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The "Road to Recovery"...and whether anyone is still buying it, What the "Shiller P/E ratio" and simple demographics have in store for the markets, Plus, Bill Bonner on the employment number "adjustments" and what's left of the Great Correction... The Daily Reckoning | Wednesday, April 7, 2010 Detaining Americans in the Name of  Economic Recovery An indication that America needs your money more than you do Joel Bowman Reporting from back in Taipei, Taiwan... Monday was Tomb Sweeping Day here in Taiwan, a national holiday. Without a tomb of his own to sweep, your Aussie editor took advantage of the long weekend and flew to Borneo for a scheduled visa run. The island is a quick, 3-hour flight south from Taipei and, with the expansion of budget airline routes around the region, one can get down there for about $150 return. Not bad. We landed in Kota Kinabalu, a quaint little town on the west coast with a smattering of tropical islands just a short ferry ride from the old English port of Jesselton. The place, as you might picture, is a slice of heaven. The people are possessed of the kind of smiles you see in the vacation ads. The seafood is cheap and drawn in from the fishermen's lines daily. The snorkeling conditions are spectacular and the water is cool and clear. As you can imagine, it was a very relaxing few days...except for one minor detail... The rains came down hard on the first afternoon, making a jaunt out to the nearby islands all but impossible. Waiting it out in our hotel room, we mistakenly flicked the television channel over to CNBC. We don't usually watch a lot of television back in Taiwan, nor do we hear a lot of American accents, so our first reaction was one of relaxed familiarity. It was like having an old friend in the room...for about a second. Maybe we've been away too long...or maybe we've become too cynical in our old age. Maybe both. Whatever the case, we highly recommend NOT polluting your weekend island getaway with any mainstream press consumption. It took more than one cocktail and at least an hour being submerged in the crystal waters with a snorkel in our mouth until we felt "clean" again. What is this "road to recovery" nonsense? Don't these people know the world is in a prolonged deleveraging stage? Don't they know that we are unwinding from half a century of credit expansion, of living far beyond our means? Don't they know that western economies are hemorrhaging and that Band-Aid welfare fixes are temporary, at best? Don't they know that living off demand stolen from the future on a currency beaten into submission is not the kind of recovery on which to build a smile and a brighter tomorrow? Don't they know that people are cutting back? That beer is the new champagne...that Borneo is the new St. Barts? In a word, "No." For a minute, we thought the program was a vintage rerun from sometime back in the mindless optimism so rampant in the Bubble Epoch. (How delayed is the news here, we wondered?) Presenters gushed about Friday's jobs numbers (on which Bill has more below), crooned over the Feds' decisive, economy-saving actions, and took bets on when the markets would reach 11,000 while, we imagined, already penning their teleprompter scripts for 12K...13K...14K...and far, far beyond. Strangely, we got the feeling that the word "recovery" was being spliced into the show reel, like a poorly executed subliminal advertising campaign at an old cinema. But no. This IS the official news. Is anybody swallowing this? Do the presenters themselves believe the words they utter? One shudders to think... And all this while Congress was sliding through capital control measures and the "Enemy Belligerent, Interrogation, Detention and Prosecution Act of 2010." Thankfully, we still had an Internet connection. Our mates over at The 5-Minute Forecast emailed us the details on these particularly despicable measures... "The first is a provision slipped unceremoniously into the Hiring Incentives to Restore Employment Act, AKA 'the jobs bill,' which passed into law on March 18, 2010," writes Addison. "The provision outlines new rules on 'Foreign Account Tax Compliance.' The gist is this: Send more than over $50,000 to a foreign bank not on good terms with the US and the IRS will withhold 30% of it for possible tax claw back - and a boatload of your private account information." Then there's the second Act in question, which "would allow the US military to detain US citizens without trial indefinitely in the US based on suspected activity." What!? Why are the talking heads chattering about an Alice in Wonderland economic recovery while their citizens are being sold down the pipeline? Americans may soon be detained without trial...INDEFINITELY. The State is planning to tax to death what precious little economic vitality still exists in the nation. They are "proposing" a European-style V.A.T. this very moment (because it worked so well for Europe?) and anyone caught attempting to flee the regime will be punished to the tune of 30% of their wealth for doing so. Matt Palmer recently wrote a superb article for the Ludwig Von Mises Institute titled "Rothbard and the Nature of the State." In it, he quotes the venerable economist: "If you wish to know how libertarians regard the State and any of its acts, simply think of the State as a criminal band, and all of the libertarian attitudes will logically fall into place." The rest of the trip, readers will be relieved to know, did not inspire any vitriolic tirades. In today's guest essay, Dan Amoss takes a closer look at this "market driven recovery" and applies some seldom sought, often need The Daily Reckoning Presents Brace for Turbulence Dan Amoss "The last time that [America] had no government debt, you had a Scottish president. His name was Andrew Jackson. Not only did he pay off the national debt, he also abolished the central bank and tried to close down all the commercial banks." - CLSA Strategist (and Scotsman) Russell