Risky Business
The Daily Reckoning
London, England
Wednesday, January 12, 2005
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*** Don't even talk to us about stocks...the basics of essentialism...the world's strong foundation of ignorance...
*** We're the most humble people in the universe!...you can't always get what you want...
*** No matter how hard they scrub, the Bush administration will never get their hands clean...dollar bulls have a sour taste in their mouth...and more!
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U.S. stocks do not offer good value; until they do...we're not interested.
On the other hand, we're very interested in bonds. Bond yields are mysteriously low. On the surface, they're telling us that the Asian central banks are recycling dollars into debt - buying U.S. bonds with the money they earn from selling Americans things they don't need and can't afford. But beneath the surface, we think they're telling us that the real economy is weak...and getting weaker. Yesterday, yields fell again - to 4.78% for the 30-year T-bond.
Long Treasuries might stay low...but watch out for junk. Spreads between junk and good credits have narrowed to the point where you get little extra yield lending to barely creditworthy borrowers. Investors don't seem to see the risk. And yet, it seems to us that there is more risk in today's financial system than at practically any time in the last 65 years. Either the Dow or the dollar could crash at any time.
There. We've made the tour of the financial markets...now let's talk about essentialism. The word has been used to describe other crackpot strains, but no one had a good grip on it, so we took it for ourselves.
Long time Daily Reckoning sufferers will recall our philosophy. It is a creed derived from studying the markets - but it applies to the rest of life.
At the foundation of essentialism is ignorance, not knowledge. Ignorance rules the world of finance...and the rest of the world. You can never know whether a given action will produce beneficial results...you can never know whether a stock will go up or down.
What do you do when you cannot read tomorrow's newspaper today? You become very modest. You follow the rules. You turn to the essentials. You focus on what you do know...and what you can control.
Essentialism venerates humility as its highest virtue. Here, at The Daily Reckoning headquarters, we are so humble; we are practically arrogant about it. No one is more humble than we are. We're Number 1!...when it comes to humility.
But the humble recognition of your own ignorance still leaves you with decisions to make. How do you make them?
Well, you turn to the essential rules - the traditions, the lessons of history,
the distilled wisdom of generations of dead people. In the investment world,
you "buy low, sell high." That's what has always worked for investors.
Buying high and hoping to sell higher is another game - speculation. If you
think you might enjoy it, do go ahead, dear reader. But it is not really investing.
Warren Buffett, an essentialist investor, says you should buy "great companies
at fair prices." We don't disagree.
Of course, it's hard work to find them. But there you are, another essential
insight - you don't get something for nothing.
The entire world is moral...even the financial world. That is why we often say, "you get what you deserve from the markets, not what you expect." Following the rules, working hard with patience and discipline - you usually get a decent result. Reckless speculation...overspending...and frenetic trading, on the other hand, usually give investors what they have coming - good and hard.
Essentialism gives the devil his due. We recognize that ignorance is near universal...and eternal. And there's a fool on every corner when you're trying to get home. We try to avoid making fools of ourselves by sticking close to home - to what we know, to what we understand, to what we can see and touch...and control. You can make your world better; but try to make THE world better and you make a public spectacle of yourself.
Somewhere in the still-unwritten Essentialist's Handbook it warns readers that they "cannot be too trusting in private...or too cynical in public." Essentialists make private life paramount. They "sweep their own doorsteps," as a Swedish proverb puts it, hoping to make the whole world clean.
But their philosophy can be applied on the world stage as well. Looking at the Bush administration's attack on Iraq, for example, we had no idea whether it would make the world a better place or a worse one. The neo-cons backing the war thought they could read the headlines six months in advance. They thought they saw pictures of American troops marching through Baghdad while young girls threw rose petals their way...and older girls planted grateful kisses on their cheeks.
We had no idea. But we had one reason to doubt that the war would be a success...and another reason to want no part of it, even if it did end up to be a success. As to the first, the gods of war rarely favor the aggressor, we noted. Instead, they allow him an early victory...setting him up for a worse defeat later on. Over the centuries, the essential rule - which used to be the guiding principle of American foreign policy, until the Bush people came up with their "pre-emptive strike" doctrine - was that you didn't strike the first blow. If attacked, you responded with as much force as you could...but until then, you minded your own business.
As to the second, there is another essential rule - recognized for thousands of years by almost everyone - "Thou shalt not kill."
Not that we have anything, personally, against killing people. But it's been a no-no for a very long time...and probably for a very good reason. So, if you're going to kill people - at least you need a very good reason. And since we didn't know whether killing Iraqis was going to make a better world, or a worse one, we figured it was a bad idea. When Bush & Co. show up at the Gates of Heaven with the blood of Iraqis on their hands, we don't know what kind of reception they should expect.
