by Dr. Marc Faber
The feature most common to previous investment booms was that a bull market
in one asset class was accompanied by a bear market in another important
asset class. Precious metals soared in the 1970s, but bonds collapsed.
Equities and bonds rose in the 1980s, but commodities tumbled.
In the 1990s, we had rolling bubbles in the emerging markets, but Japanese
and Taiwanese equities were in bear markets while commodities continued to
perform poorly.
Finally, the last phase of the global high-tech mania
(1995-2000) was accompanied by a collapse of the Asian stock markets and
Russia, as well as a continuation of the Japanese and commodities bear
markets. By the late 1990s, most emerging markets (certainly in Asia) were
far lower than they had been between 1990 and 1994. In the 1990s, emerging
markets grossly underperformed the US stock market.
Currently, looking at the five most important asset classes - real estate,
equities, bonds, commodities, and art (including collectibles) - I am not
aware of any asset class that has declined in value since 2002!
Admittedly, some assets have performed better than others, but in general
every sort of asset has risen in price, and this is true everywhere in the
world.
In the early phases of all previous investment booms, investors failed to
recognise that the "rules of the game" had changed and continued to play the
asset class that had been the leader in the previous investment mania. In
the 1980s, every increase in gold and silver prices was perceived to be the
beginning of a new bull market in precious metals (after silver prices
collapsed in January 1980, prices doubled three times between 1980 and 1990
- all within a downtrend), while investors maintained a very sceptical view
of bonds. In the early 1990s, investors failed to recognise the emergence of
a high-tech sector uptrend, although, as explained above, high-tech stocks
were already performing extremely well between 1990 and 1995. Global
investors continued to believe in the merits of Asian stocks right to the
end and actually stepped up their buying in early 1997!
Similarly, in the current asset inflation, investors have continued to focus
on the high-tech bull market and have largely missed out on the huge
increase in price of commodities, and of Indian, Latin American, and Russian
equities. At the end of each investment mania, investors believed in some
sort of "excess liquidity" that would drive the object of the speculation
forever higher.
At the end of the 1970s, the "excess liquidity" related to the OPEC
surpluses; at the end of the Japanese stock and real estate bull markets,
"excess liquidity" centered around the enormous Japanese current account
surpluses; during the 1990s emerging markets mania, "excess liquidity" was
perceived to come from foreign buying and the Yen carry trade; and at the
end of the high-tech boom the investment community believed that "excess
liquidity"
would come from record mergers and acquisitions, a reallocation of funds
from bonds to equities, and easy monetary policies by the Fed (a belief that
was fostered by the Mexican and LTCM bailouts and money printing ahead of
Y2K).
But as Albert Edwards so eloquently explained in a recent scathing report
entitled "Lies, rhubarb, poppycock, bilge, utter nonsense, caravans and
liquidity" (see Dresdner Kleinwort Global Strategy Report, January 16,
2007), "liquidity is the hocus pocus of the investment world. It means
totally different things to different people but is often cited as being a
major driver for buoyant markets".
Most presciently, Edwards explains that with respect to investment manias,
"when markets are rallying but seem expensive, when new issues fly out of
the door and when fundamental analysis often appears to fail to explain
events, the safe haven for the market commentator is often to rely on the
explanation that there is lots of liquidity". I urge our readers never to
forget these words!
What is peculiar to the current investment environment is that liquidity is
supposed to come from not just one or two sources, but from everywhere! From
OPEC surpluses, from the US Fed and other central banks, from the Asian
current account surpluses (excess savings), from the Yen and Swiss Franc
carry trade, from the large size of money market funds and bank deposits,
from rising asset prices, leverage, and a tidal wave of private equity
funds, and from artificially low interest rates.
It's no wonder that, given such beliefs, asset markets are all flying to the
moon!
