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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
- Veröffentlichungsjahr: 2014
Released to the public for the first time, writings by the incomparable Barton Biggs
Long considered one of the best brains on Wall Street, Barton Biggs acquired the stature of a legend within his lifetime. Among his many coups, he accurately called the rise and fall of the dot-com market, and was an energetic promoter of emerging markets, including China, well before American businesses began flocking there—and he made vast fortunes for his clients, in the process.
But, as this fascinating book confirms, it wasn't Biggs's genius as a market analyst and hedge fund manager alone that made him special. The product of a keen and broad-ranging intellect in full command of his subjects—and the English language—the letters compiled in this volume leave no doubt that Barton Biggs was one of the most interesting observers of Wall Street, the financial world, and the human comedy, ever to set pen to paper.
- Released from Morgan Stanley's archives and made public for the first time, the letters compiled in this volume add new luster to Biggs's reputation as a first-class finance author
- Address the most essential aspects of high-frequency trading, from formulation of ideas to performance evaluation
- Shares Biggs's fascinating insights and uncannily accurate predictions about an array of economic and financial topics, liberally peppered with historical references and wry humor
- Organized thematically, the letters showcase Barton Biggs's observations on finance, economics and the stock market, from 1980 to 2003
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Contents
Acknowledgments
Introduction
Section 1: What’s Old Is New Again
Section 1A: Market History and the Long View
In Search of History and a Word Processor That Works
Kondratieff and the Long Cycle
The Phony War
Ancient History
History, Market Deaths, and the Cult of the Equity
Section 1B: Fire and Ice
The Fire and Ice Debate
Ice Creeps On
A World Lit Only by Fire?
Section 1C: Bubbles and Panics
Manias, Panics, Crashes
Tulipomania
Anarchy
Life on the Good Ship Swine
The New New Thing
When?
Section 1D: Wars and Rumors of War
The Last Supper
The Beam That Broke the Camel’s Back
Bioterrorism and the Case for Higher P/E Ratios?
Section 1E: Geopolitics
Popcorn and the Decline of the West
Diary of Mikhail S. Gorbachev—Sunday, May 4, 1986
Close-Up
Diary of Mikhail Gorbachev, May 1987
The Diary of Deng Xiaoping: Wistful and Wishful Musings
Bottomless Pits and Nuts with Missiles
Diary of Saddam Hussein
Islamic Fundamentalism
Section 2: Economics and Investing
Section 2A: Economics and Policy
The Evolution of the Supply Side
The Tax Cut Misconception
Running the Movie of the Seventies Backward
The Piper Must Still Be Paid
The Old President with the Right Intuitions
What Kind of People Are We?
Emerging Markets Are Only for the Brave
Section 2B: Investment Discipline & Tactics
Discipline and Reading
How to Lose the Winner’s Game
You Gotta Believe
Section 2C: Market Psychology and Investing Philosophy
Contrarianism
Electronic War Rooms and Lying in the Sun
God Is a Mathematician? The Fibonacci Numbers
Beware of Linear Thinkers: Chaos on the Upside
How George Soros Makes Money: The Theory He Says Guides Him
The Horse Whisperers
Mr. Market Is a Manic-Depressive
Section 2D: Alternative Investments
Filthy Lucre
The Bull Market in Art: Mania or Magnificent Obsession?
Jewelry Is a Girl’s Best Friend
Section 2E: Market Predictions
First Class on the Titanic
“It’s a Bull Market, You Know . . .”
Beware the Conventional Wisdom . . .
Dear Diary: Up with Which I Have to Put
Praise the Lord and Pass the Ammunition
“Even Monkeys Fall from Trees”
Big Fish Do Not Live in Small Ponds
Section 3: The Global View
Section 3A: China and Hong Kong
Buy Hong Kong
Own Hong Kong Big
More on China
China: “The New Emperors” and the Risk/Reward Equation
How Fast Is China Really Growing?
China Tales
A China Traveler’s Tales
China Cooling, Us Heating
Section 3B: India
India Tilts to the Right and the Stock Market Explodes
India for the 1990s
Great Expectations
India: You Have to Go There to Understand
Section 3C: Japan
More on Japan
Long Trips
Japan Inc. Wants a Higher Yen
Japan Bought High and Will Sell Low
Section 3D: Europe, Middle East, Africa
In the Eye of the Storm
You Gotta Own Some Germany
Militant Fundamentalism Spoils the Middle East Story
Section 3E: Latin America
South America for the Nineties
No More Siestas
Argentina: The Magic Show
Buy Mexico and Brazil
Case Study: Peru
Mexico Will Make It
Mexico: Virtuous or Vicious Circle?
Brazil: An Act of Faith
Section 3F: East Asia
The Best-Managed Country in the World
Korea: Fat Premiums, Thin Pickings
Camelot
Letter from Myanmar
Victory Has a Thousand Fathers
Section 3G: Emerging Markets Roundup
A Bigger, Faster World
Jewel in the Portfolio
Section 4: Characters and Culture
Section 4A: Lunches with Luminaries
Investment Alchemy
Lunch with the Global Investor
Vanity Fair
Heroine Worship
Poker Games on the Titanic and Sir John
Section 4B: Jim the Trigger
The Summer of 83
The Trigger Comes Back for Lunch
U3 or “Many Shall Be Restored That Are Now Fallen and . . .”
