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So, in summary, if that damned caveman had not invented fire, and the
wheel was never invented, we'd all be better off!
---
Steven W. Poser, President
Poser Global Market Strategies Inc.
url: http://www.poserglobal.com
email: swp@xxxxxxxxxxxxxxx
Tel: 201-995-0845
Fax: 201-995-0846
----- Original Message -----
From: James Taylor <jptaylor@xxxxxxxxxxxxxxx>
To: <realtraders@xxxxxxxxxxxx>
Sent: Thursday, October 07, 1999 12:55 AM
Subject: Spinning Financial Illusions - The Story of Bubblenomics
> Fraser Management's
> The Contrary Opinion Forum
> (Sept. 29-Oct. 1, 1999)
>
> Spinning Financial Illusions - The Story of
Bubblenomics
> Presented by William A. Fleckenstein
>
> What is a bubble? Webster's New World Dictionary
> defines bubble as:
> - A film of liquid forming a ball around air or
gas.
> - A transparent dome.
> - A plausible scheme that proves worthless.
>
> Unfortunately, what has transpired over the last
five
> years in the financial markets has been a bubble. While the entire
market
> obviously won't
> prove to be worthless, the declines in store for
most
> securities will be tremendous.
>
> I would like to begin today by describing the
various
> factors that collectively have created the financial environment in
which
> we currently find
> ourselves. I shall then demonstrate that this is a
> bubble by comparing today to the late 1920s and offer some thoughts as
to
> the potential
> severity of the aftermath of this bubble. Lastly,
I
> will make a stab at guessing what might pop it.
>
> The seeds of this bubble were sewn way back in
1980
> when Congress passed the Depository Institution Deregulation and
Monetary
> Control
> Act. This law called for the phasing out of
Regulation
> Q, which allowed financial institutions to compete with money market
funds.
> A piece of
> that legislation was financial cancer: raising the
> insured deposit maximum to $100,000.00.
>
> That seemingly innocuous change (thank you,
Fernand St.
> Germain) spawned "brokered deposits," the primary driver of the
reckless
> lending
> practices of the 1980s. Money sought out the
highest
> bidder with no regard as to how it might be used. As a result, we
witnessed
> the funding of
> over-leveraged LBOs and the over-building of real
> estate long after the 1986 Tax Act made it uneconomical to speculate
in
> property. It is hard to
> overstate the significance of this legislation in
> creating the excesses of the 1980s, which set the stage for the even
> greater excesses of the
> 1990s.
>
> It is important to realize that the 1990-1991
recession
> was not precipitated by the Fed. Yes, rates went up, but not enough to
> matter. The
> economic contraction was instead caused by two
factors:
> one, the collapse of credit as banks and the S&L industry were
destroyed by
> these
> bad loans and two, the subsequent new-found zeal
with
> which the office of comptroller of the currency began to do its job.
> Unfortunately
> Greenspan didn't understand what was occurring as
he
> made painfully obvious in January 1990 when he stated, "But such
imbalances
> and
> dislocations as we see in the economy today
probably do
> not suggest anything anymore than a temporary hesitation in the
continued
> expansion of the economy."
>
> However, once he finally understood what was
happening,
> he got busy; ultimately cutting interest rates 24 times in a row, to 3
> percent, which of
> course drove the public (who was only just
beginning to
> focus on its retirement needs) out of CDs and money markets, and into
> stocks and
> bonds. It is ironic that the enormous reckless
frenzy
> of the 1980s, which nearly ruined the banking system, did little
apparent
> damage, and
> instead spawned a great bull market, and
ultimately an
> even greater bubble.
>
> The collapse of Communism helped precipitate this
> stunning transformation as it set off a mad dash for capitalism around
the
> globe, creating
> the first post-Cold War economic boom. The boom
> eventually forced the Fed to begin raising interest rates, thereby
causing
> the implosion of the
> carry trade, Orange County, Mexico, etc. Of
course, by
> then the deregulated banking system had discovered rocket scientists
with
> computers
> and had begun loading itself up with derivatives.
The
> combination of the Mexican peso collapse and the unwinding carry trade
> posed a grave
> threat to Wall Street and the banks, so Greenspan
and
> Rubin bailed them out.
>
> In doing so, they didn't just spike the punch
bowl,
> they put LSD in it. It triggered a new round of speculation both
> domestically and globally that
> finally began to unwind in the summer of 1997 when
the
> bubbles in southeast Asia burst, beginning with Thailand.
