another good read by Fleck...(btw, he is now short FNM)
Fleck - To Appreciate Risk, Stop and Smell the Statistics
By Bill Fleckenstein
Special to TheStreet.com
09/13/2002 06:03 PM EDT
Triskaidekaphobia Friday: Overnight, the foreign markets were weaker, and our futures were lower as well. The market opened under a fair bit of pressure, down about a percent, but after a couple of stutter steps, it had a straight-up move that brought us back to unchanged or so. Following a brief setback, we then had a surge that took us pretty close to the day's highs, and the rest of the afternoon saw surges in both directions. But for all intents and purposes, we made no net progress from the early-morning burst, such that the box-score prices you see are the highs of the day (though they are not very "high").
Honeywell Sensors Fail to Detect Recovery: In fact, it was a bit of a mixed bag, with the Dow closing down and the S&P and the Nasdaq closing higher. Of course, the Dow was held back by Honeywell (HON:NYSE - news - commentary - research - analysis), which preannounced last night, though the implications of what its CEO had to say were ignored: "We are revising our 2002 outlook, because it is clear that the broad economic recovery isn't materializing." That is a view which has been echoed by many companies. Here we are, halfway through September, and most of corporate America is acknowledging that the recovery we were supposed to have seen in the first half of 2002, which was then postponed to the second half of 2002, really isn't happening. Other than the bubble in housing, and that in autos (powered by 0% financing), it's hard to find much in the way of strength.
Kissing Chasms: But I notice that people who had expected this to be a strong year in the economy, on the basis of a belief that the recession has ended, don't seem to have changed their tune. So we appear to have a disconnect setting up, whereby a lot of people expect things to get better, but things seem not to be getting better. My experience has been that when such disconnects grow and build, they are often resolved in a violent manner over a short space of time. To me, that means another blast to the downside in the market. I guess we'll find out if that hunch is correct, over the course of the next couple months.
Away from stocks, the metals were a percent lower. Bonds were up yet again. The dollar was very strong, up over a percent. Oil bounced as well, up 96 cents, to close at $29.81 a barrel.
Nickel-Plated Debt Hypertrophies Sold Here: I'd like to devote the rest of today's Rap to discussing debt, balance sheets and valuations -- topics that I believe receive too little coverage by the mainstream press. First of all, let's talk about debt. While leverage works well when things are going up, it obviously magnifies problems when things are going poorly. In some sense, assets are contingent, but debt is forever. Here in America, total debt compared with GDP now stands at around 280% to 300%. (By definition, these numbers are estimates, since it's impossible to arrive at a precise figure, but a precise figure is not needed in order to get the gist of what's going on.)
Short-Shrift Gazette: This is the highest debt-to-GDP ratio that the country has ever seen. By my calculations, as we exited 1929, debt to GDP was about 200%, though it did rise pretty dramatically while we were in the Depression, to about 300%, according to the latest research that I received from the Leuthold Group. But by 1950 or so, the debt-to-GDP ratio came in at about 150%. It rose to about 160% in 1992, and further to some 220% in 1990. So obviously, our current ratio of total debt outstanding to GDP is the highest it's ever been, the Depression excepted. And to repeat, despite the mounting risk associated with these increased debt levels, I rarely see the media taking the time to talk about the problem.
Further, it should be remembered that as we headed into the Depression, corporate America had behaved differently than it does now. During that bubble, it had been raising equity money, and it could boast of balance sheets being in pretty good shape. Whereas in the most recent mania, corporate America took on a lot of debt and bought back stock.
Chewing on Debt-to-GDP Radicchio: One of the more disturbing reasons for this assumption of debt is that over the course of the last 10 years, and even worse, in the last five years, it has taken ever-larger amounts of leverage to generate an additional dollar of GDP. The data I am about to offer come from The Richebacher Letter, which a friend shared with me. (While not a subscriber, I have read the newsletter often in the past, and for anyone who lacks access to this kind of information, I find it to be a pretty good source.)
