An Excellent Contrarian Indicator

The Mogambo Guru, aided by the Economist magazine, puts the U.S. central bankers and prime financial authorities to a little test…with dismal results.

Fed officials believe that the U.S. economy is gathering strength, a Washington Post headline tells us. Keep this thought in mind, because it brings up a very interesting sidebar that appeared in the January 3, 2004 issue of the Economist, entitled "A Bet Comes Due." It is priceless, and follows another similar article, in the same magazine, about the same guys, and which I noted in a prior Mogambo Guru, and I would have to be crazy to do a search to tell you which issue and the date and all, because I would have to read through all of those back issues, and very soon I would be more confused than I already am, and wondering what in the hell I was talking about, and "What in the hell did I mean by that?"

But the point was, for the past few years at least, the Economist magazine has asked the attendees at the Jackson Hole conference a few questions during their annual symposium of what is supposed to be the smartest and brightest and most powerful financial people and financial institutions in the country, including the Fed, and is actually sponsored each year by the Federal Reserve Bank of Kansas City. In 2001, the Economist writers asked these hotshots, "Is this a bubble?" and they all said – and you will want to keep score, so go get a piece of paper and a pencil – "no." Now, that period of time is now definitely proved to have been a bubble, so the fact is plain: they were wrong. Now to keep score, you write a "zero" for every time these laughable idiots are wrong, and a "one" for every time they are right. So far, they have scored a single zero.

Tame Inflation: Wrong and Wrong Again

They were also wrong when they unanimously said in 2001 that they "ruled out an American recession," to which I shout "Wrong-o again, you ignorant weasels!" which is an audible signal for you to score another zero, and they also got it wrong when "Last year they predicted that interest rates would not fall to 1%." So that’s another wrong answer, as indicated by my jumping up on the table and screaming, "Nice going, chumps! I got your economic savvy right here, you pathetic morons!"

Now, on my score card I have recorded three zeroes, and a little drawing that looks kind of like a bagel, but with lightning bolts coming out of it, which does not mean anything to me or to you, but is apparently highly significant to the people assigned to my case.

The story goes on, as an Economist "update," and thus the reason for the sidebar I mentioned in the first place. This time, the Jackson Hole weenies were asked in 2003, "Will the dollar fall to $1.25 against the euro at any time in the next twelve months?" They all, except one, said "no." They were wrong about that, too, so they score another big, fat zero. So getting out the calculator and a pot of coffee for some marathon calculating, I add zero plus zero plus zero plus zero, hit the "equals" button, and I peer at the readout in puzzlement, and this is just the preliminary result and I am performing some statistical tests on the data to verify the answer, which is roughly, ummm, zero.

Now since this is a binary system, we can convert these data to indicate competence in economics, with "zero" signifying zero competence and "one" signifying complete competence. A few quick calculations later, we find that the Fed, and the dimwits they hang around with, score the lowest possible score, zero, indicating a complete lack of competence.

So you can see why I have no respect for the Fed or any of the dimwits that they hang around with. And now that I think about it, when the Mogambo is elected President, my first Executive Order will be to require that all the officials at the Fed and all their – what did I call them? – dimwit friends all have to wear a large conical hat with the word "dunce" written on it all the time. In this way, it will warn other people about their abysmal, arrogant incompetence. Nah. Now that I think about it, I will just fire them all, and use the resources to hound them to their graves, which is a hell of a lot better than they deserve.

Tame Inflation: Laughing at the "Upbeat Fed"

And, I am happy to note, the Economist magazine has the same degree of disrespect for these pompous, arrogant weenies as I do, as evidenced when they write: "In short, they provide an excellent contrarian indicator."

With that background, you can appreciate the humor in a headline that appeared in the Wall Street Journal on Thursday, January 15th, which was: "Upbeat Fed Sees U.S. Economy Improving and Inflation Tame." The aforementioned excellent contrarian indicator, which the Economist uncovered, says that you will make some big money if you bet against the asinine opinions of the Fed, and wager that the U.S. economy is deteriorating, and that inflation is not, ummm, tame.

