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The Daily Reckoning | Wednesday, August 11, 2010 Stocks plummet as deficits widen and Fed's fixes wear thin, Seeking shade under one of Wall Street's sturdiest oaks, Plus, Bill Bonner on the Fed's mini-move and that $2 trillion still in the pipeline... ------------------------------------------------------- Buy This OTC Penny Play on August 16! On Sunday, August 15, Bulletin Board Elite editor Greg Guenthner will announce his next big OTC penny stock play, giving his readers plenty of time to get in when the markets open on Monday if they want in on the action. If you want a chance at substantial gains, you need to watch Greg's brand new presentation. In it, he details how readers could have already turned $500 into $15.1 million in just 30 days. Click here to watch the presentation immediately... It gets removed from our servers at midnight on Saturday, August 14. The Fix is In... And No One's Buying It The Markets React to the Fed's Tired Response Joel Bowman Reporting from Lake Livingston, Texas... "DJIA Plunges 225 Points in Global Sell-Off..." "VIX Surges..." "US Trade Deficit Unexpectedly Widens, Exports Decline..." The news is neither good nor bad this morning. It just is. Fellow Reckoners are advised to interpret it accordingly. To the cheers of some and the tears of others, stocks appear to be gripped in a downward spiral today. The Fed's medicine (on which Bill has more below) went down like a bucket of KFC at a Miss Universe pageant, yesterday - which is to say temporarily, at best...and with immediate, violent regret. Poor Mr. Bernanke...chewed up and spat right out. Markets, apparently, are fed up with "more of the same." In times of crisis, people tend to look for a single neck around which to fasten the noose of their collective irresponsibility. Their hands clench when they see Obama, Geithner, Summers, Bernanke, et al. yapping on the television. Lynch mobs practice their running bowlines, tarbucks and slipknots. Their anger and frustration is warranted, of course, but perhaps partially misdirected. To be sure, each of the above necks probably needs a good wringing. But doing so would likely provide only fleeting satisfaction, not lasting solution. After all, the meddlers are merely doing what meddlers do. They are pretending to be in control of the situation...and for a while, the markets were pretending to believe them. You can't blame a weed for growing in the mulch. But Mr. Bernanke, for all his fumbling foibles, is only one man; one cog in a machine programmed to march right off a cliff, whether it is he or some other lever-puller at the control panel. The Fed Head is doing his very best to delay the day of reckoning. Ultimately, however, he has only two choices: print or default. The rest - cutting, easing, extending, pretending - is simply bread and circuses for those who still hold out hope that the inexorable, untiring trend toward eventual collapse in the system is somehow reversible. It is not...but that's not necessarily such a bad thing. "America today looks like Russia in 1998," Jochen Wermuth, Chief Investment Officer at Wermuth Asset Management, explained to CNBC today. "Consumers, companies and the government are all highly indebted. America as a result is a bankrupt Mickey Mouse economy." Wermuth went on to remind pundits that "Even before the (Troubled Asset Relief Program) and the expansion of the Fed's balance sheet, total US public and private debt as a percentage of GDP...stood at 290 percent..." Though that figure is much higher now, largely as a result of the meddlers' aforementioned "fixes," the trend has clearly been in place for some time. Now, it is simply accelerating. The lion's share of the national debt burden comes in the form of various structural absurdities and unfunded liabilities - Medicare, Medicaid, Social Security - guarantees and promises the government can't (and won't) ever make good on. But it also comes from over-consuming and under- producing; from plain old living beyond one's means. And that's something Mr. Bernanke can not fix, no matter how hard he tries. News across the wires this morning shows the US trade deficit widening at the quickest pace since October 2008. The shortfall jumped almost $50 billion from May to June, an 18.8% increase, as US exports declined across the board and imports rose to just over $200 billion. It doesn't take a genius to work out that a country can't export $3 for every $4 it imports forever. Eventually, debts must be made good or destroyed. They must be repaid, defaulted on or inflated away. Speaking at this year's Investment Symposium in Vancouver, perennial favorite, Doug Casey, suggested the government opt for the second choice. Defaulting on the debt, according to Doug, is about the only "honest, ethical thing" to do. "After