>
> Naturally, the central bankers attempted bailouts,
once
> again trying to postpone the ill effects of too many years of
speculation.
> However, with
> so many countries collapsing at once the Fed (&
Co.)
> could not prevent calamity from hitting those countries. Yet they did
> succeed in adding
> more fuel to the stock market frenzy raging here
in
> America.
>
> The default by Russia one year ago caused a chain
> reaction that culminated with another implosion, that of Long Term
Capital,
> the most recent
> episode in this long series of Fed bailouts. The
real
> reason for the LTCM bailout appears to have been the stock market, not
the
> bond market as
> was professed. "We were most concerned about the
equity
> book" Jon Corsine, Goldman Sachs CEO, told Businessweek. "The whole
potential
> scenario of unwinding their equity portfolio under
a
> forced environment could have had extremely negative consequences on
the
> [overall] market"
> was how David Komansky, Merrill Lynch's CEO,
described
> the situation.
>
> This is why the Fed tried to get ahead of curve in
a
> panicked attempt to change market psychology by, dare we say, market
> manipulation.
> Manipulation may be too strong a term, but what
else
> can you call it when rates are cut 25 basis points with only 45
minutes
> remaining in the
> trading day in which all index options and options
on
> futures are due to stop trading? In what is surely the biggest move in
> history, the S&P
> Futures exploded 4.9 percent in 4 minutes. The
chaos
> created by this surprise rate cut caused a systems outage at the CBOE,
> forcing it to
> halt trading and hold a closing rotation for index
> options for the first time ever.
>
> How was the Fed able to print money and create
credit
> in unlimited quantities to manufacture this bubble? The absence of CPI
> inflation! Having
> learned nothing from the '20s or Tokyo either, the
Fed
> and nearly everyone believes that nothing can be wrong if there is no
CPI
> inflation. Yet it
> is only in a period of low inflation that the
monetary
> spigots can stay open long enough to foment a bubble. Once created,
the
> damage has
> been done and good policy options don't exist. You
are
> then in the bubble-management business. (After 50 shots of tequila you
will
> feel
> crummy tomorrow no matter what you do.)
>
> We have created over-capacity and precipitated
massive
> speculation just as we did in the '20s. Inflation has been held in
check
> not by prudent
> monetary policy but by a unique combination of
events.
> In addition to the post-Cold War boom and NAFTA, the enormous
productivity
> gains
> achieved by the massive invasion of powerful
> microprocessors into our lives conspired to keep CPI inflation in
check,
> just as innovations such
> as autos, planes and fractional-horsepower
electric
> motors suppressed inflation in the 1920s. Instead of CPI inflation we
have
> created asset
> inflation in the form of the largest stock-market
> bubble of all time.
>
> Starting with Mexico in late 1994 (when we crossed
over
> from bull market to mania ) I believe these bailouts have, in essence,
> socialized risk
> and are the principal reasons why the public feels
that
> they cannot lose money in the stock market (over time). We have all
seen
> the same
> surveys that show people expect compound returns
from
> equities varying between high teens and 30 percent.
>
> In addition to the Fed, there are other catalysts
that
> have precipitated the current craze. First, demographics have fostered
a
> "need to believe"
> on the part of the public, and Wall Street has
been
> happy to supply the rationalization and schemes with which to do so.
>
> Second, there is technology. It is easy to see why
> technology is such a financial aphrodisiac. Life without television,
fax
> machines or cellular
> phones would be far less enjoyable, and life
without
> Prozac would be a boring life at "book value." Yet nothing heretofore
has
> so seemingly
> demystified and so dramatically altered the
investing
> landscape the way the PC has. It has simultaneously empowered the
masses to
> believe
> that they are in complete control and has deluded
them
> into confusing information with knowledge. Most know the price of
> everything and the
> value of nothing.
>
> Third, television (and here I mean CNBC
primarily -
> a.k.a. Bubblevision) has helped seduce the public into an
overconfident
> state bordering on
> arrogance. Folks are now certain that they possess
the
> know-how and have earned the right to be rich.
