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* * * * * * * * * * * * REMINDER * * * * * * * * * * * * *
On the days that I don't publish, like today, you 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
reinforce each other.
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2nd Annual Financial Darwin Awards
THE DAILY RECKONING
PARIS, FRANCE
TUESDAY, 15 JANUARY 2002
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*** A very peculiar recession...
*** College grads deep in debt...record bankruptcies...
*** Dow falls for 6 sessions in a row...high tech
hallucinations...Mugabe can't be all bad...Poor
Ken...and more!...
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Health club memberships can cost more than $100
per month. And members must know that they could get the
same effect from running around the block and doing sit
ups at home. So, typically, health club sales track GDP.
They boomed in the '80s...then fell off in the early
'90s...and then boomed again in the late '90s. Lately,
consumers have been going bankrupt at a record rate...
and unemployment is still climbing. But they are still
buying health club memberships.
"Economists say the statistics show how truly
peculiar the 2001 recession is," says the Arizona
Republic. "While the nation has fallen on hard times,
consumers have continued to spend, demonstrated by
strong auto sales, solid home sales and steady sales of
health club memberships."
Consumers are taking a long time coming to terms
with recession. They were told it couldn't happen. And
now that it has happened, they believe it is almost
over. So, the recession passes, they believe, without
even giving up much of anything...even the pleasure of
going to the gym to look at people who are in even worse
shape than you are.
College students are still spending too. A GAO
report says a third of college students have 4 or more
credit cards and the average student graduates with
$19,400 in student loans and $2,748 in credit card debt.
But eventually, debts and recessions need to be
reckoned with. The latest numbers show health club sales
may be easing off. They've grown at a 10% rate since the
mid-'90s. Experts expect between only 3% to 5% growth
into 2002. And people under 25 are turning to the
bankruptcy courts in record numbers.
And stocks! Earnings are falling. But in terms of
their best earnings ever - recorded at the end of the
'90s boom - the S&P is priced at a P/E of 22. The
previous record high - set in '29 and again in '73 - was
22.
So, Eric, how did those over-priced stocks do
yesterday?
*****
Eric Fry in New York...
- Farewell 10,000. Farewell 2,000...it too soon to say,
"Farewell 2002?"
- The Dow fell through 10,000 last Friday. The Nasdaq
followed up that sorry performance with one of its own,
by tumbling through 2,000 yesterday. The volatile index
dropped 31 points to 1,991, while the Dow slid 96 points
to 9,891.
- In short, 2002 is not unfolding as marvelously as the
bulls had imagined. "Better to travel hopefully than to
arrive," as the saying goes. The year is far from over,
of course. By the time champagne corks fly next New
Years Eve, the stock market may yet soar to the heights
that Abby Joseph Cohen predicts.
- On the other hand, this might be as good as it gets.
The Nasdaq clings to a 2% gain for the year, despite
trading for a gazillion times earnings...(its pro forma
operating earnings before one-time charges). If an
investor were to pocket that 2% and roll the money into
a one-year CD, he would be sure to earn about 5% on his
money in 2002. By year's end, many professional
investors might wish they had gained as much.
- Some folks are shuffling anxiously toward the door
already. Yesterday, Merrill Lynch strategist Richard
Bernstein lowered his recommended asset allocation for
stocks to 50% from the previous 60%. "There is a thin
line between a liquidity-driven market that anticipates
improving fundamentals and a bubble," Bernstein warned.
"The equity market may have stepped over that line."
- You don't have to look very hard to find individual
stocks or sectors that have crossed the line. Many
stocks are soaring despite no visible trace of
improvement in the underlying fundamentals.
- For example, the shares of Starwood Hotels & Resorts
have nearly doubled since last September, even though
the luxury hotel sector is still reeling from the post-
September 11th shock. Testifying to the sector's
troubles is the fact that the travel industry shed
32,000 jobs in December.
- Meanwhile, over in Fantasyland, a.k.a. the technology
sector, the growth prospects are even more dire. But
that did not prevent technology funds from surging 37%
in the fourth quarter. Numerous stocks in the sector
have more than doubled or tripled off of their September
lows.
- "We ought not conclude that just because stocks have
been rising recently, that economic recovery is just
around the corner and that corporate profits will
shortly begin to rise again," warns Marc Faber in the
latest issue of Strategic Investment.
- The man has a point, as the tech sector illustrates so
graphically. Back in the "New Era" 1990s, capital
spending on high-tech equipment spearheaded economic
growth. But in 2001, the tech sector suffered a
nightmarish reversal of fortunes. Semiconductor sales
tumbled 32%, while telecommunications equipment sales
collapsed 40%.
