"Defaults Soar in First half of 1999"

August 25, 1999

The bull market is in the midst of another one of its wild charges in what continues to be a most extraordinary financial market environment. From lows set on August 10th, just 11 trading sessions ago, the Dow has rallied 777 points or 7%. The NASDAQ 100 has risen 16%, the Morgan Stanley High Tech index 14%, and The Street.com Internet index has gained 29%. So far this week, the Dow has gained 225 points, or 2%, increasing 1999 gains to 23%. Most indices have outperformed the Dow as the S&P500 and Morgan Stanley Consumer indices have gained 3%, and the Dow Transports 5%. Less impressive, the Utilities have gained 2% and Morgan Stanley Cyclical index has posted a rise of about 1-%. The small caps have been relatively quiet with the Russell 2000 increasing about 1% so far this week. NASDAQ and the tech sector, on the other hand, have been absolutely on fire. The NASDAQ 100 has gained about 6% so far this week, while the Morgan Stanley Technology index and the Semiconductors have increased about 5%. Year-to-date, the NASDAQ100, Morgan Stanley High Tech index and Semiconductors have gains of 34%, 39%, and 50%. The Street.com and NASDAQ Telecommunications indices both have posted gains of about 6% so far this week. Year-to-date, these two indices have gains of 45% and 30%. All we can say is the degree of speculative fervor is absolutely astonishing but in the past this type of virtual buyers panic has been a harbinger of a reversal and stock market decline. All the same, we are so far into this speculative period that the current environment, amazingly, passes as "normal." This marketplace, however, is anything but normal.

Last week provided more evidence that the general economic environment is atypical as well. "Defaults Soar in First Half of 1999" was the title of the August 18th issue of Standard & Poors CreditWeek (www.standardandpoors.com/ratings/cwarchive/index.htm). This excellent report begins, "Continuing a trend that began in 1998, corporate defaults have soared in 1999. Fifty-five rated (or formerly rated) companies failed in the first half of 1999, exceeding in six months the already high number of failures in all of 1998. The debt involved, $20.5 billion, almost doubled the full 1998 tally. There is little doubt that 1999 will register the largest number of rated defaults ever; on dollar amounts that will represent an all-time record. As a percentage of the rated universe, however, it is doubtful that the years figures will exceed those of 1990-1991." Well, that certainly leaves little to cheer about considering the strength of the economy today compared to the recessionary environment of 1990/91.

And in what we would consider a diplomatic understatement, S&P adds, "To some degree, the rise in defaults in recent periods mirrors the markets increased appetite for risk." Continuing, the report states, "For a good portion of the 1990s, a large number of companies (many of them with below-investment grade credit) have come to the capital markets for the first time. For example, 80% of the defaulting obligors listed were first rated after 1994. Moreover, the ratings of all obligors, new and old, have experienced more downgrades than upgrades in 17 of the last 18 years. In other words, credit quality  as measured by Standard & Poors ratings  has consistently deteriorated for quite a while now."

And the report finishes, "The fact remains, however, that all those changes in the quality of the credit mix bode ill for future default counts, especially if the U.S. economy takes a downturn." Well, all we can say is that anyone who is surprised by the deteriorating credit environment has not been paying very close attention. Over the past few years our financial system has been involved in a virtual credit "free-for-all." Since the end of 1992, total corporate borrowings have increased by $1.2 trillion to $3.7 trillion, an astounding increase of almost 50%. And scanning the most recent data, annualized debt growth increased for the corporate sector during this years first quarter by $391 billion. This compares to $297 billion of growth during 1998s first quarter, and $230 billion in 1997s first quarter

We would also like to commend Scott Burns (www.scottburns.com), the exceptional journalist for the Dallas Morning News. Over the weekend he wrote an excellent piece titled, "Many of Us Live High on Credit." His insightful article begins with a quote from Stuart Feldstein, founder and president of credit research company SMR Research (www.smrresearch.com and a speaker for our Credit Bubble Symposium on September 21st); "These figures arent pretty. However, you look at it, its not pretty. Basically, about one-third of all households are broke." Continuing from Feldstein, "We believe a credit problem is developing. Its not solely because of the amount of debt. The other problem is a decline in peoples ability to pay debt. We all look at the macro-statistics and know that were in a boom. We know that real wages are rising. But these are just averages and dont apply to everyone. " We agree with Feldstein completely. And the bottom line remains that the consumer sector has taken on tremendous debt. Since 1992, consumer (non-mortgage) debt has increased $565 billion to $1.4 trillion, or 70%. Over this same period, household mortgage debt has exploded $1.4 trillion to $4.2 trillion, or 50%. And during the first quarter mortgage debt grew at an annualized $411 billion. This compares to $364 billion during 1998s first quarter, and $207 billion during the first quarter of 1997. Also for comparison, household mortgage debt expanded by $125 billion during 1993. So mortgage debt growth during the first quarter was running at a rate more than 325% that of 1993. With this in mind, is there any doubt why home prices are rising?

