Bears: Exit Stage Left
-- David M Gordon / The Deipnosophist
Bears: Exit Stage Left
Time for rock-star pessimists to wise up.
Peter Tasker Jul 20, 2009
A notable phenomenon of this past year of living dangerously in financial markets has been the triumph of the ultrabears: deeply pessimistic commentators and economists, such as Nouriel Roubini, who previously had only niche followings and have been propelled to rock-star status.
Million-dollar book deals, speeches at Davos, celebrities and statesmen lapping up your predictions of woe, gorgeous babes clustering around you—it's nice work if you can get it.
Am I jealous? Absolutely. More important, what does this runaway bull market in doom-mongering tell us about current investment prospects? To any contrarians worth their salt, it suggests that sentiment has reached extremes, as it did in the dotcom mania of the '90s. Back then, the talk was of "Dow 30,000" and the coming digital paradise. Now we hear confident forecasts of gold at $3,000, the collapse of the dollar, and the end of capitalism itself.
Is it fair to pair today's gloomsters with the wild-eyed dotcomers? The bears have much greater intellectual depth, they are more analytical, and they were correctly bearish ahead of the most serious financial crisis in decades. But remember that the dotcom gurus once had credibility too, having been bullish during an epochal market ascent. Being right gets you listened to, until you get it wrong; then people stop listening. And nobody, but nobody, is right all the time.
Furthermore, investment success has little relation to high IQ, doctorates, and Nobel Prizes. As Warren Buffett put it, ordinary intelligence is enough when combined with "the temperament to control the urges that get other people into trouble."
In fact, the dotcom gurus turned out to be right about a lot of things. The Internet transformed the way we work and play, devastating whole industries and turning geeky startups into gigantic global corporations. What they overlooked was the iron law of investment: the price paid is crucial to the returns generated. Pay a ridiculously high price and you'll get a ridiculously lousy return. Being right about everything else won't matter.
Today's über-bears are making the same mistake in reverse. They may be right about the challenges the world economy is facing—shaky banks, weak consumption, deleveraging, the flu pandemic, etc.—but they are paying insufficient attention to the prices that companies are trading at in the stock market. That is why they missed the sharp recovery of the past few months and are now desperate to label it a bear-market rally.
Since March, when the growling of the bears was loudest, the S&P index of Asia's 50 largest stocks has risen by 45 percent, and the Dow Jones Asian small-cap index by 57 percent. The move is much more intense than in the spring of 2003, when the last bear market bottomed.
Another bubble? Hardly. In the first quarter of this year, the entire Japanese stock market was trading below its book value, and the Korean, Taiwanese, and Thai markets were not far behind. In all four countries, the market index expressed in dollars was back at 1980s levels.
Even at the peak in 2007, global stock markets were not in bubble territory, meaning at absurdly high valuations, with the exception of China and a handful of emerging markets. There was indeed a financial bubble, but it was restricted to credit and the areas that feed off it, such as real estate and private equity. By contrast, stock markets had already been in a bear phase—if we define a bear phase as a period when stock prices fall relative to earnings—since the turn of the century. The credit crisis, in particular the astonishing policy blunders surrounding the unmanaged collapse of Lehman Brothers, accelerated the process dramatically.
At the start of this year in many countries, stock markets were trading at the lowest levels in a generation. In several European and Asian markets, stock dividend yields had fallen well below government bond yields; effectively, investors were pricing in a long deflationary slump. Common sense suggests that such an outcome would be tremendously destabilizing to our societies. Political leaders everywhere, once aware of the risks, will stop at nothing to avert it. In an era when central banks are using every trick in the book to get money flowing again, deficits are ballooning, and bailouts have become routine, it is government bonds, not corporate stocks, that seem out of kilter with reality.
So what next? According to another great investor, Sir John Templeton, bull markets are born in despair, grow amid skepticism, mature in optimism, and die amid euphoria. Nobody can blame the über-bears for enjoying their moment in the sun; they've earned it fair and square. And if in doing so they set the stage for the birth of the next bull market, we'll have something else to thank them for.
Tasker is an analyst at Arcus Research in Tokyo.