Never before in my lifetime have I seen such a thick layer of complacency hiding such a deep pit of dangers.
He told me about the wild euphoria of investors before the Crash of ’29 and the blind trust of depositors before the banking panic of the 1930s.
We debated why the S&L’s jumped knee deep into risky real estate in the 1970s and why giant life insurers loaded up with junk bonds in the 1980s. Deep-set complacency, we agreed, played a major role each time.
But the complacency today is far worse.
It prevails among investors, homebuyers, local politicians and world leaders. It pervades decisions about buying and selling … borrowing and saving … health and wealth … even homeland security.
The complacency is in the stock market, the bond market, Congress, the White House, and virtually every division of government. It knows no social barriers and respects no national boundaries …
Complacency in Homeland Security
Here we are, approaching the fourth anniversary of 9/11, and strategic systems long-ago identified as the most vulnerable to terrorist attacks remain largely unprotected: Mass transit systems teeming with millions of rush-hour commuters. Nuclear power plants harboring massive amounts of radioactive materials. Strategic oil reserves. Chemical depots. Ocean ports.
Nor has there been any lack of warning.
Mass transit was the target of Madrid’s 3/11 and Moscow’s 2/6 attacks — both just last year.
Meanwhile, the peril of a nuclear plant strike is vividly illustrated by the virtual meltdown of Three Mile Island on March 28, 1979 and the actual meltdown of Chernobyl seven years and one month later.
And don’t forget the worst industrial disaster in the history of the world: The accidental release of forty metric tons of methyl isocyanate from a Union Carbide pesticide plant in Bhopal, India. Even George Orwell’s “1984†did not foresee a greater horror for that year.
But accidents are random. Terrorist strikes are not. They are strategically designed to cause the most harm to the most people. Sadly, however, security efforts in the U.S. and abroad are often embellishments of outdated accident-prevention programs.
Complacency in the Stock Market
Suppose you and I had a chat a year ago.
And suppose I told you that, by mid-2005, crude oil would be selling for more than $60 per barrel … the Fed would have raised its Fed funds rate nine times in a row … the U.S. trade deficit would be the worst in history … and we’d be fighting two entrenched wars.
How would this have made you feel about the prospects for the Dow? Bullish? I think not.
And this past Friday, how would you have reacted to the government’s jobs report? Would you have bought stocks with great enthusiasm, helping to drive up the Dow by 147 points? Or would you have noticed that …
- June marked the NINTH time in the last 12 months that new jobs added to employer payrolls were weaker than Wall Street expected.
- Out of the 278 industries surveyed, only 55% said they were hiring in June, down from 57% in the month of May.
- The economy is creating mostly low-paying service jobs but continues to lose solid, high-paying manufacturing jobs. In June, we lost 24,000 factory jobs, the largest single-month loss of the entire year. Total factory jobs lost since January: 96,000.
- According to Economy.com, quoted in Saturday’s New York Times, in the past four years, real estate has added 700,000 jobs, while the rest of the economy has LOST 400,000 jobs. This has “left the country vulnerable to a housing slowdown,†says the Times.
Also on Friday, would you have leaped for joy with Alcoa’s second quarter earnings announcement? Or would you have paid more attention to the fact that …
- About $219 million of Alcoa’s $460 million profits came from its sale of Elkem shares, another aluminum maker that it owned. Plus an additional $120 million came from a tax settlement with the IRS. That means that 73% of Alcoa’s Q2 profits were from non-operating sources.
- Alcoa admitted that raw material costs increased by $60 million last quarter, mostly for energy.
- Just last month, Alcoa announced the layoff of 8,100 workers and the closure of several plants. Those are hardly the actions of a company that is expecting a gangbuster boom in business any time soon.
Yet based on the jobs report and the Alcoa announcement, Wall Street convinced itself that all’s fine and dandy. It’s not.