>
> Lastly, corporate America itself, the object of
all
> this speculation, has helped its own cause. Not so much through
earnings,
> but through the
> creative expression of those earnings. The rascals
in
> charge have enthusiastically and nearly unanimously elevated
accounting
> into pure art via
> one-time charges, merger-related write-offs,
> forward-looking statements about the improvement in business "since
the end
> of the quarter" and,
> of course, stock options with their attendant
absurd
> tax treatment. To show how acceptable outright fraud has become,
Walter
> Forbes and
> "windbag" Al Dunlap are free and very rich men to
this
> day.
>
> Having said all that about corporate America, it
is not
> clear to me whether it actually has had a part in creating the
euphoria or
> whether the
> euphoria has simply allowed it to occur.
Collectively
> these factors have convinced today's speculators that the only real
risk
> associated with
> equities is in not owning them.
>
> The total disregard for valuation, precedent and
risk
> that today's "new era" mentality has engendered should terrify anyone
with an
> understanding of the financial past. The
denouement of
> this tragi-comedy is certain even if the timing is unknown.
>
> Presently, only the GDP of the entire world at $25
> trillion overshadows the $14-15 trillion capitalization of the U. S.
stock
> market. At 160
> percent of our huge $8.8-trillion GDP, the ratio
of
> market capitalization to GDP is over 60 percent higher than it was in
1929,
> the previous
> all-time high. We are light years from the 70-year
> average of 50 percent and from the low of 33 percent seen in 1974 and
1982.
>
> In the last two and a half years, the stock market
> capitalization has increased over $5 trillion dollars, a gain equal to
60
> percent of America's
> current GDP. Unfortunately, earnings of the
underlying
> companies have not been responsible for this surge. Since the end of
1996,
> the S&P 500
> has rallied 75 percent, but S&P earnings have
grown
> only about 6 percent.
>
> Everyone has his favorite story of extremes these
days.
> For instance, the six biggest tech stocks (Microsoft, Intel, IBM,
Cisco,
> Lucent and Dell)
> are now valued at $1.65 trillion or 20 percent of
GDP.
> Microsoft alone is valued at $500 billion, making it larger than the
entire
> junk-bond market!
>
> My personal favorite anecdote illuminating today's
> hysteria is Internet Capital Group. It is an Internet venture capital
fund
> valued at
> approximately $12 billion (that has only one
public
> holding worth about $400 million). In a recent interview, a big-time
Wall
> Street analyst
> justified the current valuation by explaining that
> recent venture capital returns have been 30-fold. If all of ICGE
> investments and the cash received
> from the IPO were valued at 30 times, he said, the
> stock would be worth about what it was selling for, but that meant you
> would be getting
> management for free! Consequently, he liked it. It
has
> rallied over 30 percent since the interview.
>
> However, it is not the specific examples that are
the
> primary concern. The risk is that the environment that has led to
these
> individual excesses
> has produced a total market capitalization so out
of
> proportion with the underlying businesses, it has altered the economy
of
> the world.
>
> Former Fed Chairman Paul Volcker recently summed
up the
> situation quite succinctly when he said, "The fate of the world
economy is now
> totally dependent on the stock market, whose
growth is
> dependent on about 50 stocks, half of which have never reported any
> earnings." I urge
> you to think about that statement. It is the
reason why
> any responsible person should be aware of these facts.
>
> The numbers are so gargantuan and so completely
beyond
> our range of experience that they have lost their ability to produce a
> visceral impact.
> For instance, we all know that light travels at
186,000
> miles per second, yet how many can grasp how fast that is? We know
that
> computers
> can add numbers in a fraction of a nanosecond (one
> billionth of a second, which is how long it takes light to travel one
> foot), but who can
> appreciate that? However, if we observe that the
> relationship between one nanosecond and one second is the same as one
> second and 33
> years, we can begin to appreciate how magically
fast
> light moves and computers work. We are able to do this because we have
> experience
> dealing with seconds and years.
>
> In that same vein, I believe the best way to put
the
> current mania in its proper perspective, is not to compare facts and
> figures but to examine
> qualitative descriptions from our mania of the
late
> 1920s. New-era believers today roll their eyes at the mere suggestion
of
> this analogy, yet
> most have no knowledge of what actually took place
in
> those days. (Steve Forbes, for example, says there was no bubble. Fed
> tightening
> caused all the problems.) What follows are
excerpts
> from several books that illustrate how nearly identical the behavior
of
> today's stock market
> participants is to that of 70 years ago. I will be
> editorializing some of these passages to make the obvious even more
so.