Napier, March 24 CFA Society speech I had the good fortune to attend a speech by Russell Napier last week. Napier is a stock market historian. But he's not just an ivory-tower academic; he operates on the front lines of the investment management business as an analyst for the brokerage firm CLSA. Napier's been in the trenches of the global financial markets for several decades. Napier's speech, which echoed themes from his excellent book, Anatomy of the Bear, stressed the need for investors to understand the long- term trends in stock valuations. Secular, or long-term, bull markets are best defined as a period of rising valuations, he explained, while bear markets are the opposite. Near bull market peaks, investors become so optimistic that they pay silly earnings multiples for stocks. A simple way to view a P/E multiple is the "payback period" for the return of the capital you part with in order to buy a stock. The higher the starting PE ratio, the longer the payback period. Napier's discussion of cycles in stock market valuation is based on the work of Yale Professor Robert Shiller, and his now-famous "Shiller P/E ratio." The Shiller P/E ratio is calculated as follows: divide the S&P 500 by the average inflation-adjusted earnings from the previous 10 years. Here is a chart of the Shiller P/E going all the way back to 1880: It's the best P/E ratio to use over long stretches of history, because it smoothes out the extreme peaks and valleys in earnings, giving a better framework for thinking about future S&P earnings power. The mean and median Shiller P/E since 1880 are both about 16. Today, it's about 22. At the last four major bear market bottoms, in 1921, 1932, 1949, and 1982, the Shiller P/E fell below 10. This is a far cry from bouncing sharply off of 15 - which is what happened at the March 2009 bottom. Valuation is the main reason why I expect the bear market to last several more years into the future - probably somewhere in the 2015- 2020 timeframe. I think we'll get there through some combination of falling stock prices and modest earnings growth. Rapid earnings growth - along with rising valuations - drove the great 1982-2000 bull market. The sprint up to the 2000 peak was, in hindsight, the biggest stock market bubble in history. History shows that bubbles are nearly always corrected over very long periods. The next decade will surely be especially turbulent, because that's when markets and politics will sort out what the inevitable train wreck in the US entitlement programs will look like. How much will entitlement promises be financed by currency debasement? How much are Baby Boomers willing to sacrifice in terms of medical rationing? Or higher retirement ages for Social Security? These are the big questions of our time. The one thing that's certain is that it won't be painless. Most entitlement recipients expect a standard of living that the welfare state can simply not afford. In his speech, Napier's dry humor nailed the situation: "For 120 years, the US borrowed money to kill people [in wars]. Now, it's borrowing money to keep them alive." As it turns out, demographic trends are a crucial driver of both politics and markets. Napier cited a study that Professor Shiller and a few of his graduate students conducted to discover a data series that fits closely with the Shiller P/E ratio. The study revealed that demographics heavily determine stock market valuations. It compared the number of 40-year-olds with the number of 20-year-olds through time. If the number of 40-year-olds grows faster than the number of 20-year- olds, valuations rise. If the number of 20-year-old grows faster than the number of 40-year-olds, valuations fall. In statistics jargon, the "r-squared" of this variable, in explaining valuations, was 0.79. That's very high, meaning the demographic trends are important in determining long-term stock market returns. Over the next several years, the number of 40-year-olds will decline, due to the lower birth rates between the Baby Boomers and the Boomers' kids. So the Shiller P/E ratio is very likely to fall. Napier's talk concluded with his outlook for stock valuations. He said, "I fully expect to be here in five or six years telling you to buy US stocks at 6 times earnings - at a time when the geopolitical decline of America is on the front page of every newspaper; at a time when you have capital controls; at a time when the government is manipulating the debt market." To be continued tomorrow... Dan Amoss for The Daily Reckoning Bill Bonner Springtime for Economics: Ignoring the Bubble Era Mistakes Bill Bonner And now the rest of today's reckoning from Baltimore, Maryland... It's springtime. The temperature is 85 degrees here in Washington. New York is approaching record-breaking temperatures. Global warming is back in business. The flowers are out. Cherry blossoms are thick on the ground. The grass is yearning for the mower. Heck, everything is back in business. To hear the media tell it, you'd think jobs were picking up...consumer spending too...manufacturing - everything. Everyone thinks the recovery is as pullulating as April. Obama says we've 'turned the corner.' Larry Summers thinks we're headed to the moon. Is our old 'Crash Alert' flag still flying over the building with the gold balls? We hope so. Because, when everyone is thinking the same thing, no one is really thinking at all. And when you start thinking about it, you begin to wonder... ..what happened to de-leveraging? What happened to all those bubble era mistakes? ..what happened to all that debt consumers were carrying? ..what happened to the Great Correction; isn't there anything left to correct? You'll recall that the Great Correction seemed to be aiming to put a number of things right. Foremost were the economies of the USA and China. The US needed to correct its over-reliance on consumer spending/debt. China needed to correct its over-reliance on exporting things to America. Of course, there were a number of other things in need of