* * * * * * * * * * * * REMINDER * * * * * * * * * * * * *
On the days that I don't publish, like today, you will
receive Bill Bonner's DAILY RECKONING. This will help you
to keep pace with the changes in the markets. Bonner and
I agree on most things in the field of economics, so the
two letters will reinforce each other.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * *
The Lazy Investor's Reward
The Daily Reckoning
Baltimore, Maryland
Thursday, September 09, 2004
---------------------
*** Global recession in 2005? Feeding the enormous maw...
*** Traction... or an economy in traction? On the hunt for Dr.
Richeb�cher...
*** What Americans can do... the Chinese do bigger... Pickett's
charge, Pickett's fence... and more!
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O Lord, it comes this. The fate of the world as we know it rests
in the feeble hands of the American consumer.
"After a year of revising growth forecasts higher," said an
economist at Deutsche Asset Management on the eve of the Fed's
meeting at the J-hole a few weeks back, "we may have leapfrogged
too far."
"It is a global cycle that has never really got to
self-sustaining, cumulative recovery mode," added Stephen Roach.
"There is nothing mature about [the recovery] except the
imbalances. How strong will the recovery be when the stimulus
steroids wear off?"
In his report on the Morgan Stanley Web site this week, the
excellent Mr. Roach shows that between the two of them, the U.S.
and Chinese economies share a disproportionate amount of blame
for world economic growth over the past decade. In fact, from
1996 to 2003, U.S. demand and Chinese production account for
nearly half of the world's GDP growth.
For his part, the U.S. consumer consumed at a rate 75% faster
than anywhere else in the developed world. "It is hardly an
exaggeration," concludes Mr. Roach, "to conclude that the
American consumer has been the engine on the demand side of the
global growth equation since 1995."
And yet, wages for those same consumers have failed to keep pace
with inflation. How can they continue to be the engine of the
"demand side of the global growth equation," we ask, with the
redundancy of a 4-year-old asking for candy at the checkout line
of a grocery store. And answer with the irritable repetition of
said child's parent: "Dddddeebbbbttt!"
"Consumer borrowing up sharply in July," reads a headline in this
morning's L.A. Times, as if to punctuate the irritation with
tedious facts. "I have been expecting the savings-short, overly
indebted and income constrained U.S. consumer to slow down for
some time now," says Roach. "A slowdown in the United States
[demand] and China [production]... have raised the risk of a
global recession in 2005."
We Daily Reckoners might have said something similar ourselves,
had anyone bothered to ask.
Perhaps the greatest disproportion growing in the world today is
in the Chinese economy itself. In an attempt to feed the enormous
maw at the center of the Western Hemisphere, the Chinese have
spent 46% of their GDP on their export industry.
That figure dwarfs the eerily similar export-driven bubble that
crushed the Japanese economy in the late '80s. More on this
staggering factoid from Tom Dyson, below...
---------------------
Tom Dyson, from just across the room...
- Here's yesterday's word of the day: "traction." Greenspan said
it. He was delivering a testimony to the House Budget Committee.
- "The most recent data suggest that, on the whole, the expansion
has regained some traction," said the sheriff of E-Z County.
Greenspan maintains the weak performance in June, economically
speaking, was just a soft spot. Now he thinks we're back on the
path. He suggested to the House that consumer spending and
housing starts had rebounded significantly in July and August, as
had business investment.
- But what's this - maybe he's not quite the optimist we had him
marked as: "If it weren't for oil prices, I would be very
optimistic about where the economy is going," said he. Oil prices
have receded over the last couple of weeks. From a high of $49.40
achieved on August 20, they have fallen over 13% to $42.77 at
close yesterday. Yesterday the black goo declined another 54
cents.
- Here at The Daily Reckoning, we detect a hint of newly injected
caution in the maestro's speech. It wasn't just his comment on
oil, either. He spent a large proportion of his speech
criticizing budget deficits. Long-term prospects "remain
troubling," he warned. "Short of an outsized acceleration of
structural productivity or a major expansion in immigration, the
state of relative tranquility will end soon."