According to The Richebacher Letter, it turns out that from World War II until the late 1970s, it took about $1.40 of debt to increase GDP by a buck. Said differently, for every dollar added to GDP, 1.4 dollars were added to nonfinancial debt in this country. The latter began to mount in the 1980s, and levels really escalated in the 1990s. From 1997 to 2001, it took 2.6 dollars in additional debt to generate an additional dollar of GDP. From there, as the newsletter reports, things have gotten worse: "In 2001, the aggregate indebtedness of nonfederal borrowers rose by $1.109 billion, while GDP only grew by $258 billion. This boosted the debt-to-income ratio to the unprecedented level of 4.3 to 1." In other words, it took 4.3 dollars of debt to generate an additional dollar of GDP growth.
Sugar-Spun Torque: Now, these numbers aren't as precise as the decimal point implies. But I think the overall thrust of the information is powerful. We have piled up a tremendous amount of debt compared with total GDP, and it is taking ever larger amounts of debt to power the economy. I was aware of this during the late 1990s, and I wrote about my concerns on a handful of occasions. I always thought it was rather curious that people were giving productivity all the credit, when part of the credit may have been due to leverage. (Of course, the recent revisions have confirmed what a few of us skeptics believed all along -- that productivity was overstated at the time.)
Cash-Strapped Bulls Seek Kitty: As an aside, I might add that people always talk about how what we are seeing here can't turn into what's gone on in Japan. While we have noted a difference between our two brands of capitalism, among other things, it's worth pointing out that Japan is a nation of savers, and we are a nation of consumers. So, when they got into a protracted period of debt, they at least had domestic savings to lend money. We are not in that position, which is why, at some point, the role of the dollar could affect where our credit markets trade. But as I said, that's a bit of an aside.
Still-Mammoth Market Cap: Turning to the other side of the balance sheet, rather than look at P/E ratios when considering the big sweep of things, I have often preferred to talk about market cap compared with GDP. For those not familiar with that ratio, at the peak in 1929, it was 75% to 80%, and it never rose above 100% until 1996. In fact, this ratio had only surpassed the high 70%s for one quarter, briefly, in 1968. (This information also comes from the most recent monthly piece by the Leuthold Group.) Where we stand today is that market cap to GDP is about 100%, down from a peak of 160%, plus or minus, in March of 2000. Obviously, one could look at a chart and see in some cases that the market has corrected to 1996 levels. But one should remember that on this basis, there was nothing cheap about 1996.
Of Median Strips and Accidental Reports: People sometimes like to take the tack of asking, what is the median for the market-cap-to-GDP level? Since 1926, that is about 51%. So if we were to trade back to the median, the market would get cut in half. Now if one looks at a chart of this, as I have over the years, one sees that the market only accidentally trades at the median. It tends to trade way above it, or way below it. My gut feeling is that considering our recent period of insane overvaluation, we could have a period of quite cheap stocks, but it doesn't have to work like that. In any case, there's the math. Based on this ratio, stocks could become far cheaper, which is obviously what I believe and have been saying.
Per-Annum Anomaly: Lastly, I'd like to add a little flesh to the point I made earlier about the difference between the growth rates of the economy and the financial markets. Along those lines, the Leuthold Group provided some additional interesting data. From 1991 through 1999, the equity market quadrupled, growing at 19% per annum. GDP rose by 55%, which is 5.6% per annum. And corporate bonds outstanding expanded by 146%, which is 11.9% per annum. These numbers make clear the more rapid rate of both equity growth and debt growth vs. GDP. To the extent that the drop in the stock market is a proxy for declines in book values (admittedly, not a perfect analogy), corporate balance sheets continue to deteriorate.
Greater Liquidity Through Dry Data: In any case, I hope people find this information useful, even if a little bit dry. What they need to consider is the point that in the aggregate, the equity market is still quite rich, and that our high level of debt will accelerate any negative economic developments going forward. A company with substantial leverage (debt) can make a lot of money when things are going well, but in tough times, its debt burden dramatically increases the risk. And that is why everyone who buys stocks ought to be focusing on balance sheets as well as income statements |