In all the previous investment booms we discussed, the bull market was
interrupted by severe corrections. Gold corrected by more than 40% between
December 1974 and August 1976, equity markets corrected violently in 1987
(Taiwan and Hong Kong dropped by 50%), and bonds corrected sharply in
1983-1984, in 1986-1987, and in 1994. In the high-tech mania, technology
stocks corrected sharply in 1995-1996 and in 1998. Between its 1997 high and
its 1998 low, the Russian stock market gave back almost all its previous
gains
In the current asset bull markets, we have, with very few exceptions
(copper, zinc, oil, and sugar), not had a concerted and strenuous correction
phase à la 1987 and
1998 (and certainly not in US equities). As the advance in previous
investment manias matured, its leadership tended to narrow considerably. At
the end of the 1970s'
commodities bull market, only oil, copper, precious metals, and energy and
mining shares were still rising. In Japan, most of the listed equities
peaked out in 1987-1988, but financial stocks, including insurance
companies, banks, and brokers, drove the index up until the end of 1989. In
the rolling emerging market bubbles of the 1990s, most markets peaked out
between 1990 and
1994 but some markets such as Hong Kong still managed to make a final high
in 1997. In the TMT boom, the advance became extremely concentrated after
1999, with many tech issues only making marginal new highs in March 2000 or
failing to better their 1999 peak prices.
In the current asset boom, we haven't yet seen any significant narrowing of
the asset markets' advance (although Middle Eastern markets tumbled last
year).
Aside from a few commodities and US home prices and housing-related stocks,
most asset prices are still rising, although admittedly with varying
intensity.
A feature common to all great asset booms is that they were born from either
an extremely low valuation in real terms, an extended base-building period,
or from a lengthy and pronounced underperformance compared to other asset
markets. In 1970, the gold price was no higher than in 1933, and down in
real terms by 70% from its 1897 high. The Japanese asset boom, which had in
fact begun back in the 1960s, led to the entire Japanese stock market having
a stock market capitalisation in 1970 lower than that of IBM. In other
words, in 1970, Japanese equities were very inexpensive compared to the US
stock market. In 1982, US stocks had declined by more than 70% in real terms
from their 1966 highs. And although, at the time, US equities were, adjusted
for inflation, no higher than they had been in 1899, to be fair their total
real return (including dividends) was far higher.
Still, by 1982, including reinvested dividends, US equities were no higher
than in 1961. Also extremely depressed were US bond prices, with bond yields
at their highest level in the 200-year history of the US capital market.
Taiwanese and Korean equities in 1984 were at about the same level they had
been in the early 1970s and, adjusted for inflation, dirt-cheap. In the late
1980s, Latin American stock markets were, in US dollar terms, no higher than
they had been in the late 1970s and far lower than in the early 1970s and
early 1980s.
In 1990, US high-tech stocks were selling for about the same prices they had
reached at their 1973 peak and for around ten times earnings. Compared to
the valuation of the Japanese stock market in 1990, US high-tech stocks were
then extremely depressed. The 2002 asset price increase in all asset classes
also included some asset classes that started to rally from extremely low
inflation-adjusted prices or low valuations compared to some other asset
prices. Particularly low inflation- adjusted prices were evident for
commodities (which bottomed out between 1999 and 2001). And whereas the
Nikkei had massively underperformed US and European equities in the 1990s,
and was therefore relatively inexpensive compared to these markets, emerging
markets had both underperformed US assets since 1990 and were, adjusted for
inflation, very depressed.
However, not depressed (adjusted for inflation) or compared to other asset
prices, were US equities.
Moreover, following their 20-year bull market, US bonds - and especially
Japanese bonds - were by no means depressed! Every epic investment boom
lifted prices far higher than anyone could have imagined (although I concede
that in the mid-1990s, Richard Strong told me that if Japanese stocks could
sell for 70 times earnings in 1989, US equities could also sell in future
for 50 times earnings). In 1970, no one dreamt that precious metals would
increase by more than 20-fold. In the early 1980s, it would have been
considered heresy to forecast that the Dow Jones would double and bond
yields would decline to less than 4%! And investors certainly didn't expect
the Japanese stock market, which had already quadrupled in the 1970s, to
rise by almost another six-fold between its low in 1982 and its high of
1989. In the late 1980s, few people expected the Latin American markets
would ever recover; and in the early 1990s, no one (including myself)
expected US high-tech stocks to become the best performing asset class in
the 1990s.