In this regard, we could only chuckle yesterday evening in response to comments made by Lawrence Kudlow on CNBC. Doing his usual, he was once again espousing his view that there is absolutely no inflation and during such an environment the Fed should "sit back and do no harm." Ron Insana then questioned if such sanguine analysis was weakened in the face of rapidly rising home prices in many markets. Kudlows reply was that higher home prices were "wealth creation" and, of course, wealth creation is great and certainly not something the Fed should mess with. Well, we certainly view such analysis as quite silly. How can the bulls with a straight face call rising goods prices "inflation" and define rising asset prices as "wealth creation." This is simply nonsensical.

Certainly, old economists recognized that credit excesses could manifest into different inflationary effects, generally higher goods prices, rising asset prices and trade deficits. This makes perfect sense. If an economy creates too much money and credit, this extra buying power can chase domestic goods and services, fuel asset markets, or be used to import foreign goods. The old economists, by the way, also believed that higher goods prices were the least dangerous of inflationary consequences. Kudlow and the bullish camp, however, would have us believe that rising margin debt, derivative leverage and wild speculation actually creates real economic "wealth" by fueling a hot stock market. Additionally, the current unprecedented boom in mortgage borrowing, and resulting home price inflation, is, again, just more "wealth" for the US homeowner according to the bullish perspective. As we have said before, today the bulls erroneously mistake unprecedented credit creation for wealth creation. Real economic wealth is not created by increasing the quantity of money or the amount and price of debt and other securities. The bulls are very wrong. And in this regard, we are quite sure that the Japanese today would not in any way consider their 1980s real estate and stock market bubbles as having created wealth for their economy; of course not. All the same, the bulls have certainly been able to perpetuate this bubble much longer than we could have imagined. We continue to work diligently to control risk while maintaining exposure to profit from a most overdue and inevitable stock market decline.

-- Drken (Drken@bubble.gone), August 26, 1999

Answers

Link http://www.prudentbear.com/markcomm/markcomm.htm

-- Drken (Drken@bubble.gone), August 26, 1999.

http://www.publicdebt.treas.gov/opd/opdpenny.htm

The Public Debt To the Penny

Current 08/25/1999 $5,648,132,785,383.86

CURRENT MONTH AMOUNT

08/24/1999 $5,646,847,313,983.21 08/23/1999 $5,641,593,878,674.03 08/20/1999 $5,640,549,225,249.30 08/19/1999 $5,640,132,828,484.53 08/18/1999 $5,639,508,512,026.47 08/17/1999 $5,640,094,765,091.67 08/16/1999 $5,635,173,261,192.82 08/13/1999 $5,622,406,564,597.33 08/12/1999 $5,622,361,073,910.13 08/11/1999 $5,618,727,265,574.90 08/10/1999 $5,616,938,195,166.66 08/09/1999 $5,613,956,514,990.77 08/06/1999 $5,615,528,283,134.23 08/05/1999 $5,617,765,258,723.59 08/04/1999 $5,615,253,056,263.06 08/03/1999 $5,613,220,970,175.47 08/02/1999 $5,626,552,692,300.04

PRIOR MONTHS

07/30/1999 $5,638,655,711,931.60 06/30/1999 $5,638,780,248,334.54 05/28/1999 $5,604,198,055,526.11 04/30/1999 $5,585,839,850,171.61 03/31/1999 $5,651,615,289,284.87 02/26/1999 $5,621,945,513,528.00 01/29/1999 $5,610,117,097,678.95 12/31/1998 $5,614,217,021,195.87 11/30/1998 $5,591,979,348,249.72 10/30/1998 $5,559,254,634,398.44 09/30/1998 $5,526,193,008,897.62 08/31/1998 $5,564,553,479,478.04

PRIOR FISCAL YEARS 09/30/1998 $5,526,193,008,897.62 09/30/1997 $5,413,146,011,397.34 09/30/1996 $5,224,810,939,135.73 09/29/1995 $4,973,982,900,709.39 09/30/1994 $4,692,749,910,013.32 09/30/1993 $4,411,488,883,139.38 09/30/1992 $4,064,620,655,521.66 09/30/1991 $3,665,303,351,697.03 09/28/1990 $3,233,313,451,777.25 09/29/1989 $2,857,430,960,187.32 09/30/1988 $2,602,337,712,041.16 09/30/1987 $2,350,276,890,953.00

SOURCE: BUREAU OF THE PUBLIC DEBT

**Enjoy The Orgy While It Lasts**

-- Drken (Drken@bubble.gone), August 26, 1999.

THE 401(k) TIMEBOMB

We are deeply indebted to the folks at the Leuthold Group for pointing out to us a survey that appeared in the late July edition of Pension and Investments Age. For those unfamiliar, P&I is sort of an institutional trade mag for the defined benefit/contribution/401(k) plan sponsor, investment management and custodial crowd. (Believe us, it's a big crowd.) The article contains the results of a Fidelity sponsored survey of 401(k) participants. To us, the results of the survey are enough to make the average "thinking" investor move directly to cash. The following table is a capsulated summary of the results. Take a very deep breath before going any further:

Avg. Avg.401k Equity as% %of Participants Annl. contributions Age Balance of TotalAssets borrowing from as % of plan plan 30 $15,000 89 % 19 % 22 % 45 $54,000 83 % 35 % 40 % 57 $162,000 85 % 32 % 50 %

To us, these responses are nothing short of shocking. They clearly exemplify a "Main Street" 401(k) participant who has taken the current bullish Wall Street bait hook, line and sinker. We hate to sound so melodramatic, but these numbers suggest to us that an absolute panic lies ahead at some point. Of course, talk to any "new age" 401(k) equity investor and they will proclaim strongly that they are in it for the long term...(at least for now).

