Market Watch - June 6, 2002
The market continues to be the most expensive, overpriced market in our history. The Standard and Poor Index of 500 Stocks closed last week at a price earnings ratio of 44 to 1 and a yield of under 1.5%. The Fed is doing its utmost to help sustain a Dow above ten thousand, not an easy task considering that both personal and corporate debt more than doubled since 1992, unemployment is the highest its been in nineteen years, and corporate and personal bankruptcies are at an all time high. The daily reduction in the value of the dollar against other currencies encourages foreign investors to sell their securities and invest capital outside of America.
Non US investors hold $8.2 trillion dollars in US assets including 40% of our outstanding treasury debt, 24% of our US corporate debt and 13% of US equities. Players of this magnitude have a profound effect when their capital is withdrawn.
What Does the Market Represent?
The stock market is a distillation of all the known economic facts that affect business in this country at any particular time. When you read, “the market has discounted”, it means, “the market has already digested and therefore reflects”.
Given the fact that the US controls 75% of the world’s money supply, and given the fact that “money control is people control”, the US markets reflect the entire world’s economic situation. The potential for smooth economic sailing, in an already overpriced market, is lessened by the following looming situations:
The US is moving their manufacturing base offshore, most recently building up those parts of China close to the South China Sea. The Chinese have a huge pool of labor with 1.3 billion citizens, 80% of whom live on the 15% of the mainland closest to the sea. The market reflects continuous Chinese anger with America over our support of Taiwan, South Korea and China’s historical enemy, Japan. The Chinese are dependant upon us economically, and they have been angered by the President’s “Axis of Evil” speech – yet they are unable to confront us. From a military point of view, we have them surrounded, and vastly outgunned.
The market is aware of the government’s desperate need for funds in the face of increasing costs and decreasing tax revenues. In spite of the government’s constant assurance to us that the economic situation is improving, ask yourself this question: who do you know that has not cut back on their spending and is not cautious with their money as compared to two years ago? The current account deficit this year is bound to be $400 billion dollars, coupled with a trade deficit of at least $400 billion dollars, for a real total US spending deficit of double any previous record.
The market is aware of the fact that both gold and bonds have outperformed stocks over the last three years. Additionally, the fall out from the government’s $100 million dollar fine for Merrill Lynch could create more serious problems. The $100 million dollar fine was a tiny slap on the hand for Merrill Lynch compared, for example, to what the government has done to Arthur Anderson. Merrill Lynch analysts reached far more people with dishonest recommendations than were touched by Arthur Anderson’s Enron fiasco, but the government is desperate to bury this situation before too much surfaces of a continuing negative nature setting off more inquiries and more lawsuits. Adverse publicity, along with the public’s further loss of confidence, could cause the Dow to plunge to reasonable historical levels of around 4,000 to 5,000 where price earnings ratios and dividend yields would be historically normal. The market is aware of the fact that the government has destroyed Arthur Anderson, one of the truly great accounting firms of all times, and let Merrill Lynch off, simply because of the potential for further destruction to the markets and how that would affect both the market and the government’s revenues.
Good News in the Market
What does the market have to hang its hat upon that is good news? There are several items, already discounted by the market, so one should not think these facts will do more than help sustain the market at existing levels.
There appears to be a slight increase in the cash flow in our economy. To determine whether or not these increases are real, or whether they are a result of the timing of government statistics, will take a few more months.
After the growth in the money supply slowed earlier this year, the Fed began pumping billions of dollars a week into M3. The desperate attempt to keep the market above 10,000 points is alive and well.
Bush may have solved a military, political and economic problem, which would favorably affect the US stock markets, with a new agreement between the US and Russia. The thousands of nuclear warheads that will be disposed of are effectively taken off the world market. Russia’s vast oil reserves will be developed with American technology, just like the oil reserves in the Middle East have been developed by American technology, thereby solving a huge intermediate term problem in getting copious amounts of cash to Russia. Currently in a catastrophic economic situation, Russia is a country with a political structure that could make a quick recovery possible. Our “training of Russian troops” really means the US intends to use Russia’s very large standing army to contain North Korea and the bully regimes in the Middle East. These are potential areas of conflict where Americans will not allow their country to commit large numbers of men and women, and sustain heavy casualties. Finally, this allows us to bypass the Europeans who are angry at us for our awesome display of new weapon technology in Afghanistan which they didn’t know about, don’t have, and can’t afford anytime in the near future.
Conclusion
The market is telling us it would not be wise to be heavily invested in stocks at this time. There are too many potential negatives, and too few potential positives, for the market to display any great increase in value. The best that can be hoped for is a trading range between 9,500, on the Dow, and 10,500, which is exactly what has been happening for many months.
At the end of this bear market, there is a great probability that stocks will reach a price earnings ratio of 12 to 14 times earnings, yields on stocks will get into the 4% to 5?% range, and buying opportunities will bring sophisticated investors back into the market.
Of the seven deadly sins, greed will get us into trouble in this market. Of the seven virtues, prudence and temperance will pull us through. Patience will pay big dividends in the future, for while the short and intermediate term outlook is spotty, the long-term potential for American corporations is very great indeed.
Caveat Emptor!
George W. Rauch
May 30, 2002
