August Mega-Shocks

Just when Wall Street and Washington were breathing a sigh of relief … just when they were blindly assuming that the economic storm of the early 2000s was over … a new series of mega-shocks have struck the financial markets …

Mega-Shock #1
The Largest Trade
Deficit of All Time

The news hit like a lightning bolt early Friday morning.

Most economists expected America’s June trade gap would be similar to the one recorded in May, probably around $47 billion. Instead, it JUMPED by a whopping 19 percent to $55.8 billion — the single biggest increase in five years … and the largest trade gap ever recorded in history.

The dollar plunged — against the euro, against the Swiss franc and against the British pound. The only reason it didn’t fall quite as much against the Japanese yen is because Japan was also suffering its own mega-shocks — a weaker-than-expected economy and surging oil prices.

Mega-Shock #2
The Largest Budget
Deficit of All Time

Anyone who’s forgotten — or trying to forget — the dire reality of the U.S. federal deficit could not have possibly ignored the new facts that came to light this past week:

* For the entire fiscal year of 2003, the budget deficit was $374.3 billion. Now, just for the first ten months of the current fiscal year, it has already hit $395.8 billion.

* For the 10-month period ending July 2004, the deficit has surged by an astounding 22%.

* In the month of July, it has surged by 27.5% compared to last year.

* The government expects that the deficit for the full fiscal year which ends September 30 will be $445 billion, by far the largest dollar amount in history.

* The deficit is growing by leaps and bounds despite the recent recovery in the economy. If you take into consideration the fact that the economy is now weakening, this year’s deficit could be closer to $500 billion, and next year’s could easily hit $600 billion or more.

* These are just the official government numbers, distorted by a series of smoke-and-mirror gimmicks to make the revenues look larger and the expenses look smaller. The actual government deficit, including the money borrowed from the Social Security Trust Fund and the obligations of government-related agencies, could be close to DOUBLE the official estimates.

Mega-Shock #3
The Highest Oil
Prices in History

On Friday, crude oil prices hit another record high, catapulting above the $46 mark and hitting $46.58 a barrel.

The immediate excuse was an explosion in an Indiana refinery and fears of political tensions in Venezuela. But everyone knows that those are not the true reasons. What’s really driving oil prices higher is a chronic, unprecedented, and unmanageable imbalance between world demand and world supply.

What next?

The Chicago Tribune puts it this way: “The relentless march of crude oil to record heights spread global fear among consumer countries, as government officials expressed fear that sky-high prices are crimping economic expansion.”

Meanwhile, most market analysts now finally concede what we’ve been warning for over a year: The price of crude oil could hit $50, and it could happen within days.

Trouble is, the only force powerful enough to stop oil prices from going to $60, $70, or even higher is a sudden global recession.

Mega-Shock #4
Tech Wreck II

If you think the technology sector is still in recovery mode, look again. After a slew of profit and sales warnings from software companies last month, now the hardware companies are piling in …

* Cisco is predicting flat to 2% growth this quarter, while Wall Street had its heart set for at least 3%. Last quarter, Cisco proudly proclaimed that it would add 1,000 engineering and sales positions, but by the end of the second quarter, it has only added 64 new employees. The company’s cash flow of $2.1 billion barely exceeded its quarterly stock buyback cost of $2 billion. And its inventory has hit $1.21 billion, up 9% from last quarter — on top of a 20% rise in inventories in the previous quarter.

* National Semiconductor cut its third quarter sales outlook because of slower orders and bloated inventory. Now it expects sales to drop by 4% to 5% from the prior quarter instead of the flat to 3% it previously promised.

* Ciena got clobbered when it admitted that third quarter sales would fall far short of Wall Street estimates. The company now expects to pull in sales of $75 million and lose 24 to 25 cents a share. Wall Street was hoping for $95 million in sales.

* Semiconductor equipment maker Kulicke & Soffa slashed its sales forecast for the third quarter because of caution from its customers. It now expects $135 to $165 million in sales versus its previous forecast of $175 million to $195 million. That is a big, big miss.

* International Data Corporation (IDC) recently lowered its projection for global notebook shipments this year to 46-47 million units, down from an earlier forecast of 50 million. Weren’t notebooks supposed to be the strongest part of the computer business?!

* American Power Conversion, a maker of backup power protection systems, reported that second quarter profits fell to 13 cents a share — well short of the forecast for 20 cents a share.

* Hewlett Packard dropped a big bomb when it reported disappointing second quarter earnings and warned that profit in the third quarter would also fall short of Wall Street expectations.

