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The Daily Reckoning | Wednesday, February 9, 2011 Bonds behaving like growth stocks...and what it portends for us all, The world's growing need for clean water...and clear reporting, Plus, Bill Bonner on the rise and rise of a discontented youth and more... The Incredible Growth Stock... That’s not a Growth Stock What to Deduce from Rising Bond Yields Eric Fry Reporting from Laguna Beach, California... If the 30-year bond yield were a growth stock, you'd definitely want it in your portfolio. In fact, it would be one of the best performing stocks of the last two years. Already this year, the yield on the 30-year Treasury bond has jumped 10% - or about double the gain of the S&P 500 Index. Over the last two years, the 30-year yield has soared a whopping 78%, versus the S&P's 53% advance. But bond yields are not a growth stock. They are a reflection of both credit demand and inflation expectations. For example, when credit demand and inflation expectations are both low, bond yields typically fall...as they did in late 2008. But when credit demand and inflation expectations are on the rise, bond yields typically rise as well. What, therefore, should we deduce from the relatively steep ascent of bond yields over the past few months? Is credit demand climbing? Not really. According to data from the Federal Reserve, consumer credit outstanding is still declining sharply. Economist David Rosenberg reports that total revolving credit outstanding has been dropping steadily - from $989 billion at the end of 2008 to $894 billion at the end of 2009 to $826 billion at the end of last year. So if bond yields are climbing in the context of contracting credit demand, rising inflation expectations must be to blame...and that's probably not a good thing for the stock market. Historically, rising bond yields compete with the stock market for investment dollars. As interest rates rise, the competition becomes more acute, causing share prices to languish or fall. For now, however, inflation-phobia is not a pervasive sentiment. Few investors seem to care that food prices are soaring, that T-bond yields are climbing across the entire yield curve or that almost every central bank in Asia has started raising interest rates to combat inflation. The stock market is rising because the stock market is rising. That's all we know and, apparently, all we need to know. The S&P 500 Index has nearly doubled since the dark days of March 2009. It's been a great run. The Wall Street folks tell us that this great big rally is reflecting "improving economic data and higher-than-estimated earnings." And probably that's true...or partly true. The rest of the truth might be that the S&P 500 is reflecting Ben Bernanke's massive money-printing exercise. Eventually, this exercise will produce inflation, or at least it should. But for the moment, inflation is showing up most prominently in the stock market. Enjoy it while it lasts. When inflation starts showing up in the bond market and in the rest of the real world, share prices tend to struggle. Chris Mayer examines this phenomenon more closely in the column below... EXPOSED: The Biggest Scam In American History! Mad men drunk on power and driven by greed are robbing YOUR retirement! Most sickening of all, Washington fully endorses this bold-faced assault on your wealth. But Chris Mayer is exposing this scam in his brand new video presentation. PLUS, he'll show you how you could protect and even grow your wealth in spite of this scam, virtually spitting in the face of these elitist thieves. Don't be a helpless victim... Click here to act right now. The Daily Reckoning Presents Blowing Bubbles Chris Mayer For now, the earnings narrative dominates the market. All the big- picture items seem not to matter. Unemployment? Who cares? Debt and deficits at every level of government? Whatever. Companies are turning in good profits and the market is uncorking the champagne. There are reasons to be careful, which I'll get to. First, on the face of it, we've had a great run. The S&P 500's fourth- quarter earnings, at the halfway mark, were 17% ahead of last year's. Importantly, sales were up 9%. So this is no longer a story of cost cutting. Most everyone is doing well, save utilities and health care companies, which have reported declines in profits as a group. Mining and energy companies are doing especially well, with profit growth north of 40%. The media don't get how this earnings picture squares with stubbornly high unemployment. I talked to one reporter recently about this very thing. One simple reason for this disconnect is that some of the best sources of profits for many of these firms has been from overseas operations. Many US firms are still cutting jobs, like Boeing and Lowe's. Profits from emerging markets, meanwhile, grow apace. There are bright spots in the US, too, of course. US manufacturing is getting a boost. Caterpillar will spend $3 billion this year