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WILL MR. GREENSPAN PREVENT A RECESSION?
Prepared by The Wall Street Digest, Inc.
(January 2001) Over the past 60 days, the markets have been rattled by the five "Es": Energy, the Election, the Euro, the Economy, and Earnings. When it comes to stock picking, it is all about earnings. Ultimately, the price of every stock is determined by the present value of all its anticipated future earnings. Wall Street analysts expect a slowing economy into 2001 and, therefore, are reducing sales and earnings growth expectations for many companies.
A slowing economy is one thing, but Wall Street and Washington are both beginning to worry about a recession in 2001.
The banks have tightened credit lending standards, credit card debt is at record levels, and bankruptcies (both personal and business) are rising again. The mortgage lending industry is helping to cool the real estate boom by making it tougher to obtain loans and by requiring larger down payments. While credit is tight, liquidity (the abundance of money) has never been greater and it is an increasing problem for the FOMC (Federal Open Market Committee) and Mr. Greenspan.
For example: Between 1995 and 2000, Fed Chairman Greenspan created almost as much money as all other Fed chairmen combined since the creation of the Fed in 1913.
M3 money supply growth of 8% annually was the norm between 1995 and 1999. However, at the very beginning of 2000, the Fed drained liquidity from the banking system to compensate for the enormous sums of cash that were created to solve any possible Y2K liquidity problems. M3 money supply growth slipped below 7% annually during 2000 and caused the market to correct. By the fall of 2000, high oil prices and higher interest rates put the brakes on economic growth from 5.6% in the second quarter to 2.4% in the third quarter.
By the end of the fourth quarter, the economy was still slowing, which prompted Mr. Greenspan to acknowledge a slowing economy and to hint that lower interest rates could be right around the corner.
While liquidity is the most important force that fuels both the economy and the stock market, a cut in interest rates gives Wall Street and investors renewed confidence to invest. A cut in rates usually signals that the worst is over and the future is brighter as economic growth accelerates and produces increasing corporate earnings. Remember, it's all about earnings.
The resolution of the election has helped to reduce market uncertainty, but it will not prevent a recession.
Consequently, I believe the next leg-up will probably not begin until the Fed cuts interest rates. After a cut in interest rates, the market should rebound strongly to new highs during 2001 due to the abundance of money. Money fuels the economy and stock prices in the same manner that gasoline fuels an automobile.
Take your foot off the accelerator and your automobile slows down. When Mr. Greenspan slows money growth, the economy slows and corporate earnings are also reduced. If Mr. Greenspan slows money growth too much, the U.S.--and sometimes the entire globe--will slip into a recession. With that basic understanding of how important money is to the economy, earnings, and our investment success, let's review the five enormous faucets of money that will drive the market to relentless new highs over the next few years.
Faucet Number One: The Federal Reserve's power to control the rate of M3 money supply growth and the expansion of credit is enormous. Never be against the Fed.
Faucet Number Two: The pension fund industry was a $500 billion industry in 1982. In 1986, Congress passed legislation to encourage the growth of Individual Retirement Accounts (IRAs), 401Ks, and various other types of pension plans. By the end of 1999, the pension fund industry had grown dramatically to $5 trillion. Many corporations have pension plans that allow employees to deduct up to 20% of their gross income.
The money flows into pension plans on the first and fifteenth of every month and then flows into mutual funds chosen by the employees.
A flood of IRA money flows into the market during January. Additional large sums are deposited into pension plans on or before April 15th and July 15th. As long as the economy is growing, you can expect a rising flood of pension money to pour into the stock market via various mutual funds.
Faucet Number Three is the mutual fund industry. (over 10,000 funds). From time to time, you will hear an old economy analyst express concern that Americans have one of the worst savings rates on the globe.
Americans are too smart to save money in a 3% or 4% money market account. Americans are investors and they pour every dollar possible into stocks and mutual funds every month. Some companies have employee mutual fund savings plans that automatically deduct money from their employees' payroll checks and then that money is deposited directly into the mutual funds chosen by the employees.
These "automatic savings plans" are one of the main reasons that money continues to pour into mutual funds month after month in both up and down markets.
The stock market in 2000 had the most difficult year since 1990. Even so, net mutual fund deposits were up virtually every month in 2000. Faucet Number Four: Foreign capital seeking a safer, better return in the U. S. will exceed $360 billion this year. Compare that figure to the mere $75 billion increase in the M3 money supply in 1994. Foreign investors want to take maximum advantage of the U. S. Internet/Technology boom.