all," he continued, "We're never going to pay it back. Or if we do, it'll be with dollars that are utterly worthless." In all likelihood, Bernanke probably believes he has some degree of control over the situation. The poor fellow has the master-slave relationship entirely back-to-front. The trend is what it is. For his part, Bernanke can believe what he wants. We needn't remind our Fellow Reckoners, however, that only the blind follow the gullible. Watch the Presentation: Secret $200 Retirement Blueprint Last year $200 could have turned into $10.1 million following 5 simple steps revealed in this secretive retirement blueprint. It's happened before, but could it happen again and could it happen to you? Click here to watch the presentation now. (Turn your speakers on) The Daily Reckoning Presents When is "Cheap" Cheap Enough? Eric Fry Everyone agrees that you should buy stocks when they're cheap, but no one ever seems to agree about what "cheap" is...or least, what "cheap enough" is. The definition of "cheap" is, in fact, the opposite of Supreme Court Justice Potter Stewart's classic definition of hard-core pornography: "I know it when I see it." Almost no one knows what "cheap" looks like, even when it is standing stark naked before their eyes. When stocks were selling for seven times earnings in 1982, they didn't seem cheap enough to most investors. Sure, someone was buying Boeing, Dupont and Exxon at less than seven times earnings in 1982. But someone was also selling them. And someone was also selling these stocks at nine times earnings in 1980. With the benefit of hindsight, nine times earnings was "cheap enough" in 1980, even though these stocks would tumble 25% to 50% during the next two years. Boeing, for example, fell more than 50% from its highs of 1980 to its lows of 1982! But during the decade of the 1980s, as a whole, Boeing shares quintupled! The shares of DuPont and Exxon posted similarly spectacular results for the decade. Clearly, US Blue Chips were cheap enough in 1980. By contrast, US Blue Chip stocks have seemed "cheap enough" to most investors during most of the last 10 years. But these appraisals were frequently off target. Anyone who purchased an S&P Index fund between April 1999 and January 2001 would still be nursing a loss...more than nine years later! Similarly, anyone who purchased an S&P 500 Index fund October 2005 and September 2008 would also be nursing a loss. The good news is that this "lost decade" was not a total loss. The opportunistic buyer of US stocks at the market lows of September 2002 would have enjoyed a 60% return over the ensuing eight years - equal to about 6% per year. But guess what? Buying 10-year Treasury bonds in the fall of 2002 would have produced an even higher return...with much less volatility and risk. From this perspective, stocks were still not cheap enough, even at the lows of 2002. Maybe US stocks were finally cheap enough in March 2009, when the S&P 500 touched a 12-year low of 666. But even at that diabolically depressed quote, the S&P was trading for 12 times estimated earnings. To be sure, that valuation was very cheap relative to recent history...but not so cheap relative to the history of important buying opportunities. During the Great Buying Opportunity of 1977 to 1982, the S&P 500 never traded above ten times earnings. Nevertheless, the opportunistic buyer of stocks at the market lows of March 2009 would be sitting atop a plump 70% return...and would have amassed that gain in just 15 months. But even if stocks were cheap enough to buy in March 2009, are they cheap enough to hold (or to continue buying) in August 2010? To answer this question, we must understand what cheap isn't. Cheap is not, for example, a constant or an absolute. It dwells in a world of relativistic assessments. It is more Las Vegas than Mount Sinai. Cheap always resides in the context of competing investment opportunities. Many investors did not buy stocks in 1980, even though they were selling for seven times earnings, because long-term Treasury bonds were yielding 15%. Stocks were statistically cheap. No doubt about it. But to justify taking the risk of buying stocks in 1980, an investor would have had to anticipate annualized returns above 15%. To many investors, that hurdle seemed too high to try to clear. When risk-free Treasurys provided a 15% return, buying stocks - even very cheap stocks - seemed not just imprudent, but ridiculous. By contrast, the statistically not-cheap equities of today face negligible competition from most other asset classes. Short-term Treasury securities yield next to nothing, while long-term Treasury securities yield only slightly more than nothing. Furthermore, we would remind our dear readers, equities represent interests in enterprises that produce capital, rather than obligations from a government that absorbs