The Trigger Finds an Arb
The Trigger Comes to Lunch
Investment Life Its Own Self
A Country of His Own
Talking Technology with Jim the Trigger
Section 5: Travelogues
Africa
The Idaho High Country
Making a New High on Your Own Time
Stretching the Mid-Life Envelope
Japanese Landscapes
The Snows of Kilimanjaro
Pitfalls in Tokyo, Sand Traps in Colorado
Section 6: Books and Letters
Section 6A: Book Reviews
“Groupthink” and What to Do about It
Captain Money and the Golden Girl Ponzi
The Alchemy of Finance
I Wish We Didn’t Have to Play for George Steinbrenner
Noise and Babble
Section 6B: Biggs’s Reading List
Too Much to Read
“Books, We Know, Are a Substantial World . . .”
End User License Agreement
List of Illustrations
Figure 1 Real Interest Rates Are Brutal
Figure 2 Classic Decline in World Consumer Prices (Year-over-Year Monthly Percent Change)
Figure 3 The Ebbing of Wage Inflation Looks Secular (Year-over-Year Monthly Percent Change)
Figure 4 Inflation and Long-Term Interest Rates
Figure 5 A Secular Reversal in Total Government Employment (Millions)
Figure 6 The Lines Cross
Figure 7 The Savings Rate Has Plummeted
Figure 8 Debt Levels Still High
Figure 9 Standard & Poor’s 500 Price/Earnings Ratio
Figure 10 Replacement Cost Book Value and the Stock Market
Figure 11 Real Earnings and the Stock Market
Figure 12 Dividend Discount Model Price/Value Ratio and the Stock Market
Figure 13 Capitalization and Relative Value (Equally Weighted Averages)
Figure 14 Quality Rating and Relative Value (Equally Weighted Averages)
Figure 15 Market Leadership Groups
Figure 16 Single-Family Homes Sold
List of Exhibits
Exhibit 1 Nifty 50 versus Un-Nifty 450
Exhibit 2 Un-Nifty 450 Relative to Nifty 50
Exhibit 3 Forward Yield Gaps for S&P 500 and S&P Nontech
Exhibit 4 Value Relative to Growth: Relative Trailing P/E Ratios—United States and Europe
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Guide
Cover
Table of Contents
Begin Reading
BIGGS on FINANCE, ECONOMICS, and the STOCK MARKET
Barton’s Market Chronicles from the Morgan Stanley Years
BARTON BIGGS
Cover image: ©iStockphoto.com/nicoolay & ©iStockphoto.com/Ursula Alter
Cover design: Wiley
Copyright © 2014 by Barton Biggs. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
Library of Congress Cataloging-in-Publication Data:
ISBN 978-1-118-5723-06 (Hardcover)
ISBN 978-1-118-6546-68 (ePDF)
ISBN 978-1-118-6548-66 (ePub)
Acknowledgments
The proceeds from this book will benefit the Morgan Stanley Foundation’s Global Alliance for Children’s Health—a more than 40-year effort to give children the healthy start they need for consistent and meaningful achievement in life. Morgan Stanley would like to thank the many colleagues who volunteered their time and expertise to bring this book to life, especially Aine Abruscati, Lauren Bellmare, Laurence Bromberg, D’Arcy Carr, Richard Cunniff, Michele Davis, Joachim Fels, Michael Gallary, Brian Goldman, Karl Gunner, Vlad Jenkins, Wesley McDade, Andrew McCann, Joseph Aloysius McVeigh, Sandra Noonan, Adam Parker, Stephen Penwell, Joan Steinberg, and James Wiggins. And special thanks to Frederic Miller, Barton’s original editor, who had the foresight to keep paper copies of thousands of essays dating back to the early 1970s.
INTRODUCTION
The untimely passing of Barton Biggs in 2012 created a void for many who never wanted to imagine a world devoid of his uniquely illuminating voice. It was a loss widely felt, and we were inundated with requests for old essays. Seekers would rarely recall dates or titles but would easily refer to a phrase like “the one where he is overfed and maximum bullish.” Our team would happily search through the (mostly paper) archives, losing themselves in the guilty pleasure of reading Barton’s lucid and often prescient prose of one of Wall Street’s truly wise men.
Biggs was a world apart from the cacophony of 21st century infotainment pundits of the twenty-first century; now shouting at us via every medium. The commentaries in this collection span the roughly two decades between 1980–2000 that corresponded with a great bull market in stocks. It was a market that made people rich on paper through their IRAs and 401(k)s; it also broke their hearts. This was a cycle that Barton knew well. He understood that knowledge of human psychology and philosophy was more essential than any quantitative numbers crunching to truly insightful analysis. He was fond of personifying “Mr. Market” as an ingenious sadist or a manic-depressive. Like a therapist, Biggs sought to understand and accept his seemingly irrational companion instead of futilely attempting to change or control him. Along the way, he helped us discover that “the market” is really a mirror into the self and ultimately a foil that could lead to great personal growth beyond mere monetary gain for those courageous enough to do the work.
Biggs was the product of a superb education and insatiable intellectual curiosity that he cultivated throughout his life. His interests were wide-ranging and he read vociferously. He once, in a single paragraph, inventoried some 27 newspapers, periodicals, and commentaries that he consumed on a regular basis. This erudition contributed to a vivid and often beautiful prose style. He would enlighten his readers with a quote from the philosopher John Locke to illustrate the importance of informed judgment in successful investing, and draw upon verses from the poets W.H. Auden to elucidate equity markets psychology, or W.B. Yeats to describe the panic of 1987: “The blood dimmed tide is loosed.” Instead of single-mindedly studying charts and quantitative models, Biggs suggested keeping an investment diary and examining our own biases and temperament. “Know thyself and know thy foibles. Study the history of your emotions and your actions,” he would write.
