USA: "Busting by the Seams"!

PaulRen's picture
Non Thai Article

For some time now I have been traveling around the US so to keep my global perspective and contacts. I see the US is truly "busting by the seams". It reminds me of SE Asia in the early to mid 1990's! While it is impossible to call a top, I notice dangerous warning signals, among them:

  • Professionals in many endeavors often do not call back. Business of all sorts is starting to be taken for granted. There are too many "success’stories abound.
  • Real estate agents do not have time to show you around. One Lady told me how frustrated she was as every time her client makes an offer on a property it gets sold to another one who offered more. Every city I visited is having an outright real estate boom.
  • Hotels are full, (in Phoenix it was 95$ a day, when the official posted room rate on the inside door was 45$), in Tucson, AZ it was $125 vs. the posted rate of $49.
  • I bought a car on credit (instead of renting one) but the finance company won't even send me the monthly payment book. Truly, I never heard from them again even while I called, even while they have my current address.
  • Stockbrokers do often not call back nor send you the new account forms and just about every one (my old connections included) seem to think the market is going forever higher. Money managers are overall excessively bullish and nobody seems interested in investing outside the USA. Call it the autriche effect. (Also, "internet stocks frenzy", see below).
  • The fastest growing consulting business here (according to CNN) is "life style" brokers/consultants, they "teach" you how to "live happy" once you are making all that money. Their business is booming.


  • Conversations are abound (in and out of locker rooms) on how much "money they made on paper", yet they will not sell due to the "capital gain taxes to pay". It is just an excuse! They seem to all forget that they still keep most it, even after the taxes.
  • Record low un-employment, close to 30 year low interest rates, record highest P/E' of average 28 for the S & P 500 and few seem concerned. These mania mergers which prevail are often a sign of a market top.
  • Most US investors have limit-sell orders in place should things go wrong. They place these orders and answer my cautiousness confidently "it's all taken care of". I hate to think about what will happen when all those limit orders get executed once the market downfall is in motion.

While the new market and capital mania can continue for a while it is starting to be frightening.The problem of capitalizing on this, of course, is one of timing. The drop could come now or from 10,000 or more on the Dow. Nobody knows when, but it's coming. Watch and see.

Meanwhile around the world….

As I see it, Japan represents some threat to world economic stability. The bottom line is that for the past 7 years they have continued to use larger and larger Band-Aids to fix their ailing economy and have still failed to reform their financial sector in any meaningful way. This is of course because politics in Japan, as all over Asia, is dictated by big business and business does not want anything to do that would hurt themselves. Unless changes come in a fairly short time, I do not wonder if the market is going to tolerate this much longer. The result could well be The Yen sinking to 145-160 vs. the US Dollar, the Nikkei falling to perhaps 12,000? Because of the cozy relationship between companies in Japan (holding each others stock), there would be a lot of insolvent companies at this level. Too much regulation and lack of steep tax cuts are the big problem. The result is potential financial implosion. Of course they are trying to export their way out of the problem. We all wonder if this will work this time. The only countries in the world with strong domestic demand at the moment are U.S, Canada, and the U.K., the U.S. being larger than the other two others combined.

On Japan's effect on the US and EU, it does not look like a Japanese crash will affect much either, consider:

  • Japan's economy accounts for only 13% of global GDP
  • America's export to Japan accounts for 1% of its GDP
  • EU's export to Japan accounts for 0.5% of its GDP
  • Imports from Japan by the States and the EU account only 1-2% of GDP in each case
  • The U.S. economy is forecasted to grow 2.7% this year taking into account a 0.3% drop in Japan's GDP

But a Japanese crash would have a significant impact on mostly the big capitalized shares in Thailand economy and similar to the rest of SE Asia. Japanese investors and bankers will need to sell oversea properties or call back their loans to shore up their home base. This is another reason why in Thailand I not yet advocate buying the general market and why we are negative on most big capitalized "macro’stocks. Our selection remain specialized smaller cap's which are far more insulated, which do allot of exports of low "luxury products" and yet who still sell at ridiculous lowest valuations. We do not need a massive SET rally for those to slowly move higher.

We much like PR (52), KCE (260), and STA (74) and even CM (29), clearly still among our absolute favorites. Most just paid good dividends. Combined my favorite Thai 'niche' companies are currently valued at less than 17% of the valuation of an average US stock. Evens while their earnings recently have (and still are!), growing faster than the average US share. Another way of wording this. For every 1 Baht in trailing earnings on my "jewels", you pay 4 -6 Baht in stock price. In the US for every $1 in just past earnings (trailing) you pay $28 to $34 in stock price. Similar relation holds with current dividend yields.

Global capital mania is ignoring such lowest valuations as these companies are perceived to be too small and the increasingly so mega-mania driven funds are truly victims of their own size.

Looking again at the mighty Dow, I nearly shake at the thought of what could take place any time now. The market seems to have forgotten that interest rates do move up as well as down! Even the most conservative Chicago brokers and advisors are now finally bullish, after years of "cautiousness". I am right they tell me, except "this time it's different". History has always shown those are costly words.