- "Over a comparatively short span," Moody's observes,
"the rate of capacity utilization for high-technology
manufacturers plummeted from 2001's highly profitable
88.8% to November 2001's loss-written record low of
60.0%."
- Until demand for technology products recovers, we
should expect the river of red ink to continue flowing
out of the tech sector.
- Ironically, robust demand for technology STOCKS has
recovered already. Folks can't seem to buy enough of
these things, no matter the price. That's because it's
much more exciting to buy a red-hot stock than to forage
for shares of a well-run company. The two are not
necessarily the same thing, as the Enron debacle
illustrates.
- "What the world is now awakening to," says the New
York Times, "is that the Enron Corporation was not much
of a Company, but its executives made sure that it was
one hell of a stock"...until it wasn't...and the
casualties are numerous. Even the "smart money" got
hurt. (Enron execs' behavior earned them the top slot in
this years 2nd Annual Financial Darwin Awards...Bill
reports below).
- Remember how we're always hearing about how smart all
those institutional investors are? Are you sitting
down?...Some of those institutional investors aren't so
smart after all. Leading the pack of the "aren't"
category is the California Public Employees' Retirement
System (CalPERS).
- After chalking up sizeable losses investing in venture
capital during the 12 months ending June 30, 2001,
CalPERS stubbed its toe again by taking down a whopping
position in Enron. The pension Goliath's stake, which
was once worth more than $252 million, is now worth
about $2 million. That's a large loss, even for a $143
billion pension fund.
- Lesson One from the Enron morality play: It's better
to invest in good companies than "good" stocks.
*****
Back in Paris...
*** Robert Mugabe can't be all bad. The aspiring
dictator is making "war on democracy," says the TIMES.
There's something to be said for that...At least, a
dictatorship tends to protect the morals of the masses.
Only the elite are corrupted by power, whereas, in a
democracy corruption is shared out like campaign bumper
stickers. Voters go into the polling booth and pull the
levers they think will bring them more of someone else's
money. Their hearts must whither a little more every
election day.
*** "I want to assure you that I have never felt better
about the prospects for the company," wrote Ken Lay, CEO
of Enron, on August 14. Poor Ken was once the toast of
the town. Now he is just toast. But we salute him,
nevertheless, below...
*** "You could probably get bigger numbers by crunching
them differently," said Dan Denning in a note to
Strategic Investing (formerly Daily Reckoning Investment
Advisor) subscribers. But we do not crunch numbers here
at the Daily Reckoning. We have nothing against them...
so we try to treat them with respect.
*** So, what do we get when we merely stack up the
figures in a humane and decent way?
*** "For all 12 positions, we averaged a total return of
7.57%," Dan continues. "Our best performer last year was
Franco Nevada, up 29%. AngloGold was next, at 16.8%,
followed closely by Oxford Health Plans, up 15.4%."
Not a spectacular return. But a lot better than the S&P,
which was down 10% last week.
*** But Dan is excited: "This year is starting off with
a bang...with Oxford Health Plans up 25% last week
alone." Take a look:
DOW PLUNGES TO 6000
http://www.agora-inc.com/reports/DRI/HardProfits
*** My daughter, Maria, turns 16 today.
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2ND ANNUAL FINANCIAL DARWIN AWARDS
by Bill Bonner
"In America, everybody does it."
Jamie Lee Curtis, in "A Fish Called Wanda"
"One of my highest priorities is to restore investor
confidence in Enron," Ken Lay wrote via email to
employees on August 27th. "This should result in a
significantly higher stock price."
Why did they care so much about the share price? Aren't
profits the more important number? And, what about the
satisfaction that comes from providing a good service,
doing a good job, and running a good business?
Enron's shareholders, management, and even many of its
employees, seemed to care only about the price at which
Enron's shares changed hands.
Was the world a better place if the share price rose?
When things were going well for Enron, were people
happier, healthier, more saintly and honorable?
No, they were just more entertaining. It was fun to
watch people lie, cheat and make fools of themselves in
a spectacular way. And it was educational.
Here at the Daily Reckoning, we are a bit disappointed
by the way our colleagues in the financial press treat
the Enron story. The same journalists who celebrated Ken
Lay when he was riding high on lies and greed...now spit
on his body as he lays honestly in the dust.
But that is the problem with an open, democratic market
- it invites every investor (and analyst, strategist,
fund manager, journalist, broker...etc.) to participate
in a fraud. Investors are encouraged to believe that
they can get something for nothing...just as surely as
they think they can vote themselves another man's money.
All that is needed is the right lie at the right time -
and the great mob of investors rushes to its own ruin...
as if it were a national election.
But the mob is fickle. A man be a hero one day and a
fool the next...for the same reason each time: helping
investors defraud one another.
