-Caveat Lector-
>From the NewAustralian
> The New Australian
>
>
> Sputtering euphoria — the
> spectre of overvaluation
>
>
> By *Dr Bob Dobbs
> No. 126, 5-11 July 1999
>
> What passes for news is trite tis true.
> For networks are cosy,
> With outlooks as rosy,
> As those expressed, by brokers and stokers.
> Money men all,
> Wax optimistic, while waving their wand.
> A kaleidoscope of avarice,
> Dances, through dusk and through dawn.
>
> "What good," one may ask, "comes to those who would think?"
> "When doomsters insist we're pushed to the brink?"
> "When all we may need is just a stiff drink?"
> "Al Greenspan is there, to save us our Butts,
> Why dizzy our minds with talk of a rut?"
>
> As boomers and bubbles alike there will mix,
> Concoctions abrew which burble and hiss!
>
> That all the world's a play,
> This much we'll say —
> For those who would doze,
> Their curtain will close.
>
> We are at a crossroads of extreme overvaluation. The present US
> market sentiment is one of sputtering euphoria. Last year alone
> the banking system created over $1 Trillion, an increase of more
> than 50 per cent over the previous year. The invisible tide — a
> receding credit swell, has almost imperceptibly turned in the
> other direction. World trade is sinking deeper into a morass, as
> beef, steel beams and bananas are but the beginning of a nasty
> international trade war, yet another reminder of how much we're
> sliding back into the 30s. The US trade imbalance, headed for
> $300 billion this year, is yet another reminder of how much
> foreign credit has propped up our consumptive binges. On the
> political front, Clinton's popularity train has derailed as the
> Kosovo imbroglio is revealed as cover for his sustained domestic
> policy of "ethical endirtiment."
>
> Investment is a funny animal. Undoubtedly there are sound
> fundamental reasons to choose a particular investment vehicle,
> based on relative risk and reward, which can be judged based on
> business outlook and historical returns. On the other hand, real
> money can be made in recognising when a major imbalance exists,
> as when an investment becomes either extremely hot or cold. To a
> certain extent, there is only one reason to become involved in a
> hot investment - because everyone else seems to be investing in
> it, as reflected in its increasing price. Unfortunately the great
> majority of investors mistake such price behavior as evidence
> that the underlying vehicle has good fundamental value and is
> thus a compelling place for their money. This is probably the
> biggest investment trap of all. Buying into what appears to be a
> successful investment is usually a pitfall.
>
> There is no term in investment theory for this, so I'll dub it
> here: call it the "Illusion of the Rabbit." It is what gives
> direction and a further rationale for the herd instinct, another
> phenomenon in which the investor feels safer, with less perceived
> risk, when investing with the crowd. Herd instinct may well be
> called the "Illusion of the Warm Blanket." Together, this
> virulent duo forms a lethal wallop, because as the Rabbit
> provides an incentive to buy, the Blanket provides the motivation
> to hold what usually is an oversubscribed vehicle. This is
> exactly the very definition of a grand illusion in investing.
> However, by understanding this herd mechanism, one can clearly
> see the historic trends and how one can profit from them.
>
> It is often said by the mainstream brokerage lore, that by owning
> a mutual fund you automatically diversify and that by putting
> your money to work with a competent professional who has time to
> make intelligent stock picks, one may realize the greatest reward
> at the lowest risk. What is overlooked is that these
> professionals, once they have established a successful track
> record, become magnets for the money that is to cause their
> downfall. The hugely successful mutual funds, the Magellans, must
> by necessity invest large sums of money in well-capitalized
> stocks, so as not to disturb the market adversely when trading.
> This necessarily leads to an involuntary institutionalized
> overvaluation. The biggest and most successful mutual funds are
> now as overvalued as the bloated stocks they're forced to buy. In
> effect mutual funds have by their very popularity, become
> investment vehicles for the ignorant masses to pump up the bluest
> of blue chips into the balloonist of overvalued balloons.
>
> Equity markets have, in effect, become mutualized. It's estimated
> that a majority of stock is now held by mutual funds. This is
> higher than the last time institutional ownership was so
> prevalent, not surprisingly in the 1920s, when funds were called
> "Investments Trusts," a name unceremoniously dropped after 1929.
