-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