This was a man who devoured life. Whether climbing Kilimanjaro, raging against the corrupting economics of college football, or studying the global impacts of government policy, Biggs felt that hard work and discipline were the qualities that mattered. He cheekily poked fun at the idea-of-the-month club with his satirical characters, including Jim the Trigger and his (fictional) Plumber. And his predictions were notable in both their prescience and transcendent views.
In the early 1980s Biggs correctly believed the end of inflation was at hand which would lead to a mighty economic boom. All the while his contemporaries decried the end of the American economy itself. In 1989, he called the Japanese market downturn even as market observers-and broad popular culture-accepted Japan’s future of world economic dominance as a foregone conclusion.
Biggs was also a keen student of bubbles and panics, dissecting the historical underpinnings and discovering their commonalities. “It is fascinating,” he wrote, “to be reminded of how little human nature has changed and how the pattern of events repeats itself over and over.” He called the “dot-bust” in 1997—a couple of years early perhaps but right on the mark in terms of magnitude and impact. “The most dangerous phrase in the investment business,” he wrote, “is ‘this time it’s different’.” At heart, Biggs believed in fundamental intrinsic value-both personally and professionally. He believed equally in the value of a contrarian stance in a world where “hordes of investors routinely plunge together off the cliff of financial destruction.”
Reading through his work, it is remarkable how far ahead of the moment his mind operated. Biggs was one of the first true global strategists during a time when prevailing thought was locked in a binary us-versus-them world model dominated by the US-USSR Cold War standoff. He identified global flashpoints like Afghanistan and the growing threat of radical Islam decades before 9/11. In 1989 he wrote about the “Greening of Portfolios” and the coming trend toward environmental activism. In that same year, he predicted the skyrocketing costs of healthcare and a broken system we’re struggling with today.
He was also a driving force behind the creation of “Emerging Markets” as an asset class. He had his own “boots on the ground” in countries like Kuwait, Singapore, Thailand, India, Brazil, and Argentina before most Wall Streeters could find them on a map.
In some sense, Biggs may have been too far ahead of his time. When taking the long view, inevitable macro-trends can play out over decades despite wild market gyrations over minutes and seconds. Or in the famous words attributed to John Maynard Keynes: “The markets can remain irrational far longer than you or I can remain solvent.” All of which makes a compendium of Biggs’ forward thinking that much more compelling today now that the world has had a chance to catch up.
James P. Gorman
Chairman and CEOMorgan Stanley
“We forget that Mr. Market is an ingenious sadist, and that he delights in torturing us in different ways.”
– Barton Biggs
With the passing of our friend and colleague
Barton Biggs, the world seems a
little less colorful, insightful and eloquent.
He will be missed.
Morgan Stanley
© 2012 Morgan Stanley & Co. LLC. Member SIPC.
Section 1WHAT’S OLD IS NEW AGAIN
Back across the ages, bear markets follow bulls as famine follows feast, and 3,000 years ago Joseph proved that anticipation of the inflection point can make tremendous difference in your life-style.
—Barton Biggs, April 1, 1996
Reading through over two decades of Barton’s chronicles, it’s hard to argue with one of his favorite adages, “history doesn’t repeat itself, but it rhymes.” Biggs believed that a deep and thorough understanding of the past was important—nay, absolutely necessary—to preparing for the future. Like a symphony orchestra, the music may change and evolve, but ultimately the players behind the instruments remain the same. “The present always seems different from the past, but human nature doesn’t change, and the patterns of fear and greed repeat.”
Biggs was fascinated with the mechanics of bubbles and panics and devoted numerous weekly missives to the topic. He read narrative accounts of past market crashes and assembled lists of dozens of “stock market breaks and deaths” from around the world—most unknown to the U.S. investor—which convinced him that the boom-bust cycle was not a rare occurrence, but an integral aspect of the market. Manias and panics are simply a phenomenon to be expected, understood, and planned for like any naturally occurring and ultimately unstoppable event such as a hurricane. Or as Biggs would say more succinctly, “As long as there are markets and people, there will be panics, manias, and crashes, and the more you know about them, the better your chances of not getting killed in one.”
He also believed strongly in the reversion to the mean. While extremes do exist in nature, conditions moderate back to the normal over time, just as sunshine follows rain. “The course of events in markets really don’t change much from century to century, because the two great constants in the stock market are human emotion and prices. Patterns tend to repeat themselves.”
If there was ever an investor living at the polar opposite of today’s high-speed, black-box trader, it was Barton Biggs. Biggs didn’t just study markets over weeks, months, and years. He launched himself into geosynchronous orbit to view economic cycles on the scale of decades and centuries. He concluded that despite the ups and downs, stocks were the place to be in the long run. “History supports the cult of the equity, providing you can hang on through the air pockets,” albeit with a tempering caveat: “They really do generate the real returns, but not the double-digit ones some people now anticipate.”
Fundamentally, history is the study of past human actions. Whether the scene is the trading floor, battlefield, or political podium, Biggs saw commonalities. He studied the full gamut of history and came to his own startlingly prescient conclusions for our future.
For one, Biggs foresaw Islamic extremism as a long-term market risk years before 9/11 brought the concept front and center in the mindshare of America. He saw a future with “random acts of terrorism” that would someday “degenerate into a real shooting war.”
He was also a voice of reason among doomsayers amid skyrocketing oil prices during an existential standoff between Eastern Communism and Western Democracy. While heavyweight pundits decried the decline of the West, Biggs dismissed the catastrophization as nonsense, not because of wishful thinking or pathological denial, but because of the astute observation that events throughout history do not happen in a vacuum. Actions beget reactions, and human beings have a remarkable ability to adapt and cope—often in unexpected ways. As Biggs noted, quoting Barbara Tuchman, “You cannot extrapolate any series in which the human element intrudes; history, that is, the human narrative, never follows, and will always fool, the scientific curve.”
