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Posted 2/3/2003
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Why the lousy market? Its the Fed, stupid
Iraq is dominating and will dominate the headlines in the days ahead, but Iraq is not the real cause of our economic malaise.
By Bill Fleckenstein
As the Iraq battle looms, the battle of the stock-market bubble lingers. The policies of its founding father, Federal Reserve Chairman Alan Greenspan, continue to inflict widespread pain. But to judge by the headlines in the mainstream financial media, all our troubles fall at the doorstep of Saddam. While news of his "departure" cannot come soon enough, it's high time that Alan Greenspan's pivotal role in our problems made headlines as well.
For those readers new to the Contrarian Chronicles, I'd like to review my thoughts about our chief central banker. The bubble that was fomented under his watch during the 1990s precipitated the wild misallocation of capital and recklessness on the part of individuals who believed that Greenspan would save them. While this illusion held sway, people believed in flights of fancy like Internet stocks, stock splits, "beat the number," etc. The fervor of their belief was ultimately expressed in the Nasdaq reaching its 5,048.62 peak in March 2000.
The unwinding of that wild orgy is still our problem, exacerbated by a Fed and government still determined to fight off the "destructive side of capitalism." Capitalism is the best economic system around, but it does come with bad times that follow good times. Of course, those bad times help set the stage for the next round of good times. Trying to stop the destructive side of capitalism only leads to huge problems. In the 1990s, the Fed believed it was an omnipotent central planning agency, capable of steering us from good times to better times. Regrettably, lots of people checked their thinking caps and common sense at the door, as they willingly suspended disbelief. So, to that extent, they were not blameless.
The butcher of monetary policy
However, more should be expected of Fed officials. Sadly, Alan Greenspan refused to stand up like an adult and, in the words of one of his great predecessors, William McChesney Martin, "Take away the punch bowl." (Martin was Fed chairman from 1951 to 1970 -- the longest tenure ever in the post.) The excess capacity, reckless behavior and accumulation of debt spawned by a bubble that Greenspan fed are still the problems that plague us. Only time will cure those problems. Attempts by Fed heads such as Mr. More-Beer McTeer (aka Robert McTeer, president of the Dallas Federal Reserve Bank) to minimize them, by telling people to continue consuming, will only make the situation worse.
The incompetence of the Fed has been an ongoing topic of both this and my daily column on Real Money until last September, when I vowed to stop speaking about Al.com. I came to that decision after Al gave a speech in Jackson Hole, Wyo., saying hed missed the stock-market bubble. (To read the speech, click on the link at left under 'Related Sites'.)
Forgive me for breaking my vow at length this week, but given the popular press's difficulty in understanding our problems, the situation seems appropriate.
At the time, I opined in my daily column: "This admission of the bubble should mark the start of the process that ends in his being completely discredited. Yes, before this is all through, people will see that their apparent maestro is, in fact, the most incompetent and irresponsible Fed chairman in history. And sadly, lots of them will pay for his experiments and subsequent mistakes."
So, with that as background for new readers and review for the regulars, let me now say that Greenspan and the other lunkheads at the Fed have done far more damage to most Americans than has Iraq. (This is neither to trivialize Iraq's bloodthirsty tyrant nor the impact of terrorism.) Actually, I'd like to let my favorite mainstream columnist, Jesse Eisinger, do the talking for a minute. Recently, in another of his great columns for The Wall Street Journal, titled "The Saddam Excuse," he noted that our problems lie not with Saddam but with earnings, of which there aren't enough:
"A sustained bull market will begin when earnings estimates are too low. For now, they're too high. More important, anemic revenue growth estimates speak volumes. Analysts are looking for 18% growth in operating earnings for 2003 for the S&P 500 and 27% growth in net income, according to S&P. But analysts are looking for only a 0.45% increase in revenue for those companies this year, says Multex. So, many companies expect little growth and little opportunity to raise prices. That means more cost-cutting, which could mean more labor-market weakness, which eventually could hurt demand." Yes, earnings estimates are too high. And I agree that a bull market could begin when they become too low. But we could also see the start of a bull market once stock prices become too low (regardless of near-term earnings). Of course, "too low" is completely and totally subjective. There is never any absolute stock price that is perfect. The point is: before we can have a new sustained bull market, valuations must be supported by the underlying fundamentals, a fact that seems to escape the attention of the popular press, as I have noted frequently.
The bulls of Baghdad
Meanwhile, as incompetence plays out on the Potomac, the near-term direction of the market will, in all probability, be dictated by Iraq headlines. In the past, I noted the dichotomy in which speculators deem war angst to be bearish, but the outbreak of war itself to be bullish. I think most people, myself included, expect that there will be a rally once the war commences or in the unlikely event that Saddam leaves town and we avoid a war. Recently, in my daily column on RealMoney, I talked about a strategy that I had evolved, based on the combination of war crosscurrents and economic weakness. My view essentially was that the rally Jan. 6 to Jan. 8 should be sold, because the economic news would be bad. I expected that the war angst we're now seeing would create further pressure.