>
> In short, the late '20s bubble was caused by poor
> policy decisions, resulting in excess credit creation, which led to a
> bubble. "Modern Times"
> best describes in brief why policies were pursued,
what
> resulted and the consequences:
>
> "The aim was to avoid trouble and escape the need
to
> resolve painful political dilemmas. [The Fed policies since Mexico's
> implosion in 1994.]
> The policy appeared to be succeeding. In the
second
> half of the decade, the cheap credit the Strong-Norman policy pumped
into
> the world
> economy perked up trade... So the notion of
deliberate
> controlled growth within a framework of price stability had been
turned
> into reality. This
> was genuine economic management at last! The
American
> experiment [Greenspan experiment] in stabilization from 1922 to 1928
showed
> that
> early treatment could check a tendency either to
> inflation or to depression...The American experiment was a great
advance
> upon the practice of
> the nineteenth century.
>
> "Yet in fact the inflation was there, and growing,
all
> the time [same as now]. What no one seems to have appreciated is the
> significance of the
> phenomenal growth of productivity in the U.S.
between
> 1919 and 1929: output per worker in manufacturing industry rising by
43
> percent. This
> was made possible by a staggering increase in
capital
> investment, which rose by an average annual rate of 6.4 percent a
year. The
> productivity
> increase should have been reflected in lower
prices.
> The extent to which it was not reflected the degree of inflation
produced
> by economic
> management with the object of stabilization.
>
> "It is true that if prices had not been managed,
wages
> would have fallen too. But the drop in prices must have been steeper;
and
> therefore real
> wages - purchasing power - would have increased
> steadily, pari passu with productivity. The workers would have been
able to
> enjoy more of the
> goods their improved performance was turning out
of the
> factories. As it was, working-class families found it a struggle to
keep up
> with the new
> prosperity. They could afford cars - just. But it
was
> an effort to renew them. The Twenties boom was based essentially on
the
> car. [PCs
> anyone?]
>
> "As the boom continued, and prices failed to fall,
it
> became harder for the consumer to keep the boom going. Strong's last
push,
> in fact, did
> little to help the 'real' economy. It fed
speculation.
> Very little of the new credit went through to the mass-consumer.
Strong's
> coup de whiskey
> benefited almost solely the non-wage earners: the
last
> phase of the boom was largely speculative. [Three rate cuts in the
fall of
> '98.] Until 1928
> stock-exchange prices had merely kept pace with
actual
> industry performance. From the beginning of 1928 the element of
unreality,
> of fantasy
> indeed, began to grow. As Bagehot put it, 'All
people
> are most credulous when they are most happy.'
>
> "Two new and sinister elements emerged: a vast
increase
> in margin trading [online/day trading] and a rash of hastily
cobbled-together
> investment trusts [Internet stocks]. By 1929 some
> stocks were selling at fifty times earnings. [How about well in excess
of
> 50 times revenues
> today?] As one expert put it, the market was
> 'discounting not merely the future but the hereafter.' A market boom
based
> on capital gains is
> merely a form of pyramid selling.
>
> "The new investment trusts, which by the end of
1928
> were emerging at the rate of one a day [several internet IPOs per day
now],
> were
> archetypal inverted pyramids. They were supposed
to
> enable the 'little man' to 'get a piece of the action.' [Again, online
> trading.] In fact, they
> merely provided an additional superstructure of
almost
> pure speculation, and the 'high leverage' worked in reverse once the
market
> broke.
> [Futures, options and OTC derivatives today]
>
> "It is astonishing that, once margin trading and
> investment trusting took over, the Federal bankers failed to raise
interest
> rates and persisted in
> cheap money. But many of the bankers had lost
their
> sense of reality by the beginning of 1929. [William McDonough,
president of
> the New
> York Fed, recently embraced the new era stating,
"It's
> likely the American productivity boom will continue. I'm very
confident
> about the future
> trend of the American economy. The forces that
have
> allowed us to do so well are likely to continue."]
>
> "The 1929 crash exposed in addition the naivete
and
> ignorance of bankers, businessmen, Wall Street experts and academic
> economists high
> and low; it showed they did not understand the
system
> they had been so confidently manipulating. They had tried to
substitute
> their own
> well-meaning policies for what Adam Smith called
'the
> invisible hand' of the market, and they had wrought disaster. Far from
> demonstrating, as
> Keynes and his school later argued (at the time
Keynes
> failed to predict either the crash or the extent and duration of the
> Depression) the
> dangers of a self-regulating economy, the
degringolade
> indicated the opposite: the risks of ill-informed meddling." [This is
my
> basic reason for
> continually harping about the Fed.]