Smart foreign investors know the Internet Revolution, the Fiber Optic Revolution, the Storage Revolution, the Wireless Revolution and the DNA/Biotechnology Revolution will never end.
Faucet Number Five: The venture capital (VC) industry was a $2 billion industry in 1990. During 2000, over $100 billion poured into various new companies. VC firms brought us Yahoo, Juniper Networks, Sycamore Networks, Avanex, etc. After the "Tech Wreck" of 2000, many on Wall Street said the venture capital business was dead. Don't you believe it! Rich Karlgaard, publisher of Forbes magazine says, "Global Venture Capital could grow to one trillion dollars within five years." Here's why:
Prior to the Internet Revolution, which for investing purposes began in 1995, the value of a company did not reflect the value of intellectual capital. Nor did the value of an idea or the fastest Internet router, the fastest switch or the fastest and most efficient software. Bankers will not lend money to an entrepreneur for an idea. But venture capitalists will lend money (at least once) to any firm with an idea or product that will improve the speed and efficiency of the Internet. To explain the valuation problem today, consider this:
In 1999, the "Big Three" automobile manufacturers--General Motors, Ford, Daimler Chrysler--employed 1,102,400 people to create combined revenues of $470 billion and combined earnings of $17 billion.
Cisco Systems, by contrast, employed a mere 39,000 people to create revenues of $15 billion and earnings of $3.1 billion. Nevertheless, the stock market value of Cisco ($354.7 billion) exceeded that of General Motors, Ford and Daimler Chrysler combined ($126.5 billion). Why would smart investors want to own GM, Ford or Chrysler when most people already have a car or two or three in their garages? No wonder the P/E for Ford is 5, GM is 6 and Daimler Chrysler is 8.
Cisco Systems (CSCO) has a P/E of 89 because less than 300 million people, only 5% of the globe, are able to log-on to the Internet today without crashing the system.
Someday, as sure as the sun rises, 40% of the globe, or 2.4 billion people, will be logging onto the Internet without crashing the system. No wonder P/Es for Internet/Technology stocks are high. They represent the future of this country and, hence, the globe. Technology is still the strongest driving force in the U.S. economy. And because both the Internet and Technology are inherently deflationary, they are the two strongest forces keeping inflation under control.
China, with its massive labor force and low wages, will be an increasingly deflationary force on the U.S. and the global markets in the future. The severe shortage of Internet/Technology stocks is also contributing to excessive valuations. There are 3500 stocks on the NYSE and 5000 on the NASDAQ. However, smart investors know the Internet/Technology sector is the place to be.
Consequently, 80 million shareholders and over 10,000 mutual funds have been trying to purchase the 600 or so Internet/Technology stocks.
Approximately 130 dot.com stocks disappeared in late 2000, as I warned in the June 2000 issue of The Wall Street Digest. The only solution to the valuation problem is an increasing flood of IPOs to bring new technology companies to the market with new and better technologies. That means VC companies, not bankers, will finance the coming relentless flood of new IPOs over the next five years.
Since technology will never stop evolving, this process will never end. There are less than 600 public Internet/Technology stocks available today for investors and mutual funds with trillions of dollars to invest.
Technology will soon amount to 40% of the U.S. economy. Forty percent of more than 10,000 public companies means it will take a neverending flood of new technology companies (IPOs) to meet investor demand. In the future, when the supply of technology stocks is equal to investor demand, P/E levels will gradually fall to lower levels. Millions, even billions, will be made by investors who invest in the right technology stocks, the right venture capital firms, and the right IPOs.
Also, keep in mind: Millions, even billions, will be lost by investors who invest in the wrong stocks, the wrong VC funds, and the wrong IPOs.
Here are some technology benchmarks that I use to focus our investment recommendations for you: 1) Chip speeds double every 18 months; 2) Storage doubles every 12 months; 3) Bandwidth doubles every 6 months; 4) Three million new Web pages appear everyday; and 5) Internet traffic doubles every 90 days. These five horses dictate the pace of all Internet technology, all software, and every worthwhile business model.
Where to invest now? In the 1980's, the Computer Revolution drove the market higher. In the 1990's, the Information Revolution powered the stock market.
Between 1995 and 1999, the Internet Revolution pushed stock prices dramatically higher. Today, investors have not one, but four revolutions driving the stock market all at once: the Internet Revolution; the Wireless Revolution; the Storage Revolution; the Fiber Optic Revolution, and don't forget the Biotechnology/DNA Revolution. The last three issues of The Wall Street Digest have highlighted the best stocks in each of these revolutions.