The Fed’s most recent beige book came out and said that wages are not rising, which wouldn’t be so horrible if the Fed had, in fact, "tamed" the Inflation Monster. But separately, the Producer Price Index of the Labor Department was also recently released and showed that, in one year, Finished Goods are up 4% in price, Intermediate Goods are up 3.9% in price, and Crude Goods are up 18.5% in price.

To put a spin on it, the Fed decided to take the 4% increase in the price of Finished Goods, ignore the hefty inflation in Intermediate Goods, and ignore the roaring inflation in Crude Goods, and back out food and energy out of what is left, and that brought that index down to an inflation reading of 1%. They think this is real clever.

Then the CPI came out, and it was up 0.2%. Food prices were up 0.6% for the month, education costs rose 0.4 percent, health care costs rose 0.6 percent and housing prices rose 0.3 percent. But, and this passes for good news, I suppose, apparel prices fell 0.4 percent and transportation costs fell 0.2 percent. These are MONTHLY increases in prices, so to get the annual increase, multiply each number by twelve, which I would do for you, but given my adroit handling of a calculator it would take the rest of the afternoon for me to do that, and I would get it wrong anyway. But I will get you started, and will conscript a passing fourth-grade kid to do the math, and tell you that multiplying 0.6% by twelve equals a 7.2% annual inflation in food.

Of course, the lying weasels in the Fed and in the government proper are all strutting around saying how inflation is tame, quiescent, and non-existent. To which I say, as you knew I would, "What a load of crap!" Three percent annual inflation in food and energy used to be enough to cause heart attacks in bankers and bond holders, and here we are looking at a trend that is more than TWICE that!

If you have a heart problem, now would be the time to make that doctor’s appointment you’ve been putting off.

Regards,

The Mogambo Guru
for the Daily Reckoning
January 26, 2004

P.S. On a happier note, I am sure that you, like me, are anxiously anticipating tomorrow, January 27, which is Mozart’s birthday, and you are now busy with the preparations, what with all the buying and decorating the Mozart tree, and hanging the Mozart lights along the eaves of your house, and dying eggs for the big Mozart egg hunt and all.

And this happy time of year, as an example of how it is always feast or famine around here, also coincides with the annual Girl Scout Cookie bonanza, and so the Mogambo will soon be indulging in an orgy of sugary, chocolate treats while listening to the magical, incredible Mozart on the stereo. And I suggest that you do the same, because it just doesn’t get any better than that.

And the added benefit is that you get to forget about the Fed’s stupendous, incredible, ineffable idiocy while you’re happily munching and listening…for a day, anyway.

Editor’s note: Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the editor of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it. The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning, and other fine publications. If you’re inclined to read more, you’ll find the whole Mogambo here:

Grossly Miscalculating the Odds

No Absurdity Left Behind…

Last week, the Bush Administration proposed to lend money to homebuyers with a zero-percent down payment. Addison has more details below…

Want to get ahead in this economy? Don’t get a job…get a house. Mortgage 100% of it. Then, refinance when it goes up.

Better yet, buy a second house!

A report on CNN tells us that houses in popular resort or retirement areas – near beaches, mountains, lakes – have been rising in price much faster than houses in other places. So noticeable has been the increase that many second home buyers believe they are making an ‘investment’ when they buy.

Anything can be an ‘investment.’ But not all investments are good ones. A vacation home is typically a good way to get rid of money, but a terrible way to invest it. The happy homeowner has to pay taxes, upkeep, and insurance (not to mention mortgage installments)…just to keep his ‘investment’ from deteriorating.

But second homes in attractive areas – such as Cape May, New Jersey and Naples, Florida – are rising in price by as much as 38% per year, according to the CNN report. So go ahead…enjoy the beach, and get rich!