>
> The "New Era of Investing" chapter of Ben Graham's
book
> Security Analysis, written in 1934, describes the late 1920s
investment
> climate. "A
> new conception was given central importance - that
of
> trend earnings. If an attempt were to be made to give a mathematical
> expression to the
> underlying idea of valuation, it might be said
that it
> was based on the derivative of the earnings, stated in terms of time.
> [Momentum Investing -
> an oxymoron if ever there was one.]
>
> "Along with this idea as to what constituted the
basis
> for common-stock selection, there emerged a companion theory that
common
> stocks
> represented the most profitable and therefore the
most
> desirable media for long-term investment.
>
> "These statements sound innocent and plausible.
Yet
> they concealed two theoretical weaknesses which could and did result
in
> untold mischief.
> The first of these defects was that they abolished
the
> fundamental distinctions between investment and speculation. The
second was
> that they
> ignored the price of a stock in determining
whether it
> was a desirable purchase. A moment's thought will show that "new-era
> investment", as
> practiced by the trusts, was almost identical with
> speculation as popularly defined in pre-boom days... It would not be
> inaccurate to state that
> new-era investment was simply old-style
speculation
> confined to common stocks with a satisfactory trend of earnings.
[Sound
> familiar?] The
> impressive new concept underlying the greatest
> stock-market boom in history appears to be no more than a thinly
disguised
> version of the old
> cynical epigram: 'Investment is successful
speculation'.
>
> "The notion that the desirability of a common
stock was
> entirely independent of its price seems incredibly absurd. Yet the
new-era
> theory led
> directly to this thesis. Instead of judging the
market
> price by established standards of value, the new era based its
standards of
> value upon the
> market price. Hence all upper limits disappeared,
not
> only upon the price at which a stock could sell, but even upon the
price at
> which it would
> deserve to sell." [I'm raising my price target to
$300.]
>
> "An alluring corollary of this principle was that
> making money in the stock market was now the easiest thing in the
world. It
> was only necessary
> to buy "good" stocks, regardless of price, and
then to
> let nature take her upward course..." [How many times have you heard
> something like
> this repeated in the last month?]
>
> >From the book 1929 by William Klingaman, the
following
> captures the mood of that period:
>
> "The boom had become a full-fledged stampede.
Several
> years later, Otto Kahn looked back toward the early days of September
1929 and
> concluded that the speculative movement had gained
so
> much momentum by that time that nothing short of a crash could have
brought
> it under
> control. The American public, Kahn testified, was
> 'determined to speculate. They were determined that every piece of
paper
> would be worth
> tomorrow twice what it was today. I do not believe
the
> whole banking community could have prevented it...When it had taken
full
> sway of the
> people and there was an absolute runaway feeling
> throughout the country, I doubt whether anyone could have stopped it
before
> calamity
> overtook us.' [Just like now - slowly.]
>
> "To liberal journalist Gilbert Seldes, the final
days
> before the crash were the true time of panic. 'I call it panic to be
afraid
> to sell at a profit, lest
> additional profit be lost,' Seldes wrote. 'The
panic
> which keeps people at roulette tables, the insidious propaganda
against
> quitting a winner, the
> fear of being taunted by those who held on, all
worked
> together. [Today's motto: Never sell good stocks.] It became not only
a
> point of pride, but
> a civic duty, not to sell, as if there were ever a
> buyer without a seller.'
>
> "Although the Wall Street Journal [CNBC], the
chief
> journalistic promoter of the boom, maintained its traditionally
optimistic
> front, the editors of
> Business Week [The Economist] charged
unequivocally
> that 'stock prices are generally out of line with safe earnings
> expectations, and the
> market is now almost wholly 'psychological' -
> irregular, unsteady and properly apprehensive of the inevitable
> readjustment that draws near.'
>
> "In fact, only 388 of the nearly 1,200 issues
listed on
> the New York Stock Exchange had advanced between January 2nd and
September
> 3rd [of
> 1929], while more than 600 stocks already showed
> substantial declines from their highest point of the past few years.
