'Tis Only My Opinion!

July 2002 - Volume 22, Number 7


...Some of the People most of the time, ...

Accounting problems continue to erode Confidence

The WorldCom, Dynergy, Tyco, ImClone, Xerox and other corporate revelations and the disaster in the telecom industry sector thrust more daggers into the confidence of the world's investors into the U.S. markets. 

Here is a snippet of a telephone conversation  between unknown parties that illuminates clearly the problem facing the Bush Administration and the U.S. public.

This morning I was on the telephone to my wife over in Hamburg Germany where she is visiting. She tells me that on some financial TV show a participant was exclaiming about how, "......... as all the indexes were recovering, and why was it not a good time to invest in American equities?"

The commentator stated that, "NONE of the data, statistics and information coming from the United States has any credibility."

The result of this confidence erosion can be clearly seen in the performance of the stock market indices since January 1st.

Let there be no mistake, we are in a bear market and the bottom lies somewhere below here. The market is testing the 9-11 lows. The end of quarter window dressing efforts and outright manipulation of the market held off the slide through those lows. However, the fact that corporate insiders are selling stock by a 4:1 ratio or more during the 2nd quarter suggests to me that the profit recovery is not in sight for many companies.

As a result, while many analysts expect a rally to take place in the 3rd quarter, it may be very brief and the market may continue to slide towards more normal historic P/E ratio valuations.  The layoffs announced in the last two weeks of June and the fall in consumer confidence as well as the weakness in retail sales including auto's suggests to me that we may have started the downward leg of a "W" recession. 

The real question is "Where are the corporate profits that will justify a rally?"  While most analysts expect a small increase in the 2nd quarter profits, we need to keep in mind the following chart.

Profit recovery in the 1st quarter was anemic.  With the magnifying glass now on corporate income statements, I have serious doubts about whether the 2nd quarter will be positive.  Two main reasons are:

  • Corporations will be exceedingly careful in their accounting and items which may have been previously capitalized will find their way to the income statement reducing earnings.

  • In addition, the rate of return on pensions which many corporations have calculated at 8-10% or more will be reduced to more realistic levels also decreasing earnings.

If P/E ratios fall only to the median of the last five year average P/E ratios, we are in trouble. Based upon GAPP forward EPS estimates this market could fall by another 30-40% or more.  The table below indicates the potential stock averages before the end of the year.

Index 6-28-2002  Possible
DJIA 9243.26 5500-6500
NASDAQ 1463.21 600-750
S&P 500 989.82 500-600
Russell 2000 462.64 305-350
Gold Index (XAU) 71.46 100-150

The trickle of funds moving out of the U.S. to other markets and into other investment vehicles will likely increase exponentially during the next few months.

According to Bridgewater Associates, foreigners currently hold 48% of the U.S. Treasury bond market, 24% of the U.S. corporate bond market, and, through their equity holdings, 22% of all U.S. corporations.

In total, foreigners hold $US 8 TRILLION of U.S. financial assets.

The Achilles heel of this market is that fact that the $1.5 Billion per day that is needed to finance our ballooning Trade Balance of Payments is in dire jeopardy.  Early indications are that in June, the Capital Inflow has slowed to less than $100 Million per day.  As a result, the Federal Reserve has had to keep the printing presses running.   The growth in M3 is staggering on an annual basis.


One economist recently stated that it takes $68 in M3 growth to get $1 growth in GDP. At some point, those printed dollars will become worth what all fiat currencies become -- priced at their marginal cost of production.

When Congress finally passed the $450 Billion federal debt increase on Thursday night, June 27, 2002, the jig was up. Foreigners were now convinced that the US debt would never be repaid.  I expect that during the next quarter, we will begin to see a further increase in the flow of money overseas from both foreign investor as well as domestic investors.

If that happens, the pressure will be on the markets and they will continue to fall.  The market could drop drastically if only 20% of those foreigners holding US equity and or debt positions decided to get out. 

The conclusion of the G-8 meeting saw action taken by the major central banks, FED, ECB, and the BOJ to intervene in the markets to stop the slide of the dollar on Thursday, June 27th, and in the last 30 minutes of trading on Friday, June 28th, to clobber gold.  Unless you want to drive the price down, no reasonable investor sells 20,000 contracts of gold at market in the last 30 minutes of trading after many of the large traders have gone home! Despite the estimated $28 billion poured into the effort by the Bank of Japan in the last two weeks of June, the dollar's slide was only temporarily arrested.

On Thursday, the Euro momentarily came within a whisker of reaching parity with the US dollar until the European Central Bank intervened to stop the rise. During the past month, the dollar has fallen against every major trading currency except the Mexican peso.

