Don Coxe
April 8, 2004
Conference call from Chicago
The Terrorist War
jonesheward.com
[Last call until April 28th, Don will be traveling in Europe]
The reason for the discussion of the topic today, The Terrorist War by itself is because I really feel now that we’ve gotten the economic news pretty much in gear. We had a great jobless number and although when you dig into the jobless number, yes they were mostly part-time jobs and you can find ways of minimizing it. But the US economy is still outperforming most industrial economies, most conspicuously, of course, Europe. And in Europe, I’m convinced the war on terror is going to have more negative effects on Europe than it is on the United States.
On United States politics it’s having a powerfully negative effect. But the US economy has got the steroids of extremely low tax rates relative to where they were and extremely low interest rates relative to almost any time when the US economy wasn’t in either deep recession or outright depression. So, with that kind of macro policy plus the basic willingness of the Americans to spend up to and beyond their incomes, the US economy is rolling along.
And the war on terror has largely left Asia alone. Which means the Asian miracle, if that overworked word can be used, continues to tool along and so the China story remains intact and we’ve exited from the SARS season now without any recovery, so it’s fair to say therefore that the economic news is likely to be friendly for the kind of stocks we’ve been recommending now almost since 9/11, which is the commodity-oriented stocks.
And yes, there’s setbacks and movements in all directions because, for example this week when the Alcoa numbers came out, even though they doubled their earnings, they were a disappointment to the market and we had a pullback in the aluminum stocks but this is profit taking. The direction for those stocks remains up.
And of course for the energy stocks we are finally reaching the stage where the consensus is beginning to turn. Now that’s going to be the theme of the next Basic Points which I will write upon my return from Europe. Which is that after all these weeks that you’ve been hearing from me now for three years and every issue of Basic Points for that time where I’ve been critical of the consensus on the outlook for energy prices and for the earnings of energy companies, that we’re actually going to see a significant swing on this and I wouldn’t be surprised to see Wall Street start to factor higher prices for oil and gas into their forward earnings. And if that happens what you’re going to have is some kind of move. In other words, the oil stocks are finally going to start to behave like the metal stocks, reflecting their actual earnings.
The reason this hasn’t happened with the metals is because what you did not have was a gigantic force in Wall Street dedicated to holding down the numbers, because they didn’t care. But in the case of oil, they did care. And so we had those nine straight quarters where Wall Street predicted oil at $26 a barrel or less.
This is really starting to change and I think the evidence of this frankly is the coverage that continues to be on the front page of the New York Times which of course is not only revered on Wall Street but as American Liberalisms sort of home page…if they start to reflect the seriousness of the oil supply/demand situation, then that is a sign that the elites are starting to rethink things. And that’s going to eventually flow through to valuations.
So I really feel that what we’re going to see is in the near-term at least it will be the oil stocks which will outperform the base metals, but this is just something back and forth. We’ve had a modest pullback in copper, just down about the buck thirty level and that’s partly because of the fact that they can’t get enough into China at the moment because of backup of ships and also because of this view which is the new Wall Street mechanism here which is saying China is going to be slowing down and that’s bad for commodity prices, but I’ve addressed those themes in recent Basic Points so I won’t go into them now. Simply that all you need is to have any kind of level of growth from China and India in what they did last year and that means higher prices for raw materials generally.
So now I want to talk about where we are in the war on terror and why this is having the kind of effect it is on the markets. Now as you know the position I’ve taken since 9/11 is that we should have lower P/E ratios in world markets because of war. And I’ve documented this before by going back over all past wars and peacetime situations and showing the spread that there is on the S&P and it works out to more than two points.
And people associate the giddy years of the 90’s just with technology but a big part of it was the fact that it looked like we were going to have perpetual peace. Because such minor dust-ups as Kosovo and Bosnia and things that were important to the individuals concerned but not to the markets such as the genocide in Rwanda – these weren’t enough to stop the US from cutting back on defense expenditures and of course Europe really scaled back. The only people that didn’t were people like the Chinese and the Indians and the Pakistanis and the North Koreans, but that’s another story.
Well, now what we have is a situation where the terrorism is at a stage where it is affecting all sorts of attitudes. A year ago even, what people could say was well the war on terror was a few groups here and there and if they could catch the top people at al Qaeda, which they would do eventually, then all would be well. And then Iraq would eventually get settled. And opinion in the United States was divided on that and remains divided but opinion has now turned against the war as has happened in all past situations when the United States doesn’t seem to be doing well.
I’ll remind anybody who has forgotten that a poll was done a few weeks before Pearl Harbor about whether the United States should get involved in WWII and the vote was nine to one against. So what happens, when the US is in a war, the sentiment swings in favor of it. But now what we have is sort of a twilight war which is the war on terror but in a somewhat different form because what’s going on here is classic guerilla and terrorist works, not the kind of things that provokes full-scale battles or the kind of thing that the US can end in a matter of hours.
