 | | The Daily Reckoning | Monday, October 31, 2011 |
- Rally like it's 1974...why arepeat of the last 37 years is unlikely,
- AAA Governments: on the verge of extinction?
- Plus, Bill Bonner on unsustainable debt-based growth and the trouble with employing the French...
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|  | | | Dangerously Attractive Figures | | Rallies in October from the Past, Present and Future | |  | | Joel Bowman |
Reporting from Buenos Aires, Argentina...
Despite a dose of reasonably severe buyer’s remorse dampening markets today, the month of October turned out to be a stellar stretch for the bulls.
The thirty bluest American chips, as measured by the Dow Jones Industrial Average, closed up almost 10% for the month, even after today’s 200+-point shellacking. The broader market faired even better with the S&P 500 boasting gains just shy of 11% over the same period. The NASDAQ, not to be outdone, led the three major averages, closing the month out more than 11% higher than where it began.
Any way you slice them, you’re looking at some pretty attractive figures. But whatkind of attractive figures are we talking about here?
Are they innocently attractive in the “boy-meets-girl-at-local-fair” way, the kind that leads to blossoming summer romances and that end up in little church-on-the-hill wedding ceremonies? Or are they dangerously attractive in the “married-man-meets-woman-in-hotel-bar” way, the kind that leads to empty, withering marriages and that wind up in costly lawyer’s-office-downtown divorce proceedings?
We don’t know the answer to that, of course. Nobody does. But we do know that chasing seductive stock market tops can be a risky, not to mention costly, business. The same goes for chasing seductive tops in hotel bars.
That’s not to say that all dangerous liaisons must necessarily end in heartache and tears, mind you. Far from it. Sometimes, what looks like a dangerous top turns out, with the benefit of hindsight, to have in fact been a phenomenal bottom.
The last time the S&P 500 turned in such an impressive monthly performance, for example, was back in October of 1974. Most of those hard-won gains were wiped out by Christmas of that year, yes, but the autumnal nadir did prove an important turning point for the markets. Indeed, the Index has never again retreated below its October 4, 1974 reading of 62 points. A decade later it had gone on to more than double, clocking in at 167 points. By October of 1994, twenty years since that epic, late ’74 rally, the S&P was within 35 points of eclipsing 500 for the very first time. And by 2004, even after the fallout from the 2000-2001 tech bubble had erased roughly one third of its value, the S&P 500 stood rather handsomely, above 1,000.
So will the October rally of 2011 mirror the October rally of 1974? Or, more to the point, will the market conditions that prevailed subsequent to the ’74 rally, conditions that allowed for a near 18- fold increase over three decades, visit us again? Tracking a similar trajectory would imply a 2021 S&P 500 reading of about 3,400...and a 2031 reading of roughly 9,500...and an October 31, 2041 close somewhere in the vicinity of 22,200.
Alas, the United States of three-and-a-half decades ago is very different from the United States of today. Bill has written extensively in these pages about how the “average working stiff” hasn’t had a raise — in real, inflation-adjusted terms — since 1974. More and more women entered the workforce, yes, but inflation robbed most of their productive input, leaving medium household income about where it was shortly after Nixon cut the nation’s currency from its golden anchor. At home, American families are today where they were 35 years ago...and working twice as hard to stay there.
And it’s not just domestically where things have gone backwards. There’s also the cost of maintaining the warfare state, a notoriously costly imperial pastime. Aside from the relatively short Persian Gulf War of 1990-91 and a couple of skirmishes in Grenada (1983) and Panama (1989), the US went largely without major armed conflict during the three decades immediately preceding the twenty- first century.
Today, the United States is a decade deep into its invasion of Afghanistan and eight years into its invasion of Iraq, two countries the majority of Americans probably didn’t even know existed in 1974. According to the Center for Defense Information, the estimated cost of these two wars will reach $1.29 trillion by the end of fiscal year 2011. And that’s to say nothing of either the human or geopolitical costs, or of the growing costs related to its various other military entanglements in Pakistan...Libya...Somalia...and “elsewhere.”
And the money to fund all this? Put simply, it’s not there. In 1974, the United States had a gross public debt of roughly $689 billion, equal to around 45% of GDP. This year, gross debt will exceed GDP...somewhere around the $15 trillion mark. Again, most people on the street during the 1970s had probably never even stopped to consider “what comes after a billion.”
