The day is coming when millions of callers to their stock mutual funds’ toll-free numbers are going to receive this message, or its equivalent. “Thank you for calling. Goodbye.” If you think this can’t happen, call this number:
1-800-397-1193
I’m not sure why this number exists, but its recorded message is a herald of things to come. When today’s stock market hold-outs finally decide to sell, they had better hope they don’t get this recording.
DOW 36000
In September, 1999, four months before the Dow Jones Industrial Average peaked at 11,750, two free market economists with the American Enterprise Institute, James K. Glassman and Kevin Hassett, wrote the following prediction in The Atlantic Monthly (Sept. 1999). Read this carefully. See if it resonates with what you now know.
THROUGHOUT the 1980s and 1990s, as the Dow Jones Industrial Average rose from below 800 to above 11,000, Wall Street analysts and financial journalists were warned that stocks were dangerously overvalued and that investors were caught up in an insane euphoria. They were wrong.
Stocks were undervalued in the 1980s and early 1990s, and they are undervalued now. Stock prices could double, triple, or even quadruple tomorrow and still not be too high.
Market analysts and media pundits have also persistently warned that stocks are extremely risky. About this they are wrong too. Over the long term stocks in the aggregate are actually less risky than Treasury bonds or even bank certificates of deposit. Although the experts may not be very good at predicting what the market will do, they are brilliant at scaring people — not out of malice but out of a profound misunderstanding of stock prices. Whatever their intentions, they have performed a terrible disservice to millions of investors by frightening them away from the market.
Stocks are now, we believe, in the midst of a one-time-only rise to much higher ground — to the neighborhood of 36,000 for the Dow Jones Industrial Average. After they complete this historic ascent, owning them will still be profitable but the returns will decline. You won’t be able to make as much money from them each year. We believe that in the meantime, however, astounding profits will be made.
Many small investors are already catching on. They have ignored the dire warnings from professionals that have accompanied nearly every step of the Dow’s rise from 777 on August 12, 1982. They are rejecting the outdated model that Wall Street has used to assess whether stocks are overvalued — a model based largely on historical price-to-earnings, or P/E, ratios. That rejection reflects not their nuttiness but their sanity. Contrary to the famous warning from Alan Greenspan, the chairman of the Federal Reserve Board — made on December 5, 1996, with the Dow at 6,437 — many investors are rationally exuberant. They have bid up the prices of stocks because stocks are a great deal.
We know what happened. These two authors are rarely quoted these days, except for amusement or as a warning. But they were taken very seriously in late 1999. They even got a publisher for their book, Dow 36000. You don’t find that book in Barnes & Noble these days, except possibly in the $2.98 bargain books section.
Since March, 2000, The NASDAQ has lost 75%. Its inability to recover shouts a message to investors with assets in the conventional stock market: “The Dow is not going to come back by the time you retire.” The NASDAQ after 1997 was touted as the index of the future, but now the touts want investors to believe that it is the index of the past, that it was a fluke, a bubble, but the Dow and the S&P 500 aren’t.
Aren’t they? June’s price/earnings of 40 for the S&P 500 (“as reported” earnings) is over three times what is normal, and 6 or 7 times what it is at the beginning of a bull market, but we are supposed to believe that this market is a bull market ready to begin an upward move. The P/E ratio has remained stable. Yet the market’s index has fallen. This is because earnings have fallen in lock step with the stock market. A profits recession is in progress. The accounting profession is now about to come under the control of the U.S. government — no more “self-regulation.” The official conclusion: “Don’t panic. Hold on.” This is always the official conclusion.
Stock market volatility is becoming immense. It swung over 600 points on July 24, bottom to top. The stock market now resembles a gambling casino. This is not comforting to investors who are approaching retirement. What they want is safety. What they get are 400-point swing days, up and down, on huge volume. This tells them that uncertainty is huge (they fear uncertainty), that others (mostly kids) are making their investment decisions for them, and the days of 20% per year increases are long gone.
