Questions And Answers

We have been asked many questions lately concerning the market, it’s direction, and it’s values.

Question: The last few years, Market Watch has been skeptical about the outlook for stocks. Is that expected to change soon? Answer: No. In a column entitled “My View” published on April 23, 1998, we opined the DJIA would reach between 10,000 and 12,000 by the turn of the century. Conditions then existed for a favorable increase in values because underlying increases in corporate earnings were excellent. The outlook for corporate earnings is not now favorable.

Question: How long will this last? Answer: Another three to six years. The bull market lasted from 1982 – 2000. The rule of thumb is that bear markets last 1/3 of the length of the bull market.

Question: “1/3” seems to be an arbitrary percentage. Are you sure? Answer: The market is being manipulated today by forces more powerful than ever before. The government’s deficit has never been larger. The country’s trade deficit has never been larger. Over the last six months, the Federal Reserve System has been creating money, out of thin air, with no sweat or work behind it at all, equal to almost $1 trillion new dollars annually in a desperate attempt to provide “controlled” inflation.

Question: Why does Market Watch keep highlighting the Federal Reserve System and the creation of money, for no value in return? Answer: Historically, economic value has been created from labor turning resources (anything produced by the land) into manufactured goods that have value. That good is sold for a profit. Profits are used to purchase more resources, and more labor, to turn more goods into profitable consumer items, thereby satisfying the demand in a society of increasing population. When money is made out of nothing that money will be spent somewhere. It is unlikely that enough goods can be manufactured to keep up with an undisciplined increasing money supply, thereby causing an increase in pricing to satisfy demand, which we call inflation.

Question: Market Watch has mentioned that the secondary trend of the market for the last few months has been up, even though we are in a bear market, and that the primary trend is down. As investors, aren’t we missing the market by not taking advantage of the secondary trend? Answer: A secondary trend in the opposite direction of the primary trend of the market is dangerous. It must turn around and match the primary trend sooner or later. If we were competent in figuring out when secondary trends would commence and when they would end, we would all be richer than Solomon. This is a speculators market. When we act in a market that has no value, we are acting on the “greater fool theory”. We are buying securities hoping we can turn around and sell them to a greater fool in the future for a profit.

Question: Why is the secondary trend of the market positive when the primary trend remains down? Answer: The money supply. The M-3 (the large money supply) was $8.5 trillion on December 31, 2002, and today it’s $9 trillion dollars. Much of this new money is finding its way into speculator’s hands. Speculation is increasing the market bubble. July insider selling was 32 to 1 which was the third month in a row it exceeded 20 to 1. With speculators driving up the price of the market, insiders are taking advantage of the opportunity to reduce their risk by redistributing their wealth into cash. Insider selling and buying has long been a barometer of the direction of the stock market. Judicious investors pay attention to insider behavior, which is why the statistics are published.

Question: Personal bankruptcy’s are up 10% over the previous 12-month period to 1,613,000 families, an all time high. Does this have any bearing upon the stock market? Answer: Yes. Like the unemployed, these are families that previously had money to spend whose spending habits have been curtailed. Bankrupt families, and the unemployed, represent a decrease in cash available for consumer goods. Our economy depends upon increasing consumer spending to fuel growth, and to meet our debt obligations. A reduction in cash flow has a negative effect upon the economy.

Question: It was just published in the media that total state deficits this year would be at least $71 billion dollars or 15% of the states’ budgets. Does this impact the markets? Answer: Yes. The states are going to try to make that up on the backs of property owners. Anybody in this area who owns property not protected by homestead laws recently received proposed tax increases on their real estate upwards of 40%. That money goes into the public spending stream and is unlikely to be used for consumer goods or capital investment. A further reduction in “productive cash flow” dampens the overall economic outlook. Government is an inefficient distributor of resources as government distribution creates little value in an economy. A capitalistic economy requires efficient utilization of cash distribution to ensure an expanding manufacturing and job base.

Question: There are a lot of smart people running a lot of mutual funds in this country. Should we have confidence in them? Answer: As a percentage of all mutual funds, mutual funds are actually going out of business more quickly than the percentage of families declaring bankruptcy. Mutual funds manage other people’s money. There is tremendous pressure for their performance to “beat the Dow”. Notice how any literature you get shows that “while the Dow was down 21% for the year, your fund was only down 14%”. Most mutual fund manager’s remuneration is based upon how their fund does as compared to indexes like the DJIA. They will never have the self-interest in managing your money they would have if they were managing their own money.