in capital expenditures to add capacity, more than half in the US. And Emerson said it expects US nonresidential investment to grow 8-9%. Eaton, another US manufacturer, actually said it expects its US sales to grow faster than its overseas operations. US new vehicle sales were up 17% in January. We're at a run rate of 12.6 million vehicles, much better than the 10.8 million run rate of a year ago, but well off the 16 million automakers enjoyed pre-crisis. So it's a bit of a muddled cherry. As always, you have to pick your spots, which is what we're all about. A fly in this whole whiskey sour is inflation. It's definitely here and it's having an impact. Rising costs are squeezing some manufacturers. Whirlpool, for example, said it would boost prices 8-10% to cover rising raw material costs. This sort of thing is rippling across all sectors. Prices are going up everywhere. Nalco Holding (NYSE:NLC), a world leader in water purification, recently reported disappointing earnings, largely due to rising raw material costs. The stock sold off on the news. But looking out longer term, the world's need for clean water only grows more acute. Despite the short-term effects of rising raw material costs, Nalco ought to be able to grow core profits at double-digit percentages for years to come. It is a very strong company that generates a tremendous amount of free cash flow - $185 million last year, to be exact. So if companies as robust as Nalco are feeling the effects of rising prices, run-of-the-mill companies across the country must also be feeling the effects. In fact, I was fascinated recently by a story in The Wall Street Journal titled, "Fearing Inflation, Firms Stocking Up." The story talks about how companies are stockpiling rubber tires, cotton clothing and other goods to insulate themselves from inflation. Anecdotally, McCormick stockpiled some ingredients for its spices, Anton Sport bought more fabric than it needed, and Monro Muffler bought extra tires and oil. These purchases are still a small part of overall purchases, but it's a new trend and something we haven't seen in years. For most of the last handful of years, companies tried to shed inventory, not carry it. But what these actions essentially say is that these firms would rather hold real things than cash. I think we'll see more of the same. While inflation is here and everyone seems to see it, the central bankers of the US and Europe seem unconcerned. Of course, they have every incentive to continue to let the money presses run. According to economists Joshua Aizenman and Nancy Marion, inflation did half the work of cutting US government debt from 122% of the economy to 25% from 1945-1973. So with the US government saddled with debts it can never repay, the way out is to debase the currency. Let those printing presses hum and keep interest rates low. Of course, such money printing also puts in motion great monetary accidents. As the old Austrian economists warned, the new money stimulates investing, but it creates an illusion. It's like giving off signals that there is plenty of gas in the tank when, in fact, it's nearly empty. These easy-money policies helped create the great housing bubble. And the easy-money policies today will create a big bubble somewhere else, which will turn into tomorrow's bust. Regards, Chris Mayer, for The Daily Reckoning Joel's Note: Monday was a bit of a housecleaning day for Capital & Crisis readers. Within quick succession, Chris issued two rapid-fire sell recommendations. To the first, Chris wrote: "We have a nice 130% gain in the stock as I write in less than two years - even better if you include the dividends we received. I'm very happy with that outcome." The second company, in which Chris recommended his Capital & Crisis readers sell only half their position, garnered a nifty 110% gain in a year. You can get yourself on Chris's exclusive mailing list right now for less than the cost of a subscription to your local newspaper. Here's a direct sign-up page to get you started. There're a few other goodies in there too, so be sure to check it out. 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) Bill Bonner When the Unemployed Lose Faith in the System Bill Bonner Reckoning from Baltimore, Maryland... Dow plus 71 yesterday. Gold plus $15. Everything seems okay, doesn't it? Good, then let's look deeper...at the story behind the story... As we've been saying, elites look out for themselves. But why not? Everyone looks out for Numero Uno. No? Isn't that what you'd expect? Every organization has some people in control of it. Government is no exception. Often, the people with real control are not those who appear to have the reigns of power. Sometimes, the real power is hidden...behind the scenes... Some of the most remarkable and successful societies have been ruled by slaves. No kidding. The Mamluks in Egypt and the Janissaries in the Ottoman Empire. They were captured or bought in Europe. The boys - usually Christian - were taken to special training camps. There, they were converted to Islam and learned the arts of war and administration. They became soldiers. Or bureaucrats. Generals. Governors. They ran things on a day-to-day basis...for the elite powers behind them. Of course, sometimes, like Rome's barbarian troops, they turned on their masters and took over completely... Then, the master became the slave... But that is a long, long story. Even in a complex, modern democracy the government acts first and foremost on behalf of the groups that control it. How? Part bribery. Party larceny. They take from some. They give to others. They keep a lot for themselves. So, it was not at all surprising that in the crisis of '07-'09 the feds immediately bailed out the banks. That was an act of larceny. The big banks have power. They used the power to enrich themselves. Simple, huh? This treachery cost the nation trillions of dollars, but only one out of a 1,000 people really understands what is going on. The other 999 think the feds "saved the economy." They think Ben Bernanke is a hero, not a scoundrel. In a representative democracy, powerful elites have to pretend to act for the good of the "people." So, they pretend that bailouts to Wall Street are necessary. And they provide handouts to the poor, too. Food stamps, for example. People who get food stamps have little real power. But they vote. Food stamps are a cheap way to bribe the electorate. And as more and more people are caught up in the system - as either knave, enabler, or accomplice - the more the system becomes zombified. There are just fewer and fewer people left who are actually producing wealth. The system itself then begins to creak and crumble...and finally falls apart. We're not fool enough to think that this is what really happens. It's just what you'd call an "artist's conception." It's an idealized, simplified theory about the way things work. Real life is always much, much more nuanced...complicated...and infinitely messy. Still, it gives us a way of understanding, imperfectly, the drift of things... For example...the Fed's quantitative easing and the Obama administration's stimulus program. "The US stimulus robbed our grandchildren," writes Darrell Issa, US congressman, in The Financial Times. We were surprised. We didn't think there was anyone in congress - except for Ron Paul - who had any idea of what was going on. Mr. Issa seems to be another exception. He explains that the results from the 4th quarter are now in. They show that the stimulus program "has woefully failed to reach each of its self-imposed targets." Employment is 6.8 million short. And fourth quarter GDP is $400 billion less than promised. "Some 47 out of 50 US states...have lost jobs since the stimulus was passed," he reports. And most of the jobs that were created were zombie jobs - working in the public sector. In other words, the feds spent $814 billion. We got nothing much for it. But the bill will be handed to future generations - who are guilty of neither larceny nor complicity. How does the next generation feel about it? Keep reading... And more thoughts... Now we turn to a strange phenomenon described by BusinessWeek as "The Youth Unemployment Bomb" Here's the report: From Cairo to London to Brooklyn, too many young people are jobless and disaffected. Inside the global effort to put the next generation to work In Tunisia, the young people who helped bring down a dictator are calledhittistes - French-Arabic slang for those who lean against the wall. Their counterparts in Egypt, who on Feb. 1 forced President Hosni Mubarak to say he won't seek reelection, are the shabab atileen, unemployed youths. Thehittistes and shabab have brothers and sisters across the globe. In Britain, they are NEETs - "not in education, employment, or training." In Japan, they are freeters: an amalgam of the English word freelance and the German wordArbeiter, or worker. Spaniards call them mileuristas, meaning they earn no more than 1,000 euros a month. In the US, they're "boomerang" kids who move back home after college because they can't find work. Even fast-growing China, where labor shortages are more common than surpluses, has its "ant tribe" - recent college graduates who crowd together in cheap flats on the fringes of big cities because they can't find well-paying work. The full report is reproduced below. It is important. Remarkably, the author of this report inBusinessWeek does not seem to understand what is going on. But we have seen it first hand. Labor laws bribe the generation of CURRENT voters. They raise the price of labor to the point where it no longer makes sense to hire young workers. Inexperienced workers just aren't worth the money! Young people can't get jobs because older workers have been co-opted. So, the government then tries to bribe the young with subsidies to the universities...the aforementioned food stamps...and other welfare schemes. But then, the feds run out of money. The young are