The U.S. Equity Markets

October 23, 2001

Pushing Emotions Aside & Allowing Objective Truth to Prevail

The psychology of most investors here in the last quarter of 2001 reminds me of how I felt with respect to the gold markets when I started publishing my newsletter in 1981. I looked at the major factors that drove the price of gold higher and assumed that those same factors would remain in place for the foreseeable future. What I saw was a political and economic system that would continue to deficit spend and print money to fund a large part of that spending. With the money supply rising dramatically, why would the gold price not continue to rise at least along with inflation? I FELT comfortable with this logic in no small part because it was what I had experienced over several years leading up to 1981.

The same mood and approach to investing applies to most equity investors today. They FEEL that the most recent past is the likely path of the future. So they are incapable of changing their thinking even when objective reality dictates they do so. In other words they are blinded to the reality of the moment by their experiences of the past. I speak with some authority on that issue, because I certainly experienced it with respect to the gold markets. So given that we have just experienced the greatest equity bull market in history and one in which approximately 50% of all Americans participated, the stubbornness of Americans to accept the notion that we are in a secular bear market and that we could be heading toward something equal to or worse than the bear market of the 1930's should not be surprising.

Even so, the resistance to a major decline and the kind of market capitulation that always results in a bottom is quite surprising. The following quote from Richard Russell pertaining to Wall Street strategists who have lost the word "sell" from their vocabulary, best sums up your editor's views about the refusal of Wall Street to allow the current bear market plunge to normal bear market multiples.

"I ask my self, what would turn the strategists bearish? The greatest stock overvaluation in Wall Street history, that didn't turn them bearish.

"The Nasdaq selling at hundreds of times earnings? That didn't turn them bearish.

"The Nasdaq crashing and the S&P down 30%? That didn't turn them bearish.

"The biggest year-to-year percentage drop in corporate earnings in history, did that turn them bearish? No indeedy.

"How about a stock market where everyone is losing money and where stocks pay literally no dividends? Nope, they still didn't turn bearish.

"Oh here's one. How about the attack on NYC and Washington by religious maniacs. Hah, that didn't turn the strategists bearish.

"But what about the specter of biological or chemical attacks on the US, and a potential decade-long war against a cunning enemy who enjoys dying? Hell no - that didn't turn them bearish.

"I think I know when the Wall Street strategists will turn bearish. They'll turn bearish at the bottom of the bear market, maybe five or eight years from now when we've all lost our shirts. That's when they'll turn bearish - that is, if they still have their jobs at Morgan Stanley, Merrill, Goldman, Credit Suisse and the rest."

Profiting from Objective Thinkers Like Tice, Gordon, Turk & Others

In attempting to be objective in our thought process, we have had to solicit the wisdom of people who by their own admission are out of the mainstream of conventional wisdom. Thank God we have because we have profited greatly by people out of the main stream like Ian Gordon, Kondratieff Wave historian, David Tice, Prudent Bear fund manager, The Honorable Ron Paul, M.D., Libertarian Republican Congressman from Texas, Dr. Larry Parks, Executive Director of FAME, Bill Murphy who has bravely led a just effort against the strongest and most powerful establishment people on earth, Dr. Ravi Batra, Professor of Economics at Southern Methodist University, James Turk, editor of "Freemarket Gold & Money" and CEO of Goldmoney.com.

The inclusion of these people, who thrive by thinking "outside of the box" and who are driven by a calling higher than the ameba like impulse of getting rich, getting fed and getting laid, that drives most Americans these days, have been very beneficial to our readers. The calling I am speaking of is the quest for objective truth or truth that is not subject to their individual partisan whims and wishes. Indeed, our Model Portfolio, which is an outgrowth of the collective wisdom provided by these and others not mentioned above, has been in positive territory all years so far. At the end of this week, our Model Portfolio was up 15.80% vs. an 18.69% decline for the S&P 500.

The above named people who for the most part are personal and professional friends of mine are an ever present help in ferreting out the noise imposed on us by CNBC, CNN and the print media. With their help it is crystal clear to me that we remain in the early stages of a bear market that has "miles" further to fall. The folks named above as well as Richard Russell, are independent thinkers who help me focus on facts rather than the wishful thinking of the mainstream press who's advertising dollar income depends greatly on the media's ability and willingness to paint a bullish picture for advertising companies.

As for facts that tell me we the economy remains in decline, consider the following that hit the news this past week.