Some of his most captivating and unique work came in the form of diary entries, where Biggs provided readers a hypothetical inside glimpse of the innermost thoughts of world leaders and despots in the midst of historic events like Tiananmen Square and the fall of the Berlin Wall. The creative approach serves as a memorial to the Cold War–era mind-set, along with the unknown consequences of our current involvement in Iraq and Afghanistan.
While Biggs’s occasional articles with a historical bent are hardly a comprehensive treatment of world events, an investor could do worse. Together, the pieces constitute a powerful foundation for understanding the long view of a true financial luminary through three decades of dramatic change and tectonic world shifts.
Section 1B:Fire and Ice
The Fire and Ice Debate
April 3, 1997
Fire: You Ice guys, with your bet on low inflation and falling interest rates, will be lucky if you get a light frost. The latest batch of economic statistics shows the U.S. economy is heating up, wage gains are accelerating, the European economies are improving, and even Japan is doing better.
Ice: The Ice case was never based on economic growth slowing. We think inflation will stay low because at the margin, there is an oversupply of low-cost labor, manufacturing, and services capacity in the world. In the new global economy, there is competition almost everywhere, putting pressure on prices and wages. In the United States, financial services, health care, hospitals, retail, and fast food all have excess capacity. As result, in a relatively strong economic environment, many companies in very different businesses are reporting loss of pricing power. Obviously, this is a broad generality, and there are important exceptions. The price of gold continues to drift lower, and commodity prices are flat to down. We think that when the next recession comes, there will be even more downward pressure on prices, and for a time the CPI may actually be negative.
F: You are missing the point. There has been disinflation, but it is ending. Haven’t you guys ever heard of the Phillips Curve? In a modern industrialized economy, there is a point (in the United States, it is 2.2 percent) above which faster growth always generates higher inflation, particularly wage inflation. This is the history of the last 30 years. It’s a proven fact. Now the world is on the verge of a synchronized economic expansion that will lead to overheating, rising wages, more inflation, and higher interest rates, which will sink stock markets.
I: First, we doubt the synchronized growth surge. Sure, Europe is improving, but Japan is stumbling, the rest of Asia is struggling, and in the United States the expansion is long in the tooth, debt growth is slowing, and credit stress, particularly in the consumer sector, is rising. Even if the world economies stay healthy, there should be no serious overheating. Admittedly, industrial commodity prices will rise cyclically, but we don’t see wage rates rising much. The industrialization and urbanization of the developing countries is resulting in huge numbers of people who are willing to work harder for less money. Second, the concept of an inflationary flash point is not a law of nature like gravity. It is a recent development, but the world changes, and economies change. Are you guys just econometric historians?
F: Recall that “He who does not remember the past is condemned to repeat it.” Our econometric models forecast the future based on what has happened rather than your fanciful theories. Besides, even if growth does not generate inflation, governments will because they need to get reelected. Democracies, particularly weak coalition ones, are inherently inflationary. Politicians used to say, “tax and tax, spend and spend, elect and elect.” Now they have dropped the tax part, and it’s just spend and elect. This creates an inflationary bias in the system.
I: It is myth that the world has an inflationary bias and that growth is always accompanied by inflation. Peter Bernstein recently pointed out that inflation is only a recent phenomenon in America, and the Economist has shown that until World War II the price level in England was stable for several centuries. In the United States and Europe, the nineteenth century was a time of rapid growth and rising nominal and real wages, yet it was a deflationary century. For example, in the United States the price index fell from 140 in 1800 to 91 in 1900. Of course, there were bouts of inflation after the Civil War here and the Napoleonic Wars in Europe, but they were only episodes. As for the politicians, the voters now understand that inflation doesn’t solve problems, it just masks them for a while and in the long run causes higher interest rates, more unemployment, and stagnation. The old scams don’t work as well anymore, and the politicians have to respond to the voters. Furthermore, the huge spending on technology further reduces costs.
F: Nevertheless, despite years of prosperity, all the industrial countries are running large public-sector deficits; they have huge amounts of debt and unfunded social security and pension liabilities that are far bigger than their economies. The only politically palatable solution to these problems is for governments to depreciate their currencies.
I: The unfunded pension liabilities are a serious problem and in the longer run may result in some inflation. But in the meantime, for one reason or another, countries are stumbling toward fiscal balance. In the United States, debt growth is slowing, the deficit is falling, and there is surprising support for balancing the budget. Also, revising the CPI calculation for Social Security payments—although sidetracked for the time being—has bipartisan backing. In Europe, the EMU treaty as it reads will compel at least some fiscal discipline. In the long run, nobody knows if it will last, but over the next couple of years, it will be a force for austerity.
F: What about Japan? Although it’s had a deflationary episode, Japan’s budget deficit is the biggest of any major country as percent of GDP, unfunded pension liabilities are 150 percent of GDP, and there is a huge bad loan problem. The Japanese have no rational recourse but to try to inflate their way out.
I: We agree. Japan should be the exception, as inflation may be an important solution to its problems. However, instead of following stimulative monetary and fiscal policies, the Japanese are doing the opposite, particularly on the fiscal side with tax increases and spending reductions. They seem obsessed with the fear of becoming the “Italy of Asia.” If by temporizing they allow their banking crisis to get out of control, bank failures with all their secondary effects will be very deflationary.