Again, your editor has no idea what the S&P 500 reading will be on the close of business three decades from now...or even if the S&P 500 will even exist. Nobody does. But it seems that the United States of 2011 faces stiffer headwinds than did the United States of three and a half decades ago.
Occasionally, with the benefit of hindsight, a risky top does turn out to be a phenomenon bottom in disguise. More often, however, dangerously seductive tops tend to precede the horror of bigger, fatter bottoms still to come.
| | | | Can Ronald Reagan Save You from Obama? |
I know it’s hard out there in the markets. Obama and Bernanke have made a mess of the economy, crushing jobs and retirements from coast to coast.
But did you know about this maverick law that Ronald Reagan signed on October 22, 1986? It could be the VERY THING that prevents your retirement from taking any more hits from Obama Team.
Watch the urgent presentation on the power of the “10-86” law right now.
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| | The Daily Reckoning Presents | | Dinosaurs, Dodos and AAA Governments | |  | | AddisonWiggin |
The history of sovereign finance is a history of broken promises. Governments are very good at stiffing their creditors.
During the boom phase of a lending cycle, creditors tend to forget this inconvenient truth. They forget that government borrowers are nothing like corporate borrowers. They forget that government revenues derive from confiscation, rather than production.
As a result, during the boom phase, creditors demand much lower interest rates from government borrowers than they do from similarly rated corporate borrowers.
During the bust phase, however, creditors start to remember how dangerous government borrowers can be. They start to remember that when times are tough, governments have a tough time confiscating enough national wealth to repay their bills.
Such is the predicament in which Greece finds itself today. But the Greek government is hardly unique. Greece may be the poster child of distressed sovereign borrowers, but its grim financial predicament is not so different from that of Portugal, Spain, Italy or a dozen other sovereign borrowers around the globe... including the United States.
Accordingly, the cost of insuring a 5-year Treasury note against default is now higher than the price of insuring a 5-year Johnson & Johnson (NYSE:JNJ) bond against default. These “insurance policies” are called “credit default swaps” (CDS). And just like an ordinary insurance policy, the greater the perceived risk of an insurance claim, the higher the price of the insurance.
As you can see in the chart above, the CDS price on a 5-year US Treasury has been inching higher and is now above the price of a J&J CDS.
It may seem surprising that CDS buyers would consider Treasury debt riskier than J&J debt. And it is somewhat surprising, until you consider that J&J is the 125-year-old AAA corporation that throws off $14 billion of free cash flow per year, while the US Treasury is the 222-year-old former AAA federal agency that generates more than $1 trillion of negative cash flow per year.
In light of that comparison, the only surprise is that the prices of CDS on Treasury debt are not higher still.
The credit downgrades that are showering down on the sovereign borrowers of Europe and elsewhere are upending a generations-long belief that government bonds are “safer” than corporate bonds... and for good reason.
Throughout the Western world, governments are struggling to confiscate enough wealth to repay their creditors. Meanwhile, many large corporations around the globe have never been in better financial shape in their entire corporate lives.
Consider the striking contrast between the debt levels of the US government compared with the debt levels of the S&P 500 companies. One decade ago, when the Clinton administration was relishing America’s last annual budget surplus, US debt-to-GDP was floating around the 60% level. At that same moment in history, the debt-to- revenue of the S&P 500 companies was soaring to 90%.
Over the next six years, US debt-to-GDP inched up to 66%, while the S&P 500’s debt-to-revenue jumped to 111%! But then a funny thing happened... corporate debt levels plummeted, while Uncle Sam’s debt levels soared.
The Crisis of 2008 pushed hundreds of billions of dollars of corporate debt into bankruptcy or onto the Federal Reserve’s balance sheet, thereby producing the precipitous drop in corporate credit levels from 2007-09. But since then, corporations have continued to retire debt and to bolster their balance sheets with cash.
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Meanwhile, thanks to a variety of costly “stimulus measures,” along with the inexorable upward climb of entitlement expenditures, the US government is now counting its annual deficits in trillions, rather than billions. Accordingly, America’s debt-to-GDP has soared from the mid-60% level to nearly 100%.
Municipal finances in the States are also deteriorating rapidly. Rating activity in the “muni” market during the first half of 2011 marked the ninth and 10th consecutive quarters in which downgrades in the municipal sector exceeded upgrades, according to Moody’s.
“With negative outlooks assigned to all major municipal sectors, the trend is likely to prevail for all of 2011,” the ratings agency grimly predicts.