capital. Therefore, as James Grant argues in a recent issue of Grant's Interest Rate Observer, many US Blue Chip stocks may be cheap enough...at least relative to Treasurys. "We've come to favor the 'risky' equity of Johnson & Johnson...over any long dated 'safe' claim on the US Treasury," says Grant. "What's 'risky' and what's 'safe' is a question that time alone will answer. Ten years from now, we hazard, somebody is going to be very surprised... "Because Treasurys have been in a bull market since 1981," Grant continues, "they tend to get the benefit of the doubt. No such free pass is accorded these days even to the sturdiest of American corporate oaks." Johnson & Johnson is one of the sturdiest oaks on the Wall Street chaparral, according to Grant. "J&J has been around since 1887," he observes, "when Grover Cleveland, a gold-standard man, was in the White House. The company grew up in a monetary turmoil of the 1890s. It survived the dollar devaluation of 1933-34 and every subsequent monetary system including the interwar gold-exchange standard in the postwar Bretton Woods regime...J&J operates in 60 countries (slightly more than half of its sales come from abroad) and employs 115,500 people. In 2009, sales totaled $61.9 billion..." What's more, Grant notes, the company recently raised its quarterly dividend for the 48th consecutive year. And yet, this robust shade tree sells for a valuation that would embarrass a sapling. "Since 1980," Grant's colleague, Dan Gertner, observes, "JNJ has traded an average price-earnings multiple of 20.8 times. It is currently trading at 12.6 times trailing net income at 12.1 times the 2010 estimate. It yields 3.7% and is one of the four AAA-rated industrial companies left in United States." Johnson & Johnson, Grant concludes, is one of a small handful of "immense, fast-growing, well-financed, world beating enterprises that [are] somehow regarded by the mass of investors as a little less desirable than the 10-year Treasury." Grant suggests taking the other side of this trade. "Safety first, we say - and Treasurys last." Eric J. Fry, for The Daily Reckoning And over to Addison Wiggin, from Agora Financial's H.Q. in Baltimore, Maryland... For seven years, we've been conspiring to put together a research advisory service that covers the nexus between money and politics, between Wall Street and Washington. We wanted to cut through the clutter you see from corrupt and polluted research departments at the biggest investment banks on Wall Street to deliver you useful ideas on how to protect and grow your wealth. Now, after seven years, countless hours spent and miles traveled, conferences attended and books written, we're finally ready test the idea of Apogee's high vantage point research again...and we need your help. Details Here... Bill Bonner More Debt to Fight the Correction and Other Absurdities Bill Bonner Reckoning from Ouzilly, France... The big news yesterday was that the Fed decided to do about what we expected - not much. Bloomberg has the report: Federal Reserve officials decided to reinvest principal payments on mortgage holdings into long-term Treasury securities, making their first attempt to bolster growth since March 2009 to keep the slowing US economy from relapsing into recession. "The pace of economic recovery is likely to be more modest in the near term than had been anticipated," the Federal Open Market Committee said in a statement in Washington. "To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve's holdings of securities at their current level." The Fed retained a commitment to keep its benchmark interest rate close to zero for an "extended period." With growth weakening in the second quarter and company job gains in July falling short of estimates, today's step signals that risks of a downturn have increased enough for the Fed to delay its exit from unprecedented stimulus. Chairman Ben S. Bernanke told Congress last month that the Fed was "prepared to take further policy actions as needed." The Fed's last move in favor of easier policy came in March 2009, when policy makers agreed to buy $300 billion of Treasuries and more than double planned mortgage-debt purchases to $1.45 trillion while starting a pledge to keep the benchmark rate close to zero for an "extended period." So, the Fed has made another mini-move. And the markets reacted appropriately, in a mini-way. Stocks went down a little - minus 54 on the Dow. Gold went down a bit too - off $4, to bring the price to $1,198. Barron's was not wrong. Just early. You'll recall the newspaper says the Fed will "Print $2 trillion." Yes, it probably will. But not now...not yet. Not as long as the Treasury can finance federal deficits by borrowing and the stock market hasn't collapsed. But the Fed is in a trap of its own making. It doesn't really understand what is going on. It