With the Dow trading at the outside of its trailing P/E range (27+), with eight consecutive years of growth behind it, I doubt the economy can continue to grow at the pace that these forever expanding P/E's suggest. Master of the Universe, Mr.Greenspan has failed to raise interest rates because his inflation indicators (commodity prices being one of the main ones) do not indicate a problem on the horizon. A look at history will show that in 1927 through '29, there was a significant divergence between commodity prices and asset prices and there too, the Fed failed to increase rates to hold the market in check. With liquidity awash in the markets, they climbed at a mind-numbing pace until the threat of withdrawing that liquidity was realized with the raising of interest rates. The timing of this is always impossible to predict as tops are always frenzies and how long can a feeding frenzy go wild?

As for the reason behind Greenspan eventual raising interest rates are negative balance of payments and the slow but gradual Asian 1999 recovery. While Japan is in the tank forever larger China will soon make up the slack in demand? Also the new tax changes in Japan should produce an improvement or at least take the fear of an outright collapse away.

With Asia and to a lesser extent South America trying to export its way back to health, the U.S. is seeing a significant surge in cheap foreign products arrive at its shores - as shown in its trade balance with various countries. At the same time, due to the devaluations these same countries are importing far fewer US products. Interest rates will rise to keep what will continue to be an overly robust economy in check, and when they do, the US market will respond as they always do, downward.

I do believe that if the market can hold things together until this fall (in the mean time Dow to 10,000 is probable), that we are in for a frightening panic sell ride later. History suggests that 10 - 12% is the average return on the Dow. Going back to '91 and using this figure to inflate the Dow, I would suggest that a Dow of 7800 is reasonable. As the circuit breakers have just been adjusted to 10% (a one hour break), 20%(a two hour break), and 30% a day, this level is attainable in two days time.

All this says nothing about the year 2000, here nobody knows how the highest tech. country in the world will fare with the coming year change '99 to '00 computer bug. US radio talk shows are flatly stating: no Airline will dare to fly on that "d-day". What if there is a panic? Even one major glitch could produce such fallout. Surely we are in for interesting times and another reason why I prefer to hide it out in my "bread and butter", favored smaller and middle-sized Thai cap's.

With the Dow above 9000 at the time of this writing it's time to consider Charles Mackay's 19th century classic "Extraordinary Popular Delusions and the Madness of Crowds". For those subscribers who live in Thailand, remember it is so easy to buy 24 K Gold in the Kingdom. For the first time in over a decade, I would favor accumulating a smaller position in easily re-sellable gold. As some insurance for the year 2000, potential computers bug.

Best personal regards to all our valued subscribers!

Paul A.


Here are some excerpts from the Washington Post ,Thursday, April 23, 1998, regarding the "internet craze,

"It's like a mania,’said Michael Driscoll, chief stock trader at Hambrecht & Quist Group, a San Francisco brokerage firm that specializes in high technology. "Any way, shape or form it has ties to the Internet and they're buying it like bananas. The sudden stampede into highly speculative stocks worries some veteran traders because similar frenzies in the past have preceded big drops in the overall market. Bill Riegel, who helps manage $286 billion for J.P. Morgan Investment Management, said the market may be close to topping out. "It's very unsettling," he said.

Added Hambrecht's Driscoll: "I was joking around with someone the other day that if U.S. Steel begins to sell steel on the Internet, you'd see their stock double in price."

Murphy and other Wall Street watchers worry this Internet stock frenzy could signify the end of these heady days in the market. "This could be the classic sign of an aging bull market," Murphy said. Once all the other sectors have swelled to their limits, he said, investors turn to "concept’stocks as an almost desperate source of untapped riches. "People are stretching to make money," he said. "When it blows up, it's gonna hurt a lot of people."

April 20, 1998

Below is an article by the magazine "Economist" as of April 20, 1998.

"The American economy is showing dangerous signs of excess. A wave of financial mergers is only the latest evidence

AMERICANS have been toasting their economic success of late. In contrast to debt-ridden Japan and jobless Europe, their economy has been enjoying a happy combination of balanced growth and low inflation. Most forecasters expect this to continue almost indefinitely. But that is not the only possibility. Soaring share prices, merger mania and rising prices for property and works of art all suggest that America is developing a bubble economy.

Just as champagne tastes wonderful until the bubbles go to your head, so financial bubbles tend to create nasty economic hangovers. These can take two forms. Either they suddenly burst, with painful financial and economic consequences. Or rising asset prices feed through into the wider economy, pushing up the prices of goods and services until, eventually, they are burst by the deliberate efforts of the central bank. With American consumer prices rising by only 1.4% in the year to March, that may seem a remote problem. But rapidly rising asset prices boost household wealth, encouraging a spending spree. As domestic demand becomes overheated, general price inflation rises. Either way, the bubble could put America's expansion at risk.

Evidence of speculative excesses is widespread. There are four main symptoms: overvalued share prices, merger mania, rising property prices and a rapid growth in money supply.

