* * * * * * * * * * * * 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.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * *
Commerical Catastrophes
The Daily Reckoning
London, England
Thursday, October 14, 2004
---------------------
*** Survival debt... credit cards pick up the slack for
household budgets...
*** Busts, busts and more busts... keeping it cheap and
simple...
*** Mass delusion... the new "truth"... the band plays
on... and more!
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House prices on the West Coast have "flattened," according
the L.A. Times. We have no word from the other coast... but
the house builders' stocks are going down.
Here in London, prices seem to be going down, too.
Three busts are coming:
A bust in China - the country has been adding capacity for
demand that does not really exist.
A bust in the United States - consumers have been buying
things (often from China) that they don't need with money
they haven't got.
A worldwide bust in property - goosed by the Fed's low
rates, it's gone up so far, in many areas, that the typical
householder can no longer afford the typical house.
How and when these busts happen, we don't know. But the
bust in American consumer spending threatens to be more
painful than we expected. For as it turns out, consumers
have not only been buying things they don't need with money
they don't have, but things they do need too.
"Today people are incurring a more dangerous kind of debt,"
says Tamara Draut, director of economic opportunity
programs at Demos, a public policy organization in New York
that's conducting a nationwide study of Americans and debt.
"People are living paycheck to paycheck, and after they've
paid the bills, everything else - like groceries or
back-to-school clothes - goes on the credit card," Draut
adds. "Credit cards are picking up the slack in the
household budget."
This new kind of credit card debt is called "survival
debt." The savings rate fell to only 1.3% last year.
Without savings, every setback must be met with debt.
Little by little, people get in the habit of putting
everyday expenses on a credit card - groceries, rent, etc.
- and then waiting for a paycheck to keep up with the
payments. "The bills mount up," says Draut, "it's not just
the rate going forward, it's everything you purchased on
that card."
Survival debt is unlike other credit card debt in that it
is less easily curbed, say the debt counselors. You don't
have to take a trip to the Bahamas, they point out, but you
still have to pay the rent. You can't even put it off. Last
year, consumers charged $50.6 billion worth of household
expenses on Visa alone - a 27% increase over 2002.
We are suspicious. In the article we read on "survival
debt," the authors mentioned cable TV as though it were an
ordinary living expense, rather than a frivolous, and in
our opinion obnoxious, luxury.
We recall a recent study of people "struggling" to get by
on $36,000 for a family of four. And yet we recall also our
story of Morning Naughten, whose family lived on only
$30,000 - and saved $500 each month! Did the poor woman's
family go hungry? Did they shiver in the cold? Or did they
merely have to make do without the purchasing power of
credit cards or the cultural enrichment of cable
television?
Americans may have less money to spend in the future. But
so what? Their problem has not been too little purchasing
power, but too much. Would it be a bad thing if they spent
less and saved more? Would it be a bad thing if house
prices fell; perhaps they could afford to buy one, rather
than simply making payments on an interest-only mortgage?
Would it be a bad thing if stocks dropped to the point
where they gave their owners a decent dividend yield?
We remain optimistic, as always. The coming busts will
crush the American consumer, we believe. He will be broken
and bent - but perhaps into a better shape.
More news, from Eric Fry in Manhattan:
---------------------
"In an era of $50 oil, and increasingly unreliable supply
chains, the oil sands of Alberta assume a far more
prominent position - strategically and geologically - among
the world's largest deposits. For one thing, $50 oil
renders the relatively high-cost production of syncrude
immensely profitable... "
Want to find out more? Check out The Rude Awakening...
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m&qs=id=4176
---------------------
Bill Bonner, back in London:
*** "For the first time in the post-World War II era, the
United States faces a future in which every major category
of federal spending is projected to grow at least as fast
as, or faster than, the economy for many years to come.
That means not just pension and health care benefits for
retiring 'baby boomers,' or increasing interest payments as
deficits and interest rates rise, but also appropriated or
'discretionary' spending for national defense, for foreign
aid and for domestic homeland security programs," writes
Pete Peterson.
*** "When the Asian financial crisis hit in 1997-98, the
U.S. Federal Reserve tolerated a liquidity boom that
spawned the Internet bubble. When the Internet bubble
burst, the Fed tolerated another wave of liquidity, which
has led to the global property bubble," says Andy Xie of
Morgan Stanley. And the debt bubble in Anglo-Saxon
countries. And the capital investment bubble in China.
"China's boom is itself partly the product of the Fed's
super-lax monetary policy," concluded the economist. "With
its currency pegged to the dollar, China has been forced to
import America's easy monetary conditions. Its [China's]
higher interest rates have attracted large inflows of
capital that have inflated domestic liquidity, encouraging
excessive investment and bank lending in some sectors that
could lead to a bust."
*** Busts, busts, busts... and more busts. Get ready for
them, dear reader. Enjoy them.
*** Money. Money. Money. It seems as though people think of
little else. We write about it every day, but we don't
understand why people make such a fuss about it.
Here in Europe, we the humble scribes at The Daily
Reckoning like to keep things simple and inexpensive. Like
Morning Naughten, we have discovered that you can live
reasonably well on relatively little money.