And so the death rate is higher now than it was at times during the so-called war. And with the discovery of the willingness to have even more bombings in Spain after winning the election there, what that has done is bring hope to Europeans their basic problem, which is they’ve got over 40 million Arabs living there and what you’ve got is a situation where they’re starting to wonder about how these people feel.
I was talking to David Hale who pointed out to me that when he was in London recently, the front page story of the Times showed a picture of two Arabs – Arabs technically, but they were born and raised in Britain – fully educated, and they looked like just middle-class Brits. But they were off to what they said was Palestine to be suicide bombers.
Well that’s the kind of thing you see that is giving people in Europe a sense that this is different from the kinds of smaller wars on terror that they’ve dealt with in the past like ETA in Spain, the Irish Republican Army, the Red Guards, the Brigate Rossi in Italy. This is something where ____ what you had was small terrorist cells who had bombs or were willing to capture high politicians. Now we’ve got a situation where apparently what there is is such a widespread sympathy even among people who’ve been raised in that culture.
See when we first had the blow up of the war on terror, the prevailing view was “well they’re so poor in the Arab world and this is their frustration, that it’s the poor and the disaffected who had no future that are willing to commit suicide”. Well, sure we thought that at the time not 9/11 because the Saudis who captained the planes were well-educated and they were certainly of the middle class but now it is sinking in and for Europe this is a new kind of horror story.
Because you see they do have some experience with this. Go back to the post-WWII period on the Continent. It was a dangerous time to be an American soldier, particularly in Germany and there were lots of killings going on. And the killings were from two groups, the ex-Nazis, and I say ex-Nazis because they no longer could prominently identify themselves as Nazis, and of course from the Communists. Because what was the objective at that time of the Communists was to destabilize this fragile government in what was becoming West Germany. And so what you had then was a situation where they were working along with the fact that both Italy and in France the largest political parties were the Communist parties. And although they weren’t engaged, although small factions were, in terrorism, what you had was enough sympathy for the acts of terror that were committed – it was a fragile situation and that lasted for several years.
So the Europeans are very much aware of the fact that you can have what amounts to a Fifth Column in your ranks and it’s not necessarily rooted in poverty, it’s rooted in an ideology which is tough to crush.
Given the fact that the real threats then, that the leaders of the terrorist groups are well-educated, what we’ve got is a situation of something that’s going to go on for years. Those who want to say “Well this would never have happened if the US hadn’t invaded Iraq”, well, it’s one of those things you can’t prove one way or the other except that what is going on in Iraq and I’ll get to that in a minute, is still only part of a much bigger story, which is the determination of these people to destroy the West. And the reason they feel they can do it is because of what terror is all about. Terror introduces fear, terror introduces changes in behavior patterns.
And so they’ve discovered, now that they’ve managed to swing an election, that the more that they can make people alter their behaviors, the more they can have influence even though they were only a small group of Tunisians and Moroccans that managed to destabilize democracy in Spain. This is amazing. And we’ve got elections coming up this year. Got elections coming up in Japan, we’ve got the US election, we have the Indonesian election. So you can expect that they’re going to flex their muscle elsewhere.
And although we’ve learned to defend airports, the rest of society is almost impossible to fully defend. Particularly with trains and subways and all of these things. So people have a sense of fear now about going about their daily work and that has to affect consumer sentiment and it certainly affects business sentiment.
So, the question that really is out there is how much does it do to the price/earnings ratio of the market? Because the market has been very generously priced anyway, and now if you get a sense that the terror is ubiquitous, it’s metastasized out of Afghanistan and out of a few cells here and there into something that may spring up anywhere. Then all of this means that there are going to be more problems and it should mean that the P/E ratio has to be cut.
So I hesitate to tell you what the appropriate level is, but we’ve got the Olympics coming up and Greece had an absolutely dreadful record on dealing with terrorists until very recently. There was only one consistency, 476 people were murdered politically by a group and they were all from the West, Brits and Americans and anybody who was seen to be in Greece who was allied with them. Well they finally got that group, turned out to be a handful, like about six men who were doing it, but they were very efficient and what it meant was you had trouble getting Americans willing to serve as military attaches and so forth in Athens because they knew they were targets.
So that’s the negative. The downside of all this is that what we could have is a series of horrors this year which will make people feel depressed. And if that happens it permeates from consumers to business people to investors and then they’re going to be able to find all sorts of reasons to doubt the stock market.
So, I don’t believe that this is a necessary outcome, but what I’m having this call about is to alert you to the fact that we’re going to have more bad news. You may say “How can the news get worse in Iraq than it is?” Well, it probably will. But even if the news got better in Iraq, then it’ll spring up somewhere else. And capturing Osama bin Laden, if he’s still alive, would be a brief victory, but remember, they’ve captured most of the high command of al Qaeda, or killed them, and still what you see is more terrorist activity. What the Spanish bombings did was showed us how easy it is, I mean this was just dynamite triggered by cell phones, no suicide bombers, no learning how to fly planes, no having to go through security, just leaving backpacks on trains. So that’s the big reason why it is I think Europeans are feeling negative.