- The markets must have detected his hesitancy, too - or maybe
the "regained traction" comment caused traders to fret about
another 25-basis-point hike in interest rates at the next FOMC
meeting. Either way, Mr. Market humped off in a sulk. The Dow
dipped 29 points, down to 10,313, while the Nasdaq lost 8. The
S&P ended the session at 1,116, about 5 points lower for the
session.
- "Former Fed chief Paul Volker once declared, 'Sometimes I think
that the job of central bankers is to prove Kurt Richeb�cher
wrong.' Good luck, Mr. Greenspan. Dr. Richeb�cher has a much
stronger track record for being right about the economy than
you," writes good friend of The Daily Reckoning and International
Man Thom Hickling in a missive sent yesterday.
- Thom was at the Gare du Lyon in Paris when he e-mailed us. He
was just about to board the TGV to Cannes. Thom is on a mission
to track down world-famous economist Dr. Richeb�cher at his house
on the French Riviera.
- "In just the few minutes that I was on the phone with Kurt to
set up our meeting," Hickling states, "he was already shocking me
with crystal-clear perceptions on the global economy." Readers
might conclude the good doctor doesn't believe in small talk;
they'd be wrong. This is Richeb�cher's version of small talk. You
see, with an inhuman tolerance for minute statistical detail and
the patience and thoroughness to pick through reports and data
releases, Dr. R. finds things the other lazy economists
overlook.
- For instance, this comes from a sneak preview of October's
Richeb�cher Letter: "During 2003, no less than 58% of China's
imports of goods and services came from Asia, as against 8% from
the United States and 13% from the European Union. In short,
China is running a big trade deficit within the region.
- "But China's trade deficit with the Asian countries has been
more than matched by trade surpluses earned in the United States
($88 billion in 2003) and in the European Union ($29 billion).
During the first half of 2004, China's U.S. surplus was up to
$137 billion when presented as an annual rate. Overall, China
had, in 2003, a trade surplus of about $29.6 billion."
- And what's the Chinese government doing with all these
earnings? Dr. Richeb�cher answers this for us, too... an amount
equal to 46% of China's 2003 GDP was invested in the export
industry, he calculates. "That's insanely high," exclaims Thom.
"It's more than double the equivalent rate in Japan."
- The conclusion is obvious... but we'll spell it out anyway.
Dollars are flowing from the United States to China and then into
the rest of Asia. China has made an extraordinarily large bet -
47% of 2003's entire GDP - on the American consumer perpetuating
this dynamic. Malinvestment on this scale reminds us of Japanese
government policies in 1988 - but unlike back then, the rest of
Asia has been pulled irreversibly into the fray.
- "This could be the mother of all Asian crises!" concludes Thom.
[Ed. Note: As we noted above, Richeb�cher is a masterful number
cruncher and goes beyond the boundaries of most other idle
analysts. Now he has pounced on the payroll statistics produced
by the BLS. Here's Richeb�cher's report...
Phony Jobs and Falling Profits
http://www.agora-inc.com/reports/RCH/broke904
---------------------
Addison Wiggin, still in Baltimore...
*** What Americans do, the Chinese do bigger... a lot bigger.
In 1864, the death toll as the Union sought to put down the
"Southern Rebellion" crested 600,000... a figure so high it
nearly destroyed the country. That same year, the Taiping
rebellion in China drew to a close. Souls lost? Thirty million.
According to recent census reports, there are somewhere between
1.2 and 1.5 billion Chinese living today. Which is to say, some
300 million Chinese may or may not exist. Total population of the
United States as of 11:40 a.m. this morning? 294 million.
And this from Dennis Gartman, in his requisite daily read, The
Gartman Letter: "There is a huge... and absolutely stunning
large... migration of people from China's impoverished western
provinces to her far more modern, far wealthier, and far more
economically sound provinces along the Pacific coast... The
movement of the 'Okies,' so wonderfully detailed in Steinbeck's
'Grapes of Wrath' was perhaps 2-3 million people. The movement in
China is of at least 200 million people thus far. And will almost
certainly be 400-500 million by 2020. This is a tidal shift of
breathtaking proportions."
U.S. consumer demand for geegaws built in Chinese factories is,
at least, a significant contributing factor to the largest
migration of people in the history of the world.
*** Our Pittsburgh correspondent, Byron King, on a critical
juncture in the War Between the States...