'This
> has been a highly
> selective market,' observed the Cleveland Trust
> Company's resident market guru, Colonel Leonard P. Ayres. 'It has made
new
> high records for
> volume of trading, and most of the stock averages
have
> moved up during considerable periods of time with a rapidity never
before
> equaled.
> Nevertheless the majority of the issues had been
> drifting down for a long time...In a real sense there has been under
way
> during most of this
> year a sort of creeping bear market.' [Exactly,
today's
> market action.]
>
> Roger Babson [the spiritual grandfather of Marc
Faber,
> Jim Grant and me] prophesized the coming debacle (as he often had
before) in
> September 1929 as follows: "Fair weather cannot
always
> continue. The economic cycle is in progress today, as it was in the
past.
> The Federal
> Reserve System has put the banks in a strong
position,
> but it has not changed human nature. More people are borrowing and
> speculating today
> than ever in our history. [These days even student
> loans are used for speculation.] Sooner or later a crash is coming and
it
> may be terrific.
>
> " 'Things have never been better,' Charlie
Mitchell
> [William McDonough] told reporters on the evening of Friday, September
> 20... Mitchell
> cheerfully advised investors to 'be a bull on
America'.
> 'Money is all right' he assured everyone. 'There's nothing to worry
about
> in the financial
> situation in the United States'." [And everybody
knows
> what happened one month later.]
>
> The best analysis of the economic and monetary
policy
> of the 1920s comes from a book entitled Economics and the Public
Welfare
> 1914-1946
> written by Benjamin M. Anderson. From 1920-1937,
he
> wrote the Chase Economic Bulletin and was the bank's chief economist.
He was a
> contemporary critic of the monetary authorities,
as he
> understood at the time that the policies being pursued were reckless
and
> would lead to
> disaster. Since the book was not published until
1948,
> he had 20 years to reflect on that period. This is his opinion: "Those
who
> see history
> only from the outside easily convince themselves
that
> impersonal social forces are overwhelming and that individual men in
> strategic places
> make little difference. But this is not true. The
> handling of Federal Reserve policy by Strong and Crissinger in the
years
> 1924-1927 led to
> ghastly consequences from which we have not yet
> recovered. Competent and courageous men occupying their positions
would
> have avoided
> mistakes which these men made."
>
> Three years of irresponsible monetary policy set
off a
> chain reaction of trouble that lasted nearly two decades. Today Tokyo
is
> still floundering
> nine years after its bubble burst. Regrettably,
future
> historians are unlikely to describe the current Fed as either
competent or
> courageous.
> While rare, bubbles are not trivial - they are the
> financial equivalent of a nuclear holocaust.
>
> Which brings us to the critical question. Should
we
> expect the fallout from this bubble to be more or less severe than the
> 1930s here and the
> 1990s in Japan?
>
> First let us acknowledge that every time is
different
> and that much of the damage to occur post bubbles is a result of bad
> decisions made
> during the aftermath. Also complicating any
assessment
> of the facts is the "unknown" factor. By that I mean dangerous
practices
> that are
> occurring now during the bubble that will only
come to
> light later.
>
> Those who say the fallout should be manageable
believe
> our situation is not comparable to Japan. In hindsight, they say that
Japan
> was a
> corrupt, over-leveraged command economy that had
> forgotten about rates of return and obsessed instead with market
share. In
> addition, the
> Japanese bubble was primarily a real estate bubble
that
> the bureaucrats there have proved particularly inept at solving.
>
> They will argue that the 1920s are a poor analogy
> because our economy is now far less cyclical than it was then, that we
have
> huge financial
> shock absorbers in place and most importantly an
> enlightened, nay omniscient Fed, all of which make an economic debacle
> unlikely.
>
> There is a fair amount of truth in all of these
claims
> (along with some revisionist history) but the zeal with which that
view is
> believed has caused
> us to dramatically push the envelope from a
"balance
> sheet" perspective.
>
> Let's compare a few data points, recognizing that
the
> old data may not be as accurate as today's. In 1929, government debt
stood
> at 17 percent
> of GDP versus 63 percent today. Total debt is
nearly
> 260 percent of GDP versus 200 percent then. It is true that in 1929
broker
> loans were
> nearly 30 percent of GDP, while today margin debt
is
> only 2 percent of GDP; however, consumer installment loans plus
mortgage
> debt stands
> at nearly 70 percent of GDP. In addition, the
national
> value of derivatives held by the banking system is $40 trillion,
nearly
> five times GDP, and
> we have absolutely no idea how they might behave
if the
> financial world were to function differently prospectively than it has
in
> the last decade.