Seeing no risk, investors continue to err on the side of hazard. Nothing ever goes down, they think, except interest rates…which only go down.

As long as rates go down, everything else seems to go up – including junk bonds. Jim Grant reports in Forbes that the average 10-year junk bond yields only 6.5%. Investors take on the extra risk of owning junk without asking a penny in extra compensation. It is absurd, of course, but what isn’t?

"We are in a period unlike anything since the 1930s, when the world is confronting deflationary forces," said New York fund manager Arnold Schmeidler to the Asia Times. Falling inflation rates allow interest rates to fall, too. People borrow more…and bid up prices for financial assets and property.

Those who have financial assets get richer – for a while. Those without them get poorer; wages, at the lower end of the scale at least, have gone nowhere in the last 30 years. The middle class disappears.

"American auto companies are selling their production at zero interest rates because there is excess capacity," Schmeidler continues." But China is building auto plants to make hundreds of thousands of vehicles, so we have extra capacity being brought into a market where we already have excess capacity. So the trend is towards 40 cents an hour wages and top quality competing against the U.S.. "The single-greatest force for deflation is when you have open trade between nations that have the ability to import the most efficient manufacturing expertise into a low-wage- base society, and so can produce products of the same quality as the high-wage economy. The price pressure on the product allows consumers to get more for their money and they benefit. But it is disinflationary, if not deflationary."

"As the ‘boom’ of President George W. Bush takes off," Asia Times concludes, "puzzled American commentators are asking where are all the extra jobs that the apparently positive indicators should be creating. In fact, they are being created abroad – mostly in China."

More on deflation…keep reading…

But first, here’s Addison with more news:

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Addison Wiggin, plumbing the depths of absurdity…

– For the first time in eight weeks, we open the Monday session with a less ebullient stock market. The Dow slipped 32 points for the week to 10,568…calling into question, if ever so slightly, the sustainability of the "bull" coming out of Wall Street.

– The S&P 500, on the other hand, lost 2 points on Friday but closed the week up – its ninth straight winning week. The Nasdaq slumped 16 points itself, closing Friday at 2,123. For the stock market, this week marks the busiest in the Q1 earnings report season for the calendar year 2004. Most analysts expect earnings to come in strong across the board. Still, strong or no, earnings will hardly justify a stock price 29 times their number, on average…but such is life for the skeptical observer of markets, life and politics.

– "U.S. economic statistics have been heavily exaggerated," our friend Marc Faber told London’s MoneyWeek magazine last week. "In fact, the economy is pretty soft. Let’s distinguish between real and fictitious growth. In 2004, everything rose except the dollar. This can’t go on – not every asset class can keep going up."

– Elsewhere, the dollar renewed its retrenchment last week, falling once again to $1.25 against the euro. Gold edged higher to $408 from $406. Oil continued to get more expensive; March crude closed at $34.94 a barrel.

– Friday, as you may recall, we looked at absurdities in the housing market, homebuilding stocks and a friendly rivalry between two of our favorite analysts Steve Sjuggerud and Daniel Denning. Today, word is leaking out of the financial press about a new program the Bush administration has proposed for the Federal Housing Authority (FHA), which will make the housing market even more absurd…and potentially more lethal.

– First the winning trade, thus far: "I know homebuilders are officially stocks," writes Dr. Sjuggerud, "but homebuilders are cheap and stocks in general are expensive…also homebuilders are hated, while stocks are loved…so I see more gains to come."

– The story, as Sjuggs sees it: Homebuilding stocks are still super-cheap, selling at single-digit forward P/Es. The supply of homes, he contends, is still way short of demand and the big homebuilders will eat the "mom and pops" for lunch. "But my favorite part of the story," writes Steve, "is that ‘the common people’ hate these stocks. Actually, everyone hates these stocks. For every three shares of Beazer Homes that people have bought, there is one that people have sold short – meaning they’re betting on the share price falling. This is comedy. The stock is at a forward P/E of 6.5 – and growing like a weed. Forward earnings for homebuilders have increased 29% per year on average since 1995, and they’re up 34% in the past 12 months. This is an extraordinary opportunity still."