Since the current asset price increases got under way in
2002 - and contrary to the expectations of some of the perma-bulls on US
equities - commodities, and emerging stock markets and economies, in which,
fortunately, platform companies are largely absent, have performed
substantially better than US asset prices. Since 2000, the Dow Jones has
lost more than 50% of its value against gold and much more against
industrial commodity prices.
Moreover, since 2002, the Argentine and Russian stock markets, whose
economies are perceived as "knowledge absent" when compared to the great
"knowledge-based"
American economy, are up ten-fold or more!
Now, I will concede that the current "asset inflation" (a pompous and
potentially dangerous notion, to quote my friends at GaveKal Research) may
be far from over and that the end game in the current asset price increases
is far from predictable, but, based on the experience of the previous four
investment booms, it is likely that the significant diverging trends in the
relative performance of asset classes (underperformance of US assets) will
persist for far longer than is now expected.
Another common feature of the last stage of every asset boom was high
trading volume, widespread public participation, high leverage, and money
inflows into all kinds of money pools (Zaitech and Tokin funds, investment
clubs, mutual funds, LBO funds, venture capital, private equity, emerging
market, art and collectibles, and equity, commodity and index funds). In
this respect, the current asset boom is no different than previous
investment manias, except that it includes all asset
classes and is taking place practically everywhere in
the world.
In the four great investment booms we have described, and also in previous
investment manias, once the boom came to an end, most, if not all, of the
price gains that occurred during the mania were given back. In 1992, silver
prices were lower than they had been in 1974. In 2003, the Nikkei was lower
than at its high in 1981. In 2002, in dollar terms, most Latin American
markets were no higher than in 1990 and most Asian markets had declined to
their mid- or late 1980s level. By 1998, the Russian stock market had given
back its entire advance since 1994; and in 2002, most high-tech and
telecommunication stocks were no higher than they had been in 1996 or 1997.
And in those manias where prices didn't retreat in nominal terms to the
level - or, as frequently happened, to below the level - from where the
investment boom had begun (as was the case in 1932), prices retreated in
inflation adjusted terms to those levels.
Adjusted for inflation, in 2001 the CRB Index was far lower than it had been
in 1971, while precious metals, oil, and grains were all either no higher,
or lower, than they had been in the early 1970s. Following all great
investment booms, the leadership changed. The 1970s' precious metal boom was
followed by the boom in financial assets in the 1980s. The Japanese stock
and real estate mania of the late 1980s and the emerging market boom of the
early 1990s were followed by the parabolic rise of high-tech stocks in the
late 1990s.
Therefore, while it is possible that in a prolonged environment of "excess
liquidity" all asset markets could continue to increase in nominal value, it
is most unlikely that the leaders of the previous boom - the US stock market
and, specifically, the TMT sector - will be the leaders of the current asset
inflation. And whereas it may be premature to make a final judgment about
this point, as the current asset inflation could last for much longer, so
far the gross underperformance of US equities and especially of the Nasdaq
(still down by 50% from its 2000 high) compared to the emerging markets and
commodities seems to confirm that the leadership has indeed changed.
Regards,
Marc Faber
for The Daily Reckoning
Bill Bonner in sunny London:
"Goodbye America" says the page 3 headline in this morning's Metro
newspaper.
After 66 years, the story reports, Marvel Comics, is finally laying to rest
our hero, Steve Rogers, a.k.a.
Captain America. The super hero had beaten the Nazis, the commies,
terrorists and mutants. But he was brought down by a sniper's bullet as he
left a courtroom.
R.I.P.