trapped between a rigid labor market that is rigged against them and a welfare system that can't afford to support them. "The older generations have eaten the future of the younger ones," says a former Italian prime minister. The result? See for yourself: In each of these nations, an economy that can't generate enough jobs to absorb its young people has created a lost generation of the disaffected, unemployed, or underemployed - including growing numbers of recent college graduates for whom the post-crash economy has little to offer. Tunisia's Jasmine Revolution was not the first time these alienated men and women have made themselves heard. Last year, British students outraged by proposed tuition increases - at a moment when a college education is no guarantee of prosperity - attacked the Conservative Party's headquarters in London and pummeled a limousine carrying Prince Charles and his wife, Camilla Bowles. Scuffles with police have repeatedly broken out at student demonstrations across Continental Europe. And last March in Oakland, Calif., students protesting tuition hikes walked onto Interstate 880, shutting it down for an hour in both directions. More common is the quiet desperation of a generation in "waithood," suspended short of fully employed adulthood. At 26, Sandy Brown of Brooklyn, N.Y., is a college graduate and a mother of two who hasn't worked in seven months. "I used to be a manager at a Duane Reade [drugstore] in Manhattan, but they laid me off. I've looked for work everywhere and I can't find nothing," she says. "It's like I got my diploma for nothing." While the details differ from one nation to the next, the common element is failure - not just of young people to find a place in society, but of society itself to harness the energy, intelligence, and enthusiasm of the next generation. Here's what makes it extra- worrisome: The world is aging. In many countries the young are being crushed by a gerontocracy of older workers who appear determined to cling to the better jobs as long as possible and then, when they do retire, demand impossibly rich private and public pensions that the younger generation will be forced to shoulder. In short, the fissure between young and old is deepening. "The older generations have eaten the future of the younger ones," former Italian Prime Minister Giuliano Amato told Corriere della Sera. In Britain, Employment Minister Chris Grayling has called chronic unemployment a "ticking time bomb." Jeffrey A. Joerres, chief executive officer of Manpower (MAN), a temporary-services firm with offices in 82 countries and territories, adds, "Youth unemployment will clearly be the epidemic of this next decade unless we get on it right away. You can't throw in the towel on this." The highest rates of youth unemployment are found in the Middle East and North Africa, at roughly 24 percent each, according to the International Labor Organization. Most of the rest of the world is in the high teens - except for South and East Asia, the only regions with single-digit youth unemployment. Young people are nearly three times as likely as adults to be unemployed. Last year the ILO caught a glimmer of hope. Poring over the data from 56 countries, researchers estimated that the number of unemployed 15- to 24-year-olds in those nations fell in 2010 by about 2 million, to just under 78 million. "At first we thought this was a good thing," says Steven Kapsos, an ILO economist. "It looked like youth were faring better in the labor market. But then what we started to realize was that labor force participation rates were plunging. Young people were just dropping out." Youth unemployment is tempting to dismiss. The young tend to have fewer obligations, after all, and plenty of time to save for retirement. They have the health and strength to enjoy their leisure. "I spend many hours a day playing soccer with my friends," says Musa Salhi, an 18- year-old Madrid resident who studied to be an electrician but hasn't worked in over a year. Even as fighters on horses and camels galloped through Cairo's Liberation Square on Feb. 2 and the U.N. estimated that 300 people had died in a week of clashes, the world's investors continued to perceive the consequences as largely local. The Standard & Poor's 500-stock index rose 1 percent in the week following the first mass protests on Jan. 25. Crude oil prices rose less than 4 percent over the period. But the failure to launch has serious consequences for society - as Egypt's Mubarak and Tunisia's overthrown President, Zine al-Abidine Ben Ali, discovered. So did Iranian President Mahmoud Ahmadinejad, who in 2009 dispatched baton-wielding police against youths protesting his disputed reelection. "Educated youth have been in the vanguard of rebellions against authority certainly since the French Revolution and in some cases even earlier," says Jack A. Goldstone, a sociologist at George Mason University School of Public Policy. In December the French government released a