The Daily Spin: CRB Index - A Picture of Things to Come
By James J Puplava CFP, September 4, 2002
The CRB Futures Index is widely viewed as a broad measure of overall commodity price trends because of the diverse nature of the 17 commodities of which it is comprised. As a broad measure of commodity price trends it serves as an excellent price measure for macro-economic analysis. This reflects the fact that a more diverse price index contains more information and, thus, can be used to better analyze economy-wide market forces. Also visit our Raw Materials Resource Page.
It is always interesting to hear the daily spin as to why stocks rose or fell. The days stocks fall are usually accompanied by some piece of news relating to the economy or corporate profits. With weak economic numbers and declining profits it would make sense for stocks to fall. Valuations at today's level make stocks grossly overpriced, so in order to sell investors stocks, various spin cycles have been resurrected to keep John Q. fully invested in his shares. If there is a good economic report, it is spun way out of proportion. When it is later revised lower, the number is kept quiet.
A good example was the government's revisions of the GDP numbers from 1999-2001. Those revisions not only showed lower productivity, but also the fact that the economy grew at a much lower rate, and that the recession of last year was much more severe than originally reported. This fact alone would warrant much more attention then it received given the rosy scenarios projected for the second half of this year.
When it comes to financial or economic numbers today, there isn't much you can put faith in anymore. The economic numbers are seasonally adjusted, massaged, manipulated and restated so frequently that you never know the real story. When it comes to earnings, we are still dealing with fictional numbers. The bottom line reported to the SEC, which reflects earnings according to GAAP, is no longer discussed. In its place we now have operating earnings or some other variation of pro forma earnings, which don't reflect reality. What goes on today in the financial field is a farce, if not fraud. Wall Street knows it, and so does Washington. The problem is that the economy is much more dependent on bubbles today than in the past. If the stock market bubble was to fully deflate, along with the mortgage and housing market, the US economy would be in deep trouble. It is now necessary to maintain the illusion that all is well, when in fact the patient is terminally ill.
The simple fact is that the American economy is requiring more and more doses of cheap credit to finance its day-to-day functioning. Without massive daily infusions of credit, the economy would implode. In order to postpone the day of reckoning it has been necessary to use every means of artificial stimulus available. All this has done is to postpone judgment day, and nothing more. Analysts and commentators can talk all they can about how this market has bottomed, but this talk is meaningless in light of stock market valuations. I hate to keep harping on this fact, but valuations do matter when you are in a bear market. The only time they don't matter is when you are in the midst of a bubble as we saw in the late 90's. However, with the S&P 500 trading at 32 times trailing earnings and dividend yield of only 1.73%, the S&P 500 would have to drop in half from here just to get back to normal, much less become cheap. This talk about market bottoms, or for that matter, brokerage analysts and fund managers talking about stocks as cheap, is based on no sense of reality. A stock that has dropped 75% may be cheaper than it was before it fell, but it doesn't make the stock a value if it still trades at 35 times earnings. A dividend yield of less than 2% only looks cheap if you compare that dividend to t-bills, which are offering yields slightly less than that. One should point out that t-bill yields are considerably safer than a stock dividend.
There are other measures of valuation other than dividends and P/E multiples. Price/book and price/sales ratios also indicate that stocks are grossly overvalued. The price-to-book ratio is an interesting one to look at since book value has been destroyed by the merger and acquisition binge of the last decade. In order to inflate stock prices in an effort to capitalize on stock options, CEO's went on a buying spree overbuying and overpaying for companies through the issuance of stock. Now those companies have to write off those assets by big writedowns, which are decimating book value. This is one reason, in my opinion, why analysts and anchors don't talk about earnings according to GAAP, because the GAAP numbers reflect these massive write-offs.
The book value of a company is the shareholder's bank account. That book value is supposed to reflect assets that were invested in to produce higher returns for shareholders, rather than returned to shareholders in the form of a dividend. When money is retained by management, instead of distributed to shareholders as owners of the enterprise, shareholders have the right to ask of management how well they have done as stewards of that money. The answer is very clear by looking at what has happened to book value over the last two years. It has been destroyed by reckless acquisitions and diluted through the aggressive use of stock options to reward CEO's and top management. As stewards of shareholder value, most management teams would have received an "F" for failure to do their duty, an "F" for fraud, and an "F" for free-wheeling with shareholder money.
