From: Greg Simmons
Sent: Thursday, October 21, 2004 10:16 PM
To: Greg Simmons
Subject: "MARKET UPDATE"
OCTOBER 21 2004
THE SPX CLOSED UP 2.83 @ 1106.49
THE VIX CLOSED DOWN .31 @ 14.54
BETWEEN 1100 AND 1140 I REALLY DONT EVEN HAVE AN OPINION ANY MORE...
MY GUESS IS THE MARKET WILL CONTINUE TO FLUCTUATE - - I AM STEALING A LINE FROM SOMEONE RICHER, SMARTER, AN OLDER (PROBABLY DEAD) THAN I.
I REAL LIFE, I AM ALWAYS AMAZED THAT MY WIFE WATCHES "HORROR" MOVIES, IT DOESN'T MAKE SENSE TO ME i.e. THEY ALL SEEM THE SAME - - I AM AFRAID I MAY BE GUILTY OF THE SAME THING WITH SENDING OUT THE "MARKET UPDATE" AND INCLUDING ALL THE GORY AND SCARY BEAR MARKET COMMENTS I MANAGE TO READ.
I CANT STOP READING PEOPLE WHO SEEM TO DO LEGITIMATE RESEARCH AND THAT SEE MAJOR FLAWS IN THE SYSTEM i.e. THE DEBT BUBBLE, CRAZY VALUATIONS, AND HOW BUBBLES UNWIND THEMSELVES.
MY FEELINGS ARE THAT WE ARE IN FOR 5 TO 10+ YEARS OF PAIN IN THIS COUNTRY TO UNWIND THE PARTY THAT THE FED HAS THROWN TO PROP UP A FEEBLE ECONOMY AND MAKE IT LOOK LIKE A LONG BEAR MARKET WONT IN FACT FOLLOW A LONG BULL MARKET, I ALSO FEEL THAT MAJOR TRENDS ARE MORE SYMMETRICAL AND THAT THE BULL MARKET FROM 1982 TO 2000 DIDN'T HAVE A TWO YEAR BEAR MARKET AND THEN RESUME.
AS I SAID ABOVE, I JUST CANT STOP TRYING TO POINT OUT REALITY, SO BELOW IS A GREAT ARTICLE ( KNOW ITS LONG, BUT WRITTEN WELL AND I THOUGHT ENTERTAINING) REGARDS HOW REAL ESTATE WILL (AS I MENTIONED YESTERDAY) BE A HUGE CATALYST TO THE MARKETS (NO ONE KNOWS THE REAL TIMING OF COURSE) COMING DECLINE.
The Daily Reckoning PRESENTS: Americans seem to be carelessly floating away on the housing bubble...Chris Mayer gives us a closer look at the history of financial cycles and shows us that this boom has nowhere to go - but down...
PANIC AND PROFITS
by Chris Mayer
"To be ignorant of what happened before you were born is to be ever a child."
George Peabody may not be a name familiar to you, but surely, you have heard of J.P. Morgan. Well, there may never have been a Morgan if not for George Peabody. What follows is a bit of his story, a small study in the creation of wealth in 19th-century America. The opportunity for Peabody emerged in the aftermath of the Panic of 1837.
The Panic of 1837 itself is a great tale, not only because of its useful parallels with today's markets, but also because it gives us an example of the great truth about financial crises - they are midwives of opportunity.
Generally, the study of the bubbles and busts of the past should be a staple in every investor's diet, because speculative manias and panics are bound to be a part of every investor's experience. There is much to be learned in mining these old experiences. The more we know (so we hope), the better prepared and less surprised we will be when things start to break.
Panics always have their beginnings in the boom that precedes them. Just as all hurricanes first develop over warm waters from pre-existing conditions, financial storms are spawned by surging growth in money, debt and speculation - the tress hombres of financial upheaval, if you will.
From the perspective of European investors, 1830s America was a booming emerging market full of promise and potential, a lure for hungry European capital.