On July 24, when the Dow Jones Industrial Average ganied just under 500 points, an invisible sell-off was occurring. On that day, the five major American stock exchanges recorded the following statistics. Stocks that reached their 52-week highs: 7. Stocks that reached their 52-week lows: 983.
Stock buyers have remained on the sidelines. The market’s fall so far has been the result of the absence of new buyers, money in hand. The longer that the market fails to exceed its January 2000 high, the fewer the number of believers in Dow 36000, or even Dow 12000. But a mass sell-off has not begun. Will it? I think it will. Despite bear market rallies, business investing and business profits remain in full recession mode. Corporate profits after taxes for the nonfinancial sector are in the negative 30% range, up from -42% in late 2001, which was lower than at any time since the early 1970’s.
“WHERE IS THE BOTTOM?”
The blown-dry talking heads on the Evening News keep asking the experts — mainly, commissioned brokerage house researchers who are unknown to the public — “Where is the bottom for this market?” The answer is obvious, but nobody dares say it:
When the Nielsen ratings for CNBC fall below PBS’s “Antiques Roadshow.”
Alternatively,
When nobody even pretends that Louis Rukeyser’s weekly opening monologue is funny.
When viewers, having lost even more trillions of dollars of on-paper-only supermoney — the imputed value of a person’s total holdings multiplied by the latest share price (which will collapse when lots of people try to sell their shares at one time) — finally refuse to watch Rukeyser’s show (now on CNBC), in order to avoid his monologue, which only reminds them of their shattered hopes and dreams, the bottom will have arrived. After Rukeyser retires, there may even be a slow return to a bull market.
Until the Evening News shows have not run a lead-in story on the stock market for at least six months, we have not seen the bottom.
The evening news shows run “Where is the bottom?” or “Was this the bottom?” segments because the networks are able to get high ratings by asking these obviously unanswerable questions. Millions of viewers are watching their dreams get smashed by the relentless fall of the stock market. They are paralyzed. They do not have the good sense to phone their retirement funds and say, “Switch me to a money-market account.” They have not yet panicked. They think they can “get even” with this market by staying in this market. So, even if share prices rise, those buyers who got in earlier will get even by selling. This will keep the market from rising to its January, 2000 high.
The panic will eventually come if this is truly a long-term bear market, which I think it is. The panic will not be followed shortly by a new boom market. Long-term bear markets do not end with panics. They bottom with panics, and then they sit for years, stagnant. They end with boredom and a determination of the now-demoralized victims, “I’ll never buy stocks again.” Owners sit and sit, paralyzed, reinforced in their paralysis by the “buy and hold” gang who got them into their predicament in the first place. But when they at long last the masses sell close to the bottom — which is why it’s the bottom — they are locked in concrete. “Never again.” Psychologically locked into a falling market, they remain frozen out of it for years.
For as long as viewers tune in nightly to hear the story of what happened today in the stock market — a story that they have already verified repeatedly on the Web — then this stock market is nowhere near the bottom. It will hit bottom only when viewers say, “I don’t want to hear about the stock market any more. I’m sick of the stock market. I sold my shares this morning. No stock broker is ever going to hear from me again.”
Until at least 50% of today’s stock brokers are fired, this market has not seen the bottom.
Bear markets that follow a long-term bull market end only when a new generation of investors who have never been stock market investors believe that they can be successful because conditions have changed. A few people begin buying with a little of their money. Not until after an event like October, 1987, where a sell-off reverses fast, do large numbers of investors decide that it’s safe to get into the market.
This requires years of post-panic boredom with the stock market. Long-term bull markets do not end with a bang. They end one morning with a yawn, a rubbing of the eyes, and members of a younger generation saying, “Maybe a price/earnings ratio of 7 is safe. I may put a few bucks into stocks.”