>
> Further complicating matters, we currently run a
trade
> deficit that is about 3 percent of GDP versus a unilateral surplus 70
years
> ago, and we
> have a negative savings rate, both of which place
our
> currency at a far greater risk than it ever was then, potentially
> complicating the Fed's
> future rescue efforts.
>
> Lastly, on top of this leverage, the value of
equities
> to GDP now stands 160-200 percent (depending on which measure of total
> market cap you
> use) compared to roughly 100 percent in 1929. In
short,
> valuations are 60-100 percent higher at the same time debt is 30
percent
> higher while
> we are being financed thanks to the kindness of
> strangers (foreigners).
>
> You can easily see that those who believe that
previous
> periods of trouble have no relevance have acted accordingly, thereby
> "raising the bar"
> for the "shock absorbers" and the Fed.
Unfortunately
> there are no road maps for the future, but we can be guided by
precedent.
> The fallout from
> this bubble may be ameliorated for the reasons the
> new-era apostles cite. The economic dislocations will probably not be
as
> gruesome as the
> 1930s and might not even be as difficult as the
Japan
> of the 1990s. However, given the facts I think it is safe to conclude
that
> it will be plenty
> bad enough and will be far worse than most have
imagined.
>
> So, what could end this bubble? Everyone knows the
> obvious choices and I won't elaborate on them. Likewise, I obviously
can't
> elaborate on an
> unknowable shock. However, I believe that the
bubble
> could burst if people lose confidence or faith in the technology
stocks
> that have carried
> the bull market. I don't think the market can go
down
> for real unless, and until, the bull market in technology stocks ends.
>
> What could derail technology stocks and bring them
back
> to reality? In short, corporate America and the year 2000, dubbed
"nuclear
> winter" by
> my good friend Fred Hickey, the world's best tech
> analyst. (For those of you who haven't heard the term used in this
context,
> it refers to the fact
> that corporate America has purchased all the
hardware
> and software it needs to be ready for the year 2000. Consequently
order
> rates are in the
> process of collapsing and will stay that way for
quite
> some time).
>
> uoting Fred, "Tech stocks have been on a gigantic
tear
> based upon the perception that end-user demand for computer technology
> products is
> strong. They believe that surging PC demand is
behind
> the pickup in semiconductor sales. While they do not know it yet, they
are
> wrong! In
> fact, the second-half "nuclear winter" slowdown in
> computer sales anticipated by market researchers for two years is
hitting
> with full force.
> Unfortunately, Wall Street is too blinded by greed
to
> notice it. Just as it has never noticed a shift in spending in the
past."
>
> Here, some recent history will explain the
previous
> statement. In 1995, almost all analysts and investors believed that
widespread
> semiconductor shortages and surging prices were a
sign
> of huge Windows 95-related pent-up demand for computer products and
> peripherals.
> Unfortunately, Windows 95 was a disappointment
relative
> to expectations leading to a sizeable tech stock decline that lasted
until
> the middle of
> 1996. In fact, 1995's worldwide semiconductor
sales of
> $150 billion is a peak that has yet to be surpassed.
>
> More illuminating still is the fact that there's
been
> no revenue growth worldwide in the PC industry in the last 21/2 years.
> Amazingly, despite the
> favorable impact of the Y2K upgrade cycle, unit
growth
> has not been strong enough to offset ASP declines. Yet hope springs
eternal
> as every
> year for four years running Wall Street has
believed
> that the year's first-half PC debacle has had no relation to the one
the
> year before. The
> analysts have been incapable of connecting the
dots
> each time, as they appear unable to grasp that the problem is
horsepower
> saturation and
> excess capacity.
>
> Last fall there was another channel stuff,
primarily by
> Compaq. Weaker-than-expected PC demand in the first half of 1999
finally
> exposed this
> long-running charade and led to the ouster from
the
> company of Eckhard Pfeiffer and Earl (the pearl) Mason, two of the
> industry's biggest
> fibbers.