The cotton industry was thriving, as the United States was a major global exporter of cotton. Cotton prices were probably as important as the price of oil is today for Middle Eastern countries like Saudi Arabia.
In addition to the cotton industry, there was a great surge in canal construction. The Erie Canal was completed in 1824 and made a big impact on trade. As Marc Faber reports in his excellent book Tomorrow's Gold, the Erie cut travel expenses by 90% on some routes. New canals linking the St. Lawrence River to the Great Lakes allowed for easier transportation of Midwestern grains to New York.
The canal was like any of our recent technological marvels, in that it cut costs and improved productivity. This should concern those investors who are banking on productivity and breakthrough technologies to make them rich, because the canal boom and bust is another in a long line of examples (including airlines and automobiles) in which investors lost boatloads of money betting on life-changing technologies.
In any event, the success of New York's canals helped make the state the financial and commercial center of the young republic. It also inspired numerous imitators, as other towns and cities sought to copy its successes. New bubbles need a crowd of support to wreak havoc, just as politicians need votes to get started.
The canal mania also stimulated rampant speculation in land as speculators tried to position themselves to profit from the growing canal boom. Land prices soared, and properties were flipped like Internet stocks.
Much of this expansion - the cotton boom, the canal construction and the speculation in land - was financed on credit. The banking business, too, was a growth industry. The number of banks in the United States rose from 330 in 1830 to 788 in 1837 - a 139% increase.
The Second Bank of the United States (an embryonic Federal Reserve, which was disbanded in 1836 after Andrew Jackson vetoed the bill to renew its charter) and its coterie of state banks fueled a credit binge that would have made Greenspan proud.
Total bank loans and money supply more than doubled in the six years running up to 1836. In short, there was a huge amount of money chasing cotton plantations, canal projects and speculating on land.
Austrian business cycle theory, as crafted by economists Ludwig von Misses and Murray Rothbard, dictates that any bank credit inflation leads to the boom-bust cycle. All that money and debt creation leads to malinvestments. Malinvestments are investments that later prove to be unprofitable. The word is perfect to express what happens in a
boom - malinvestments multiply. The 1830s boom would be no exception.
The immediate causes of the bust were numerous, and all happened in 1837, precipitating a period of tighter money in which the house of cards began to collapse on itself.
But the immediate causes of the Panic are not important. What is important to remember is that massive borrowing and speculation put the economy on the inevitable path of all bubbles. It also important to note that as prosperous as America was to become, it was plagued in its early stages with regular economic crises - in 1819, 1837, 1857, 1873, 1884 and 1893. Emerging market investors of today take note (because as promising as China looks today, it will not have a smooth ride, if history is any guide. In fact, I think 19th-century America is probably a good metaphor for China).
During the ensuing depression, cotton prices would fall 70%, bankrupting a number of speculators and plantation owners who had paid inflated prices for their land. U.S. banks, facing the withdrawal of foreign credit, began to shut their doors, unable to meet the redemption demands of their depositors. U.S. bank shares fell to small fractions of their previous highs.
Many of the investments made in canal construction were based on unrealistic high-growth assumptions and caused great losses for investors. Many projects, starved for capital after the Panic, were never finished and became worthless.
It was in this maelstrom that George Peabody would build the fortune that founded the House of Morgan. A Baltimore merchant, he opened a merchant house in London in 1838, trading in dry goods and trade finance. American securities had become a specialty of Peabody's, and he sold many U.S. bonds to British investors. State governments had become big debtors in the infrastructure boom - spending money on canals and public works projects.
Peabody actually saw what was coming, and in anticipation, he began to curtail some of his operations, collecting debts he was due, selling stock and getting into cash-building a kitty that would see his business through the Panic and give Peabody some dry powder to take advantage of inevitable new opportunities once the air finally came out of the balloon.
Like contemporary Russia or Brazil, the United States was the emerging market crisis of that time. The state governments were the deadbeat debtors of the day. As author Ron Chernow notes, "British investors cursed America as a land of cheats, rascals and ingrates."