America's stockmarket has risen by more than 30% over the past year. Share prices have continued to climb, exploding to new records again this week despite increasing signs that profits are likely to be squeezed over the next 12 months. The Standard & Poor's 500-stock index has seen a cumulative real return of 825% since 1982, the start of this bull market, even larger than the 730% real gain during the bubble of the 1920s.

Some of the rise in share prices reflects improved performance. Inflation has fallen, the government's budget deficit is moving into surplus and new technologies have reshaped huge parts of the economy. Corporate earnings have set record after record. But even all this does not justify current prices.

The recent merger craze, including a wave of huge bank mergers (see article), is a strong characteristic of a bubble economy. American mergers and acquisitions are at record levels: deals worth $957 billion (equivalent to 12% of GDP) were announced last year, up from $138 billion (2% of GDP) in 1991 and well above the previous peak of $352 billion (7% of GDP) in 1988. This is set to be another record year: $441 billion-worth of mergers had already been announced by April 13th, according to Securities Data Corp. If account is taken of the inflated value of companies, mergers in 1997 were equivalent to only 7% of stockmarket capitalisation compared with 10% in 1988. But activity this year could exceed 1988 even on this measure, reckons Steven Kaplan of the University of Chicago.

The four previous big merger waves this century-in the early 1900s, the 1920s, the 1960s and the 1980s-all coincided with three things: strong economic growth, rapid credit expansion, and a stockmarket boom. The first three ended in the crashes of 1904, 1929 and 1969; the 1980s boom petered out as the economy slipped into recession in 1990.

Merger waves may often be caused by new technology or deregulation. But they tend to be encouraged by soaring stockmarkets, according to F.M. Scherer of Harvard University, because the inflated value of shares relative to earnings provides a cheap way to finance acquisitions. In turn, the surge in mergers adds to the stockmarket's buoyancy. More mergers ensue as managers worry that acquisitions will become even more expensive if they delay.

That is when booms can turn to bust. Many of the mergers late in the cycle will be rushed and ill-conceived; their trumpeted benefits will often fail to live up to expectations. That, in turn, may dent investors' rosy outlook and contribute to a crash. Mr Scherer detects such end-of-cycle hubris in the merger announced on April 6th between Citicorp, America's second-biggest banking company, and Travelers, an equally big financial-services group: "The law of gravity has not been repealed. That's what they thought in the 1920s. They were sadly disabused of that notion."

The third symptom of a bubble economy is a frothy property market. In 1997 commercial rents rose by around 20% or more in San Francisco, Boston and Dallas. In New York, bidders recently offered the equivalent of $180 per buildable square foot, twice the price paid for a comparable site six months ago, for a pair of development sites near Times Square. House prices are rising rapidly in many cities, fuelled by lower mortgage rates.

Franklin Roosevelt famously said that the only thing to fear is fear itself. In the stockmarket the opposite can be true. Perhaps the most convincing evidence that a bubble is being inflated in America is the widespread complacency about the economy and the stockmarket. Bears have nowadays become an endangered species. According to a Merrill Lynch survey of Wall Street strategists, fewer investment advisers are currently bearish on shares than at any time in the past six years. Even as share prices break record after record and corporate earnings growth slows, they are recommending that investors shift still more of their money into equities.

Related to this is the increasingly widespread belief that the American economy has entered a new golden era in which the old rules (eg, that what goes up can come down) no longer hold. This feature has been common in past bubbles. "For the last five years we have been in a new industrial era in this country. We are making progress industrially and economically not even by leaps and bounds, but on a perfectly heroic scale." So wrote Forbes magazine in June 1929, four months before America's stockmarket crashed. "As the result of all that has been happening in the economy . . . during the last decade, we are in a different-if not a new-era and traditional thinking, the standard approach to the market, is no longer in synchronisation with the real world," Forbes opined in October 1968, just before the onset of a six-year slump that knocked share prices down by 60% in real terms.

Last, but by no means least, the most damning evidence of a bubble is America's rampant monetary growth. The broad measure of the money supply, M3, rose by almost 10% in the year to March, its fastest since 1985. Another gauge, M2, is also expanding rapidly. Many economists stopped watching money-supply figures some years back when the different measures started to give conflicting signals. However, the monetary aggregates may be useful once more. Just as too much money chasing too few goods causes goods-price inflation in the real economy, too much money chasing too few assets causes asset-price inflation. This is why central banks are wrong to focus solely on consumer-price inflation when setting policy. They also need to keep a keen eye on asset prices.

The fizziness of America's bubble economy suggests, therefore, that the Federal Reserve needs to tighten the monetary screws. That, however, may be harder than it seems. The Fed's ability to raise interest rates to dampen speculative excesses is constrained. It has a legal mandate only to curb consumer-price inflation, which has been falling, not rising. And pricking a financial bubble is a risky business, hard to do with delicacy. This is why it would have been better if the Fed had raised interest rates sooner to prevent a bubble in the first place. But one thing is sure: the longer America's party is allowed to continue, the worse the eventual hangover will be.This will be the last straw on the camel's back.