The Pre-Retirees

As you would imagine, the largest absolute dollar balances reside in the earliest to retirement baby-boomer accounts. Not only is this crowd most driven to build the assets with the working life they have remaining, but also should have had the largest balances at the outset of the rapid bubble growth period some three or four year back and should have been the largest dollar beneficiaries of the equity mania. Despite all of the claims that the currently negative savings rate is misleading because the public is saving in it's 401(k)'s, contributions by this group stand at only 50% of the maximum allowable. The real shocker is that 32% have borrowed from their plans. Now what was that about the strong saving that is happening by the boomers again? Run that by us just one more time.

The clincher for us is that the pre-retirees have 85% of their assets invested in equities. Just imagine what a normal 25-35% bear market would do to these accounts. A normal bear market could easily turn 30% of total asset value into dust. God forbid the market go down and stay down. We have argued for some time that we do not believe the real equity selling will begin until the market is already down 25-35%. If for some strange reason we are correct, we could easily have a down 50%er at some point. Clearly with the most to lose, we have to believe the pre-retiree crowd would simply panic for the door. Would they have any other choice so close to retirement? What makes matters worse is that the very age group with the most to lose also has the most stock to potentially sell. The balance of the average 30 year old is simply peanuts compared to their nearly retired brethren. We have to believe that the largest risk to this wonderful bull are the pre-retirement baby boomer set. Lastly, although we make zero predictions, any lightening of the old equity exposure prior to Y2K would most like come from the near retirement bunch.

The Early and Mid-Lifers

Certainly those in the 20-45 age bracket do have and can afford to adopt a longer term investment horizon. Unfortunately, we strongly believe that this bull market, coupled with the objective media coverage coming from those such as the CNBC "gang", have bred expectations that are simply not realistic. Are the early and mid-lifers prepared for an extended sideways market? Would they ride out a down cyclical bear without emotional reaction? Would they increase contributions to their 401(k)'s to buy more at lower prices? Human nature is tough to gauge. All we can divine is that history has taught us that human nature really never changes. Greed, fear, and panic are indelible components of the human DNA chain. Maybe we are in a new era where all investors fully realize that toughing it out for the long term is the proper course of action. Or maybe not.

Some final comments. Clearly these numbers throw a bit of cold water on the "American's are saving in their 401(k)'s" commentary so blithely spewed forth by Wall Street's best "salesmen/strategists". The level of participants in the 40-60 year old age bracket borrowing from their plans is quite disturbing. To make matters worse, this borrowing is happening in the "best economy in generations". Just what do you think will happen in a cyclical economic downturn? Americans are clearly not maximizing the savings function of the 401(k) vehicle. The best of the annual contribution statistics can't even crack the 50% of maximum allowable number. Just what does this say about the stock market "savings boom"? Lastly, with equity exposure for the entire surveyed group in the mid-80% range, there certainly isn't a lot of existing money left to be allocated to equities as an asset allocation choice in 401(k)'s. As we've remarked too many times in the past, "just who is left to buy?". Since the level of real personal savings in the economy is presently subzero, these 401(k) assets will be critical in any individual's retirement plans. We guarantee that given these statistics of the Fidelity survey, emotions will dictate decision making at some point in time. In fact, we're quite surprised that Fidelity would want these numbers made public. To us, this isn't exactly a strong mutual fund marketing piece. Quite the opposite. http://www.contraryinvestor.com/mo081999.htm

-- Drken (Drken@bubble.gone), August 26, 1999.

Avg. Avg.401k Equity as% %of Participants Annl. contributions Age Balance of Total borrowing from as % of Assets plan plan 30 $15,000 89 % 19 % 22 % 45 $54,000 83 % 35 % 40 % 57 $162,000 85 % 32 % 50 %

**YIKES**

-- Drken (Drken@bubble.gone), August 26, 1999.

Avg. Age Avg. 401(k) Balance Equity as % of Total Assets % of Participants Borrowing from Plan Annl. Contributions as % of Max. 30 $ 15,000 89 % 19 % 22 % 45 $54,000 83 % 35 % 40 % 57 $162,000 85 % 32 % 50 %

Last try go to site if it doesn't work

-- Drken (Drken@bubble.gone), August 26, 1999.

This is shocking information. That there will be a severe retrenchment is not in doubt. How many other market bombs are out there that we know little about?

The debt that is running the economic engine will cause it to seize soon.

-- Mike Lang (webflier@erols.com), August 26, 1999.

Everybody off the boat! This ship is going down!

-- cody (cody@y2ksurvive.com), August 26, 1999.