I could go on and on. But it’s not over yet. More warnings are coming.

The Next Mega-Shock
World Stock Markets
Headed SHARPLY Lower

The S&P 500, the Nasdaq, the Dow, and the German DAX have already busted to new lows for the year. Other markets are soon to follow.

On Friday, for example, while the U.S. markets were quiet, the Nikkei fell nearly 2.46%, or the equivalent of 237 points on the Dow Jones Industrials. Stock also fell in most of Europe, Asia, and Latin America. And this morning, the Asian markets are down AGAIN!

Globally speaking, the tech-heavy Nasdaq is clearly leading the way. In fact, it is now close to giving up 400 points from its peak. A few more points, and it will have lost about 40% of the entire stock market rally that began in October 2002 and ended early this year.

“How can that be?” you ask. “Didn’t nearly all the analysts on Wall Street say that stocks were fairly valued? Didn’t they say that price-to-earnings ratios were down to near their historic average? What went wrong?”

Mark Hulbert, writing in yesterday’s New York Times provides an answer: “The P/E ratio,” he asserts, “is still far above its historical average, but many Wall Street analysts are misusing the numbers to engage in some wishful thinking.”

Hulbert bases his argument on a study by two money managers — Clifford S. Asness, the managing principal at AQR Capital Management in New York, and Anne Casscells, formerly the chief investment officer for Stanford University’s endowment and now chief investment officer in Menlo Park, Calif., for a unit of Aetos Capital.

Their conclusions: Wall Street bulls have been duping investors by comparing apples to oranges. Specifically, for their historical data, the bulls have been using trailing earnings. But for their current data, they have been using projected earnings.

Here’s how it looks if you compare apples to apples … or oranges to oranges.

Historically, the S&P has sold for 13.7 times the earnings of the previous 12-month period. Now, it’s selling for 19 times the earnings of the past 12 months. So, based on this apples-to-apples comparison, the stock market is now overvalued by 38.7%.

Prefer to use projected earnings? Fine. Although there are some missing years of data, the authors of the study estimate that the S&P has historically sold for about 11 times what analysts expected them to earn in the following year. Now, it’s selling for 15.5 times next year’s expected earnings. So based on this oranges-to-oranges comparison, the stock market is now overvalued by 40.9%!

How did Wall Street trick you? Simple. They took an historical number based on trailing earnings (in the mid-teens) and compared it to a current figure based on projected earnings (also in the mid-teens). But guess what. Even with that distortion, the market is still somewhat overvalued, according to the figures produced by the study.

Their conclusion about today’s stocks: “You have to cheat to call them cheap.”

The Politics of Complacency

Both Bush and Kerry rarely talk about the stock market decline, the tech wreck, the trade deficit, or the oil price surge. And when they mention the federal budget deficit, they typically leave out the most critical facts.

Both promise to cut the deficit but don’t say how.

Both talk about major tax cuts, but never seem to explain where they’ll get the money to pay for them.

Both refer to the official estimates of the current budget, but fail to mention the stealth borrowings from Social Security … the huge looming deficits in Medicare … the mounting cost of the alternate minimum tax … and the new spending for the wars in Iraq and Afghanistan.

nd neither wants to even touch this looming issue: The budget-busting potential of a third front in the war — against Iran, now racing forward with its nuclear weapons programs.

All this drives me batty.

Here we are with our stock market starting to tumble and the economic recovery about to crumble … but the best the presidential candidates can seem to deliver on these issues is an occasional fumble.

They shower us with the same complacent attitudes and the same old platitudes that have adorned virtually every presidential campaign in recent memory.

They give us assurances of more help from the government …

They make promises of more prosperity …

And they offer virtual guarantees of more money in the form of tax cuts … spending hikes … or both.

Are they blind to the real crisis that is now upon us? Or are they merely responding to their polls which tell them that optimism, even false optimism, gets more votes?

Do they not care about the long-term future of the country? Or are they merely responding to their polls which tell them that American voters prefer instant gratification over long-term solutions?

Whatever the explanation may be, the presidential election of 2004 seems to be in fantasyland — a world far removed from the mega-shocks I’ve just told you about.

That’s too bad. It means that while your vote is important, you will also need to vote with your dollars — by cashing in vulnerable investments.

My advice in a nutshell: Get to safety. Now.

Good luck and God Bless!

Martin

Martin D. Weiss, Ph.D.
Editor, Safe Money Report
Chairman, Weiss Ratings, Inc.