Last Friday, NBC’s Tom Brokaw flew to Omaha to interview Warren Buffett. (Note: Buffett did not fly to New York City to be interviewed. Buffett is not seen being interviewed by no-name faces on CNBC. In short, anyone who the news media’s top spokesmen believe really might have a clue as to where this market is headed is not interested in appearing on CNBC.) Buffett smiled, and, as he smiled, drove a nail into the investing public’s coffin of naive dreams. He said that long-term bear markets can last for a long time. He used the example of 1966 to 1982. Brokaw did not pursue this suggestion on-camera. What Buffett was saying in effect was this: “The millions of would-be retirees who expected to retire in comfort based on their stock market profits may not see this come to pass.”
KNOW WHEN TO FOLD ‘EM
Thom Calandra writes a column for CBS’s “Market Watch.” In his July 23 column, he reported on the fact that the buying public has retained basically the same portfolio of top-choices since at least 2000. This is additional evidence that this stock market has only begun to fall. Only a collapse will finally change the minds of the losers, who finally give up all hope and sell. The holders of these stocks have not yet folded. They will, of course, but only in the panic. They are already suffering losses of 40%, with much worst losses in technology stocks. Still, they cling to the losers. Meanwhile, the commission-seeking experts keep touting these same favorites. Calandra wrote:
SAN FRANCISCO (CBS.MW) -The biggest technology losers are among the top holdings among CBS MarketWatch portfolio users, a new survey shows.
Battered shares of Cisco Systems, Microsoft, Intel Corp., Lucent Technologies and AOL Time Warner are the most popular stocks for individuals who use CBS MarketWatch portfolios to track their holdings. A year ago, when both stocks were far higher in price, Cisco and Microsoft also held the No. 1 and No. 2 spots, respectively.
The findings indicate Main Street investors are holding onto their failing technology shares even as the stock market suffers a third year of deep losses. The willingness of individuals to go down with their losers — or sit frozen as their taxable and retirement accounts suffer heavy losses — is seen as a sign the stock market has waves of frantic selling still ahead. . . .
In this new portfolio survey, shares of media company AOL Time Warner moved to the No. 5 spot from No. 3. AOL shares have lost 75 percent of their value in the past 12 months. In the top 10, only one company lost marquee status from a year ago: AT&T, whose shares are down by more than half since July 2001.
AOL wasn’t the only 75 percent loser that portfolio users stubbornly kept registered in their online tracking system. Portfolio users also stuck with Sun Microsystems, the computer server company whose shares have lost three-quarters of their value since July 2001. Sun was No. 10 on the list compared with No. 9 a year ago. See the July 2001 survey. . . . For the most part, the behavior of online investors resembles the activity of those whose most popular holdings are catalogued by brokerages such as Merrill Lynch. Account holders at Merrill Lynch are sticking with their losers. Every stock among the top 20 in Merrill Lynch’s most widely held list is down sharply since Jan. 2, and down sharply from a year ago. Wal-Mart shares, which are also in the CBS MarketWatch top 20, have fared best with a mere 18 percent loss in the past 12 months.
Absent from the top CBS MarketWatch portfolio holdings were gold mining shares. The miners have posted steady gains for investors in the past 12 months as the price of bullion surpassed $300 an ounce. . . .
Professional market watchers often trawl the behavior of individual investors for anecdotal signs of acceptance or rejection of stocks. Most Americans are suffering 40 percent and greater portfolio losses in 28 months of a declining stock market. Those with technology stocks are suffering the worst losses.
A look at these portfolio results is further evidence most Americans are frozen in the headlights of the continuing bear market. Their inaction almost surely will lead to grave losses in a market where there are few potential buyers at current prices and tens of millions of potential sellers. See: Still No Panic in Detroit.
The Top 20 right now
Cisco, Microsoft, Intel, Lucent Technologies, AOL Time Warner, General Electric, Dell Computer, Hewlett-Packard, Oracle, Sun Microsystems, IBM, AT&T, Pfizer, WorldCom, EMC, Home Depot, Wal-Mart, Yahoo, JDS Uniphase, Walt Disney.