The stain of default also tainted the federal government's credit standing. When the United States sent Treasury representatives to meet with the august James de Rothschild, he reportedly answered, "Tell them you have seen the man who is at the head of the finances of Europe and that he had told you that they cannot borrow a dollar. Not a dollar."
Because of U.S. debt troubles, Peabody became persona non grata around London (after all, he had sold the Brits much of that debt). But that did not deter him. He bought the depreciated state bonds when they were trading for pennies on the dollar. When these bonds paid interest again, in the late 1840s, Peabody reaped a fortune. By 1848, American securities had come to be seen as something of a safe haven as Europe was engulfed in the flames of revolution. The American railroad boom was going strong too, and gold was soon discovered in California.
The promise of America once again won the hearts (and investment dollars) of Europe's moneyed elite. Proof once again that investors of all times and places have short memories.
Peabody's reputation was restored, as America once again became the place to invest. By the 1850s, he had amassed a fortune of some $20 million and had an annual income exceeding $300,000. He was financing everything from Chinese silk to iron rail exports to America.
Peabody, though, was careful with his money. "My capital is ample," he wrote, "but I have passed too many money panics not to have seen how often large capitals are swept away and that even with my own I must use caution."
Junius Spencer Morgan, J.P. Morgan's father, was invited to become Peabody's partner in 1854. Fortunately for Morgan, Peabody had no heirs or a spouse - not even a nephew to whom he could pass on his vast fortune and thriving business. Not only that, he was determined to find an American of good standing and talent to take the reins. As Chernow writes, "This placed the Morgans in the exceedingly nice position of inheriting somebody else's empire on a platter."
It was to Morgan that such a fortune would fall when Peabody retired, although Peabody broke their agreement by refusing to allow Morgan to use the Peabody name (or perhaps the House of Morgan would have become the House of Peabody). In September of 1864, George Peabody & Co. became J.S. Morgan & Co.
The Morgan family would prove to be good stewards of Peabody's empire. The senior Morgan, whether you view him as villain or hero, was a shrewd investor. Morgan and his partners were patient, taking a long view of their investments and allowing their companies to develop without panicking at short-term setbacks.
Long-term patience like that is not a hallmark of today's institutional money. A whole culture of meeting quarterly earnings estimates seems to have vastly shortened investment horizons - to the detriment of today's shareholders.
Taking the lesson of past crashes and heeding the warnings about rampant debt creation and widespread speculation, let's look at today's market for areas that might be potential panic spots for 2005 and beyond.
It is hard to look at today's market and not see housing as a potential panic spot. It is like looking at a normal-sized man with elephant ears: It's hard not to notice. The housing market has all the makings of a bubble - lots of debt (mortgages), artificial government stimulation, incredible price increases and a belief that housing is always a good investment. As Grant's Interest Rate Observer notes, "Since the stock market peaked, Americans have shifted their hopes for capital appreciation to the roofs over their heads, net of the mortgages on their backs."
The United States has not seen such a long bull market in housing since at least the 1950s.
In some parts of the country, the gains have been staggering. Since 2000, in the Washington, D.C., area market, where I live, prices have gained 70%. Housing prices do decline, lest we forget. According to research by HSBC, "Declines occurred in 1975, 1979-82 and 1989-94, using the OFHEO House Price Index. In the past 116 quarters that we have data for (1975Q2-2004Q1), real prices rose 73 times and fell 41 times and were flat twice. In other words, real prices declined 35% of the time." This time, the run-up in prices was unprecedented. Will we soon be able to add housing to the long list of great bubbles in American history - along with canals, railroads and all the rest?
In short, the housing bubble is stretching itself awfully thin. Take this story to heart and become more knowledgeable about risks, and learn to appreciate the timeless qualities of financial cycles. Like Peabody, let's heed the warnings and keep our capital safe.
for The Daily Reckoning