thinks there is a problem in the economy caused by consumers who are unwilling to spend. It believes it should use its policy tools to help pry the money out of their pockets. Trouble is, consumers don't have any money in their pockets. And if they did have some, they wouldn't want to spend it. Of course, the Fed knows this much. But they think that if they can get people spending again, the economy will take off, employment will rise, incomes will go up and everything will be hunky dory again. They don't seem to wonder why - if things were so hunky dory in the bubble years - there was a crisis in the first place. Never once have we heard anyone of them - not Bernanke, Summers, or Geithner - explain that the private sector had run up too much debt (largely because of their own economic policies)...and that now it is paying the price. Instead, they think the economy is sick and that they are all Dr. Schweitzers. The whole thing - meaning, the body of ideas, theories, prejudices, plans and programs of the financial authorities - is really asinine. Which is what is really interesting about this episode in history. So many very smart people have come to believe such absurd things. It's a marvel. And marvelously entertaining to watch. What will they say and do next? They don't have much choice. Their silly ideas drive them into silly positions...from which there is no gracious exit. The economy is correcting from too much debt. They're determined to stop the correction with the only thing they have to offer - more debt. And funny money, of course. They're not stupid, though. They also know that they can't go too far or they will do even more damage than they're doing now. So, they'll save that disastrous step for later...when they're really desperate. Then, we'll see them "Print $2 trillion." Or print $3 trillion. Or more. In the meantime, it's "muddle onwards" for the authorities! One misstep after another. Headlong into one trap...then onto the next! And more thoughts... More zombification... As an economy matures, more and more people begin to shuffle and drool. They figure out how to use the political system to get something for nothing. The article below, from USA Today, tells the tale of government employees. They went to Washington to do good...and they've done very well. Federal workers earning double their private counterparts At a time when workers' pay and benefits have stagnated, federal employees' average compensation has grown to more than double what private sector workers earn, a USA TODAY analysis finds. Federal workers have been awarded bigger average pay and benefit increases than private employees for nine years in a row. The compensation gap between federal and private workers has doubled in the past decade. Federal civil servants earned average pay and benefits of $123,049 in 2009 while private workers made $61,051 in total compensation, according to the Bureau of Economic Analysis. The data are the latest available. The federal compensation advantage has grown from $30,415 in 2000 to $61,998 last year. Public employee unions say the compensation gap reflects the increasingly high level of skill and education required for most federal jobs and the government contracting out lower-paid jobs to the private sector in recent years. "The data are not useful for a direct public-private pay comparison," says Colleen Kelley, president of the National Treasury Employees Union. Chris Edwards, a budget analyst at the libertarian Cato Institute, thinks otherwise. "Can't we now all agree that federal workers are overpaid and do something about it?" he asks. Last week, President Obama ordered a freeze on bonuses for 2,900 political appointees. For the rest of the 2-million-person federal workforce, Obama asked for a 1.4% across-the-board pay hike in 2011, the smallest in more than a decade. Federal workers also would qualify for seniority pay hikes. Congressional Republicans want to cancel the across-the-board increase in 2011, which would save $2.2 billion. "Americans are fed up with public employee pay scales far exceeding that in the private sector," says Rep. Eric Cantor, R-Va., the second- ranking Republican in the House. What the data show: Benefits. Federal workers received average benefits worth $41,791 in 2009. Most of this was the government's contribution to pensions. Employees contributed an additional $10,569. Pay. The average federal salary has grown 33% faster than inflation since 2000. USA TODAY reported in March that the federal government pays an average of 20% more than private firms for comparable occupations. The analysis did not consider differences in experience and education. Total compensation. Federal compensation has grown 36.9% since 2000 after adjusting for inflation, compared with 8.8% for private workers Regards, Bill Bonner for The Daily Reckoning