The top 20 from July 2001
Cisco Systems, Microsoft, AOL Time Warner, Intel, Lucent, Dell, Oracle, AT&T, Sun Microsystems, General Electric, IBM, WorldCom, Yahoo, Pfizer, Compaq, EMC, Home Depot, Wal-Mart, JDS Uniphase, Qualcomm. . . .
Stock market investors will learn their lesson — that the hypesters failed to recognize a bubble — only by suffering horrendous pain. This pain will come during the final panic. Panics are generally followed by years of stagnation and low investor interest in the stock market.
WHERE THE ACTION ISN’T
This market was in bull mode from 1982 to 2000. The NASDAQ turned bearish on March 11, 2000. Of that, we can be sure in retrospect. It was a classic bubble. It had a P/E of 200+. There was never any possibility that the suckers who had rushed into that mania-driven game of musical chairs would ever get out with more than a fraction of their money. I warned about the NASDAQ bubble in Remnant Review in February, 2000, March, and April. The Dow had also topped in January, but I wasn’t sure it was in bear mode. But, as for the Dow, I think it clear in retrospect that it had entered its bear phase in late summer 2000 — I would say early September. I was convinced that the bull market had ended by June, 2000, and said so.
Today’s continuation of that bear market was not called a bear market by the talking heads until early this year, a year and a half after it had clearly gone into bear market phase. The experts then began telling the public that this market, which they had insisted had not been a bear market, was, in fact, a mild bear market, but just about over. In short, they asked investors to believe that an 18-year bull market had almost invisibly turned into a bear, but that was a retroactive bear, ready to wander off. Therefore, “don’t panic.” Well, the bear is still here.
Night after night, I see and hear the experts interviewed by TV’s talking heads, and the experts all say the same thing: “Don’t panic. Hang on. Don’t sell in panic.” Why do they say that? Because they don’t want to be blamed for causing the panic that always accompanies the end of a long-term bull market. Either they have forgotten that all long-term bull markets end this way (if so, they don’t qualify as experts), or they are saying that this is a New Era in which long-term bull markets are forever. Or maybe they are in paralysis mode, seeing their economic futures as being completely dependant on the revival of optimism regarding this market.
What every commodity futures trader is told from day one — cut your losses early — the general public is told not to do. What will bankrupt a commodity futures investor — hanging on to a bad position — is seen as the best economic wisdom for the public. Selling short is part of the commodity futures business. But selling the stock market short is seen as unpatriotic, immoral, foolish, and an affront to the integrity and wisdom of the Federal Reserve System.
“Don’t panic.” This is good advice. Let me make myself perfectly clear:
The best way to avoid panic is to sell all of your shares before the general panic hits. Panic hits the masses of investors who stared in disbelief and paralysis, who believed the expert dolts who advised, “Don’t panic.” Then, not able to bear the pain any longer, in a mad dash, they sell.
The best way to avoid panic-creating pain is to accept market-imposed pain early. The best way to avoid panic selling is to sell out rationally, early.
What we are seeing is the beginning of the end of the impossible dream. It’s time for me to reproduce my closing words in the June, 2000 issue of Remnant Review. My subscribers have probably forgotten the following.
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Pareto’s Law and the Levitating Stock Market
Who owns most of the wealth of the United States? Not the poor. The middle class? You might think so, but you would be wrong. The middle class has too much debt. The richest 20% own most of the tangible, marketable wealth. This is nothing new. This is the same old story. It is a story that will smash the middle class dreams of easy, automatic, “buy and hold” riches. The only question is: How soon?
Back in 1897, economist-sociologist Vilfredo Pareto’s study of income distribution appeared. He surveyed the larger countries of Europe and found that there was a strange income distribution curve in all nations that he studied. Something in the range of 20% of the population received about 70% to 80% of the income. This figure has not changed much over the last century. Later studies by other economic historians indicated that in 1835-40, 1883, and 1919 in Great Britain, the richest ten percent received fifty percent of the nation’s income. An economist wrote in 1965: “For a very long time, the Pareto law has lumbered the economic scene like an erratic block on the landscape; an empirical law which nobody can explain.” (Josef Steindl, “Random Processes and the Growth of Firms: A Study of the Pareto Law” [London: Charles Griffin, 1965], p. 18.)