As the flood begins, any hope for an improvement in the major stock indices should vanish until the Price/Earnings ratios approach levels more consistent with historic levels.  Unfortunately, that means that these indices will probably fall considerably from the June 30th levels.

Those analysts who view the action of the market during the past week as the bottom will likely be proven wrong as the Plunge Protection Team will be unable to plus the dike.  They don't have enough fingers!

It is entirely possible that the US Dollar index could fall to the low-mid 80's before the end of the year. 


Arrogance beyond belief!

At this year's West Point graduation, George Bush, the President of the U.S., made official the policy of an American Empire as he stated:


  • "America has - AND INTENDS TO KEEP - MILITARY STRENGTHS BEYOND CHALLENGE, thereby making the destabilizing arms races of other eras pointless and limiting rivalries to trade and other pursuits of peace."

This statement should send fear into every American citizen's heart and brain.  With our currency under attack, the freedoms which the Constitution and Bill of Rights guaranteed destroyed by the Patriot Act, we are now told by our President that we will maintain a military so powerful that no one can challenge us.

Unfortunately, the costs to the world and the American public of the Presidents statement were not well thought out by either the President, his advisors or his speech writers.

From the Privateer, an Australian newsletter, the following is noted:

"Reflect calmly upon the above statement. It is a political statement of policy, which for the first time in world history, relegates all other nations to a secondary status. Literally, it lays down as a global law, the principle that the United States will act, militarily if it must, to deny all other nations a co-equal standing. Conversely, it condemns all individual Americans to sustain this global unchallengeable military supremacy economically as well as in actual military action. It will, inescapably, militarize life inside the United States. The U.S. civil economy will have, as its central purpose, the sustaining and maintaining of this global military supremacy, with the inescapable economic consequence that private individual Americans will be poor, or poorer than they otherwise would have been. The U.S. military will, on the other hand, be "rich".

There is only one way to avoid making the U.S. military "rich" at the direct expense of American individuals. In ancient Rome, this was called "tribute". It is the extraction of wealth - BY FORCE - from the rest of the world."

The Privateer suggests that the only way to stop the American Empire is to prevent the flow of funds to the United States. 

"The U.S. requires an annual inflow of $US 420 Billion to fund its current account deficit. This inflow adds to U.S. net external debts. Were that inflow to slow or to stop, the U.S. Dollar would have to fall in value, as it is currently doing. But what would happen if this inflow turned into an accelerating outflow?


Many foreign investors and politicians are well aware of Mr. Bush's historic policy change. And they don't like it.  As a result, they now have another reason to withdraw their funds from the US markets.


The Foreign Capital Flows

The following chart from the Contrary Investor shows the problem.

While it is clear that the totals have fallen from the peak, the real question is,

 "What happens if foreign capital flows turn negative?"

 Based upon the falling dollar and the fact that many overseas markets have outperformed US markets for the last six months, that is a real possibility.  The following table shows just how badly the U.S. market which is negative has done against major foreign markets through May 2002.

Ask yourself . . . why do you stay in a market which is falling?  To the foreign investor, the answer to that question is obvious.  And that is why, the trickle of money into the U.S. from private foreign sources to fund our huge balance of payments is about to stop.  For a time, however, I would expect that the Bush Administration will arm-twist foreign governments into attempting to fight the inevitable downward slide by throwing good money after bad. 


The SEC needs a complete overhaul

Apologists will say that the SEC has been hamstrung by lack of manpower and its budget to do its job.

I'm sorry but the whole SEC staff needs to be fired. The agency has largely overlooked the major problems facing the credibility of the markets and spent most of its man-hours and budget chasing small firms that don't have the muscle to fight.  It took the NY attorney general to even look into the Merrill Lynch problem.  However, the verdict was only a $100 Million fine and no jail time for Merrill Lynch employees.  But were any of the investors reimbursed by the settlement? NO. The lousy $100 million fine went to the government.

Those individuals who make a living by investing and/or recommending stocks to the public should be held to high standards.  The Merrill Lynch settlement is a farce . . . something Merrill Lynch probably considers "just a cost of doing business!"  Moreover, aren't you offended by the full page ads that Merrill's top people are taking out in many publications?

The turf-wars between the state governments and the SEC also need to be fixed.  If the SEC was truly an agency with teeth and not staffed by people whose next job was in the securities industry or government, a lot of people would be going to jail.

We send three-time felons to jail for life in California for stealing less than $25 in groceries. Yet, Merrill Lynch fleeces investors of billions of dollars through its recommendations and gets a $100 million fine and no one goes to jail.  PLEASE!