Incidentally, we believe that what happened in Japan between 1990 and today is a fair model for what happens when a stock market bubble infects an economy. As stocks and real estate collapsed, the economy was severely affected, and there were periodic episodes of deflation. Mutual funds suffered very heavy redemptions. Bonds, however, were superb, with the 10-year rate falling from 8 percent to 2.2 percent, but it is fascinating that falling interest rates did not revive the stock market. A less extreme but still very unpleasant version of this liquidity trap scenario could happen in the United States.
F: You guys keep babbling about pricing power diminishing, but as the world economy continues to grow, shortages will develop, and prices will rise as they always have.
I: Maybe, but there is an oversupply of so many things, from fast-food restaurants to sneakers, TV sets, and electronic chips, which means competition and price cutting. There is also an oversupply of labor. As people in the developing world move from farms to cities, they join the industrial labor force. When a poor country becomes richer and moves up the wage scale, manufacturing capacity migrates to another country with lower labor costs. If the first country uses its new wealth to educate its labor force, it can begin to compete on more sophisticated products. In the industrial countries, the bull markets in stocks have resulted indirectly in capital spending booms that have meant more capacity and more competition.
F: Nevertheless, faster growth will mean higher wage costs because workers still want more money, and as shortages of labor develop, they will be able to get it. Do you realize that new unemployment claims as a percentage of total employment are at the lowest level since 1969, and wages in February rose 4 percent year-over-year?
I: So wages are rising 4 percent. Productivity is improving at 1.5 to 2 percent, so unit labor costs are increasing 2 to 2.5 percent. Let’s say wage increases escalate to 5 percent, so unit labor costs rise at over 3 percent; so what? This is hardly a terrifying inflation threat at the top of the cycle. However, we doubt it will come to that, since many workers are in industries that have foreign competition or are employed by companies that can build products, process credit cards, or write software someplace else in the world, so they have little bargaining power. Globalization is basically disinflationary, maybe even deflationary in bad times.
F: We think the world is still in an inflationary cycle, and as economic growth accelerates, so will inflation. The Fed and other central banks will raise interest rates again and again. Bond prices will fall, and the 30-year Treasury rate should reach 8.0–8.5 percent. As a result, we are bearish on stocks, not because of earnings but because multiples will decline as bond yields go up. You can’t fight the Fed.
I: By contrast, we think there is more than a 50 percent chance that the United States and the world are entering a new cycle of generally stable price levels, with cyclical swings up into low inflation and probably shorter cyclical swings down into low deflation. In the short run, over the next couple of years, the world’s economic system will have to adapt itself to this change, and it will be painful for profits. Much slower top-line growth will wreak havoc on companies that are leveraged both operationally and financially. Besides, corporate profits, particularly in the United States, have been overstated by accounting artifices such as awarding options in lieu of cash compensation, nonrecurring charges, and one-time restructuring benefits. As interest rates decline in the United States, for a while stocks will do well because everyone is conditioned to believe lower interest rates mean higher stock prices. Then, as profit margins are squeezed by higher wages and no pricing power, profits will prove very disappointing, and there will be a bear market.
F: How do you square this thesis with the fact that the greatest watchdog of inflation, the Bundesbank, is now a wimp because it is so worried about unemployment in Germany? The Bundesbank is intentionally depreciating the strongest, best currency in the world, the mark, to export the Federal Republic’s deflation and unemployment to the United States. As countries have problems, the tendency in a linked world economy is to depreciate your currency, improve your terms of trade, and export your deflation. Competitive devaluations are inflationary. If the EMU fails, this will exacerbate this trend.
I: Look, we concede there is a chance we are wrong about the secular trend toward low inflation. However, we do feel fairly confident that the cyclical trend is for “freezing rain” at least, and we will just have to see what happens over the longer term. As Keynes said, in the long run, we are all dead. The risk/reward ratio on U.S bonds is incredibly favorable, everyone is light bonds and record-heavy stocks, and real interest rates are very high. High-quality, not low-grade, bonds are where the value is.
F: It’s obvious the Federal Reserve, Alan Greenspan, and the bond market agree with us and not you.
I: Central bankers, like generals, are admirable and get a lot of honorary degrees, but they are always preparing to fight the last war instead of the next one.
Ice Creeps On
August 18, 1997
I still believe the Ice scenario is playing out, and as a result, the present uncertainty and volatility in the stock market is not about the direction of interest rates but about Ice and slush and its heavy effect on earnings.
Whether the decline last week was just a brief correction or the beginning of something more serious will depend on what happens in the next few weeks. If the weakness continues, I expect there to be heavy carnage in some of the emerging markets like Russia, Hong Kong, and Mexico that are still up on stilts.
Many people seem unconcerned about equity prices falling much further because, as they point out, a bear market has never begun with interest rates stable or falling. It is as though they believe it was ordained by God that stocks and bonds are forever linked and perfectly correlated.
I say: Beware the conditioned response because it could be wrong this time. Yes, stocks and bonds have been correlated in the United States for almost 40 years, but it is also true that over the long run, the coefficient of correlation between stocks and bonds is only 0.2, in other words, mildly positive. Furthermore, when inflation is around zero, history shows stocks and bonds have had an inverse relationship. In Japan recently, a secular bear market in stocks began just as the greatest bull market in bonds was commencing because the country was going from inflation to deflation.
As I have discussed previously, the evidence is quite conclusive that above some innocuous level of inflation, probably around 1.5 percent, stock and bond prices are closely correlated. It makes sense because in a world plagued by inflation, the primary fear of investors is not of recession and falling earnings but of rising prices and wages and higher interest rates. In this environment, which has prevailed in most of the world since the early l960s, good news is bad news. Strong economic news is bad for both bonds and stocks. Investors want a Goldilocks economy.
