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Tuesday, March 23, 1999 Page: C7
Section: Financial Post
Comment By Bob Hoye
Stock market veterans view
mining promotions and serious financial theories with the same healthy
skepticism. This, of course, is not new. As the well-regarded financial
editor of the New York Times, Alexander Dana Noyes, described in his 1930
account of the 1929 bubble:
``[The speculative 1901 bull
market assumed] that we were living in a new era; that the old rules and
principles and precedent of finance were obsolete; that things could
safely be done today which had been dangerous or impossible in the past.
The illusion seized on the public mind in 1901 quite as firmly as it did
in 1929. It differed only in the fact that there were no college
professors in 1901 who preached the popular illusion as their new
political economy.''
If a boom becomes so
irresistible as to become the opiate of the intellectuals, it must be
close to the end. The March 18 article by James K. Glassman and Kevin A.
Hassett, ``Dow 10,000 isn't too high: It's much too low,'' extrapolates
yet another financial bubble -- the sixth since the infamous South Sea
Bubble in 1720. Each was touted as a ``new era,'' and each had remarkably
similar characteristics.
New-era advocates
compulsively narrow quality spreads inordinately. Low consumer price index
inflation has been a feature of every great financial boom, and its
associated decline in nominal interest rates launches manias to reach for
the ``extra one eighth'' in yield. Extreme disregard for creditworthiness
in narrowing spreads warns in itself of impending speculative collapse.
In previous examples, it was
mainly the public that compulsively bought junk securities. But in our
boom, Nobel Prize-winning economists at Long Term Capital Management (the
mother of hedge funds) and central bankers responding to an official
promotion about converging interest rates in Europe exacerbated the mania.
They overlooked the
considerable spread between U.K. interest rates and, say, those in Italy
when most European countries were on a gold standard (which really was a
common currency). The collapse of LTCM, though it had severe
repercussions, was the normal consequence of widening spreads that are
typical of the transition from boom to contraction. According to my firm's
models, which are based upon the behaviour of the key characteristics
common to all great financial booms, the pattern that ends a great boom is
weakening commodities (which began April, 1997); the end of the bubble in
lesser exchanges (Asia, July, 1997); and widening interest-rate spreads
(began October, 1997).
The LTCM hedge fund disaster
has likely only trimmed financial adventurers' activities in interest-rate
markets. Although the scheme involved both the private sector and a
surprising number of central banks, it is likely that only LTCM will be on
the tombstone.
Obviously, the stock market
has rejuvenated the party, but with increasing concentration on fewer and
fewer issues in New York. This also is typical of a bubble's last stages,
but Messrs. Glassman and Hassett's conclusions, based upon a relatively
brief period, seem remarkably risky and arrogant. In touting a P/E of 100
and 36,000 on the Dow Jones industrial average ``tomorrow,'' they discount
the valuation range of the past 72 years. Thankfully, the lack of earnings
data prior to the early 1920s limits this amazing claim.
Their call for long-term
holding of common shares is remarkably similar to those that were
foolishly employed in the 1929 bubble. In a lengthy Atlantic Monthly
article, John Moody (yes -- the Moody) enthused about the wild success
stories of the era, which were inspired by powerful developments going
into and during each boom.
Before each bubble, severe
inflation favoured high inventories; then disinflation and associated high
real interest rates forced rapid inventory turnover. Mr. Moody described
it with a catchy phrase: ``Keep your shelves as bare as you dare.''
Intensifying price competition forced restructuring, downsizing, new
methods and, most importantly, business applications of new technology.
Of course, declining nominal
interest rates and low CPI inflation attend every financial ``new era,''
yet Mr. Moody celebrated these as policies of a reformed central bank
rather than as a natural condition. Ironically, in the 1873 bubble, the
U.S. did not have a central bank, so the influential newspaper of the day
editorialized that its Treasury System was infinitely superior in
preventing any contraction. Academics called the interval from 1873 to
1895 ``The Great Depression'' as late as 1939.
Mr. Moody's other long-term
point was that the end of too much government and strife in Europe had
opened up new consumer markets.
His final point combined
faith and tautology in insisting you had to invest: ``The mistake that
many, no doubt, make is to assume the times have not fundamentally
changed. They have changed. We are living in a new era and Wall Street, in
its present condition is simply reflecting this new era.''
The justification for interventionist economics comes mainly from
intellectuals outraged by the sudden discovery of financial distress.
Prompted by recurring examples since the 16th century, this body of
thought is generally classified as mercantilism. Sadly, it has been
overemployed through much of this century.
Normally, long periods of
good growth don't provoke academics. The New York Times' Mr. Noyes
correctly saw the academics' conversion to the popular delusion of a new
political economy as not only novel but a major error. Despite this old
newspaper wisdom, many newspaper articles late in our bubble's maturity
are still cheerleading reckless financial behaviour.
Illustration:
o Cartoon: Illustration of a bull standing on a chart line representing
the Dow 10,000.
Idnumber: 199903230040
Edition: National
Story Type: Business; Opinion
Note: Bob Hoye is the publisher of Institutional Advisors, which serves
institutional subscribers in a number of countries.
Length: 894 words
Keywords: STOCK MARKET; HISTORY; UNITED STATES
Illustration Type: CA
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