Once the preserve of widows and orphans, the muni bond market has become a game of chance that would feel at home on any casino floor — right between the craps table and the roulette wheel.
The deteriorating condition of government finances worldwide is causing an entire generation of investors to question the value of a government guarantee, at least in comparison to the value of a strong corporate balance sheet.
This loss of faith in a government guarantee is already forcing government bond yields higher in most parts of the globe. But the potential consequences of this lost faith extend far beyond the bond market.
If investors lose faith in sovereign debt, they are not far away from losing faith in all government guarantees, like the guarantee that a government will make good on its entitlement promises or on its implicit guarantee to preserve the power of its currency.
In other words, the fissures opening in the sovereign credit markets may be signaling the beginning of a tectonic shift in global finance — a shift that forces investors to select investments according to their real-world merit, rather than their government-contrived merit.
Once a government starts breaking its promises, all government guarantees are in jeopardy.
Regards,
Addison Wiggin,
for The Daily Reckoning
Joel’s Note: By now, most of you would have heard about Addison’s brand new project, one he’s codenamed, “Project X.”
“It’s unlike anything we’ve ever done at Agora Financial,” says Addison of his mysterious endeavor. “It’s not a newsletter, or a book. It’s not a conference or even a documentary. But, provided we can pull it off,” he continues, “it does have the potential to revolutionize the way our readers look at the world...even how they create and preserve wealth.
“This is big,” concludes Addison. “And to say I’m a little nervous...well...that would be a vast understatement.”
If you haven’t yet viewed Addison’s invitation to join him (and 15,000+ of your Fellow Reckoners...and counting) on “Project X,” you’ve still got time...but not much.
Doors close this Thursday, after which time only those on the list will be privy to just what this mysterious, revolutionary project is and how it can serve you in the coming, uncertain times ahead. If you want in, act fast. Here’s what you need to know.
| | | | Addison Wiggin’s Apogee Advisory Presents... |
Why the warning behind this image could...
Forever change the way you think about the stock market...
Open your eyes to what you can and can’t expect from the United States government...
And even change the ease at which you’re able to buy and sell things...
Click the image play button to first learn the warning...and some simple ways to prepare for the uncertain times ahead.
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| | | | Bill Bonner | | A Delusional Belief in Debt-Based Growth | |  | | Bill Bonner |
Reckoning from Paris, France...
Last week, the bull market continued. Investors were sure that the bailout of Europe’s wobbly debtors was a done deal. The details of the deal have yet to be worked out. Just details, of course...such as who’s going to pay for it and where they’re going to get the money.
That, and whether Europe’s 17 nations will go along with it...when they finally figure out what “it” is.
For now, nobody knows.
Here’s how we look at it. After WWII, Europe rose from its ashes while America went from strength to strength. The entire developed, non-communist world — including Japan — enjoyed its “30 glorious years” of growth.
Then, something went wrong. The zombies gained power...and gradually shifted more and more resources to unproductive sectors. At the same time, the payoff from increased use of fossil fuels (the real cause of above-trend growth since the advent of the Industrial Revolution) reached the point of declining marginal utility. Energy prices rose and it was more and more difficult to find applications that would pay off.
Together, these phenomena caused real growth rates to decline. Neither in France nor in America have real wages shown significant improvement since. That is, for the last 40 years, the earnings of the typical working stiff have barely improved.
How to react to this challenge?
In the US, households ran down their balance sheets. They made up for the lack of income growth with debt growth. This allowed them to continue improving their standards of living until the 21st century.
In Europe, it was governments who ran down their balance sheets. They made up for the lack of income growth with increased public services, financed by debt. This allowed people to improve their standards of living even though they weren’t earning more money.
In terms of total debt, there is not much difference between the countries of Europe and the US. All have total debt-to-GDP ratios in the 250%-300% range. Some a bit more. Some a bit less. In Europe and Japan, the debt is concentrated in the public sector. In America, it is mostly in the private sector...with the public sector gaining ground fast.
Of course, the people who sell debt — namely, Wall Street, the City in London, and the rest of the financial industry — did wonderfully well. In America, for example, the percentage of total corporate profits coming from the financial industry rose 300% during the last three decades.
That is why people think the banks were the cause of the problem. Mostly, they were just in the right time at the right place to benefit from a trend that they didn’t cause and couldn’t possibly control.