I’ve spent a lot of time over the years in London and I can tell you that during the time when the IRA was active, if anybody saw a bag sitting anywhere with nobody around it, what you would see is a bobby would come up very quickly and get it. And they dramatically reduced the number of trash bins around London, particularly near any important buildings. What the British did was learn to live with this but remember, this was the spirit also of the people who survived the Blitz.
Countries that have more fragile records of democracy functioning under stress - which includes nearly all countries on the continent - are apparently less willing or able to handle this kind of sustained, day in day out, week in week out, stress. I say apparently because we’re going to find out.
What’s clear is the declarations that have come from these shadowy groups, basically they declare war on all countries who are doing anything to oppose terrorism. So therefore, there’s going to be more troubles and in the case of Europe, what they’re doing is they’re scaling back - in the case of the Eurozone - growth forecasts by about 1/10th of a basis point per month.
That doesn’t sound like much but when you start at a 2, if you keep clipping out .1 just as we did yesterday, you start to get down to the level where you’re down to a virtually zero growth forecast. And that’s one of the reasons why the Euro is struggling to hold above 1.20.
Because once again, the US with the decent employment numbers that we got is looking good by comparison and there’s a sense that the Fed is going to be raising rates. Plus, once again we’re coming back to the notion that maybe the Americans seem to be the only ones who get it right, apart from the Brits. The Brits have a much lower unemployment rate, but despite all the attacks on Tony Blair and everything, he’s got a stable government because the opposition is all within his own party. The Tory opposition of course, supports his policies on Iraq. They can chip away at what they claim are tactical errors here and there but it’s not something basic.
Well, one country that’s been able to ride above all this is Canada. And Canada continues to have all sorts of reasons for an investor to want to put money in. One of them of course is when you look at crude oil at 36.95 a barrel, natural gas at 5.88, when you look at the prices for metals, then there’s a good reason.
Secondly, you look at the fiscal position of the country, the trade position of the country, and the political position of the country is thoroughly better than it was. Regardless of who wins the election this year, what Canada now has is a credible small seat Conservative opposition that may be able to force a minority government on the Liberals. Which means that the kind of really crazy left liberals that the rest of the world would hear about because they would appear at the international conferences and so forth, they’re just not going to be let out of their cages by the Paul Martin government.
So, it’s going to be a better image in the world, an image of recognizing what kind of world it is. And Canada’s going to look more mature and all of this is something that I think is good for the Canadian Dollar and good for Canadian stocks. I really believe that the world is going to be upwardly revaluing the P/E ratios on Canadian stocks relative to other stocks in the MSCI Global Index.
We’ve talked about this before, but in a funny kind of way the war on terror situation actually works in Canadian stocks favor. Because what Canada has been able to do so far is indicate that it’s sitting this one out. And depending on whom you quote from Canada, you can get things that indicate that Canada’s really involved in prosecuting the war on terror or at least being a meaningful partner, or you can take the attitude that Canada wants to remain as inoffensive as possible and therefore will be left out. So, whatever one might think of the ethics of that kind of position, a sort of neutrality can be a prosperous thing to do.
Look the Swedes got rich in WWII by selling to both sides, and the amazing part of it was that after the war was over, Swedish wealth was taken as proof that democratic socialism was the best system in the world. And the left praised Sweden as the model when the only reason they had gotten to where they did was because they hadn’t accumulated war debts, in fact they got rich out of the war. And Switzerland is the place people go for all these conferences because the Swiss have sat out all the wars.
So there seems to be a neutrality premium that you can get. I happen to think of course, my personal view is that’s not a very good way to do it and I doubt that Canada will be able to sustain that as things heat up in the war on terror and I don’t ascribe that to the view of Paul Martin or most Canadian leaders.
So what I think you will see is that Canada will be recognized as being a country that does have a sense of responsibility but it won’t be high on anybody’s terror list. Better not be because of course all that Canada has to do is show that it’s really averting its gaze from this and you can bet that that border is going to get closed. So there’s that discipline. So I think the fact that Mr. Martin is coming down for a meeting in the White House with the President this month is a good sign about how Canada’s going to get itself aligned but not in a way that really offends people too much.
Now if that sounds mealy-mouthed, I think it’s because Canadians are so deeply conflicted about what it is they want to do and the fact of the way the handled the prosecution frankly of the Air India slaughters indicates that Canadians still seem to have some difficulty in really getting angry at terrorists.
That said, I believe that we’re still going to see more action in the commodity stocks, there’s lots of opportunities out there and market pullbacks should be used as an opportunity to get out of stocks that rely on consumer optimism and get into the stocks that are tied into where the war on terror doesn’t seem to touch at all, namely mainland Asia. That’s it, any questions? |