>
> The weight of the industry's problems caused
> market-darling Intel to miss revenue estimates in both the first and
second
> quarters by $400
> million. AMD corroborated this weakness as they
> couldn't find a home for almost 2.3 million processors.Yet shortly
after
> Intel reported its
> results in mid-July, for no apparent reason DRAM
prices
> began rising substantially. Strange happenings were occurring in the
> disk-drive market
> too. All of a sudden, there were shortages in the
> popular 4 and 6 gig drives, and prices firmed. Semiconductor and PC
related
> stocks celebrated
> these events by embarking on the (recently ended)
> enormous rally, which saw Intel, for example, spring from 50 to 90.
>
> What happened to create all this euphoria? Three
> things. First, the perennial belief in a strong second half for PC
sales
> that I have described.
> Second, a brief surge in retail PC demand in June
and
> July precipitated by the introduction of subsidized (so-called "free")
PCs.
> Last, the fear of
> potential Y2K production disruptions outside of
the
> United States lead to a fear-driven Y2K inventory build complete with
> double and triple
> ordering.
>
> Human nature is such that the fear of shortages
always
> leads to over-ordering and hoarding, as we've seen many times in the
past
> in the
> semi-conductor (and other) industries. In the
perfectly
> perverse fashion of markets, just as the free-for-all in component
buying
> and stock
> ramping was reaching a speculative frenzy, nuclear
> winter sneaked in like the proverbial thief in the night.
>
> While Wall Street focused on the fact that vendors
at
> the back of the food chain were ordering parts and building hardware
like
> there was no
> tomorrow, the folks on the front line, trying to
sell
> products to corporate America, were hitting a wall.
>
> The top three computer distributors with combined
> revenues of $50 billion (in a world that buys $150 billion of PCs
annually)
> led by Ingram
> Micro, the largest with $24 billion in revenues,
> divulged that results were disappointing. Privately, certain companies
are
> advising that
> computer-spending lock-downs are in place. This
should
> come as no surprise; after all, it takes time to stabilize and
integrate
> software and
> hardware. If you expect it all to be tested and
running
> smoothly by Jan. 1, 2000, you can't wait until the fourth quarter to
> install it - that's too
> late.
>
> Systems integration and sub-assembly companies
have
> also disclosed a fall-off in business while Oracle just reported
> year-over-year revenue
> growth of just 12 percent, its worst in 30
quarters.
> This is an especially powerful indictment since they are direct
> beneficiaries of all the new
> Internet start-ups.
>
> Recent body English by IBM, Hewlett Packard and
Intel
> tend to corroborate the view that business is worsening by the week, a
> trend that will
> only accelerate. Soon reports of additional
problems
> should be flying fast and furious. There is little chance that Dell,
Intel
> and IBM, to name
> three of the five biggest tech stocks, can make
their
> fourth quarter estimates, and that is just the tip of the iceberg.
>
> At some point, the cumulative damage should be
> sufficient to crack the misplaced confidence that investors have in
these
> dramatically
> overpriced businesses which, by the way, have
lower
> barriers to entry and are more commodity-like than most care to admit.
When
> that light
> bulb goes off and the stampede for the exit
ensues, it
> will be a debacle in which many stocks will fall over 50 percent.
>
> Mainly, tech stocks are priced as they are not
because
> investors have studied the businesses and judiciously bought them, but
because
> people have piled into them due to momentum and
blind
> faith. Everyone wants to own what is going up, not what is priced
> attractively.
> Consequently, we have created a dramatic
disconnect
> between both expectations and valuations versus reality that can only
be
> rectified by a
> huge downward adjustment in the price of these
stocks.
> To quote Steve Ballmer, "there's such an overvaluation of tech stocks,
it's
> absurd."
>
> I should mention that it is not just PC-related
and
> semiconductor stocks that are at risk. Networking companies have
benefited
> from Y2K
> remediation efforts as well, and they could be
> susceptible to a falloff in demand. Ultimately the stock market itself
via
> its ability to float Internet
> companies has helped create demand for networking
and
> telecommunications products. If the companies that currently have
problems
> indirectly shut the IPO window, more companies
will
> experience weakness prospectively.
>
> In summary, technology-stock bulls have placed an
> over-trillion-dollar bet that demand will stay strong when it is more
> likely that we will
> encounter not just our now-typical,
> weaker-than-expected second half, but a true collapse in orders. Never
> since the mania leg of this bull
> market began in 1995 have so many factors been
aligned
> so perfectly to pull the rug from under the feet of technology
investors.
> Nuclear winter
> may just be the catalyst to end the mania.
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