Section 1C:Bubbles and Panics
Manias, Panics, Crashes
November 30, 1981
Not that I think we are going to have a panic or a crash again soon, but human nature being what it is, one certitude is that we will have both again in our investment lifetimes. Fortune favors the prepared mind, as they say, so it’s worthwhile to study the anatomy of financial distress at leisure rather than in the eye of the storm. The definitive work on this subject, Manias, Panics, and Crashes, was published in 1978 by the well-regarded economic historian, Charles P. Kindleberger, and is now available in paperback from Palgrave Macmillan. Another good study of American crashes is Panic on Wall Street by Robert Sobel.
Walter Bagehot, first editor of The Economist, described the explosive combination of people and money as well as anyone in his essay on Edward Gibbon when he said:
Much has been written about panics and manias, much more than with the most outstretched intellect we are able to follow or conceive; but one thing is certain, that at particular times a great deal of stupid people have a great deal of stupid money. . . . At intervals, from causes which are not to the present purpose, the money of these people—the blind capital, as we call it, of the country—is particularly large and craving; it seeks for someone to devour it, and there is a “plethora”; it finds someone, and there is “speculation”; it is devoured, and there is “panic.”
Kindleberger’s book is full of the fascinating details of manias, panics, and crashes, but it is a serious analytical work and not meant to entertain as is Charles Mackay’s epic Extraordinary Popular Delusions and the Madness of Crowds. Kindleberger emphasizes the important role of the fallacy of composition (in which the whole differs from the sum of its parts) in inflaming mob psychology. In other words, each individual is acting rationally when, for example, he sells his stocks, or would be, were it not for the fact that others are doing the same thing. Each participant, by rationally trying to save himself, contributes to the ruin of all. Related to this is the so-called cobweb effect in which demand and supply are not linked simultaneously, as in an auction market that clears at each moment of time, but instead are connected with a lag. A destabilizing exogenous shock occurs that radically alters expectations, but otherwise-rational expectations fail to take into account the effect of similar responses by others. In other words, buying a scarce commodity in response to a shortage is rational on an individual basis but excessive when many do the same. The participant in financial markets must understand and compensate for cobwebs and for the “chain letter” aspect of successful investing. We are buying stocks, not companies, which is a crucial distinction.
Kindleberger relates how the history of manias and panics is full of cases of rational men who sensed an engulfing madness, sold out, and then were sucked back in and ruined by the speculative atmosphere. The great Master of the Mint and epitome of the rational scientist, Isaac Newton, said in the spring of 1720 in the midst of the South Sea Company bubble: “I can calculate the motions of the heavenly bodies but not the madness of people” and sold his shares in the South Sea Company at a solid 100 percent profit. But as the stock continued to climb, infectious speculative enthusiasm overcame him, he rebought, and was wiped out in the crash. Apparently, so bitter was his loss that for the rest of his life he could never bear to hear the name “South Sea.”
It is also fascinating to be reminded of how little human nature has changed and how the pattern of events repeats itself over and over. The objects of speculation change from cycle to cycle, but greed and fear are always there. In previous centuries, successful speculators bought country houses during the latter stages of bull markets, just as they did in the 1960s and 1970s. Anyone with a memory and discipline who reads and thinks about the chronology of events and the signs of forthcoming trouble that Kindleberger lays out has no excuse for getting caught in the next wave of euphoria.
Kindleberger makes the case that, to have a really significant crisis, two or more objects of speculation have to be in play—a bad harvest coming at a time of a railroad mania, for example, or an orgy of land speculation. The two markets are usually interconnected by excessive money creation, and in the case of truly serious panics, almost invariably they tend to become international, either running parallel from country to country or spreading from the centers where they originate to other countries.
In another interesting section, Kindleberger argues the historical case that when circumstances change—in his words “a displacement event” occurs—the investor must sell immediately. It may seem to be rational and resolute to hang on and not panic in the hope of some improvement, but it usually is the wrong thing to do. Kindleberger cites a whole series of past events where individuals and institutions, from Jay Cooke & Company to the Hamburg banks, were ruined by hanging in there. In other words, if you’re riding an irrational, speculative animal, at the first change of direction, get off fast.
Kindleberger also cautions that a common failing of many intelligent people is to have a rational model in mind, but the wrong one. He calls this “Maginot Line psychology.” “When man’s vision is fixed on one thing,” said Ponzi, “he might as well be blind.” A good point because it happens to all of us from time to time.
Kindleberger also makes the argument that speculative manias gather speed through expansion of money and credit or even get started because of an excessive expansion of money and credit. He states that throughout history, the market, in its ingenuity, has created new forms of money in periods of boom to get around the currency regulations of the authorities. Certainly, we have seen this in the last few years. This subject leads Kindleberger into a rather tiresome couple of chapters on the need for a lender of last resort. He also describes the many methods that the promoters and authorities have used in an attempt to avert disaster once a panic has begun. Frankly, the discussion seemed rather useless to me as no strategy does anything more than delay the inevitable, which is all the more reason to sell quickly at the first sign of serious trouble.
As long as there are markets and people, there will be panics, manias, and crashes, and the more you know about them, the better your chances are of not getting killed in one.