But it was time for him to go. Captain America was invented to defend the
land of the free. But now, after the War on Terrorism...the Patriot
Act...and the Prescription Drug Bill...what freedom is left? We are free to
dye our hair purple, dress up as a priest and wed a two-headed calf. But
that is not the freedom we once looked for.
So it is. Every great empire begins in deceit, develops into farce and ends
in disaster. The farce - at a high point in the Clinton and Bush
administrations - has been great fun. But in order to see what lies ahead we
have to be looking far behind. And if we look far enough behind what we see
is old Rome in grand decline. Mind you, it was not a bad time for a man with
money and a villa on the coast of Dalmatia. But it was a very sad one for
someone who had to rub against the sweating masses thronging the centre or
try to hold back the barbarians crowding the periphery. The Roman emperors
spent too much money - on war, on bread, on circuses. They had to clip the
coins, rob the citizens, and squeeze the whole empire for tribute to keep up
with it. But it couldn't go on forever. The barbarians grew bolder while the
empire's own forces weakened. Finally, the Vandals swept across the frontier
and brushed aside the remaining defenders, and Rome itself - the capital
city of the greatest empire in history - was sacked.
It is an old story, dear reader. Does it tell us anything useful about the
future?
"If there is one thing that can bankrupt America, it's health care," said
Comptroller General David Walker.
Walker has been giving speeches lately, warning Americans that they are
spending too much money. On '60 Minutes' recently, he explained that the
Bush administration's Medicare Prescription Drug Bill was the single most
disastrous piece of legislation to come along in many decades.
At the centre of America's empire is a jolly pack of clowns, liars, and
cowards. As to the prescription drug bill, the Bush administration told the
nation that it would cost $400 billion in its first 10 years. Now, says
Walker, the bill is sure to be closer to $1 trillion. At the present rate of
growth, he explained, Medicare and Social Security alone will take up the
entire federal budget by the year 2040.
That obviously wouldn't leave much money for keeping the barbarians outside
the gates. But here, too, the dissemblers rush in to back up the fools. It
was foolish to waste the nation's troops and treasure in a messy war in
Mesopotamia. Rome did it...and regretted it...more than once. Now, American
centurions patrol the streets of Baghdad while the Caesars on the Potomac
inflate the casus belli while deflating the cost estimates.
What happens? What gives? How does it end? We can tell you. Farce gives way
to disaster. Sooner or later, the commitments can't be met. The total value
of all the household wealth in America is about $50 trillion - about the
same amount as the total net 'financing gap' of the Federal government.
Which means, dear folks, we are already broke.
But it is not only the feds whose spending is out of control. The U.S. trade
deficit, born out of runaway consumer spending, is also careening down a
winding road at top speed. Each year, the deficit effectively transfers more
U.S. capital to foreign hands. According to figures we found yesterday, now
more than half of new federal debt is going to foreigners.
The U.S. current account first went negative in the mid- 80s...about the
same time that Alan Greenspan took over at the Fed. But it took another 20
years before the total of U.S. assets in foreign hands was so great that the
net income from overseas investments turned against the U.S.
That milestone was passed last year.
Warren Buffett described the situation in his annual report to shareholders
last week:
"The "investment income" account of our country - positive in every previous
year since 1915 - turned negative in 2006. Foreigners now earn more on their
U.S.
investments than we do on our investments abroad. In effect, we've used up
our bank account and turned to our credit card. And, like everyone who gets
in hock, the U.S. will now experience "reverse compounding" as we pay
ever-increasing amounts of interest on interest... Our citizens will also be
forced every year to ship a significant portion of their current production
abroad merely to service the cost of our huge debtor position.
It won't be pleasant to work part of each day to pay for the
over-consumption of your ancestors. I believe that at some point in the
future U.S. workers and voters will find this annual "tribute" so onerous
that there will be a severe political backlash. How that will play out in
markets is impossible to predict - but to expect a "soft landing" seems like
wishful thinking."