But war is sometimes necessary...and though it is often dirty work, you might protest, someone has to do it.
Perhaps you are right. But in our near-complete ignorance, we only presume to know things close to us, things that concern us directly. And them, but just barely. A man may drive his car off a cliff in the Alps...and thus free up a parking place in Paris; but, we don't want to be that man. Nor do we want to be among the men showing up at the Gates of Heaven with the blood of Iraqis on our hands. We don't doubt that they will get what they deserve; we just don't know what it is...and are happy to let them find out, without us.
More news, from our team at The Rude Awakening:
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Tom Dyson, reporting from Baltimore...
"On November 19, 2004, Greenspan warned: 'rising interest rates have been advertised for so long and in so many places that anyone who has not appropriately hedged this position by now is obviously desirous of losing money.'"
For the rest of this story, and for more market insights, see today's issue of The Rude Awakening:
The Bond Crusher
http://www.dailyreckoning.com/body_headline.cfm?id=4407
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Bill Bonner, back in London:
*** Irwin Greenstein reports from Baltimore's cultural district...
"The IPO market is hot again...opening the spigot for a flood of small-cap opportunities in 2005. But why now? Let's recap 2004's extraordinary action:
"Last year, 205 IPOs raised some $41 billion - triple the volume of 2003...and shy of the 249 in the IPO mania of 1999. Unlike the bubble years, however, companies are more financially solid: 64% of companies that went public in 2004 were already profitable, compared to 2000, when only 26% were profitable. And the average 2004 IPO has risen 30% from its offering price - the best performance since 1999. That return beat the Dow, Nasdaq and S&P 500.
"Okay, so why now? Increased IPO activity coincides with rising interest rates, which can really hurt small-cap companies. As lending institutions tighten their requirements for loans to companies with market caps of $1 billion or less, we'll see more small caps turning to the public market for cash. Alan Greenspan signaled Wall Street far in advance of the first rate hike, giving the venture capitalists and investment bankers plenty of time to start filling the IPO pipeline.... about 80 VC-backed companies have already registered with the SEC for IPOs in 2005...the momentum is certainly there."
[Editor's Note: To learn more about small-cap opportunities, be sure to check out what Irwin and the rest of the Penny Sleuth team have in store for you in 2005. See here:
Penny Sleuth
http://www.dailyreckoning.com/Sub/PSsignuphub1.cfm
*** Gold is still in a long-term bull market, in our opinion. Buy it. Even if we're wrong, it's a good thing to hold - just in case.
And on that note, our own Kevin Kerr was quoted on CBS MarketWatch today:
"Gold's moving solidly higher on the back of all the relentless selling" [in the dollar] "a dose of bad-tasting medicine for the [greenback] bulls with the reality that things aren't so rosy."
"The U.S. trade number was appalling and is a good indicator of the pain
still to come. This should continue to undermine the greenback and send more
investors running for cover back to the safe-haven of gold and precious metals."
*** And here, a pilgrim, hopelessly lost in the forest of macro-economic
statistics. Arthur Laffer cannot seem to tell the difference between owing
someone money...and having him owe it to you!
"Just because the United States has its largest trade deficit ever doesn't mean it is living beyond its means. Far from it. In fact, the characterization of the United States as a land of chronic overspenders, hell-bent on selling themselves into global servitude doesn't make sense at all. And once the overconsumption model is put into question, every policy remedy based on the presumption of squander looks pretty weak.
"In an era of floating exchange rates, the trade deficit (or more appropriately, the current account deficit) is one and the same as the capital surplus. The only way the United States can have a trade deficit amounting to 5.6% of GDP is if foreigners invest that amount of their capital in the country. It's a matter of simple accounting. But once you realize that the trade deficit is, in fact, the capital surplus you would clearly rather have capital lined up on our borders trying to get into our country than trying to get out. Growth countries, like growth companies, borrow money, and the United States is the only growth country of all the developed countries. As a result, we're a capital magnet."
Arthur Laffer is, of course, among the architects of America's consumer economy. It was he that helped push the Republican Party away from its traditional bias towards honest accounting and balanced budgets. Thanks largely to him, George W. Bush runs some of the biggest deficits in history - and hardly a single card-carrying Republican complains. And thanks partly to him, Americans now lug around the heaviest debt burdens in history...and the whole nation aches under a weight of financial obligation - much of it to foreigners - that the world has never seen. And thanks to him, at least in part, the U.S. economy now depends upon the kindness of strange people in strange places. If they ever tire of sending their capital to the United States, where American consumers borrow and spend it, the U.S. economy will almost certainly go into a sharp decline.