Tulipomania
November 18, 1982
The news last week of tumbling prices in the Hong Kong real estate market and the collapse during the last few months of the over-the-counter Kuwait stock market reminds me again how human nature never changes. Over the centuries and despite different cultures, excessive speculation is invariably followed by panic and collapse. In this regard, the most incredible episode of all occurred over 300 years ago when “tulipomania” engulfed the normally stolid, conservative Dutch nation. My understanding of this strange mania is based on Tulipomania by Wilfrid Blunt, onetime art master at Eton College; Charles Mackay’s epic Extraordinary Popular Delusions and the Madness of Crowds; and the novel The Black Tulip by Alexandre Dumas.
Tulips—so named, it is said, from the Turkish word signifying turban—were introduced into Western Europe from Turkey around 1550. The tulip becomes most beautiful when intensively cultivated and bred. But the more exquisite it becomes, the weaker and more fragile it grows, so that only with great skill and most careful handling can it be cultivated. By the seventeenth century, tulips had become the fashion of the wealthy, especially in Germany and Holland. Prizes of increasingly large sums of money were given at competitions for the most beautiful bulbs. The winning bulbs could then be sold for cross breeding.
By 1630 the Dutch people in particular were becoming obsessed with the growing and trading of tulips. Amateur growers began to bid up the price of certain species that were especially popular or that had the potential of winning prizes, and by 1634 an adjunct to the Amsterdam stock exchange had been set up for the trading of tulips. The rage to own tulips became such that “persons were known to invest a fortune of 100,000 florins in the purchase of forty roots.” Soon, everyone who had a few square yards of back garden was growing bulbs, and at first all were winners as the price of bulbs kept rising. Stories of common people cultivating rare bulbs and suddenly becoming rich abounded, and working men began to quit their jobs in order to have more time to grow and trade tulips.
As the new wealth swelled the money supply, the price of everything else began to rise also. In addition, money from England and other parts of Europe poured into Holland, and the Dutch imagined the passion for tulips would last forever and that the wealthy from every part of the world would buy Dutch tulips because they were uniquely beautiful. In the early days of the mania, sales took place between the end of June, when the bulbs were taken out of the ground, and September, when they were replanted. But, as the fever increased, trading continued all year with delivery promised for the summer. As Wilfrid Blunt describes it:
Thus a speculator often offered and paid large sums for a root which he never received, and never wished to receive. Another sold roots which he never possessed or delivered. Oft did a nobleman purchase of a chimney-sweep tulips to the amount of two-thousand florins, and sell them at the same time to a farmer; and neither the nobleman, chimney-sweep or farmer had roots in their possession, or wished to possess them. Before the tulip season was over, more roots were sold and purchased, bespoke and promised to be delivered, than in all probability were to be found in the gardens of Holland.
The height of tulipomania was between 1634 and 1637. The price of prime bulbs soared to the present equivalent of $100,000. As the mania expanded, the fabric of society began to unravel. Farmers sold their livestock to raise capital to speculate in tulips, and houses and estates were mortgaged. No man’s garden was safe from thieves, and in The Black Tulip there are tales of greed and depravity as the passions of the people became inflamed. Some growers only cultivated secret plots at night so rivals would not know of their stock. Visitors to Holland were astounded, and MacKay recounts the story of an ignorant English sailor off a visiting ship in Rotterdam happening to eat a tulip bulb from a garden, thinking it was an onion. Its owner turned out a lynch mob, and the sailor was committed to debtors’ prison for 10 years. The craze spread to France and England by 1635, but most of the trading activity and wild speculation was centered in Holland.
In 1636 various coolheaded people warned of impending disaster and tried to restore the country’s balance. One Evard Forstius, Professor of Botany at Leyden, could not see a tulip without attacking it with his walking stick. Eventually because of his antitulip harangues and attacks, he was judged criminally insane and committed to the dungeons at Loewstein where Dumas’s hero languished. Other notables cautioned of the consequences, but were mocked and derided.
The operations of the tulip trade became so intense and intricate that it was found necessary to create an entire infrastructure of notaries, clerks, and dealers. Tulip exchanges were established in many towns across the country. Normal trade and manufacture were neglected, and except for tulips, Dutch exports declined. But as long as prices stayed high, it didn’t matter, and in fact the Dutch people had never been so prosperous.
But the false prosperity couldn’t last, even though prices swept higher throughout 1635 and 1636. Suddenly, early in the spring of 1637 the crash came. Neither Mackay, Blunt, nor Dumas describes any trigger event that suddenly disrupted the psychology of the market. At first only a few people wanted to sell in order to convert their tulip holdings into other forms of wealth. No one wanted to buy. Prices declined 25 percent, and more sellers entered the market. In vain the dealers and exchanges resorted to such devices as mock auctions to build confidence, and new larger prizes were announced in the hope they would restore prices. Nothing worked, and suddenly prices really collapsed as sellers panicked. The value of prime bulbs such as Semper Augustus, General Bol, and Admiral van Hoorn fell in a few weeks from 6,000 florins to 400 or 500 florins as it dawned on people that what they owned was bulbs and not real assets. As MacKay describes it:
Hundreds who a few months previously had begun to doubt that there was such a thing as poverty in the land suddenly found themselves the possessors of a few bulbs which nobody would buy, even though they offered them at one quarter of the sums they had paid for them. The cry of distress sounded everywhere, and each man accused his neighbour. The few who had contrived to enrich themselves hid their wealth from the knowledge of their fellow citizens, and invested it in the English or other funds. Many who for a brief season had emerged from the humbler walks of life were cast back into their original obscurity. Substantial merchants were reduced almost to beggary, and many a representative of a noble line saw the fortunes of his house ruined beyond redemption.
Eventually, there were so many lawsuits filed that the courts could not handle them, and in April of 1637 the Court of Holland intervened in an effort to stabilize the social situation of the country. However, the court’s complicated rulings were to no avail, and the sharp contraction of the wealth and money supply of the country caused a depression that lasted for some years. However, in spite of the carnage, the Dutch have retained a great partiality for tulips.