– Last week, the Bush administration proposed that the FHA allow zero-money-down financing for first-time homebuyers. Zero money down for a house. The new provision would give additional teeth to an already absurd mandate of the FHA: approving applicants who have demonstrated they pose too high a credit risk to get a loan through the conventional mortgage market.

– Lenders, of course, love the idea. "Any down payment," Angelo Mozilo, CEO of Countrywide Financial Corp. told the LA Times, "even 3% [the current requirement of the FHA] is a major, unnecessary obstacle for lower-income borrowers…" Right now, the FHA allows its applicants to have monthly housing payments as high as 29% of their monthly income, and total monthly debt as high as 41% of their income. Countrywide has traditionally been one of the highest-volume FHA lenders and is a participant in other low-or-no-down-payment programs targeted at low-income homebuyers backed by Fannie Mae and Freddie Mac.

– "I hate to be on the opposite side of the trade [than Sjuggerud]," Denning says. "But these low mortgage rates have led directly to the ‘financialization’ of the American economy. The retirement of millions of Americans now depends on low-income homeowners to make their monthly payments."

– Denning: "According the most recent data, corporate private pension plans have $1.5 trillion in assets. Agency securities – bonds issued by Fannie Mae and Freddie Mac – make up 11% of those assets held outright. Fannie and Freddie bonds are the third-largest asset type held by private pension funds. What is NOT disclosed is the dollar value of ‘agency assets’ held by publicly traded corporations – which make corporate bonds and equities vulnerable to the direction of the mortgage market." Bottom line: pension exposure to mortgage debt is huge…and growing.

– Meanwhile, federal regulators, reports the Financial Times this morning, are asking Freddie Mac to add additional capital reserves to the company’s coffers…because it "remains exposed to ‘substantial management and operations risk.’"

– But that’s only the half of it. "Since the Nasdaq bubble burst," says Denning, "home equity and real estate have skyrocketed as a percentage of total household net worth. In 1999, real estate and housing values accounted for $11.5 trillion worth of household net worth, or about 27% of the $42 trillion total. Stocks and mutual funds, at $12.1 trillion, made up 28% of household net worth. They were about even.

– "The mortgage bubble has changed all that. By the third quarter of 2003, real estate and housing values totaled $15.8 trillion, or 38% of household net worth. Stocks, still well down from their 2000 high, are only 19% of total household net worth at $8 trillion.

– "This bubble," concludes Denning, "is even more dangerous than the stock market. Housing and real estate are at the epicenter of American household net worth."

– Should the zero-money down proposal get approved by Congress, you can bet investors in homebuilding stocks will continue to be rewarded. But the idea gives Dan Denning the creeps. [For more, see Dan’s article "Fear and the Mortgage Bubble" on the Daily Reckoning website

You’ll also find details on getting a free copy of the Strategic Investment special report: 10 Ways To Survive A Crumbling Housing Market.]

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Bill Bonner, still in Paris…

*** Hmmm…Gold dipped to $408. We’re wondering if it will sink down to our most recent buying target – $400. Or, should we buy now? We don’t know, dear reader. Will we get the violent correct we’ve been expecting? Or will we never see $400 gold again in our lifetimes? If we only knew…

*** "DEFLATION HAS ARRIVED."

We quote Bob Prechter from our own Daily Reckoning of last Wednesday.