I have no idea how long the present decline will last, but I expect that at some point, there will be a rally leading up to -- or just after -- the outbreak of war. I anticipate that once war breaks out and a rally is launched, all previous fears will be abandoned and all economic weakness will be blamed on the present war angst. People will take up the pompom chant about the bottom being in, and how wonderful the second half will be.
I don't believe any of those things. Also, while it's very likely that the "battle" with Iraq will be won, it's not clear whether or not the "war" will be won.
Speculative juice suspended in pea soup visibility
In any case, I am getting ahead of myself once again. This is a long way of trying to give my two cents' worth on the "State of the Economy/Stock Market." (Click here to read my comments on President Bush's State of the Union address, which were posted on MSN on Jan. 29.)
Over the next several weeks, I anticipate that the stock market will be wildly speculative, with huge surges in both directions. The market will be more "unanalyzable" than usual, because we have this big geopolitical fog. However, once that fog starts to lift (and at some point it will lift), we'll have a better chance to assess whether or not our true problems are being discounted. Of course, when speaking of the stock market, nothing would be more useful than lower prices. Lower prices would reduce the risk in owning equities and indicate that our problems had been discounted. That said, lower prices only benefit those who don't own stocks now, so that they can buy them later.
Marc time with foreign intrigue
Right now, we have a whole host of problems to deal with going forward, not the least of which is war. Stock prices come nowhere close to discounting any of these problems, but, in the meantime, investors remain remarkably complacent. That is certainly the view of most of the "pros" who weighed in at Barron's Roundtable these past three weeks. As an antidote to all that noise, people might want to read some potential long ideas described by one of its participants, Hong Kong investor Marc Faber, in the Jan. 24 issue. I thought that many of Fabers foreign stock recommendations looked interesting, and I plan to investigate some of them. By the way, I heartily recommend his new book, Tomorrow's Gold: Asia's Age of Discovery. I am only about halfway through it, but it is phenomenal, and one of the best investment books I have ever read. I think that anyone with even a passing interest in equities and investing should pick up a copy of this book and read it.
Pundits peddle DD batteries
I would suggest, however, that people turn away from what still passes for investment advice in the popular press. Case in point: a recent story in The Wall Street Journal titled "Getting Ready for a Double Dip." This is essentially a primer on how to "play" the double dip, complete with rules that are basic to Wall Street lore. "You don't avoid the market," says Standard & Poor's chief economist, David Wyss. And from an investment strategist with Frank Russell Co. comes the suggestion that people not dismantle their portfolios for a worst-case scenario (I assume he is referring to a double-dip recession), because this "means you'll only be right in one case -- the worst case."
That is just gibberish. It's the same sort of advice we have heard repeatedly throughout the bear market. At the end of the day, the basis for a successful investment is the price, or valuation, of the company you are buying. You need to have some margin of safety -- whether that be in relation to book value, revenues, earnings, or margins. That way, if you are wrong about why it is that you are buying something, you won't be destroyed.
Arm-waving isn't a way to build a margin of safety. It is a recipe for trouble. Yet here we are, deep into the bear market, and all too often the popular financial media, notably Bubblevision, drones on about how it's the third year of a presidential cycle, or stocks can't go down three years in a row or four years in a row, or they're down so far, they're down so many days in a row. We still play the game of who beat the number, or who did better than the pretend guidance. Notwithstanding people's angst over the impending war with Iraq, we still don't seem to focus the discussion on what really matters, and that is the valuation of the companies underneath their stocks.
Pain and suffering succotash
Of course, if you are a class-action lawyer, what matters these days is getting a piece of the $1.4 billion settlement that Eliot Spitzer has extracted from Wall Street. Recently, The Wall Street Journal chronicled their efforts in a rather revolting story titled "Wall Street May Be the Next Legal Jackpot." After wreaking havoc with medical malpractice, asbestos, etc., a group of ambulance chasers is shown honing its skills and knives at a conference called "Mass Torts Made Perfect," where one Robert Weiss tells them, "This is not brain surgery. This is a car accident. It just happens that your grandmotherly client was rear-ended by a Mack truck being driven by a CEO."
Im not saying Wall Street or corporate America is blameless. Regular readers know how I feel about those two groups. They have erred badly, and something needs to be done. But the behavior of class-action lawyers has gotten out of control. Their legalized blackmail has produced an incremental cost of business that does no one in this country any good.
We would be better able to compete in the tough global business environment if we could restore order to our out-of-control tort system. Perhaps this goal can be attained, now that the Republicans have the Oval Office and both houses of Congress. We just need to see some regulations put in place to help restore ethics and honesty to the business and legal arena. Unless checked, the army of class-action lawyers poised to pounce on Wall Street and corporate America will just boost its war chest for assaults yet to come.
William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. William Fleckenstein's investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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