report on the nation's Sensitive Urban Zones, also known as banlieues, which said that the young men in the neighborhoods find it "extremely difficult" to integrate into the economic mainstream. The heavily Muslim banlieues exploded into rioting in 2005; last year a series of violent attacks there brought police face to face with youths brandishing AK-47s. A demographic bulge is contributing to the tensions in North Africa and the Middle East, where people aged 15-29 make up the largest share of the population ever, according to multiple demographic sources. The Egyptian pyramid that matters now is the one representing the population's age structure - wide at the young bottom, narrow at the old top. Fifteen- to 29-year-olds account for 34 percent of the population in Iran, 30 percent in Jordan, and 29 percent in Egypt and Morocco. (The U.S. figure is 21 percent.) That share will shrink because the baby boom of two decades ago was followed by a baby bust. For now, though, it's corrosive. In a nation with a healthy economy, a burst of new talent on the scene spurs growth. But the sclerotic and autocratic states of the Middle East are ill-equipped to take advantage of this demographic dividend. Sitting at the fringes of a protest in Cairo's Liberation Square on Jan. 29 and wearing a bright yellow head scarf, Soad Mohammed Ali says she hasn't found work since graduating from Cairo University with a law degree - nearly 10 years ago. She says the only offer of government work she has received is cleaning jobs at $40 a month. At age 30, Ali says, "I am old now." For the young jobless, enforced leisure can be agony. Musa Salhi, the Spanish soccer player, says, "I feel bored all the time, especially in the mornings. My parents really need and want me to start working." In Belfast, Northern Ireland, 19-year-old Declan Maguire says he applied for 15 jobs in the past three weeks and heard nothing back. "I would consider emigrating, but I don't even have the money to do that. It is so demoralizing." For decades, Mubarak coped with Egypt's youth unemployment problem by expanding college enrollments. That strategy couldn't last forever. This past March, scholars Ragui Assaad and Samantha Constant of the Middle East Youth Initiative, a venture of Brookings Institution and the Dubai School of Government, put it bluntly: "In Egypt, educated young people who spend years searching for formal employment, mostly in the public sector, are now forgoing this prospect as the supply of government jobs dries up. Formal private sector employment - quite limited in the first place - is not growing fast enough... Hence, young people are left with either precarious informal wage employment or expected to simply create a job for themselves in Egypt's vast informal economy." Even so, rich democracies ignore youth unemployment at their peril. In the 34 industrialized nations in the Organization for Economic Cooperation and Development, at least 16.7 million young people are not employed, in school, or in training, and about 10 million of those aren't even looking, the OECD said in December 2010. In the most- developed nations, the job market has split between high-paying jobs that many workers aren't qualified for and low-paying jobs that they can't live on, says Harry J. Holzer, a public policy professor at Georgetown University and co-author of a new book, Where Are All the Good Jobs Going? Many of the jobs that once paid good wages to high school graduates have been automated or outsourced. The spike in youth unemployment should ease in the West as the after- effects of the 2008 financial crisis diminish. Eventually, growth will resume in the U.S., Europe, Japan, and other nations. The retirement of the baby boomers will increase demand for younger workers. "I believe the tables will turn. Employers will be lining up" for younger workers, says Philip J. Jennings, general secretary of UNI Global Union, an international federation of labor unions with 20 million members. That's cold comfort to the young people who are out of work now. The short term has become distressingly long. Although the recession ended in the summer of 2009, youth unemployment remains near its cyclical peak. In the U.S., 18 percent of 16- to 24-year-olds were unemployed in December 2010, according to the Labor Dept., a year and a half after the recession technically ended. For blacks of the same age it was 27 percent. What keeps the numbers from being even higher is that many teens have simply given up. Some are sitting on couches. Others are in school, which can be a dead end itself. The percentage of American 16- to 19-year-olds who are employed has fallen to below 26 percent, a record low. What's more, when jobs do come back, employers might choose to reach past today's unemployed, who may appear to be damaged goods, and pick from the next crop of fresh-faced grads. Starting one's career during a recession can have long-term negative consequences. Lisa B. Kahn, an economist