"A few years ago, during a trip to the National Battlefield at
Gettysburg, Pa., I walked the route of Pickett's Charge (an event
that occurred on July 3, 1863).
"I had always envisioned Pickett's Charge as a line of Southern
soldiers running across an open field and being systematically
mowed down by a line of Union soldiers. The fundamentals of the
tactical maneuver seemed so suicidal that I wondered why anyone
in his right mind would follow the order to attack and subject
himself to that type of fate.
"The answer to my question came when I walked the battlefield,
step by step. The march from the Southern positions toward the
Union lines covered about 3,000 yards. The first 90% of the
advance was remarkable for its use of terrain masking. That is,
for most of the soldiers in the advance, Pickett chose the route
that was shielded from the line of sight of the Union boys and
their guns by hills and lines of rises. Casualties in Pickett's
division were relatively low for that part of the maneuver.
"The last 300 yards or so, the closing phase of the engagement,
well... that is another story.
"That last maneuver of the advance was supposed to be a fast run,
up a gently sloping hill against the Union barricades. This type
of rapid charge under fire was similar to so many other
engagements, of so many other battles that occurred during the
Civil War. The tactic was not remarkable for the era, but the
outcome has shaped the national destiny ever since the fateful
day.
"The Southern advance encountered an unanticipated problem. There
was a 5-foot-tall wooden rail fence down the slope from the Union
positions. The fence had not been knocked down by artillery or
taken out by advanced units or sappers. The fence was of
relatively solid construction, and its presence halted the
advance by Pickett's men.
"The Union troops rained gunfire and cannon shot down the hill
and into the mass of Southerners. By the time the Southerners
moved over and past the fence, their momentum of attack had been
broken. A very few Southerners struggled their way to the Union
lines and beyond, but the energy of the moment shifted to the
Boys in Blue. The rest, as they say, is history. And myth. And
legend.
"People say that the Civil War was central to the history and
political evolution of the United States. And they say that the
Battle of Gettysburg was central to the outcome of the Civil War.
And they say that Pickett's Charge was the key engagement of that
battle. And the fence at the bottom of the hill is what broke the
momentum of advance of the Southerners.
"So that damn fence must be the single thing that decided the
fate of a nation."
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---------------------
The Daily Reckoning PRESENTS: Is being lazy the secret key to
riches? Can you grow your portfolio by 2,000% with just one
decision? John Mauldin investigates...
THE LAZY INVESTOR'S REWARD
by John Mauldin
There is a concept thrown around in hedge fund circles called
second derivative investing. Allow me to explain...
In physics, we are taught to think of speed as the first
derivative. The second derivative would be acceleration. If you
are asked the classic question, "A car is going 50 miles per
hour. How long will it take to get to Hoboken from Miami?" it is
pretty simple math. But if they throw in the curveball that the
car is accelerating at 10 miles per hour, the answer involves a
much more complex equation. That would be the second derivative.
But what if we add a third derivative and state that the
acceleration is increasing at 10% every 39 minutes?
Don't even think about fuel consumption, highway construction,
kids in the back seat, the age of the drivers, caffeine
consumption and other effects from the space-time continuum. It
can get complex.
In this case, the first derivative is simply the price of the
stock market or mutual fund. First derivative thinking would be
simply projecting past price performance into the future. And
that is what buy-and-hold proponents do. Now, admittedly, they
may not all promise you a 12% compound rate. But they imply the
market, over long periods of time, will grow as fast as it has in
the past. You cannot beat the market, so you might as well invest
in the lowest-cost fund that represents the market. They contend
that any other choices than index funds are simply wasting your
time and losing you money.
I might agree with that view for investors with few choices - as
in many 401(k) plans - if we could make the long period of time
126 years rather than a mere 26 years. But even then I would have
to admit there are some very major exceptions in which active
management, especially if it is value-focused, will outperform.
The average P/E ratio for the S&P 500 since 1926 is around 15.
Typically, 21-22 is in the upper end of the range with 8-11 being
the lower end of the range. Over long periods of time (secular
bull and bear markets), the market fluctuates around the mean. I
think it is quite possible that in 2030 we may be at the end of
the next bull market. Valuations, after dropping into the low
teens (or lower) this decade, will turn around and a long bull
run will commence. What will the S&P 500 be in 2030 if we are
once again at a P/E of 21?