Empires do not typically land softly.
They blow up...loudly.
More news...
---------------------------
Adrian Ash, chewing on the numbers at home in Tunbridge Wells:
- Everyone of us accords himself smarter than the average bear - your
editors included, despite bitter experience.
- And for every above-average investor there must always be a below-average
lump. No amount of government meddling with GCSE results can change this
mean law of statistics.
Yin-yan...smarties and schmucks...winners and losers.
- The worst fund managers, however, get to read the same research and
analysis as the finest brains do. And while they might not quite grasp its
meaning, that can put them into the same investments as their brighter
brethren are chasing.
- Take gold, for instance. It famously offers a way of spreading your risk.
Science proves it, in fact, thanks to gold's non-correlation with stock
markets and bonds.
There's simply no link between changes in gold and the change in paper
securities. So when paper assets take a bath, investors holding gold should
only get their feet wet.
- Gold's historic non-correlation is right there in the numbers. Comparing
the metal with US stocks and US bonds, "the correlation coefficient is not
significantly different from zero," says the World Gold Council. Ditto for
UK, German, French, Italian and all other stocks and bonds, too.
- Just how close to zero? Quant-jocks in the City will love to learn that
over the 5 years to Dec. 2006, the link between changes in the Sterling
price of gold and the return from Sterling bonds ran to 0.098. For the FTSE
All-Share, gold's correlation ran to just 0.072.
- If only The Daily Reckoning were a TV advert for shampoo! An actress
wearing a lab-coat would now step forward, smile into camera and reveal
that: "Expert statisticians say this means only 0.5% of gold's movements can
be explained by changes in the London stock market."
- Half-a-percent? That's so close to a big fat zero, only Gordon Brown's
chances of winning a General Election get nearer!
- Ergo, buy gold and you'll balance the risk of holding stocks and bonds.
The smartest investment advisors think they know this. Trouble is, more and
more schmucks think they know it, too. And that's why, low as it is, gold's
correlation with shares has been rising. It trended higher in the 12 months
to January to reach 0.22, up from
-0.23 at the start of 2001.
- The link between gold and stocks is rising fast thanks to the meltdown and
bounce seen in both asset classes over the last two weeks. "The correlation
between equities and gold has been quite strong," noted Andrew Harrington of
the Australia & New Zealand Banking Group earlier today.
- "The recovery in the stock market has helped forge a bottom in the gold
market," said Tom Hartmann, a commodity broker at Altavest Worldwide Trading
in California, on Wednesday.
- "Gold usually has a reverse correlation with stocks and the Dollar," added
a Japanese trader today. "But that isn't the case now."
- "Look what happened to oil last week," said David Guthrie, a seriously
smart hedge-fund advisor, over dinner last night in Soho. "Stocks and gold
sank, Sterling was toast, emerging bonds tanked...and yet oil simply did
nothing."
- No one was playing it, explained our friend. "Oil has become last year's
story...so it's escaped the turmoil in everything else. But gold, on the
other hand, is increasingly popular with professional investors. So when
everything falls, gold takes a dive too."
- "That doesn't look good for gold's non-correlation,"
said your editor, "which is supposed to be a major attraction, right?"
- "But it's only to be expected as gold attracts new investors," laughed
David Guthrie. "Non-correlation only applies when no one much cares for it.
If everyone wants a piece of diversification, gold will offer less
diversification as a result."
- "So you're selling gold now?"
- "Heavens no!" came the answer. "I'm still incredibly bullish on gold. The
fundamentals haven't changed - in fact, they've only grown stronger. But you
can read all about that in my piece for The Fleet Street Letter on
Saturday...
- "Now, shall we have another bottle of red?"
----------------
And more thoughts from Bill...
*** A reader poses a very good question: "How can you continue to expect
gold to go to $1,000 an ounce when the world is entering a deflationary
meltdown?"