"Virtually everyone – and I do not use that word lightly – believes that inflation will accelerate…The general population is convinced that prices of their homes and property can only go up… "This consensus is not merely overwhelming, but reflects a belief as vast and deeply held as a religion. Investment News in September reported a survey by the National Association for Business Economics in Washington. It revealed, ‘None of the respondents to the May survey, all of whom were responsible for making macroeconomic predictions, predicted a decline in the consumer price index during the next two years.’ USA Today confirmed the fact, reporting, ‘Not one economist [of 67 surveyed] said it was "very likely" the economy would slip into deflation.’ That is a consensus! "As this is written, not a single major newspaper, magazine or TV network has done a story on the dramatic contraction in M3. People are so drunk with inflationary certainty that they can’t even see that deflation is happening. And if they do, they don’t believe that it is meaningful… "The money supply might rebound for a quarter or two as the stock market and economy top out this year, but at the largest degree of trend, the credit bubble – 70 years in the making – has burst…"

*** And Richard Russell on the same topic:

"…The forces of world over-production and deflation are at work. But so is the Fed. After a long string of losses in the broad (M-3) money supply, two weeks ago M-3 surged $30 billion, and the latest figure for the week ended January 12 showed M-3 shooting up a monster $37 billion. The Fed, it seems, has decided to go all-out, preparatory to the November election. Greenspan has taken the lid off the M-3 money supply, and the word, I assume, is ‘Let ‘er rip!’ "As an aside, two weeks of this kind of money supply growth would buy all the gold stocks in existence."

*** And here…a note from David Theroux of the Independent Institute:

"Thank you for your great recent article, ‘Lost In Space’! The question to ask is: Has the ‘Era of Really Big Government’ now arrived?

"Over the past three years, with inflation at record lows, federal spending has increased by a massive 28.3% – with non-defense discretionary growth of 30.5% – the largest deficit in U.S. history and the highest rate of government growth since LBJ.

"As predicted by Bob Higgs, senior fellow in Political Economy at the Independent Institute, this explosion of government power has only been possible in the aftermath of 9/11, as politicians take full advantage of a frightened American public.

"During this time, President Bush has become the first president since James Garfield (serving only in 1881) and Millard Fillmore (1850-1853), neither serving full terms, and then John Quincy Adams (serving a full term, 1825-1829) not to have vetoed a SINGLE bill, with the result that we now have record pork spending on agriculture, education, Medicare, energy, transportation, foreign aid, etc. Meanwhile, federal agencies have been given new powers to secretly search any American’s property and intercept phone, Internet, and other communications, as well as health, financial, and other records.

"During this period, there has been near silence from most Washington think tanks and the media. According to former Congressional Budget Office director Rudolph Penner, ‘I don’t remember a time when there’s been so little commentary on it, and I can’t really explain it.’"

*** A reader comment:

"This is my first effort to reply to any of your messages, which I always read carefully and many of which I share with friends. I even bought ‘the Book,’ read it and recommended it to family and friends. What you have done for me is to educate me as to the vulnerability of the old ‘buy and hold’ philosophy. I have come to the realization that the current run-up is best viewed as a gift, helping me to repair some of the damage of 2002-2003.

"However, this gift is likely to be a finite one followed by another big opportunity for ‘holders’ to lose their shirts. Thus, I have taken to carefully examining every one of my holdings, and will be placing stops as a routine, and will be selling those with no current or future promise. As a retired physician, I am not interested in returning to work to ‘make it back one more time.’ What I am saying is that you guys have been a big help in causing me to become more engaged in the oversight of my financial destiny. I haven’t bought any gold or opened any accounts investing in foreign currency, but that isn’t to say I won’t. I still have, over at the bank, some silver bars I purchased many years ago at about 9 dollars. Who knows if they ever will hit that level again. I live in Dallas, and know Scott Burns, so I am always interested in the occasions when he cites you, or you cite him. Finally, Ouzilly sounds like a wonderful place. Someday I’d like to see it for myself…"

*** Yes, Ouzilly is a wonderful place…almost paradise in some ways. But every paradise comes with its apple trees and serpents. Your editor has become concerned that the place might be fatal to him. Oddly, he has developed an allergy to something. It is, after all, an ancient stone building that is barely heated. Mold, mildew, dust…he doesn’t know what is it, but after a night in the house, he can barely breathe.