Market Watch - January 29, 2003
In January of 2001 the top 22 Wall Street analysts estimated the Dow would close the year of December 31, 2001 between 11,400 and 12,300. The Dow closed at 10,021.
In January 2002 the same 22 analysts estimated the Dow would close on December 31, 2002 between 10,750 and 12,100, and the Dow closed at 8,341.
In early January of this year, leading Wall Street analysts estimated the Dow would close above 10,000, except for one analyst who was looking at 9,500.
Is it likely that 22 of the smartest, best-informed market analyst in the world could be wrong three years in a row? Upon what do they base their projections? Let’s look.
1. New investment in plant and equipment? Nope. Companies are reducing employment and cutting back. They are hording cash and trying to meet their over extended debt obligations. Dividends are being cut back, earnings are depressed, and capital investment is way down.
2. Perhaps the analysts are optimistic because the dollar has lost so much value against the world’s major currencies in the last year. A cheaper dollar makes it more likely that foreigners will buy our exports. Similarly, foreign goods are more expensive for US consumers because it takes more dollars to purchase each foreign good. Such a scenario should have a favorable impact upon our trade deficit which is running at more than $400 billion dollars annually. But wait a minute. More than 70% of the world’s reserve currencies are dollars, so when the dollar goes down, other nation’s currency reserves that are held in dollars also go down, thereby reducing the purchasing power of all foreign nations who hold dollars. This creates worldwide deflation in the money supply.
3. Perhaps the analysts are excited about the prospects for the market this year because the Federal Reserve has reduced interest rates 5-1/4% the last 2 years. All business and personal loans, then, must be down 5-1/4% — right? No, not at all. Interest costs to consumers and businesses are down about 2% at most. Financing the federal government’s debt, however, has been favorably affected because the 6.4 trillion dollars of debt the government is carrying is costing 200 billion dollars a year less to carry than it did a few years ago.
4. Since the government is not paying as much to carry the debt, could the analysts be excited about the prospects of the market because the government is going to balance their budget? Not quite. The US government fiscal year beginning October 1st, 2002, predicted a deficit of 135 billion dollars. The government’s fiscal first quarter ending December 31, 2002, produced a deficit of 109 billion dollars. This suggests the deficit predicted by the government is likely to exceed 400 billion dollars this fiscal year.
5. Could these analysts be excited about the prospects for the stock market in 2003 because of the Feds astute management of the nation’s money? This is a toughie. The fed is increasing the total money supply (M3) at a rate of more than 1 trillion dollars this year. Such an increase of 12 to 14% in the money supply in the face of declining business conditions means more dollars are available to buy the same number of goods. A greater supply of dollars than demand for dollars will cause goods and services to increase in price to meet an increasing supply of money. That’s inflation. But wait a minute. Prices are going down. What we have is deflation, not inflation. So if the fed is increasing the money supply at this rate in the face of a deflating economy, they must be trying to inflate prices. Why? Because if we have all around price deflation, we will not be able to service total US consumer, corporate and government debt of 38 trillion dollars.
6. All right, could it be that the price of gold will go down as many of these same analysts are predicting? Gold going down would cause the dollar to increase in value. But what would cause gold to go down? Before President Johnson did away with the requirement, US laws mandated a 1 to 4 maximum ratio between our gold stock and the money supply. If we converted our dollar, backed by nothing, to a dollar backed by our existing gold supply at a 4 to 1 ratio, gold would be re-valued to $8,100 per ounce. Even at a 1 to 8 ratio of gold to the money supply, gold would still be $4,100 per ounce. It appears that under any circumstances gold is undervalued.
7. Could it be these analysts expect a boom in consumer spending, which spending drives about 65% of our GDP? Unlikely. It was a lousy holiday season, households are already loaded with debt, and household net worth has dropped to the lowest levels since the early 1970’s.
8. Ok, then it must be the security the world feels in doing business with US companies because of the extension of our military power around the globe during these uncertain times. But that’s expensive. There are 189 nations that are members of the UN, and the US has a military presence in 140 of these nations. The US has major foreign bases in 36 nations with thousands of sailors floating over the seas in US carrier groups. The US has 800 bases overseas including 60 major bases. Dollars spent overseas were welcomed when the dollar was high, but there is now less demand for dollars. Plus we’re looking at a 400 billion dollar current account budget deficit, a 450 billion dollar trade deficit and an additional 1 trillion dollars added to our money supply by the Fed. This will further depress the value of the dollar against other currencies, in general, and gold, in particular.
9. Could it be that analysts are expecting to attract foreign capital to prop up our stock markets. Why would they? Foreigners are suffering from a double whammy: the dollar is going down, so as compared to their own currency they are losing money, and the US stock market is going down, from which they are also losing money.
It is impossible to determine from which data these analysts have drawn their conclusions that the market will close above 10,000 points this year. What is it that is going to push a market that is already highly overvalued to “higher values”? All of what is happening is symptomatic of the second phase of a bear market where stocks continue to erode value as they discount continued deterioration in the economic, social and political fabric of a nation. It is not apparent why 22 of the smartest analysts in the world feel we will return to a bull market. After the frenzied bull market we had from the early 80’s until 2000, Dow Theory states a bull market will resume only after price earnings ratios and dividend yields return to values that can only be realized when the market returns to the 5000 range or below.
Will it happen? 44 million pension investors have lost 8 billion dollars so far from the announcement last week that the federal agency guaranteeing pensions has suffered tremendous investment loses. In addition, US companies have pension shortfalls of 240 billion dollars. Any future growth in profits will first go to funding pensions before the growing pressure on increasing wages is even addressed. Who would have guessed that the market would go from 4,400 to over 11,000 in less than five years? With the economic scene as painted above, why isn’t it more likely the market will return to 4,500 to 5,000 before returning to 10,000?
Conclusion
The 200 day moving average of the Dow on January 27th hit a new bear market low of 8,846 and the 50 day moving average stood at 8,580. The market closed at 7,990, below both moving averages, in full bear market mode.
Inflation, capital consumption (instead of capital creation), government intervention, negative savings rates, and overwhelming indebtedness are not the path to prosperity. They are the road to economic destruction and financial perdition.
Caveat Emptor!
George Rauch
January 29, 2003