Complacency about Surging Energy Costs
Everyone knows energy prices are going through the roof. Everyone can see how, just last week, the prices for oil, gas and diesel smashed all records and hit the highest levels in history. But few people seem to care enough to change their habits.
Despite paying an all-time high of $2.31 per gallon for gas, drivers are still driving, and demand for gasoline is still up 2.5% from last year.
Despite another broken record last week — $2.34 per gallon of diesel — truckers are still trucking, and they’re still transporting two-thirds of all American goods.
And despite the fact that corporate profits are getting clocked by rising energy costs, investors are still buying or holding America’s energy-guzzling corporations.
Some recent examples:
FedEx just said that rising fuel prices helped push fourth-quarter profits below estimates. In response, its shares plunged 8.3%, the biggest drop in three years.
And late last month, already-bankrupt United Airlines reported a $93 million loss, largely due to what its chief financial officer called the “brutal challenge” of higher fuel costs.
But it’s not just airlines and transport companies that are getting slammed.
Even wheelchair-maker Invacare warned that its earnings in the second quarter — and for all of 2005 — would fall below expectations.
The problem? Lower-than-expected sales and a rise in freight costs. Invacare even went so far as to quantify precisely how much higher fuel costs have hurt its earnings: “Freight costs also negatively impacted prior guidance by approximately $0.06 per share largely due to fuel surcharges driven by the high price of oil,†they said.
Meanwhile, Del Monte reported that its fourth-quarter earnings decline was driven by “increased inflationary costs in steel and energy, logistics and other transportation-related costs.â€
Ditto for most companies. Indeed, TEC International just surveyed 2,000 CEOs. Their response: High energy costs are currently THE NUMBER ONE CONCERN. Plus, 70% of the CEOs said costs have risen in the past year. Only 3% are reporting a drop in prices.
This morning, Hurricane Dennis has been downgraded and the feared damage to oil facilities in the Gulf of Mexico has not occurred. Result: Crude oil prices are temporarily below $59 per barrel and you can expect still more complacency about rising energy costs.
The single best indicator of a bubble is rapid growth in debt; and the most volatile form of debt is the kind that’s bought and sold like a commodity or a high-flying stock.
Case in point: An asset-backed security (ABS).
How do issuers create them? Simple: They take a batch of debts. They pack ’em up in a bundle. And then they sell securities to investors that represent shares in the bundle. They do this for credit card debt, short-term corporate IOUs, trade receivables and … especially home loans.
The Fed’s Flow of Funds of June 9 (page 34, Table F.127, line 7) tells the story — a drama that began just five years ago, in 2000.
Back then, it was rare for a home loan to be used as the basis for an asset-backed security. Indeed, there were only $31.5 billion of them.
But by 2004, the amount ballooned to $398.3 billion, a growth of more than TWELVE times!
And in the first quarter of this year, the issuance of these asset-backed securities was up a whopping 48% over the year-ago quarter.
If we continue at that pace, you’re going to see at least $590 billion in new home-loan based ABS’s in 2005 alone.
Industry folks think that’s great. They figure it’s an efficient way to pawn off their risks to investors. Problem: The investors are fickle, and many are overseas. If they turn sour on real estate … on the dollar or … on the United States as a whole … suddenly a major source of financing for American homes will dry up.
Even more alarming are some facts about the REST of America’s debt pyramid …
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FACT |
According to the Fed, at the end of the first quarter, the total interest-bearing debts in the U.S. had piled up to $37.3 TRILLION. |
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FACT |
Real-estate-related debt is now the largest single category — $10.7 trillion. That’s more than DOUBLE the total amount owed by the U.S. Treasury. |
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FACT |
Just TWO companies — Fannie Mae and Freddie Mac — hold over $3.5 trillion of the real-estate-related debt, more than all of America’s thousands of commercial banks put together. This virtual monopoly, is, in itself, a big danger — not only for investors in these two companies, but also for the entire real estate market. |
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FACT |
This huge build-up of debts implies great upward pressure on the cost of debts — interest rates. |
STILL, complacency reigns supreme.