We don't need much. Just the other day, the gardener at our
country place asked if we would like to install an
automatic watering system in the new ornamental gardens we
are building. "No," we replied, "just do it the
old-fashioned way... you can water them with a hose."
Keep it simple.
And then, our secretary asked if we would like to have some
new-fangled cable TV system at our apartment in London.
"No," we replied again. "We don't have that at our
apartment in Paris. We'll make do without it here,
either."
Keep it cheap.
*** A Daily Reckoning reader comments:
"Today, we are witnessing two unfortunate realities. First,
an administration that has lied so much they actually
believe their own lies and preach them at every opportunity
as if it the new gospel. When faced with overwhelming
evidence that the cause of the war was unjust, all they do
is stage more press conferences with even more
determination and emotion that they have done the right
thing to protect America. I believe it was some famous Nazi
who said, 'If you make the lie big enough, it becomes the
new truth.'?
"The second seems to be the incredible gullibility of the
public to believe these lies despite all the evidence. It
would be unpatriotic to question them.
"So the band plays on, and people dance, eat and drink. All
the while the water rises deck by deck through the ship.
Peak oil arrives, and people look upon it as some strange
thing they have never seen, much like the dinosaurs must
have looked upon the light that streaked through the sky on
that fateful day some 65 million years ago. Report after
report is starting to reveal just how much financial
trouble there is with Social Security, medical and all
these government programs. The water rises, but just one
more dance - the music is so good.
"I live in a world of mass delusion, which believes it will
not end. Trust me, I live in California! This is why there
is no outrage, because there is nothing perceived as wrong.
In fact, I feel that the public in general is completely
unaware of just how bad the future could be in the
not-so-distant years.
"This morning, I was in the backyard and saw a passenger
plane (maybe a 737) fly over, and I could not help but
think that in 30 more years, they will be no more, and I
will only be 65 at that time. When you really look at Peak
oil alongside the demographics of aging in this nation, I
think it is the closest thing to Armageddon I have ever
seen. Yet, not a damn word is said in these debates about
this iceberg.
"How can people not notice the slant? Do people not hear
the water? Is the music so wonderful that it drowns out all
else? Lies have become truth, and the truth is called lies.
Regardless, I am 35, and I plan to live a long and good
life, within my means, protecting my wealth through all
that will come in the next 30 years.
"So every month I travel to the local coin store and
contribute to the only savings I can see lasting in the
face of such problems... sometimes silver, sometimes gold,
because when I look towards my retirement some 30 or more
years from now, paper has no real value except for fires,
wrapping stuff and wiping your privates.
"History is incredible at times, and historically, we must
be completely blind."
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---------------------
The Daily Reckoning PRESENTS: In the summer of 2004, five
major storms hit Florida, causing losses that rival those
seen after Sept. 11. Sound terrible? Depends on how you
look at it. Dan Ferris explains how to double your money
with disaster...
COMMERICAL CATASTROPHES
by Dan Ferris
"Forgive me if this sounds crass, but it's true. Disasters
like Hurricane Andrew and 9/11 are exactly the type of big,
ugly misfortune that creates Extreme Value opportunities."
Those are my words.
They appeared in the letter I wrote to subscribers in
January of this year. I went on to describe how an
opportunity to safely double your money over the next few
years was created by some of the worst catastrophes in
history...
Hurricane Andrew struck in 1992, causing record insurance
losses of approximately $22 billion. That record stood
until 9/11, estimates for which top $50 billion.
Then came the summer of 2004.
Hurricanes Charley, Frances, Ivan, Jeanne and Tropical
Storm Bonnie all hit Florida in a 48-day span, the most
tropical activity one state has suffered in 130 years. More
than one in every five Florida homes has sustained some
type of storm damage. The number of insurance claims this
season is expected to hit 2 million, far surpassing the
700,000 claims filed after Andrew 12 years ago.
Bob Hartwig, chief economist for the Insurance Information
Institute, estimates the four hurricanes that made all the
headlines cost $21.7 billion in insured losses. To put all
these numbers in perspective, take note of this tidbit from
the August issue of Reinsurance magazine: "The annual mean
insured damage bill and its standard deviation for
hurricanes striking the continental United States between
1900-2002 is $2.9 [billion] and $6.7 [billion]." Hurricanes
from 1992 and 2004 are 7 1/2 times the mean, and more than
three times the standard deviation.
But $21.7 billion is not the whole story. The storms that
have made headlines aren't half of what took place this
year. So far this year, 12 named storms have formed,
including eight hurricanes. Six of the storms had winds
greater than 110 mph. It's no wonder, then, that Jay
Fishman, CEO of St. Paul Travelers Companies Inc., says
losses from this year's hurricane season now rival those
seen after 9/11. Some estimates of the damage caused by
hurricanes in 2004 are as high as $45 billion, more than
twice the estimates for the four headliners. That's about
15% of one year's premiums for the entire U.S. insurance
market ($300 billion), wiped out in just 48 days.
