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Home  Picks  Figures  Great Investors  Vault  Contact              c2003-04 Thomas Barnard

August 4, 2004   Cash is King

The two titanic forces fighting it out at the present are the forces of deflation and inflation.  Greenspan has lowered interest rates and made money easy.  Perhaps more money was created by the Fannie Mae and Freddie Mac than by the Fed itself.  More money chasing few goods is supposed to make each good cost more dollars, that is classical inflation.

And inflation has surged up in medical expense, and more recently, gasoline.  But it has also risen in a kind of insidious manner: in the prices of homes.  Usually, when stock prices decline, so do real estate prices (to a lesser extent).  With this stock market decline, housing prices actually increased by 20%.  And it is directly related to low interest rates.  Low interest rates mean you can pay against a larger principal amount with the same dollars you would have paid for less house.

But I think the greater force is deflation.  I don’t think the mini downturn was sufficient to wash out the oversupply and create any significant pent-up demand.  Unfortunately, it may turn out that the last vestiges of what demand was left were brought out by the extremely low interest rates (lowest in 46 years).  Cars were sold at no or very low interest rates, and it could turn out that sales from future years were stolen by low rates.  Car sales for June were not good, but it is too early to claim our thesis is fact.

I think that housing is also going to suffer some kind of slow down.  Goldman Sachs recently said that houses in the U.S. are high by 10%, but in Britain they are high by 15%, and 29% in Australia.  We recently read that a Harvard study puts normal demand at 1.4 million houses per year.  Once again demand may have been stolen from future years because we have been running above 1.4 million houses, which suggests there could well be a lull in demand at some point.  Further, it appears to me that banks have been reducing their standards to book loans, so there could be trouble down the road for them.  And foreclosures, already high, could add to the supply of homes on the market, and damping demand for new homes.

Washington Mutual recently announced its 2004 earnings would be 11% below expectations, perhaps an early warning that the housing bubble is about to pop.  One wonders how strong the balance sheets are of financial institutions when you receive unsolicited faxes like the one I recently received advertising the following: 

·        Bad Credit – OK

·        Bankruptcy – OK

·        Foreclosure – OK

·        No Documentation Required

On to China and India, which appear to us as titanic forces for deflation.  Cheaper and cheaper goods and services prevents any kind of pricing power.  Classic deflation is too many goods chasing too few dollars.

Coincidentally, lower retail sales, lower auto sales and lower employment figures may be early signs that the economy has run out of steam.  Pundits down on the economy claim that the lower retail sales are the result of the end of the tax refunds.  Too early to say for sure, but that’s the camp I’d be in.

I submit that lower pent-up demand will result in a slowing economy which will spill over into the equity markets, with lower demand for shares, and lower prices there as well.  Further, it is possible that bonds will be sold off as, with lower principal prices meaning higher interest rates.  In such an environment, the only thing to have is cash.

Cash is King.  Warren Buffett closed out his bond positions a year ago and has accumulated billions in foreign currencies.  John Templeton recently stated, “Keep your powder dry,” and said no stocks anywhere in the world are cheap.  Richard Russell of the Dow Theory Letters says cash and gold are the only things to own.  This thinking is echoed by Martin Zweig's choices for Wall Street Week.  If you need reassurance, there it is, the best brains in investment.

Nevertheless, stock prices may well bounce up to grab your interest and your dollars on the way down. 

Meanwhile, the election approaches and we can observe ratiocination on a grand scale, with party loyalists defending their candidates with thinking equal to the schematics of an Intel pentium chip.

August 4, 2004