A 1998 study by the Centre for the Study of Living Standards in Ottawa, Canada, revealed that the 20-80 rule still applies quite well in the United States. The top 20% percent of the population owned 81% of household wealth in 1962, 81.3% in 1983, 83.5% in 1989, 83.7% in 1995, and 84.3% in 1997. For the top 1%, the figures are as follows: 1962: 33.4%; 1983: 33.8%; 1989: 37.4%; 1995: 37.6%; 1997: 39.1%. These changes have been in the direction of greater concentration of tangible wealth in the United States.
This seems impossible. Don’t middle-class people own their homes? No; they reside in them, but they borrow to buy them. They pay mortgages. The rich are the holders of these mortgages. Title is passed to the home owner, but the asset has a debt against it. Most middle-class Americans own very little debt-free marketable wealth. They use debt to buy depreciating assets: consumer goods. They do not save more than a small fraction of their income. There is no known way for any industrial society to alter significantly the share of tangible wealth owned by the rich. Whenever political force has been applied in the form of tax policy, the percentages have stayed pretty much the same. It is not even clear that there will be different wealth holders after the new taxation policies are in force, unless the existing wealth owners are deliberately expropriated or executed, as they were in Communist nations.
Getting rich is simply not possible for 80% of the population. Anything that offers the hope of riches to the middle-class majority is a delusion. There was a time when Communist revolutionaries offered this dream to the poor. Those dreams failed to come true. The same dream is being offered to middle-class Americans today. It will also fail to come true.
The next President will get to put up the detour sign on Easy Street. This will probably be Mr. Bush. I wish him well. I hope the junior Senator from New York decides not to run for President in 2004. But I can see what is likely: a political reaction against Bush as the destroyer of dreams. This stock market is levitating because of the promise of pension fund money, which seems to insure a floor. This faith is a faith in the debt-burdened middle class. Somehow, they will stick with this market, no matter what. Their pension fund managers will continue to pour their clients’ money into stocks, no matter what. Somehow, they will not cash out when they retire. Somehow, there will be enough of them to sustain this market.
This market is a market that is being sustained for the benefit of the richest 20% of the U.S. population. It seems self-perpetuating. But the fact is, this market is the product of the credit system, which is based on faith in a stream of income to maintain interest payments. What happens to these hoped-for income streams when those who are the major investors, who hold most of the nation’s wealth, derive most of their money from stocks? How will a 1.17% S&P dividend yield pay for the margin debt system that demands 7% or more?
Americans’ investment money is now about 75% in stocks. Margin debt is holding up this market as never before. Margin financing must be paid for. How can it be paid for if dividend yields are under 2%? The dividend income generated by the capital assets underlying the shares does not support the level of debt used to purchase the shares. The stock margin’s debt meter is ticking relentlessly. It is being fed today mainly with after-tax money generated from outside the stock market. Those buying shares on margin must have a fast return; otherwise, they cannot feed the meter. The market’s boom phase has ended for the Nasdaq’s high-flyers. Any hope in a fast profit sufficient to enable the speculator to sell shares and pay off his debt with the profits is now utterly naive. We are now ominously close to the day when stock market investors will run out of coins to feed the ticking meter. I presented evidence for this in my March 3 issue. I quoted Alan Newman:
Margin debt now stands at $228.5 billion — 2.41% of GDP — the first time since the Roaring Twenties margin debt has been above 2% of GDP. Note that even in the manic year of the 1987 Crash, margin debt only amounted to 0.9% of GDP. Adjusted for the effects of inflation, the picture becomes even worse. Margin debt is up 3.3 times since the mania began in 1995 and is nearly double what it was only two years ago.