The Consequences
Modern society is remarkably resilient to terror. Real estate prices are rising in lower Manhattan. Tourism is up sharply in Madrid. Calm has already returned to London.
But modern financial markets are more fragile. Among investors, complacency initially breeds bliss and euphoria. And, inevitably, it also brings fear, shock, even panic.
No one can pinpoint when this transition will occur. But for an advance indication, I recommend you keep a watchful eye on two markets:
First, commodities: The Commodity Research Bureau’s Index (left) hit rock bottom just around the time of the 9/11 attacks.
Since then, it has been marching steadily higher, surging through the 200 level in early 2002 … rocketing above 250 in late 2003 … and smashing through the 300 barrier early this year.
Prognosis: As long as this trend continues, the fires of inflation are bound to spread, and with inflation, you can expect a major surge in the cost of money.
Second, long-term Treasury bonds: Until recently, these bonds have been surprisingly strong in price and unusually weak in yield.
For months, bond investors pooh-poohed the smoke signs of inflation and even ignored the Fed’s relentless hikes in its Fed funds rate.
But since the latest rate hike on June 30, long-term bond prices have begun to decline, carrying their yields higher.
The low point you see in the price chart of the long-term T-bond was reached on June 15 at 115 26/32. If it breaks this low, it could fall swiftly to 113. That will be the first tip-off of trouble ahead — not only for stocks and bonds, but also for corporate profits, real estate, and ultimately, the entire economy.
Here’s What To Do …
My first recommendation is to keep your cash short term, liquid and safe. The best vehicle in my opinion: A Treasury-only money market fund.
With these specialized mutual funds, you’re protected against falling bond prices. You can promptly take advantage of higher yields on short-term Treasuries as they become available. You get truly free checking. And, unlike other money funds, your yield is exempt from most local and state income taxes. Some examples:
- American Century Capital Preservation Fund (800-345-2021)
- Dreyfus 100% U.S. Treasury Fund (800-645-6561)
- Fidelity Spartan U.S. Treasury Fund (800-544-8888)
- USGI U.S. Treasury Securities Cash Fund (800-873-8637)
- Vanguard Treasury MMF (800-662-7447)
- Plus, also consider our own Weiss Treasury Only Money Fund (800-814-3045).
Second, for much higher yields PLUS the potential for large capital gains, take a look at Canadian royalty trusts specialized in oil and gas. On one of these royalty trusts, subscribers to my Safe Money Report should be pocketing a total return of 59.6% before commissions right now. The actual results they achieve will vary depending on the price they get in today’s trading. But it should be close to 59.6%.
Plus, I recommended they hold on to half of their position in anticipation of still more gains to come. For the details, download my special report on this company.
Third, using strictly funds you can afford to risk, the extreme complacency of our time gives you a unique opportunity to profit from the extreme consequences of that complacency.
You simply buy put options on stocks most likely to fall as inflation and interest rates rise. Your risk is strictly limited to the amount you invest. But your profit potential is virtually unlimited. Click here for my report on the most vulnerable companies.
Good luck and God bless!
Martin D. Weiss, Ph.D.
About MONEY AND MARKETS
MONEY AND MARKETS is written by the editors and financial analysts at Weiss Research. To avoid any conflict of interest, our editors and research staff do not hold positions in companies recommended in MAM. Nor does MAM and its staff accept any compensation whatsoever for such recommendations. Unless otherwise stated, the graphs, forecasts, and indices published in MAM are originally developed and researched by the staff of MAM based upon data whose accuracy is deemed reliable but not guaranteed. Any and all performance returns cited must be considered hypothetical. Contributors: Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, David Dutkewych, Larry Edelson, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Anthony Sagami, Julie Trudeau, Martin Weiss.
© 2005 by Weiss Research, Inc. All rights reserved.
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