While the SEC requires full disclosure of facts, today's 10-K, 10-Q and the prospectus is so difficult for most people to fathom, that very few really have the time to understand the data contained therein.  As a result, many investors rely on the analyst, newsletters or brokerage house to provide them with information. Unfortunately, the quality of that information is often non-existent.

Jack Grubman of Salomon Smith Barney as well as Amy Joseph Cohen of Goldman, Sachs to name just two exalted mouthpieces have cost investors billions of dollars based upon recommendations and lousy research.  Yet, there they are on TV and quoted in the paper continuing to push stocks.

Despite two years of falling stock prices, how many sell recommendations have been made by any of the major brokerage houses.  Look at the record on Enron and WorldCom.  Brokerage houses were still recommending the purchase of those stocks almost up to the Chapter 11 filing.

One thing the SEC could do is to keep a scorecard of every analyst's recommendation and if an analyst's recommendations failed to increase in value more than 50% of the time, their credentials should be lifted.

Until the SEC gets tough and starts pulling licenses of major players, sends people to jail, the little Main Street investor does not have a prayer in the manipulated markets.

Yet, they are still being told to "Buy and Hold" for the market will come back. When, I ask, in 20 to 30 years?

The erosion of confidence in the markets by both domestic and foreign investors may have generational effects.  For once lost, it takes a generation or two before confidence can be restored.

President Bush and the Republicans blew it!

When President Bush and the Republican majorities in both houses did not forcefully attack the former Clinton administration policies and immediately set out to instill a strict accountability code and go after the transgressions of the previous 8 years, the die was cast.

Now we are facing a "W" type recession just before the mid-term elections with the economy in trouble, our dollar sliding, and the markets tanking.

They can play the statistics game of hedonic, seasonal, core, non-core, productivity numbers to suggest that the economy is coming back and that there is little or no inflation.

Unfortunately, they are inside the Beltway and  don't have any inkling of the economy outside of the Beltway.  We have many friends and classmates who have spent most of their lives living inside of the Beltway.  Whenever we get together or talk on the phone, I often wonder if we live in the same country.

The real world sees property taxes up, insurance costs increasing, food prices rising, farm prices at record lows, prescription drug prices soaring and jobs continuing to disappear.

Bush's failure to move decisively and set a new mood in 2000 and demand that the people of this nation return to the fundamentals on which this country was founded will make the mid-term elections very interesting.  The Republicans could lose both the Senate and House.

The Bush Administration will be blamed for the economy!

Also, a growing number of citizens are finally realizing what has happened to their freedoms as Bush's "perpetual war against terror" takes center stage.  Little by little, the noose is being tightened.  Remember those asset forfeiture laws which were only going to be used against the Mafia and drug dealers.  Well, the Patriot Act will be expanded to be used against citizens who are not terrorists.  We know have librarians reporting on what books you've read!

Airline security is a joke!  Weekly, no daily, terrorist threats are beginning to numb the senses. Refusing to arm pilots (although less than 8 months ago, they could be armed) while allowing them to pilot an airplane is not only stupid but could only have been made by an irrational mind.

The founders of our nation and those who wrote the Bill of Rights must be wondering when, not if, as Benjamin Franklin said, "We've given you a Republic . . . can you keep it?"


Will the Sierra Club and its friends be blamed for their policies.

For the last 30 years, the environmental movement has created problems throughout the world and the US. The Sierra Club has been at the forefront of many of the practices which have stopped logging, removed roads and bridges into the forests, and generally stopped economic development in large portions of the Western United States and the Southeast.

So far this year, we are experiencing the worst fire season on record. Perhaps, the members of the environmental groups should admit that we have already burned more lumber during the past two years thanks to the policies that they were largely instrumental in adopting than the logging industry would have cut in more than a decade.

Some day they will be held responsible.

Where to now?

The storm that is facing the US dollar may be more fierce and have more long-lasting effects than the forest fires that are ravaging many areas of the West.

The next few months may be very difficult for the economy and the pocketbooks of American citizens.  Let us hope that at least some of the economy is not consumed by the coming storm.

I would urge you to down-size, build your cash reserves, be very careful.  For in this environment, you must be aware that capital preservation is more important than capital appreciation.

But then - 'Tis Only My Opinion!

Fred Richards
July 2002

Corruptisima republica plurimae leges. [The more corrupt a republic, the more laws.] -- Tacitus, Annals III 27

This issue of 'Tis Only My Opinion was copyrighted by Adrich Corporation in 2002.
All rights reserved. Quotation with attribution is encouraged.
Tis Only My Opinion is intended to provoke thinking, then dialogue among our readers.

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Last revised - July 7, 2008