Anarchy
On or about October 23, 1987
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed; and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
—William Butler Yeats
Of all the words babbled about last week, Louis Rukeyser quoting Adlai Stevenson put it best on Friday night: “I’m too old to cry but it hurts too much to laugh.” The world financial system, shaken by the blood-dimmed tide and the anarchy of the markets, will hold together, will prevail. Many now say that it won’t, but to bet against it, you have to assume an unlikely convergence of bad luck and mismanagement. The system has great resilience, and everyone, except for the short sellers, will be working very hard to maintain it. It’s not 1929 nor is it 1927. It’s 1987, which will have its own profile.
I am almost but not quite amused by the avalanche of venom and doom poured on the Reagan administration, stocks, supply-side economics, and Wall Street in general by professors, the liberal press, and a lot of people who should know better. “Close down the casino and string up the money changers.” I read today that after last week another Republican president and the August high in the Dow will not be seen for 20 years. The total demise of the New York condominium and Greenwich real estate markets is gleefully anticipated, and all the vicious MBA yuppies and the fat cats with their Porsches will disappear into a pool of distilled greed. The politics and dialectic of envy are overwhelming. However, although there will be distress, I doubt Wall Street will be transformed into a wasteland.
Last week, we had a real, honest-to-goodness, old-time financial panic. A panic is really psychological in nature, and, as I count it, this is the ninth in American history. The best book on the subject is Panic on Wall Street by Robert Sobel.
Each panic has to be different from its predecessors—otherwise it wouldn’t be terrifying—but each has the same general psychological background and characteristics. Last week’s panic had all the usual ingredients of optimism, speculation, leverage, greed, and stupidity being transformed into fear, uncertainty, and despair, but it was the biggest, most intense financial panic of all time.
History shows that panics do not necessarily lead to recessions. The stock market’s bark is worse than its economic bite. Recession or depression did not follow the panics of 1869, 1901, 1914, or 1962, and even the 1929 crash did not cause the Great Depression. Every post–World War II recession except that in 1980 has been preceded by a falling stock market, according to Geoffrey Moore of the Center for International Business Cycle Research. He points out, however, that numerous other market declines were not followed by recessions. The stock market has predicted eight out of the past five recessions. It’s still very early to guess, but my hunch is that although there may be some weakness in consumer spending this winter, the combination of lower interest rates and surging liquidity will offset the negative wealth and confidence effects of the panic, and 1988 will be a year of moderate economic growth. Unless the governments bungle things, a depression is not in the cards.
So far, the governments and central banks are doing a fair job of counteracting the panic. Walter Bagehot, who lived through several English panics, said: “The best palliative to a panic is a confidence in the adequate amount of the bank reserve and in the efficient use of that reserve.” I know that Alan Greenspan believes that also, but the central banks must provide liquidity. A U.S. budget compromise is essential also, and time is running out.
The history of panics also shows that sometimes their stock market impact fades quickly, as in the Northern Pacific Corner panic of 1901 and the panic of 1792, while on other occasions the aftereffects lingered for years. My feeling is that because of the severity of the damage and the shock of seeing blue-chip stocks fall 35 percent in a week, the effects of this panic will be with us for a long time. For example, the specialist system, the derivative markets, and program trading may be materially changed.
Also, equities have been discredited and proven to be much more volatile than anyone thought. A higher risk premium will be demanded. My guess is that fiduciaries will want lower equity ratios for years to come. Bonds and probably income-producing properties that are not quoted will have enhanced appeal. The structure of the money management business is bound to be affected. Clients don’t like round trips.
Are we still in a secular bull market, or are we now in a bear market? Or, have we already had most of the bear market? I don’t know, because I think we have to see what happens in the next few weeks. Thus, I believe strategic planning about country and group leadership is premature. Supply versus demand and panic versus value—that’s the battle for now. My hunch is that a big rally is coming. There’s too much bearishness, with too many futures contracts sold and too much portfolio insurance written. I am not selling anything now and would be a buyer with our 10 percent cash position if the beast broke again to last week’s lows. After the smoke of battle clears, we will have to take another look at strategy. The accompanying table shows comparative country valuation levels as of the end of last week.
Major World Equity MarketsComparative Absolute Valuations
Source: Morgan Stanley Research.
Life on the Good Ship Swine
June 25, 1990
Section 1D:Wars and Rumors of War
The Last Supper
January 21, 1980
With the bond market in disarray, questions arising about the restrictiveness of Fed policy, and with market analyst John Mendelson maximum bearish from a technical viewpoint, the stock market’s rally is at a crossroads. If the market reacts in its usual way to higher interest rates, prices should fade. But if the market is now being driven by the “profitable stagflation,” store-of-value psychology I discussed last week, then prices could work higher, confounding those who think the market pattern doesn’t change. My guess continues to be that prices are going higher.
Meanwhile, a bizarre story that is making the rounds in London and the Middle East, if true, could explain the crude brutality of Russia’s sudden move into Afghanistan. One of the sources of this tale is the same one that accurately described to us the dimensions of the attack before the true story appeared in the Western press. Anyway, it is known that in early December the Russians sent Lieutenant-General Victor Paputin to Kabul. Paputin, age 52, was first deputy chief of the Ministry of Internal Affairs and a candidate member of the Central Committee of the Communist Party. He was considered a real star by the Politburo and was Russia’s premier political-secret police operative, which means he was their main man when high-level arm twisting (and breaking) was required.