correction too: ..like the huge credit expansion of 1946-2007...in which debt went from 150% of GDP to more like 370%. ..and the phony baloney post-1971 money system in which the reserves of one central bank are the IOUs of other central banks. In the case of Europe, nobody is exactly sure who's supposed to pay the IOUs. In the case of the US, everybody knows who's supposed to pay...and everybody knows he can't pay. He doesn't have that much money. Even if you liquidated all his assets and all his citizens' assets, Uncle Sam would still be about $50 trillion short. ..and there's the stock market too. We're still in bounce mode, following the big drop from 2007 to March of 2009. In the short run, our chief researcher - Charles Delvalle, who keeps an eye on our investments at our family office - is bullish: "The intermediate trend in the Dow Jones is still up. This trend was confirmed after the Dow Jones surpassed its Jan 19 peak. We could see a test in the trend, with a drop back down to the Jan 19 highs. As long as the Dow manages to stay above this, we could see a charge to 11,000 as soon as [this] week." But if this Great Correction is as great as we think it ought to be, it will wipe out this bounce...and sink another 50% before finally hitting bottom. ..and don't forget the bull market in bonds. No one knows for sure, but the 10-year T-note hit its all-time low below 3% in November 2008, after a 27-year bull run. This week it went back over 4% - its highest point for this cycle. "The fun's over," says old-timer, Richard Russell. Are 10-year yields headed back to 15%? ..finally, there's the very big picture...the Anglo-saxon empire...begun by the British in the 16th century...and carried on by Britain's former colony, America. Is it time to take the English- speakers down a notch? Maybe... Well, what do you think? Has the Great Correction fizzled out? Is it time to party like it was 2006 again? Is China going to make even more money by selling even more stuff to the US? Are Americans going to go further into debt to buy it? Are their houses going to recover 25% to 30% losses and keep on going? Is the Dow going back up to 14,000 - and beyond? Are bonds going up - even though the supply of them is soaring? And what about the empire? Has it got greater glories still in store? We don't know. We just watch...wait...and wonder... ..along with everyone else. And more thoughts... Our old friend, Graham Summers points out that the latest employment numbers are close to fraud: Let's have a look at these 162,000 jobs. Right off the bat, we know that 48,000 of them came from hiring census workers. I won't completely put this down because these ARE new jobs. But they're hardly sustainable (the census is a temporary employer) or productive: paying someone to count other people adds literally NOTHING to the US's manufacturing or productivity base. If it did, we could simply start hiring people to count clouds or trees and have an incredible economy in no time. So without census workers, we added 114,000 jobs in March. Then there are the +81,000 via birth/death adjustments. This metric is so complicated that it's not even worth trying to explain. In simple terms, the BLS tries to adjust the jobs numbers to account for the birth/death cycle of businesses. But the reality is that it is an 'X' factor used to downplay job losses and boost job gains. Without these adjustments, we added 33,000 jobs in March. Then, of course, there are the weather adjustments. The winter of 2009- 2010, was by all counts, a rough one. So the BLS made various adjustments to atone for the fact that for several chunks of 1Q10, people couldn't even get to work, let alone hire. Now that the winter is over, the BLS is adjusting numbers upwards to make up for former downward revisions. The total number of jobs "created" by adjusting for the nasty winter? 100,000. Without these adjustments, we LOST 67,000 jobs in March. "Bill, you should come down here...this Saturday, they're auctioning off Tulip Hill. It's probably the nicest house in the county. And it's gorgeous... I don't know if I've ever seen such a pretty place..." Our cousin was calling to tell us about a house owned by another remote cousin. It's a beautiful place. Built in the early 18th century by a rich planter...it is an authentic Georgian brick colonial, with a park that reaches down to the river. They didn't build many houses of that quality in America. Of those, few have survived. This is one of them. One friend bought the place for $1.2 million (if we recall correctly) back in the mid-'90s. Then, another friend bought it for over $4 million in the bubble years. When he went to sell it, however, he found that he couldn't get anywhere near his money back. So, it's up for auction, with a $1.6 million minimum. "Don't even think about it," said Elizabeth. "We've got more than enough problems already." So, we called our cousin back... "I'm not even going to look at it. Because if I look at it, I might start thinking about ways to get it. The next thing you know, I'd have another roof to fix and another pile of bills to pay. A man has to know his limitations..." And finally, this from Bloomberg: Los Angeles will run out of cash on May 5, city Controller Wendy Greuel said today in a release in which she requested a $90 million transfer of reserve funds to pay bills. The controller said she received a letter from the Los Angeles Department of Water and Power today indicating the utility wouldn't send an anticipated $73 million payment to the city's general fund. That money is part of an annual contribution of 8 percent of power revenue that the utility makes in lieu of paying taxes to the city, according to Ben Golombek, a spokesman for the controller. "The question I have been asked most often during the budget crisis is, 'When will the city run out of money?' Greuel said in the e-mailed release. "Unfortunately, we finally have the answer." Regards, Bill Bonner 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