at the Yale School of Management, estimates that for white, male college students in the U.S., a 1 percentage point increase in the unemployment rate at the time of graduation causes an initial wage loss of 6 percent to 7 percent - and even after 15 years the recession graduates earn about 2.5 percent less than they would have if they had not come out of school during a downturn. There's a psychological impact as well. "Individuals growing up during recessions tend to believe that success in life depends more on luck than on effort, support more government redistribution, but are less confident in public institutions," conclude Paola Giuliano of UCLA's Anderson School of Management and Antonio Spilimbergo of the International Monetary Fund in a 2009 study. Downturns, the study suggests, breed self- doubting liberals. The coincidence of protests in Egypt and record youth unemployment elsewhere has caught the attention of the world's most powerful capitalists and diplomats. At this year's World Economic Forum in Davos, Switzerland, held while Cairo was in chaos, the hallways buzzed with can-do talk about improving employment opportunities for the young. Even before the latest whiff of grapeshot, the U.N. declared the year beginning last August as the International Year of Youth. In December the Blackstone Group (BX) and CNBC held a conference in London with top experts to discuss solutions to youth unemployment. Companies from AT&T (T) to Accenture (ACN) to Siemens (SI) are working on ways to prepare high school and college students for the working world. The only surefire cure for youth unemployment, however, is strong, sustained economic growth that generates so much demand for labor that employers have no choice but to hire the young. Economists have been breaking their teeth on that goal for decades. "If we knew how to get growth right we'd win the Nobel Prize," says Wendy Cunningham, a specialist in youth development at the World Bank in Washington. To free-market economists, one solution to youth unemployment is simple: Clear away the government-imposed obstacles to hiring young people. They blame high minimum wages, for instance, for discouraging companies from hiring promising young people who haven't had a chance to accumulate the knowledge or experience to justify being paid even the minimum wage. Following that counsel, most European countries, where minimum wages are high relative to average pay, have lower minimums for young workers. (The evidence is that high minimum wages do exclude some young people, while benefiting others by raising their pay.) Likewise, too-strong protections for the permanent workforce can hurt young people because they aren't similarly protected and bear the brunt of downsizing in hard times, the ILO warned in a 2009 report. Right or wrong, the free-market argument hasn't carried the day: Britain and New Zealand actually raised their minimum wages during the global downturn. And the argument for the negative effect of worker protections hasn't convinced Austria and Germany, which have strong employment regulation and yet have had healthier job markets in the past two years than countries such as the U.S. with fewer worker protections. Thea Lee, deputy chief of staff at the AFL-CIO, argues that unions can't be blamed for high youth unemployment: "Business likes to have workers with no power, no rights, no protections." 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 atjoel@dailyreckoning.com Ben Bernanke’s Hot Money As anticipated, “higher commodities shrink profit margins,” reports Barron’s. Some analysts were justifying high stock prices on the grounds that earnings were at record highs. Of course, if they were at record highs, we commented, they would most likely come down. What’s bringing them down? Ben Bernanke’s hot money. He juices up the world’s hot money. Commodity prices go up. Growth or Hot Money: What’s Really Affecting Food Prices Governments Struggle to Stand Still Buying Silver While It’s Still Relatively Cheap James Cook of InvestmentRarities.com reminds us, in his “Market Update” newsletter, that the silver inventory held above ground totals 1.4 billion ounces, and that annual industrial use of silver is 900 million ounces, so that a year and half’s worth of silver exists, “although a third of it is destined for industrial consumption,” which has been increasing its use of silver by 18% in 2010. The Government-Gold Screw Job of 1933 Why Food Prices Must Go Up Options A Brief History Options may be the most lucrative type of investment you’ll ever find. Just a small option investment can turn into massive gains. Why? Because each option contract controls the profit potential of an investment many times the size of the actual amount you have at risk. In my options trading service, Options Hotline, I’ve been able to show readers various triple and quadruple-digit returns. Is the Carry Trade Returning to the Markets? The Inflation Tipping Point (Part Two of Four)