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Author: instride Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 10561  
Subject: Random acts of market Date: 5/8/2003 5:45 PM
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I am not an economist but I have started to delve into an arm chair role as of late. I had no such courses in college. I did take quite a few math courses because the subject matter seemed easy to me. This background helps my self teaching process which began a little over 3 years ago from scratch (Before then, stock was beef and chicken and Bond was James). However, I am still trying to sort out a potpourri of ideas to find some cause and effect relationships in the random acts of market violence. For this reason, I am presenting in bullet form so as to dodge any bullets from faulty logic. My thoughts are not nearly as organized as others on this board so comments on my random thoughts are greatly appreciated.

*The economy was coming out of the 2001 mini-recession on record in which capital spending was the first and only component of GDP to go down. Capex accounted for 150% of the peak-to-trough decline in GDP during the recession; historically, it accounts for barely 20% of the overall contraction. The consumer never went away (although that might be the next problem on the horizon). Historically, auto sales have collapsed by 35% in a recession; last time around, the peak-to-trough decline was only 3%. Home sales have typically plunged by 27% in a downturn and never by less than 20%; last time, they slipped by 4%. Moreover, in the GDP accounts, overall consumer discretionary spending actually rose by 4% during the last recession, a far-cry from its usual decline of 7.5%. In short, a look at the figures for the atypical recession of 2001 leads to an important conclusion: no pent-up demand built up during the setback, suggesting that the recovery will probably be tepid.

*Corporate earnings seem to cosmetically rising. I say cosmetically because businesses are moving forcefully to boost profits by cutting back on payrolls, wage growth, and increases in benefits. Who knows what else is in the accountant back of tricks to boost the bottom line with flat or shrinking top lines. I read that earnings account for only 6% of GDP while personal income represents 60%. It seems to me as if the market is overreacting to this corporate news.

*The number of Americans lining up for first-time unemployment benefits rose a surprising 8,000 in the week ending April 19, the tenth week in a row above 400,000. Even though the jobless claims are a lagging indicator while the durable goods orders are a leading indicator, that was still another sign that although the economy is technically expanding -- the gross domestic product grew by all of 1.6 percent at an annual rate in the first quarter -- what we are experiencing is a jobless recovery. Employers are learning to make do with fewer workers in order to reduce their costs. Indeed, the rap against this recovery is that companies are improving their profits not by selling more goods and services but by cutting costs. I realize such maneuvers will make US corporations more efficient and competitive than before. Eventually, this will lead to higher demand for workers and rising employment but not before a lot of pain.

*A Today/CNN/Gallup poll showed that 91% of the 2,146 house-holds
surveyed did not think at the time that the military conflict would affect their spending. This kind of spending accounts for roughly 70% of U.S. economic activity (and about 20% of global economic activity).

*GM has announced 5 year 0% financing a couple of months ago. The ongoing and lengthening perks of financing seem to be less from a position of strength and more towards desperation in my mind.

http://www.gm.com/automotive/vehicle_shopping/overdrive/retail/index.html

*Recent flow-of-funds data provide fresh numbers with which one can value the market. Any way I slice it, valuations are look high. Looking at the broad non-farm, non-financial corporate sector (which goes beyond the S&P 500 and includes non-listed companies), the “trailing-reported” P/E ratio (market value of equities/after-tax profits) was 41.5 at the end of the fourth quarter of 2002. That was higher than the pre-bubble 1998 level of 37.9. Things aren't much better based on free-cash-flow yield, investors' new favorite measure. On a four-quarter trailing basis, the FCF yield (the financing gap as a percentage of market value) was down to 1.1%, below the 1.3% of last year and the peak of more than 2% in 2000. My quicken S&P 500 price to earnings says an eye popping 57.3 I know this differs from some numbers bantered around out there and don't know what method they use to determine it. However, it is alarming to see.

*“Tobin's Q” (named for Nobel economics laureate James Tobin, it is the market value of assets divided by their replacement cost).
Tobin's Q was 89.4% at the end of 2002 vs. 124% at the end of 2001 and 141.8% the year before that. Even so, the ratio is well-above its long-term average of 73.3%. Though technology has accelerated the obsolescence rate of the capital stock, our work has found that corporations have recently been depreciating the capital stock over longer periods of time. That suggests that a capex revival might be further away than many expect. If history is any guide, the consensus investment-spending forecast will soon be coming down. Wall Street economists' business-spending estimates have been overly optimistic in recent years. The initial consensus capex forecasts for 2001 and 2002 were higher than 6%; they declined precipitously as those years went on, and GDP growth forecasts followed suit. I suppose they will get it right one of these years. For now, I think history is likely to repeat itself.

*Stock options are the new kid in town and juvenile delinquency is my first thought. The average options currently outstanding as % of shares outstanding was 8.52%. The median was 7.20% The average annual options grant as % of shares outstanding was 2.68%. The median was 1.82%. The average value (cost) of stock options currently outstanding as a % of market cap was 4.45%. The median was 2.92%. Value was estimated in this case by Black-Scholes adjusted for shorter than contracted useful lives and the expected tax benefit. Will balance sheets get the Black-Scholes black eye? Money and equity shares do not grow on trees. They must cost something.

http://papers.ssrn.com/sol3/delivery.cfm/SSRN_ID376580_code030305560.pdf?abstractid=376580

*I was going to talk about derivatives, which Buffett and Munger think “might amount to financial terrorism.” However I see in today's news that Greenspan identified its potential risks.

*The nation is entering a new era of geopolitics that will differ significantly from those of the past. Taking a broader view, it seems that the1990s were atypical times for a post-war era. During that decade, the Pentagon actually encouraged the use of innovative technologies for commercial purposes. Joe consumer became Inspector Gadget. Even an LYBM luddite like me bought some gizmos. I have heard that it was certainly not the case during the Cold War. Indeed, the Pentagon's relaxation of restrictions on the use of innovative technologies was one of the “peace dividends” associated with the end of the Cold War.

*The U.S. government will have to borrow a $79 billion in the April to June 2003 quarter - a record for the period. The percentage of GDP to debt went up to 4.6%.

*I get about a half dozen junk mail offers and cold calls from banks and other lending institutions asking me if I want to borrow money. Some offers have several months of a promo rate or interest free. It has the feel of a drug pusher offering a free sample to get you hooked. Then, you are slowly robbed of your health and wealth.

*Buffett's State of the economy with regards to consumerism:
He feels the consumer is somewhat better off today but not dramatically better. He also feels consumer businesses are soft. Buffett thinks we have been in recession for two years. GDP is up 2% over that time, but population is up too, so GDP/capital maybe only 1% growth. Its GDP/capita that counts. GDP lately also included extra police, extra security at airports – its not what we want, but what we need and it goes into GDP. Cost of war goes into GDP. If we lose planes and have to build new ones to replace lost fighters – that goes into GDP. In Buffett's opinion quality of GDP growth lately isn't something that's talked about.

*"More people are thinking things are going to turn around," said Andrew Kohut, director of the Pew Research Center. "The same thing happened in 1991 (after the Persian Gulf War) even more dramatically. There was a boost in consumer confidence in 1991 and again in 2003. It proved to be short-lived a dozen years ago."

My bullets are flying in bearish shock and awe. Is it a suckers rally? I think so, but calling tops is luck rather than skill. So I'll leave that for those who, unlike me, have a knack for luck.

Instride

If it wasn't for bad luck, I would have no luck at all.
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