mistakes. Markets make mistakes. Often, they are misled by their own financial authorities, such as Ben Bernanke. The US Fed chief meddles in the economy and distorts the picture. Investors look, but get the wrong idea. Our guess is that stock market investors are seeing the distorted picture caused by the feds' meddling...not the real picture. They look. They see low interest rates. They see stimulus. They see a stock market that seemed so friendly and so rewarding for so long that they can't imagine anything else. They see a government taking action...and making things better. They read Thomas Friedman and think the 'political class' can fix whatever problems it encounters. But in the real world, the political class is a life-threatening parasite. Allow it to grow large enough and the host - the private economy - will shrivel up and die. And in the real normal world, markets go up...and then they go down. We are in one of those periods of decline. We are in a depression, with a growing, parasitic political class. This phase won't end any time soon. --- A Special Report from Capital & Crisis Research --- Urgent Retire-Easy Alert: Introducing the Single Best Way to Make Sure You'll Never Run Out of Money... The Endless "PAYCHECK PORTFOLIO" Using these three simple steps, unleash a steady flow of work-free income...starting with up to 48 automatic "paychecks" deposited directly into your account. Act now or risk missing the next "payday"...* *Two "paychecks" per day on at least eight of the days listed. NEXT "PAYDAY": January 15, 2010 --------------------------------------------------------------- And more views... Gary Shilling is probably right. He says to buy Treasury bonds and the dollar. They're both probably going up this year. Why? Because we are in a depression. And when investors finally realize it they will seek safety. They will buy US Treasury bonds, raising prices and lowering yields. Those Treasury bonds are in dollars, by the way. Investors will want dollars. There are two main emotions that drive investors - fear and greed. Lately, greed drives them to buy emerging markets, stocks generally, and commodities. Fear drives them to dump all their risky investments and head for cover. They believe cover is found in the dollar and in US Treasury bonds - traditionally, the world's safest credits. "Ireland has changed so much," said a colleague at last night's dinner. He was speaking early in the evening. Later, we went to Henry Downs' place...where the #9 whisky is as smooth as a baby's derriere. We can't remember what happened after that. "The Irish had big families. Everyone had five or six children. We were a big exporter of people. People were our major export. And of course, the world is full of mics and paddies. America, Canada, Australia, New Zealand...but there are also a lot of Irish in Argentina. "Birth control was illegal. I remember when I was 16...I had a friend who wanted to sleep with his girlfriend. Since I was tall and looked older he asked me to go into a pharmacy and buy condoms. It was so awkward. I waited until there were no other customers in the shop. Then, I went in....trying to make my voice lower than it really was...and asked the middle aged woman behind the counter for condoms. It was so embarrassing. It's a wonder people had sex at all." "People in Ireland are still funny about sex," said another Irish colleague. "My boyfriend and I 'lived in sin' before we got married. Everybody knew it. But 'living in sin' was not just a joke. People thought it was a real sin. They didn't really mind it, but they expected us to pretend we weren't sinning. So when my parents would visit we had to pretend we had separate bedrooms...even though it was obvious we were sleeping together. "But nowadays, it's different. Now couples only have one or two children." Regards, Bill Bonner, for The Daily Reckoning --------------------------------------------------------------- Joel's Endnote: Readers are reminded to save the dates, July 20-23, 2010, when investors and industry experts from all over the world will again converge in Vancouver for our annual Agora Financial Investment Symposium. "What does an AF Investment Symposium look like?" you ask. Well, take a thousand or so free market enthusiasts, give them rooms at a luxury hotel...then mix in a jam-packed program of robust debate and a few crates of whiskey. This year we expect to hear from a 2010 US congressional candidate - one who actually "gets it" and can explain why most in Washington don't - plus, what he hopes to do about it. We've also locked in a well-known Moscow-based fund manager who'll present his unique perspective on the kind of global investment opportunities most people will never take the time to discover... The senior-most executive from the international petroleum company that recently unveiled one of the largest oil discoveries in four decades... A gold and silver coin expert with exclusive connections to government mints in North America, Europe and Asia... And many, many more. Attendees will also hear from our Reckoner-in- Chief, Bill Bonner, as well as Eric Fry, Addison Wiggin and a host of other long-serving "Agorans." Also, by committing early, you can take advantage of our hefty, early-bird discount. Each year the event gets bigger and bigger, so interested parties will want to get on it in advance. We hope to see you there. Cheers, Joel Bowman Managing Editor for The Daily Reckoning --------------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com   The Daily Reckoning - Special Reports: The US Trade Deficit: Fort Sumter...And The U.S. Trade Deficit US Recession: By far the Weakest Recovery "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the BIGGEST FINANCIAL SWINDLE in world history.