How will this end? Badly. How badly? The international credit markets would completely unravel in a worst-case scenario. The derivatives market would become illiquid. This is what Jim Cook describes in his new novel, “Full Faith and Credit.” Cook’s narrative offers one of the best introductions I have read on the nature of the systemic risk of a rapidly falling stock market. His main point is this: it’s not just the equity markets that are at risk. It’s the credit markets, too. The spread of credit to finance every aspect of the world’s economy has put this economy at risk. This is not just a domestic American problem today. There are too many foreign investors in U.S. markets.
* * * * * * *
Years ago, I heard my friend Jimmy Napier announce one of his many laws:
“When you’ve got a million dollars in your hand, close your hand.”
I heartily agree. But there is a corollary:
“When you’ve got a loser in your hand, let go of it.”
The reason why long-term bull markets do not recover rapidly after a panic sell-off is because panic selling does not produce enough cash for the late sellers to reinvest in a significant way. They have lost their on-paper wealth, which was only supermoney. They have very little money left to invest. They have also been shell-shocked. They are forever immunized to the lure of “big money in these 10 mutual funds.” The newsstand magazines on getting rich will go out of business. The junk mail offers will be tossed out, unopened. The mania will end, not in panic, but in the grim realization that “I lost out. It was in my hand, and I let it go.”
But the masses never really had great wealth in their hands. They had only supermoney. They had an asset that would disappear in a puff of smoke when they all closed their hands at the same time. Supermoney disappears when the low-commission brokerage funds’ toll-free phone lines are busy from morning to night. “Sell!” “To whom?”
Pareto’s law is true. The only way for the great masses of 80% of any population to get richer is for the economy to grow by 2% or 3% a year for 80 years. At 3% per year, most people’s wealth doubles in a little over 24 years, which is spectacular. In one lifetime, most people find themselves eight times as rich as their grandparents were at the same age. There is no other road to “wealth for all” except “productivity by all.” Any other program is a myth based on some version of supermoney: the masses wealthy on paper, but only for as long as no more than 10% of them seek to close their hands on their wealth at the same time. When 10% do, the panic begins.
WHO STILL BUYS STOCKS?
The buyers are people who got out before the panic. They preserved their assets. They have money to buy bargains at panic prices. But these are not the people who say, “Should I sell before the panic?” These are people who didn’t ask. They knew better than to stay in a loser’s game. They sold before the thought of a panic was even for public discussion.
As soon as the talk of panic is widespread, you are just about out of time. You have to sell. As soon as you hear, “Where is the bottom?” you know: this is nowhere near the bottom.
You get into cash, not because cash will sustain your retirement, but because cash will let you buy income-producing assets at fire-sale prices. Note: you are not buying more supermoney. You are buying the streams of income that initially called into play the supermoney strategy. You are buying earnings at a low P/E ratio. You will need cash to make these purchases.
Anyone who says, “I can’t afford a money market fund because I can’t live on the income it generates,” doesn’t understand investing. He doesn’t understand that the way you live off an asset’s income is because you paid cash for it when nobody else had much cash. Your absent competitors were barely getting by, barely meeting their monthly bills. So, there were few buyers. The person with cash is in the market for income-producing assets because he has ready cash. The low rate of return that prevailed at the time when he sold his stocks and went into one or more passbook savings accounts will not prevail after the stock market bottoms. He will not face a federal funds rate of 1.75% when investment capital gets scarce.
If you want to make money both ways, up or down, you must do what commodity futures investors do: short markets before they fall. You must bear uncertainty both ways in order to make money both ways. When bubbles pop, those who were short make fortunes. But few people have the stomach for shorting. So, they should remain content with breaking even on the downside leg of the stock market, holding onto cash, and buying high-yield, income-producing assets after Louis Rukeyser’s show has been cancelled.
CONCLUSION
I’m with Jeffrey Tucker. The falling stock market has been good for America. Click here to find out why.
July26, 2002
Gary North is the author of Mises on Money. Visit http://www.freebooks.com. For a free subscription to Gary North’s twice-weekly economics newsletter, click here.
Copyright © 2002 LewRockwell.com