In today's markets, the reason given for stock prices rising was that investors now believe the July lows were the final bottom of this bear market. The markets veered between losses and gains early in the day. Stocks supposedly rose after a report that zero-percent loans helped to lift sales at Ford, which is hemorrhaging from red ink, and GM. Between discounts and zero-percent loans, the auto companies are giving cars away. This concept has spread to other industries that have seen sales dwindle. Recently we went to upgrade our copier machine. Instead of paying cash I was offered a zero-percent loan. We took the zero-percent option. If they are giving away free money, why not? Maybe next we will get zero-percent mortgages. Here in San Diego my friend, the mortgage broker, tells me they are bumping housing prices so that zero down payment homeowners can have their closing costs rebated to them by the seller.
If you follow this through to conclusion you can see that a very frightening situation is developing in our credit markets. The Fed is inflating the banking system along with quasi government entities such as Fannie and Freddie through the securities market. The Fed lowers interest rates by injecting reserves in the banking system through its purchases of Treasuries from the banks. This increases their lending base, which can be multiplied through our system of fractional reserve banking. The GSE's are also fueling the credit cycle through the securitization of mortgages. Financial intermediaries are also inflating credit by securitizing everything from auto loans to credit cards. Today most kinds of loans can be turned into asset backed mortgages. This is creating another bubble in the bond market. The money that has been fleeing stocks is going into bonds, mortgages and real estate. All three are becoming bubbles and are dependent on a Ponzi scheme structure that is going to implode in the same way as the Nasdaq and Internet mania of only a few years ago. Today bond fund managers are buying asset backed securities along with Treasuries for their bond portfolios. The credit created is simply offloaded to the securities market.
So instead of one bubble, we have multiple bubbles. We also have multiple new bubbles in the real estate, mortgages, and a new bond market bubble. These bubbles must be added to the already existing bubbles in the stock market and the US dollar. The stock market, although lower today, has yet to fully deflate itself. It is being held up by spin and intervention. If you look at the larger picture, the US economy is built on the shaky ground of debt, which sooner rather than later will come crashing down from its own weight. The US is now in a debt trap of its own making that is going to take more than spin an illusion to solve. As I see it, there is no way out other than to hyper inflate. As far as deflation and inflation are concerned, it is a moot point. We are going to see both. The coming implosion of credit will see deflation in those areas where credit had its greatest impact, which is in the stock and bond market, the housing market and in luxury goods. We will see inflation in basic necessities, such as raw materials, energy, and imported manufactured goods that we need to live. Forget pure deflation; it isn't in the cards. The US is too dependent on foreign goods and raw materials as well as energy for all the things we need. At some point, the rest of the world is going to get tired of taking our paper money in exchange for the goods and raw materials they ship us. When that point arrives, you will be paying more for the things you need from the food you eat, the fertilizer that is used to grow food and make your garden grow, to your utility bill and the gasoline you put in your car. That is what today's graph of the CRB is showing. If reflects the future price of goods we consume from coffee, cocoa, soybeans, sugar, oil, natural gas, cotton, to wheat and orange juice.
Forget the CPI, which is a worthless gauge of inflation that is a contrived and manipulated index for the benefit of public consumption. Look at your checkbook and do your own survey. Look at what your food and energy bill was a year ago. Look at what it now costs you to send your kids to school, or even worse, to college. Look at your insurance premiums; examine your medical bills. Look at the size of your mortgage, your credit card bills and what you will pay in social security taxes this year. Then ask yourself if this jives with the CPI.
Stocks rebounded today on what has been a persistent pattern of weakening volume. Traders bought technology stocks, biotech, and airlines. Analysts and economists have almost begged investors to ignore the economic news, which keeps getting worse. Forget the double-dip. What is coming is a consumer led recession that will be added to the profit recession giving us a full-blown recession. The double-dip is a mild palliative suggesting that things will eventually get better.
Volume came in at 1.34 billion shares in the NYSE and 1.48 billion on the Nasdaq. Market breadth was positive by 22-9 on the big board and by 21-12 on the Nasdaq. Be wary of today's rebound. What happened yesterday was the first instance of a 90% downside day since April of last year. It indicates that more days like it are ahead of us.
European stocks rose on expectations profits will improve at companies ranging from Carrefour to Gallaher Group, Volkswagen and Axa. The Dow Jones Stoxx 50 Index gained for the first day in three, adding 0.8% to 2547.81. Six of the eight major European markets were up during today's trading.
Asian stocks fell, with Japan's Topix index closing below 900 for the first time in 18 years, after a U.S. manufacturing report indicated a recovery in the region's largest overseas market is faltering. Exporters, such as Sony Corp. and Hyundai Motor Co., led declines in the region. The Topix lost 2% to 886.39, and South Korea's Kospi index had its biggest drop in a month. Taiwan's TWSE Index slid 1.2% to a nine- month low.
At last check, the price of the benchmark 10-year Treasury note rose 5/32 to yield 3.94% and the 30-year bond was up 5/32 to yield 4.80%.
© 2002 James Puplava