The Big Picture
(November 16, 2003)
I am going to discuss the big picture here, and I
mean the really big picture. I came across this quote last week, and I would
like to share this with my readers:
"I place economy among the first and most important
virtues, and public debt as the greatest of dangers to be feared. . . . . To
preserve our independence, we must not let our rulers load us with public debt.
. . . We must make our choice between economy and liberty or profusion and servitude."
A prosperous society has never maintained its status
by consuming more than they have and living beyond its means. Think of the
Romans, the various imperial dynasties in China, and 20th century
Britain. Think of the typical American household and your household. What
happens when your credit cards are maxed out or when your living expenses are
beyond your income? Why, you cut back, of course. Take a look at the following
chart from Comstock Partners, Inc., and it is obvious why I think America is
on his way to a collision course not dissimilar to the ones taken by the Romans
and 20th century Britain.
The total credit market debt (government, business,
and households) as of the end of this year's second quarter is $32.9 trillion,
which would put it at over 300% of GDP - a figure never seen before in modern
My grandfather passed away on the 1st of
this month and his funeral was held last Saturday on the 8th. In
the eulogy that I delivered, I praised my grandfather on his ingenuity, admirable
worth ethic, his philosophy of self-dependence, and his financial conservatism.
He never lived beyond his means, and yet he still lived a comfortable life.
He was also very happy, spending the later years of his life with his family
here in Houston.
His belief of financial conservatism was shaped by
events early in his life in 1930s and 1940s Hong Kong - when mortality was high,
food was scarce, and government assistance was non-existent. He led a hard
life as a business owner specializing in metalwork but he was a free man - free
because he was his own boss, free because business in Hong Kong was not overly
regulated, free because of low taxes, and free because he had no business or
household debts so he had no creditors to answer to. His philosophy of economy
also allowed him to save a huge cushion of money for use in a "rainy day" -
enough money to build a few apartments during those early days.
Hong Kong prospered after World War II because of
people like my grandfather. The opportunities were there and people were encouraged
to pursue them. People did not seek security because there was not any. Saving
and investing was greatly encouraged - and the payoffs were huge. Not working
hard was generally frowned upon -- people worked seven days a week under harsh
conditions. There were no such things as 30-year (or for that matter, any n-year)
mortgages or financing your car purchase. People did not consume today. Instead,
they saved and invested, hoping for a better tomorrow.
The story is different today, here in America and
in Hong Kong. The above graph is a prime example of a society that has enjoyed
too many years of stability and prosperity and living well beyond its means.
Like I said to one of my friends, peace and stability has bred mediocrity and
laziness in nearly every one around me (myself included). Aside from your
typical immigrant from a developing country, what you have here is a huge number
of people who have always enjoyed life and who cannot deal with economic adversity.
We rely too much on other people to look out for us. Some of us work hard
but are unprepared for changes. Every one of us is encouraged to seek
security and study a "safe major" in college such as business or engineering.
We may work over 50 hours in our job every week but we fail to keep track of
and to prepare for the bigger picture.
Our consumption of material goods have also grown
exponentially. Instead of 2,500 square feet houses, we live in 5,000 square
feet houses. Instead of driving Camrys and Tauruses, we drive Hummers and Lexus.
And instead of saving and investing time in our families, we put everything
on our credit cards and bet our retirements with speculations in the stock market.
Make no mistake - the S&P currently has a trailing P/E of 30 and a miniscule
dividend yield of 1.7% -- if you're putting money into the stock market today,
you're purely speculating. That is all you are doing.
Just like Thomas Jefferson "predicted," most of us
in society today have been enslaved. If you hold a 30-year mortgage in your
house, you have become enslaved to your house (or in other words, enslaved by
the banks). Likewise, if you have college loans outstanding, you have become
enslaved. If you are currently working for someone else and have no ambition
of starting your own business, you have probably become enslaved forever. The
typical American today does not have any chance of being able to retire at 65
and to maintain his or her current standard of living for all the reasons I
mentioned above, and the fact that Social Security will need to be cut back
in the next few decades (unless we can tolerate much higher taxes or much lower
defense spending). It is also interesting to note that if Jefferson was alive
today, he would probably be calling for "revolution" once he sees what kind
of taxes we are paying.
If your typical household or business was run like
the United States of America, it would have gone bankrupt a long time ago.
Or worse, members of that same household or business would have gone to jail.
It is not unlike the "wealthy household" with lots of farmland but which spends
105% of its income every year from its produce and rack up huge debts with its
creditors. Or for that matter, Enron. Sooner or later, this huge "house of
cards" will tumble, taking everyone down with it.
My opinion is that in the next five to ten years,
the typical American household will be handed a harsh lesson in financial conservatism
and in independent thinking. Globalization has given the world a more level
playing field - America has now totally lost its comparative advantage in virtually
everything from manufacturing to software development. 50% of the world's population
lives on less than two dollars a day and you can bet that countries like China
and India will be flexing their muscles on getting what they want. Current
demographic trends also suggest that Western Europe and Japan will decline in
relative economic power. No longer will America be able to dictate terms at
will. In the worst case scenario, the U.S. dollar will lose its reserve currency
status and if that happens, the current standard of living we have enjoyed over
the last 50 years will come down drastically.
I will discuss the stock market in more detail next
week but to sum up the current situation: I do not like this market at all.
Breadth has been getting narrower and on a relative strength basis, the biotechs
have been lagging since July. To refresh one's memory, the biotechs also lagged
before the start of the decline in May 2002 and it has not happened again until
now. Walmart also missed earnings (and stated that they did not see the recovery
that most of us are "seeing" out there) and Applied Materials had a huge reversal
after they released earnings and told everyone (for the umpteenth time) that
the recovery was finally here (you can read more about AMAT
The Nikkei in Japan has now broken 10,000 as I am writing this and it looks
like it has completed a huge heads and shoulders pattern. The four-week average
in mutual fund inflows as of last Wednesday (per
was at a 30-month high and even that failed to move the market in any sort of
meaningful way. M-3 also declined last week again. The fact that gold rallied
to a seven-year high is also another red flag for the stock market.
My conclusion: I still believe the market will not
top out until sometime early next year but in the meantime, the stock market
may correct at any time - especially given that we have not had a meaningful
correction in eight months. Even if the stock market does not top out until
next year, any upcoming rallies should be narrower in breadth - so anyone without
superior stock-picking skills should probably think of selling their holdings
in the next few months.