But don't worry, dear reader. Laffer says, "we're a capital magnet." We're so attractive...we get better looking each time we look in the mirror! According to Laffer, the poor foreigners schlep night and day for 21 cents an hour just so they'll have some money to invest - in America. My, oh my...won't someone please wake Mr. Laffer from his reverie?
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The Daily Reckoning PRESENTS: While it may be tempting to invest in a high-profile, "cool" company; Porter Stansberry shows us why companies like Google or Yahoo!, with faster growth and seemingly better opportunities, doesn't always equal a sound investment. Read on...
RISKY BUSINESS
by Porter Stansberry
Don't you wish you'd bought Google...?
I've watched the shares of Google almost everyday since it went public at $85. In only a few months time, Google had soared to $200 a share, making it one of the best stocks to own in 2004.
At first glance, not buying Google was a big mistake.
Google is certainly a great company. After only five years in business, it's already a household name. It has $2.6 billion in sales and 32% gross profit margins. With only 2000 employees, it's producing operating profits of $520 million each year. That's $266,000 in profit per employee.
Google is also growing unbelievably fast - as fast as Internet usage itself. Google's sales were up an unbelievable 233% last year. Plus, like Apple, this is one of those companies that's "cool." It's okay to be a corporation when you're like Google, which gives its employees one day of each week to work on whatever project they choose.
Ironically, Google is exactly the kind of stock I used to cover in my newsletter. It has great margins and is in hyper-growth mode.
But I don't recommend stocks like Google anymore.
I've found that profits like these are too hard to hold onto, that the volatility of the shares makes it nearly impossible for disciplined investors to lock in any profits at all.
Let me show you an example of what I mean.
I recommended Yahoo!, a business that's very similar to Google, in 2001. I bought at the right time, around $17.87 per share. But we were stopped out of the position after 9/11 happened, at a loss. Today Yahoo! trades at $35.00 per share. It was almost a huge winner for me. But not quite. We were stopped out too quickly.
You might say, "Well, stop using a trailing stop loss!"
But that's a recipe for total disaster. Passive investors (common stock holders) who don't exercise discipline in regards to risk management will eventually blow themselves up.
I have good friends who lost millions and millions of dollars on Enron. They bought it all the way down. It only takes one big mistake like that to wipe out an entire lifetime of investing - which is why you cannot afford not to cut your losses.
I don't think you should buy Google - because it's way too expensive and far too volatile.
I've come to believe that buying expensive stocks is simply the wrong thing to do - regardless. It might feel good. It might be exciting. But it leads you where you don't really want to go. And, what's worse is that by spending time with risky investments, you end up missing the truly great stocks to buy.
Imagine if, instead of buying Yahoo! in 2001, I'd recommended shares in a boring, cheap and safe company, like the one my brother-in-law works for, the homebuilder, NVR.
He told me his business was booming. He explained why it was safe. NVR, unlike most large homebuilders, doesn't buy and develop large tracts of raw land. NVR is simply a contract builder. In 2001, like today, NVR had a huge backlog of future orders. Mortgage rates were plummeting. And I knew the stock was extremely cheap.
If I had recommended NVR in 2001, we'd be sitting on a 1,500% profit right now, without experiencing much volatility at all.
Or imagine this...
What if I could go back in time to 1996 when Yahoo! went public? What if I offered to buy you shares in either Yahoo!'s IPO or shares in the boring homebuilder, NVR? Which stock would you ask me to purchase for you?
In this example, you wouldn't have to follow a trailing stop loss because you know that today Yahoo! trades for $35.00. There would be no risk to you - you could take either stock and sell it immediately today for a profit. Under these circumstances, which company's stock would you choose? Would you rather have Yahoo! shares from 1996, or NVR shares from 1996?
If you picked Yahoo!, you made the same mistake I did when I started writing my newsletter in 1999. You assumed that bigger opportunities, wider margins, faster growth and new technology necessarily lead to bigger investment returns.
But even when you discount volatility, they don't.
Regards,
Porter Stansberry
for The Daily Reckoning
Editor's note: Porter Stansberry is the founder of Pirate Investor LLC, a financial publishing group dedicated to providing high-quality research for high net-worth investors. The former editor of several well-known financial letters, including Latin American Index, China Business and Investment, and the U.S. edition of The Fleet Street Letter, Mr. Stansberry is regularly quoted in leading financial journals, such as Barron's and World Money Analyst.
With all of Mr. Stansberry's financial experience, he's a name you can trust in the investment world...and he often has the inside scoop on the next big thing. To find out more, see here:
Porter Stansberry Investment Advisory
http://www.agora-inc.com/reports/PSI/WPSIEA07
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