> The long growth spurt in the demand for paper assets has resulted
> in a complacent lot of investors. When history repeats, this
> flock will be fleeced.
>
> Now its time to put your calculus hats on. There is a curious
> characteristic of equities. In the limit as a stock's dividend
> goes to zero, the stock converges to an adult baseball card.
> Business ownership doesn't mean much, since liquidation value is
> almost always next to zilch. The only added kicker is that you're
> able to vote for the All-Star Team once a season. Who can forget
> that dividend yields, averaging 5 per cent over the previous two
> centuries, have recently shrunk to below 1 per cent? That's a
> major league record. The mania in stocks has also proliferated a
> breed of investor who's only in it for the short term, as
> accurately personified by the day trader. These internet
> intrepids are in a Mexican standoff with fingers nervously
> gripping the mouse pad, shooting glances at each other at an ever
> more frenzied pace. Even the average Jose has gotten into the
> action.
>
> It is an old maxim, followed by the saaviest of Contrarian
> investors, that one should buy what everyone is selling and sell
> when everyone wants it. Applying this to today's environment
> should lead one to see why stocks are overvalued and that the
> most attractive opportunities are the ones most overlooked.
>
> Take precious metals, for instance. I can't think of a more
> unpopular investment vehicle — and yet most everyone on the
> street will tell you gold and silver are an anachronism —
> irrelevant in this cashless world, as if gold were no longer a
> haven for financial difficulty or that financial difficulty has
> been legislated away. These are overblown sentiments. In contrast
> to objects like pet rocks, Beanie Babies, or bell bottoms, gold
> and silver are not tied (entirely at least) to ephemeral
> aesthetic trends. They are tied to physics, the search for
> permanence in life, the need for a reliable wealth storage
> medium, and the fundamental relationship between debtor and
> creditor. The popularity of gold over six millennia is due to the
> fact that there is no known substance which shares its unique
> physical attributes of divisibility, scarcity, and permanence. As
> a non-debt based asset, gold is the premier financial
> counterweight to a system built upon promises to make good on
> debt. This includes not only bods and mortgages, but fractional
> reserve, credit in all its forms, and fiat money systems as well.
>
>
> The tools of Wall Street are those that are built upon the
> Efficient Market Hypothesis or EMH, and its frankenchild Modern
> Portfolio Theory, or MPT. Their two key assumptions are that
> markets are liquid and investors are rational, neither of which
> is necessarily true at any given time, or for any given decision
> maker or market. Even Burt Malkiel, through successive editions
> of his popular A Random Walk Down Wall Street, has become
> increasingly disenchanted with accepted models of risk, though he
> accepts the basic tenets of EMH. A thorough debunking of such
> myths as beta was dispensed by David Dreman's excellent books
> including Psychology and the Stock Market and Contrarian
> Investment Strategies: The Next Generation.
>
> Perhaps the longest dagger to pierce the body EMH is the
> existence of an anomaly which can't be explained in its tidy
> universe. This is Warren Buffet himself, a living EMH
> counter-argument. In statistical jargon, he's a "six sigma
> event," or a person with a track record that is so utterly
> improbable that he can't exist in a mere population of 5 billion
> people. Speaking of Buffett, when asked just how expensive US
> companies were at the moment, Mr. Buffett replied: "Too expensive
> for me in virtually all cases." Anyone concerned about
> overvaluation should know that Warren has been a net seller of
> stock and a purchaser of silver last year. I'll play my cards the
> same way as the guy behind the mountain of chips, thank you.
>
> EMH calls into mind another acronym, the "Emergency Medical
> Hologram." True believers will require the good doctor's service
> when their beloved assumptions break down, because he's about the
> only portfolio insurance available.
>
> Myself, I'll opt for preventative medicine — I'll choose
> investments the crowd doesn't want.
>
> *Dr. Bob Dobbs
> [EMAIL PROTECTED]
>
> Bob's Bombshelter Bear Page
> http://www.jps.net/snowyang/MarketSavvy/Contrarian/contrarian.htm
>
> The New Australian
>
>
>
>
>
>
A<>E<>R
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