"It's all as American as apple pie," wrote Richard
Russell yesterday. "Wall Street's not much different.
Phony earning statements, leaving out regular expenses
in statements, "pro forma" earnings statements, no
dividends being paid (you need actual earnings in order
to pay dividends).
"Greed, greed, greed - it's the story of Wall Street and
its analysts and accountants and brokers and customers
over recent years. Now we've got the Enron story - the
biggest bankruptcy in U.S. history. From Wall Street to
Washington, the story is one of corruption, dishonesty,
greed and the lust for money."
We tend to look down our noses at people who lose large
amounts of money. If they lose their own money - making
a public spectacle of themselves in the process - we
think they are stupid. If they cause others to lose
their money, they are calumnied as knaves. But what is
oft forgotten is that the dimwits and knaves perform a
valuable public service: both help separate fools from
their money.
What's more, they offer valuable moral lessons to us
all. "They are like the human mine detectors used by the
Soviets in WWII," I wrote in my preface to last year's
awards. "Punishment battalions were simply marched
forward across the minefield. Those who didn't blow up
showed the way forward. Those who did, well...they
cleared away the mines. How grateful the troops
following must have been! Their comrades had cleared the
way - and marked it with little scraps of uniform, blood
and bootlace."
So, let us take this opportunity to show some gratitude,
and honor a fallen hero by awarding our Second Annual
Financial Darwin Award to Ken Lay, Jeffrey Skilling and
their colleagues at Enron.
Enron is the clear winner. Not that it did anything
other companies did not do.
"Corporate America went long in debts and short in
assets," says Dr. Kurt Richebacher. Management joined
the "shareholder value cult," he explains, seeking "the
quickest and most effective devices to maximize [short
term] profits and shareholder value. The result was the
well-known collective shift towards mergers,
acquisition, downsizing and restructuring."
Stock prices rose, explains Richebacher, as
"corporations, stampeded into debt, retiring equity
across the board through mergers, acquisitions and
stocks buybacks, while downsizing their capital spending
on new plants and equipment."
None of these things added appreciably to the real goods
and services - and long-term profits - the companies
could produce. But they provided company chefs with
plenty of books to cook...
"Deal making offered numerous opportunities for
companies to generate phony financial profits that were
sold as emblems of new corporate efficiency," Dr.
Richebacher concludes. "In reality, a large and growing
part of the company-reported profit bonanza had accrued
directly or indirectly from gains in the stock market.
As the bear market unfolded, this source of profit
growth essentially dried up. The consequence is that
desperate CEOs have to pursue ever more aggressive
tricks to hide the dismal profit truth."
Everybody does it. Business Week reports that 400
companies have had to restate earnings in the last 3
years.
Enron merely pursued "shareholder value," with greater
energy. It reinvented itself as a New Economy company in
the late '90s...and then began acting as if the old
rules of accounting and business management no longer
applied. It misstated earnings of more than half a
billion dollars - from '97 forward. And it managed to
run up some $27 billion in debt - without mentioning it
to shareholders. But why bother? Shareholders wanted
lies...Enron gave them plenty.
As the Enron success story reached its peak, Enron's
insiders sold their shares. A New York Times article
says "29 Company Executives Pocketed $1.1 Billion by
Selling Firm's Stock." Meanwhile, lower-level employees
held Enron shares in their 401 (k) plans. Half the
assets of the plans were in the form of Enron shares -
about $1.2 billion worth. Now they are worthless.
That is a small part of the loss suffered by investors.
Enron collapsed faster than almost any major corporation
in history...and provided the bankruptcy courts with
their largest case ever. Investors are out $61
billion...more or less.
All of this seemed to come as a shock to Mr. Lay. Asked
about the off-the-books debt, he seemed unaware of not
only the details but the big picture too. "You're
getting way over my head," he protested.
Ken Lay may or may not have been out of his depth in a
puddle in the company parking lot...we don't know. But
his successor, Mr. Skilling, claims to be equally
ignorant. He said he knew nothing of the critical off-
balance sheet partnerships and resigned "for personal
reasons" in August.
There was no shortage of ignorance in the Enron story.
Ron Barone, an analyst at UBS Warburg, covered the
company. After a meeting with Mr. Lay on August 17,
Barone was quoted by Bloomberg: "Ken met with us to
reassure us that there is nothing wrong with the
company. There is no other shoe to fall and no charges
to be taken."
But less than 3 months' later, a whole leg fell off
Enron when the company announced that $600 million was
wiped out as the company restated earnings for the
previous four years. By November 28, when Enron's shares
were nearly worthless, Barone changed his recommendation
from "strong buy" to "hold."
Congratulations...and with much appreciation for them
all,
Bill Bonner
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