Then, in 2007, the reckoning began. All of a sudden, the private sector in the US buckled under the weight of so much debt. People couldn’t pay their mortgages...and then the geniuses at the finance companies realized that they were broke. Their sliced and diced mortgage debt was not nearly as solid as they had thought.
Governments rushed to bail out the banks, who just happened to be large campaign contributors. The feds swamped themselves in the process. Iceland and Ireland were the first to sink. Then, all the periphery of Europe was shipping water.
Back in America, whole towns were soon underwater...such as Las Vegas and Orlando. In Europe, whole countries were submerged, such as Greece.
And what did the authorities do? What was their solution?
Alas, they are all one-trick ponies. And the only trick they know — adding more debt — doesn’t work. But they keep at it...lowering interest rates, offering more credit on EZ terms to everyone. Students are encouraged to shackle themselves to a lifetime of ball- and-chain education debt. Homeowners, who should swim away from their underwater houses, are encouraged to refinance. Everyone is encouraged to spend money he doesn’t have on products he doesn’t need so that the economy will go where it shouldn’t go — further into debt!
But even if the feds can get households to repeat their errors...they won’t be able to keep it up; they’re running out of money. A Wall Street Journal blog explains:
Like the Cardinals’ David Freese, the US consumer stepped up to the plate and hit one out of the park in the third quarter. Unless job and income gains pick up, though, the household sector may not get past first base this quarter.
Consumer spending powered the 2.5% annualized gain in real gross domestic product last quarter. The monthly numbers show spending ended the quarter on a very strong note in September, despite surveys showing the household sector very downbeat about the economy.
Can consumers keep buying in the fourth quarter?
There are, however, a few reasons for caution. Income gains are trailing spending increases. Personal income edged up just 0.1% in September. After taking price changes and taxes into account, real disposable income has fallen for three consecutive months.
As a result, last quarter’s spending gain came at the expense of savings. The September saving rate dipped to 3.6%, the lowest rate since the recession began in December 2007.
Consumers cannot ignore their nest eggs indefinitely. Households need to pay down existing debts (a form of saving) and to replenish retirement funds eroded during the financial crisis. A saving rate closer to 5% is needed to repair household finances.
Looking beyond the fourth quarter, much faster hiring and wage growth are needed to solidify the consumer outlook. Good luck on that!
Debt has become an impediment to growth, not a facilitator. Like energy, it reached the point of declining marginal utility years ago. The feds can still add debt — at least in America — but it won’t make the economy grow. Instead, it crushes it.
And when investors finally figure this out they will sell their stocks...and the markets will be free to complete their rendezvous with the bottom.
Stay tuned...
And more thoughts...
“We’re very glad we moved here. And both of our girls have thanked us.”
We were having dinner with an English/Dutch couple who had moved to France 12 years ago. They live out in the country, where he raises cereal crops and she teaches French to foreigners.
We had just explained how our children moved back to the US. Despite growing up in France and attending French schools most of their lives, they seem to want to make their lives in America.
“It is just the opposite for our children,” our friends explained. “At first, the girls weren’t so sure. They thought they wanted to go back to England. And they blamed us for ruining their lives, because they thought they had lost their identities.
“But when they went back to England they didn’t like it very much. I mean, we had visited many times. And my family still lives there. But when they went to university there they were a little shocked. They said that young people in Britain just want to get drunk. So, they both came back here.
“Of course, France is not an easy country. The people are very nice once you get to know them. But it’s a hard place to work or do business. There is so much bureaucracy...paperwork and taxes. And there’s such an us-versus-them tension in French working places. If you hire someone...they think you are the enemy. They treat you like you were a rich capitalist. Even if you’re just a small farmer like me. Then, you spend your time filling out forms and trying to figure out how the labor system works. And if you come across a rotten apple employee, they take advantage of you.
“I prefer to work with English or Dutch people. It’s just easier to get along with them.”
*** “France is screwed,” said a friend at a wedding on Saturday. “We think we’re going to finance this bailout of Greece and Portugal...and the banks. But who’s going to bail us out? We think we have such a strong economy, but our figures are actually worse than those of Italy or Spain. And we don’t have any margin for error. We already have the highest taxes in Europe. Raising taxes to cover deficits is out of the question. And you know how much we have in our accounts to pay for our pension system? Nothing. There’s nothing there. It’s all a gigantic fraud that we’re going to discover later. And then we’re screwed.”
Regards,
Bill Bonner
for The Daily Reckoning
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