Catastrophes are hard on insurance companies. In the
aftermath of Hurricane Andrew, 12 insurance companies went
out of business. The events of 9/11 put 38 companies out of
business, including Kemper, then the seventh-largest
insurer in the United States, and Gerling Reinsurance, the
seventh-largest reinsurer in the world.
So far, the 2004 hurricane season hasn't put anyone out of
business, but it's an easy bet that it will. Bear in mind
that the amount of new capital that entered insurance
markets after 9/11 wasn't nearly enough. Michael Paisan,
insurance analyst with Williams Capital Group, said last
year, "Despite the sideline capital that has entered in
this market in the aftermath of 9/11, it is not nearly
enough to supplant the lost capital. Moreover, the capital
that is entering the market now has to be disciplined
capital (unlike that in 1992) because the low interest rate
environment is not as conducive to cash flow underwriting
as it was back then. Hence the capital inflow should not
curtail the hardening pricing cycle as it has done in the
past."
(A hardening price cycle, or hard market cycle, is easy to
understand. It's just like when you get into a car
accident: Your insurance goes up. Same thing here. Soft
cycles are the opposite, when prices fall; it's harder to
make money selling insurance. If you're a really good
driver and never get into an accident or get so much as a
parking ticket... you get the picture.)
About $20 billion of new capital entered the reinsurance
business in the four months following 9/11. That's less
than half of the $50 billion estimates for that day's
tragic losses. And now, the 2004 hurricane season has come,
with losses currently estimated in the mid-$20 billion
range. In other words, the 2004 hurricane season has
already obliterated all the new capital that rushed into
insurance markets in the wake of 9/11. International
Finance Corporation reports, "All told, 10% of the world's
insurance capacity - the amount of money available for
insurance - was wiped out by the [9/11] terrorist
attacks."
Think about that last sentence for just a minute, and
you'll begin to realize that there's some serious money to
be made here. If 10% of the world's oil supply suddenly
went up in smoke, you'd want to be long oil in a big way.
Not only that, everybody and his brother would be telling
everybody else to buy oil. It would hit all the headlines,
magazine covers and cable TV financial shows. People would
make money. They'd feel the financial acumen coursing
through their veins, making them sexier and smarter every
minute, even though the whole world already knows what they
just found out, indicating that the opportunity was
probably about to fall apart on them.
But for some reason, that hasn't happened in the insurance
stocks. Ten percent of the world's insurance capacity goes
up in smoke, and I can't name one investor, friend,
acquaintance or shoeshine boy who's yelling it from the top
of his lungs. No CNBC. No magazine covers. No headlines.
Nothing. It's like there's some type of political blackout
on reporting the opportunity in the insurance business.
But that opportunity is very much like the one in oil.
Capital has avoided this sector for years in favor of
technology and financial markets. For most of the last 25
years, the insurance industry could make money buying
stocks and bonds. Interest rates were 15% back in the early
1980s. Stocks produced double-digit returns from 1982-2000.
Making money in the financial markets was easy. Who needed
to know anything about insurance? Nobody. You could just
buy Microsoft or Cisco or Amazon and then wait a couple of
years. With everybody making easy money in the stock
market, capital - of which there's a finite supply at any
given moment - was diverted from other industries, like
oil, shipping and insurance.
Lots of people are interested in oil now, even though oil
prices are already at 450% of their level at the bottom in
late 1998. Reinsurance prices shot up only 20-100% in the
wake of 9/11. Surely, there must be more upside in
reinsurance than in oil. When people talk about reinsurance
the way they're talking about oil today, then I'll know
it's time to sell. It feels right to be interested in the
reinsurance business at a time when the fundamentals are
improving and nobody else seems to care about it.
"S&P estimates that the reinsurance industries' average
combined ratio fell to about 97% in 2003 and, barring major
catastrophes, expects it to improve further in 2004. This
clearly shows that investment income does not subsidize
poor underwriting anymore," said Clemens Muth, head of
economic and insurance research for Munich Re, the largest
reinsurance company in the world.
As a result of the laziness born of easy money, the
property/casualty and reinsurance industries have done a
miserable job of pricing risk over the last two decades or
so. They're like a bunch of fat boxers who've run out of
money, and now they think they're going to get back in the
ring after sitting around eating bonbons for 20 years.
Since 1975, the entire property/casualty industry took in
more premiums than it paid out in losses in only two years.
Pathetic.
Of course, the property/casualty companies are the ones who
buy catastrophe reinsurance, the type of coverage an
insurance company needs to handle events like hurricanes
and 9/11. The Reinsurance Association of America reports
that reinsurance industry losses were never less than
101.5% of premiums for the period from 1981-2002. The
average ratio was 111.6%. Put another way, the best the
reinsurance industry could do was to pay out 1.5% more in
losses than it made in premiums. On average, the
reinsurance industry as a whole paid out 11.6% more than it
received in premiums.
Regards,
Dan Ferris
For The Daily Reckoning
P.S. This situation has Extreme Value written all over it.
Capital is scarce. Performance has been miserable since
before I had a driver's license. And reinsurance prices are
likely to remain strong in the wake of yet another record
year for catastrophes. The time is still right to make
money in stocks of disciplined, financially strong
reinsurance companies.
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------------------------------------------------------
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