  • Ford has a $692 million third-quarter loss on lower sales and production cuts.
  • Dana announced it would cut 11,250 jobs and slash its diffident.
  • Merrill Lynch may cut 10,000 jobs, take a $1 billion charge. In this morning's news it was reported that the company will invite all 66,000 employees to accept an "early retirement."
  • J.P. Morgan Chase's profits drop 68% in the third quarter (I don't know why this makes me feel so bad!)
  • Intel reports its third quarter sales will be weak and its third-quarter earnings plunged 96%.
  • Charles Schwab's net plunged 91%.
  • IBM reported a 19% drop in earnings.
  • Instinet's earnings dropped 75%.
  • Japan continues to sink deeper into its depression.
  • US Industrial production fell for the 12th month in a row in September, the worst record since WWII.
  • Consumer credit is getting shaky evidenced last week by a confession by Providian Financial which said its credit card loss would be just over 10% and also by the American Bankers Association which said the default rate on credit cards is the highest in 21 years.
  • Corporate credit is getting much more risky as well. Not only is the market requiring a bigger premium for junk bonds, but in general corporate balances sheets have gotten much weaker in no small part because corporations borrowed money to buy their own stock over the past five years.

And for those of you who like our fathers during the 1930's tend to believe everything you are being told by the main stream media, consider the following quote taken from Chad Hudson's excellent article titled "Where is the Good News?" This article which is temporarily on display www.prudentbear.com and subsequent articles written every Wednesday should be read by everyone.

"Earnings season is upon us and FirstCall is forecasting S&P 500 earnings will decline by 22.4%. When combined with poor results in the first two quarters and the likely poor fourth quarter FirstCall expects this year should be the worst year for earnings in a decade. Of course FirstCall uses pro-forma earnings, so reality is much worse. FirstCall reported that 788 companies have issued an earnings warning for the third quarter, near the record pace of 866 issued for the first quarter. However, fourth quarter warnings are running at a faster pace than previous quarters. Earnings for technology and transportation companies will be the hardest hit. Earnings for the S&P 500 technology companies are forecasted to fall 72% and transportation companies are projected to fall 108% this quarter and 148% in the fourth quarter."

Objective Truth Dictates Bearishness on Stocks at this Time

So stock market bulls who want stock to rise find reasons to think they will, just as I found reasons to believe the price of gold would inevitably head above $850 back in the early 1980's when I began publishing this newsletter. But if we remove our sunglasses or our rose colored glasses, so that we can peer into the economic landscape an unbiased vision, there most certainly is no reason to expect equity prices are anywhere nearly ready to rise. In fact they remain poised at dangerously high levels which suggest a major decline is still in the offing, as my good friends Ian Gordon and David Tice insist is the case.

At the end of this past week, the S&P 500 earnings yield declined to 3.43%. In other words, when you spend $100 to buy this index, you are buying $3.43 of earnings of which you receive only $1.46 is in the form of dividends and $1.97 is in retained earnings. The flip side of the earnings yield is of course the PE ratio. Accordingly, the current PE ratio for the S&P 500 at the end of last week stood at a near all time high of 29.18 times.

Now, "CNBC Speak" tries to convince investors that because the S&P 500 has declined so substantially, stock picking bargains abound. But that notion smacks in the face of reality. As was true last week also, the S&P 500 is actually MORE EXPENSIVE now than 52 weeks ago despite the fact that this index has declined by 23% so far this year. Last year at this time, the S&P 500 was selling at a PE ratio of 26.91 which equates into an earnings yield of $3.72 per $100 invested. Now you are getting only $3.43 per $100 invested.

Could it be that the market sees something that Jay Taylor doesn't see. Well sure, I would have to humbly admit that is ALWAYS possible. Isn't it possible that the market is implying that an earnings turnaround is in the offing, thus justifying these high multiples over the longer term? In theory it is possible, but I do not believe the prospects are anywhere in sight until the cycle runs through what Ian Gordon describes as the Kondratieff winter, simply because excessive layers of debt accumulated over the past several decades, inherent in a fiat currency system such as ours, is now beginning to strangle the economic life out of our economy. The reasons as we note continuously are 1) mal investment that results from the abundance of money created out of thin air and 2) the accumulation of debt servicing requirements that saps the economy of effective demand which is also in decline due to mal investment and wasteful consumption.

Another quote I picked up from Chad Hudson in his midweek piece posted at www.prudentbear.com represents some of the earliest mainstream thinking I have seen that is now beginning to confirm economic predictions made by Ian Gordon, David Tice and other heroes of this newsletter. Chad quoted the following statement by a Mr. Steinhardt who participated in a roundtable discussion between some of the most successful and experienced investors of recent times.

"Can I conceive of this being the start of a more serious bear market? Certainly. And my intuition is that the markets acted as if there remains a bullish sentiment. But my sense is that there remains a vast legion of investors who became investors for the first time in the 90's and who are, for the purpose of even a plain old bear market, virginal, much less that which we're experiencing now. And all of that, plus relatively high valuations, plus the negative impacts of globalization in a period when things start contracting, create for a range of uncertainties beyond that of a typical cyclical decline."

Gold has been discovered on every continent on earth.

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