Comstock Partners, Inc.April 23, 2001
The CEO of Cisco, John Chambers, was questioned regarding why he didn’t foresee the severe slowdown in technology spending and adjust accordingly. He explained that as recently as November Cisco’s orders were growing at a 70% annual clip and then ran into an “unanticipated economic chill”. “I don’t know anybody that can adjust to that”, Mr. Chambers said, “it is like anticipating a 100-year flood”. He was forced to write off $2.5 billion of inventory, but keep in mind that just because the inventory was written off, it did not disappear. Cisco STILL OWNS the inventory that will probably be sold at drastically reduced prices. We don’t believe that Mr. Chambers realized it, but what he failed to anticipate was not a 100-year flood, but a 70-year or so deflation. We have been criticized for using the term deflation (and admittedly were premature in calling for it) because of the fact that it is not a phenomenon that occurs often. In fact, the last significant deflation in the US started over 70 years ago. However, if you look at the latest facts, you have got to at least consider the possibilities of the US approaching a severe deflation. First of all, it is highly unusual for a company that only months ago was the largest corporaton in the world in terms of capitalization ($560 billion), to suddenly see its business come to a screeching halt unless there is something very eerie going on. Cisco is far from unique. Orders throughout the technology arena fell off a cliff sometime in late November to early December, and have continued plunging since that time. The only way that can happen is if capital spending leads an economic boom coinciding with over-leveraged consumers, up to their eyeballs in “stuff”. This also happened in the US in the late 1920’s and Japan in the late 1980’s. Other eerie statistics (1) Corporate earnings as a whole have dropped from positive year-over-year growth rates of over 20% in the first quarter of 2000 to a negative 10% in the first quarter of this year. (2) Corporate layoff announcements of 170,000 per month for the past five months were by far the highest in history. (3) Consumer and Business confidence have dropped sharply. (4) The NAPM declined to the low 40’s, which signals recession. (5) The CRB Raw Material Index just fell to a 15-year low. This index is not influenced by energy, which is holding up the other commodity indicies. (6) The private debt to GDP ratio is at an all-time record of 135% of GDP. This includes corporate and consumer debt and essentially equates to excess capacity for corporations making widgets, with consumers already owning too many widgets (both leveraged). (7) Public ownership of US equities is at an all time high as a stock market bubble is in the process of breaking. (8) $5 trillion of US wealth and $11 trillion worldwide has already been wiped out in the latest stock market decline. The 100-year flood, whether John Chambers knew it or not when he made the statement, equates to deflation. Under these conditions bear markets are much worse than normal and the Fed has little or no control!