The best DNA/Biotechnology stocks will appear in a forthcoming issue of The Wall Street Digest. I am waiting to see how President-elect Bush and Congress deal with health care, prescription drugs and DNA research.
Ultimately, you and I, not the Federal government, will pay for those campaign promises. In the meantime, the stocks and sectors that you should avoid are: 1) The long distance phone business will die as calls are placed free over the Internet. If you have not sold the three biggest long distance phone companies, do it now: AT&T, MCI Worldcom and Sprint.
2) The Computer Revolution is over in the U.S. If you have not sold these companies, do it now: Sell IBM, Intel, Dell, Gateway and Compaq.
3) Under President Bush, a Republican attorney general will probably drop the government's case against Microsoft. Wait for Microsoft's bounce in price and then sell. No one rushes out now to purchase the next version of Microsoft Windows or the next computer with a faster chip.
4) There are some companies that just never seem to get it together and always disappoint Wall Street. If you have not sold Motorola, Xerox, Lucent Technologies, Texas Instruments, and Eastman Kodak, do it now.
5) Amazon.com still cannot make a profit and has made some disastrous acquisitions. Any company whose business plan is the cheapest price or the biggest, broadest selection will have profit problems. I never recommended Amazon.com because of mounting red ink. Amazon's price could drop to zero or the company might go bankrupt someday. It is still not too late to sell.
6) CEOs are increasingly rated on their ability to attract and keep great people. Michael Eisner of Disney and Michael Armstrong of AT&T have driven away their best and brightest people to other companies. If you have not sold AT&T and Disney, do it now.
The Greenspan Dilemma
When Paul Volcker's second term as chairman of the Federal Reserve ended, President Reagan named economist Alan Greenspan to replace him. We predicted that Mr. Greenspan would produce a bear market and a recession. He did exactly that. The bear market of 1987 began almost the day he took over, as he "hit the ground running" with an interest rate boost.
Later, Mr. Greenspan gave us the first Wartime Recession in U.S. history.
That recession came as money supply growth failed to keep up with the needs of a growing economy. (He was determined to block the impact of sharply higher oil prices in the Gulf War from causing general inflation.) Fed Chairman Greenspan produced only $40 billion in new money in 1991 and $21 billion in 1992. Former President George Bush was blindsided. He never had a chance when Clinton ran on a theme of "It's The Economy, Stupid."
But in 1993, Greenspan had a change of heart about new money growth when he was invited to sit in the VIP box between Hillary and Tipper during Clinton's first State of the Union Address to Congress. The Fed produced $60 billion in new money in 1993, $75 billion in 1994, $254 billion in 1995 and another $344 billion in 1996 which propelled Clinton into a second term.
Over the next 21 months, the Fed presided over the creation of one trillion dollars in new money, boosting the total to $5.887 trillion by September of 1998.
Greenspan brought another trillion into being in the 24 months ending September 2000, swelling the money supply to $6.884 trillion. That means Mr. Greenspan has created almost as much money in his 13 years as did all previous Fed chairmen between 1913 and 1987--a span of 74 years that included four major wars. A lot of Chairman Greenspan's new money flowed to Wall Street, which drove up stock prices.
Some went into real estate, pushing prices up there, too. (Neither of those is included in the Cost of Living Index.)
Despite all the talk of tight money, stemming from minor fiddling with the overnight rate that banks lend surplus money to each other, the truth is that Alan Greenspan has been, and continues to be, the all-time champion of "loose money." The trouble he faces is that even his current prodigious rate of money expansion, which averages $10 billion a week, has not been enough to prevent a drop in stock prices this year, and now may not be enough to keep the economy from sliding into a recession. Here is the dilemma he faces:
If he keeps expanding money at the current rate, America will almost surely slip into a recession with a brand new huge Federal deficit, upsetting everyone in Washington and on Wall Street.
If he opts to double the rate at which money is being created--to $20 billion a week, or one trillion over the next year--he could probably avert a recession, or at least postpone it. But the price almost certainly would be a jump in the inflation rate from the current official level of 3.5% . Some choice. (Source: Adrian Van Eck, Money Forecast Letter.)
Investment Summary
The Bottom Line--What To Do Now
U.S. Stock Market: A cut in interest rates by the Fed is a very strong message to become fully invested.
January 2001 Donald H. Rowe, Editor and Publisher The Wall Street Digest, Inc. One Sarasota Tower, Suite 602 Two North Tamiami Trail, Sarasota, Florida 941-954-5500
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