Question: Market Watch has emphasized good dividends. Why are they so important? Answer: A strong dividend of 4 to 6% represents a return of one’s investment. Five years of collecting a 6% dividend represents a 30% return of one’s investment. Over the last one hundred years dividends represent more than 60% of the return investors received on common stocks. The current mania to build wealth on increasing stock values without the underpinnings of a good cash return represents a hope to receive a return without any underlying substance.

Question: Do we just have to work our way out of this for a period of time or are there fundamental economic changes that need to be addressed? Answer: Both. (1) The dollar is too high, and until the dollar is recapitalized against other world currencies, we will not be able to rebuild our manufacturing base. Manufacturing is what creates value. 50% of our manufactured goods are made abroad, up from 31% in 1987. The portion of our work force involved in manufacturing is 11%, down from 30% of our work force being involved in manufacturing in 1966. In addition to our manufacturing business being exported, there is now undergoing a huge increase in the exportation of our service industry. This results from labor rates around the world being so much lower than in the United States and can only be addressed by the lowering of the value of the dollar. (2) The U.S. economy is continuing to pile on debt at an unsustainable pace of about $2 trillion dollars annually. Our existing future obligations are around $50 trillion dollars and our current GDP is only just over $10 trillion dollars. (3) The Federal Reserve System making money out of nothing promotes continued speculative excesses and heightened financial fragility, which leads to deeper economic maladjustment and impairment. (4) Healthy economic growth depends upon three things: a high percentage of savings, a high percentage of investment of profits, and a high percentage of profits. Currently, we have none of those. Both liberal and conservative economic thinkers have been uniformly apodictic in their agreement of those three things. (5) In the perception of the public, the stock market is coterminous with the economy, and this misperception can end up costing an investor a significant percentage of their portfolio. If the economy is getting better, the stock market can still have a huge downward adjustment in it’s values before the market establishes a base from which investors can enjoy successful gains. (6) More than 50% of the incremental growth in earnings for the US corporate sector is generated from financial services, not from manufacturing. Thirteen years ago only 10% of corporate profits were from the financial sector. It is frightening that all of GM’s earnings come from their financial sector and the car business is break even.

Question: These are morose and discouraging thoughts. Can you offer encouragement? Answer: Yes. There is no doubt the rest of the world is economically worst off than we are. We have a currency that represents 80% of the world’s money. In a country with a decreasing manufacturing base that represents only 4.5% of the world’s population, the dollar’s breadth is a huge benefit. The strength of our institutions, our military, and our political philosophy has carried us through prosperous times. If we are patient with our current situation, and are able to forestall our natural desires to invest (to ”do something”), we may have opportunities in the future to make money that have never existed before. Such opportunities will only become available if there is a continued re-valuation of the dollar and a continued re-valuation of the stock markets. There must be a renewed increase in our ability to create and keep jobs in this country. The sooner the American public realizes what is really happening and can see through all the misinformation that exists in the press, the sooner they will force changes in their political institutions which have driven us into these unstable and dangerous bubbles.

Question: This seems pretty repetitious. Is there anything new to add? Answer: Learning is repetition. On the “pro-investment – buy now” side, you have thousand and thousands of brokers and money managers who get paid one way: commissions. Commissions are not being created unless people are buying stocks. Therefore, the onslaught of misinformation concerning why we must be in the market is overwhelming. Such information must be rebutted repetitiously with cold-blooded facts. Mark Twain said, “Get your facts first, and then you can distort them as much as you please”. The investment community, in concert with the government, continues to distort the facts. Market Watch desires only to present facts as they are and let the potential investor analyze them accordingly. A review of these facts can be obtained from the author’s website (www.gwrauch.com).

Question: Are there any new investment recommendations? Answer: No. We continue to believe that the frugal investor is best advised to be sitting on the sidelines, primarily in cash and short-term paper. The market remains overvalued by at least 3,200 points on the Dow. Anxious investors might consider gold and silver, and gold and silver stocks. Dabbling with a modest percentage of one’s portfolio in high yielding (4% and above), low price earnings ratio (12 times earnings or below) stocks that are at least “A” rated can provide some income and upside market potential over a longer period of time. Anything else is speculation.

Caveat Emptor!
George Rauch
August 26, 2003

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