The answer: we don't know what the world is doing...apart from shivering and
shaking. It's got a fever from excessive exposure to liquidity. How this
illness progresses we are not sure. All we know is that the epizootic will
have to run its course. And we presume it will include spells of hot flushes
from inflation as well as cold, damp, teeth-chattering deflation. The
inflation is likely to send gold up in price. The deflation is likely to
send it down. But at some point, the fever will break. Many paper assets
will probably be dead by then.
As to the value of the dollar, relative to gold, we can't say. But when you
enter one of these periods of grave illness, the goal is to survive. Maybe
you will be able to make some money out of the general suffering and
cluelessness; maybe you won't. But gold will probably help you survive, and
probably leave you in better shape than most other investors. That is about
the most you can hope for, in our opinion. As to what price gold will sell
for...during and after the ailment, we can't say.
*** We were trapped on the train today. The Eurostar lost power. We sat. We
waited. Finally, the conductor announced that we were on board the poor
little train that couldn't. Another train would come along to take us to our
destination.
This left us in the compartment...sitting. We found that we were surrounded
by a group of American girls, apparently part of a school group. They were
all very plump, all dressed in jeans, white running shoes, assorted
tee-shirts, sweat-shirts and sports jackets.
We couldn't help but listen to their patter.
"And I was like...yeah...all right."
"And he was like...well I don't care..."
"And I was like...okay..."
"And then I like said, well forget it."
A dark cloud passed over our spirits. How did a group of youngsters come to
be so fat and foolish, we wondered?
Normally, it takes many years to get that way. What will become of them as
they grow older?
*** "I hadn't thought about it before. But now that I think about it, the
idea is a little frightening."
It was Elizabeth talking. And what she hadn't thought of before was the
possibility that we might sell our farm in Maryland and never move back to
America.
We have lived overseas for more than 10 years. We have gotten used to it. As
the years pass, the canyon between us and modern American culture grows
wider. We don't know who Antonella Barba is. Who's John Popper? Or Lance
Bass?
We don't know. We don't care. Who won the Super Bowl? We couldn't tell you.
Who's leading in the next presidential race? You would know better than we
would, dear reader.
Most people know who they are and where they belong. But when you take leave
of your mother country a number of questions arise.
Elizabeth went on, "I don't know...I always thought that we were going home
some day. I always thought we were Americans who were spending a few years
overseas.
"But now I see what you mean. America has changed while we've been gone. And
we've changed too. I'm not sure why we would want to go back. But the idea
that we won't go back leaves me wondering who we are...what we are...where
we should be."
Generations of immigrants came into the U.S. to become something different.
They gave up being Poles and Italians and became Americans, as quickly as
possible.
But when we moved to Europe, we never intended to stop being Americans. We
never wanted to become French. Our children never expected to become
Europeans. We were Episcopalians from the sovereign state of Maryland and
expected to stay that way.
"I don't know, Dad," said Jules recently, on a call
from Boston, "there's a whole group of French kids here.
I spend a lot of time with them. Maybe we stayed in Europe too long. I don't
have much in common with these American kids."
"If we're not ever intending to go back to America...what are we? Are we
still American?"
We thought about it. The idea of the expatriate has been around for a long
time. The British had long experience with it when they were still in their
imperial chips.
They often lived in Africa or Asia...but as Englishmen.
They got their papers from London...had tea at 4...and became, in many ways,
even more English than the people they left behind. They kept up their ties
with England too...sent their children to school there...and always expected
to go home.
So too are there many thousands of expatriate Americans who read the
International Herald Tribune...vote in US elections...have children in
American universities...and look forward to the day when they will return to
the 50 states and collect their pensions.
But over time, the ties grow weak.
"But then, if you aren't what you came from, what are you?" Elizabeth
continued.
"What do you believe? What group are you a part of? How can you describe
yourself...even to yourself? When people ask what we are, I say 'American'.
What should I say...?
Well, we used to be American'? But if so, what are we now...? I don't think
I'm ready for this...maybe we just need to go home."
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