Somewhere in the neighborhood of 4,800, give or take a dime. That
4,800 is less than 25% of what it would be at a 12% compound
rate. At 3% inflation, a dollar will only be worth 46 cents. It
will take $2.15 to buy what is worth a dollar today. That is a
compound growth rate of (surprise, surprise) 5.7%. But
"objective" profits in that rearview mirror may be smaller than
they appear.
Your return will be less than that, because you have to pay
taxes. The S&P 500, if past is prologue, will change 250-300
companies through mergers and through dropping and adding
companies due to growth. As the dropped and added companies are
bought and sold, that will create taxes due. And don't forget
dividend distributions and capital gains, for which you will have
to pay taxes in the meantime.
Not to mention that even though the average return for the S&P
500 for the last century was 7.2%, the compounded return was a
far more modest 4.8%. That is because when the market drops 20%,
it must climb 25% to get back to break-even. So assuming 5.7% may
be aggressive if we experience a few recessions and a bear market
or two in the coming decades.
I should note that this makes a very big difference in retirement
lifestyles. At a 5% return, we are talking about the difference
between $2,400 per year and $11,000 per year on that original
$10,000.
The real reasons the S&P 500 compounded at 12% the last 26 years
are twofold. First, we started with a P/E ratio of 10 at the end
of 1975. Over the ensuing years, we simply valued a dollar's
worth of earnings at a much higher rate. Perhaps not as high as
the bubble levels of 1999 (over 40), but still historically quite
high. As has been shown through research, 80% of the growth of
the S&P 500 was simply due to increased valuations and not to
earnings growth.
Second, we had the highest period of inflation in the last
century in that period. An inflation calculator shows 326%
inflation for the entire period. For just the first six years
alone, it was 70%.
Are these two items likely to be repeated in the next 26 years?
Anything is possible, but not all things are likely. It is
doubtful we aspire to a P/E of 40, let alone 97, once again in
our lifetimes, and if we do, it will prove to be just as
ephemeral. Say what negative things you will about the Fed; does
anyone really think we will ever see sustained 10% inflation
again?
And let's not forget the Reagan tax cuts and the coming of the
Digital Age, which drove the markets. There was more going on
than simple market action that made for the largest and longest
period of sustained results in U.S. history.
And that does not even take into account the third and fourth
derivatives of demographics and international trade. Can we talk
Muddle Through Economy? Investing is far more complex than simply
buying the S&P 500 and hoping you can retire on 12% compound
growth. Anyone relying upon such a fantasy will find he is
working an extra 10 years after his hoped-for retirement date.
One day in the future, I will also become a believer in buying
and holding the Vanguard 500 as part of a reasonable asset
allocation program. But that is not this day. I think one day in
the future that 8-10% compound returns (or more) will be
possible. But that is not this day. It is not part of my DNA to
mindlessly chase some fantasy by trading peripatetically. I do
hope to beat the markets over time - that I will readily admit.
And I think I lay out a reasonable road map in my book, Bull's
Eye Investing.
I believe that by using a few facts, some logic and an eye to
history, it is in fact possible to do well. But it takes more
than being a lazy investor. Let's be clear on one thing. If you
are a lazy investor, you will earn the rewards of being a lazy
investor. In secular bull cycles, when values are rising, when a
rising tide lifts all boats, those rewards are a good thing.
But when you are on the wrong side of the value curve, it is a
prescription for working long past your retirement. Assuming the
next few decades will be like the last few violates the first
rule of investing: Past performance is not indicative of future
results. It is first derivative investing in a multidimensional
world.
"A little sleep, a little slumber, a little folding of the hands
to sleep - so shall your poverty come on you like a prowler, and
your need like an armed man." (Proverbs 6:10-11.)
Words to the wise, indeed.
Regards,
John Mauldin
for The Daily Reckoning
Editor's Note: John Mauldin is the creative force behind the
Millennium Wave investment theory and author of the weekly
economic e-mail Thoughts from the Frontline. As well as being a
frequent contributor to The Daily Reckoning, Mr. Mauldin is the
author of Bull's Eye Investing (John Wiley & Sons), which is
currently on The New York Times business best-seller list.
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