‘The pendulum of the mind alternates between sense and nonsense, not between right and wrong.’
Occasionally we’re presented with extremes that are so extreme, they make no sense at all.
The mind games of the markets are a fascinating study in the folly of man.
In moments when it seems the pendulum only has one directional momentum, all manner of reasons are given to rationalise the irrational.
Within weeks of the 1929 crash, famed Yale economist Irving Fisher said ‘stock prices have reached what looks like a permanently high plateau.’
It was from that not so permanently high plateau that the pendulum swung from Roaring Twenties excess to the depressing thirties austerity.
In the annals of pendulum swings, Japan definitely earns a mention.
‘At its height, in 1989, real estate in Tokyo sold for as much as [US]$139,000 a square foot—more than 350 times as much as choice property in Manhattan. Such valuation made the land under the Imperial Palace in Tokyo notionally worth more than all the real estate in California.’
What do you think…just a tad on the excessive side?
But that’s what happens in bubbles. Nonsense replaces common sense.
In 1990, Japan’s residential property market began a long and painful swing back to more realistic levels.
A decade later, the US was gripped by dotcom fever.
Right at the very peak of the tech boom, the 1999 Annual Report of the Federal Reserve Bank of Dallas was titled ‘The New Paradigm’.
Source: Federal Reserve Bank of Dallas
‘New Paradigm’ is another way of saying ‘this time is different and you just watch me rationalise why it is’.
The opening paragraph of the Dallas Fed’s report (emphasis added):
‘The United States entered the 21st century with its economy on a roll. GDP growth averaged more than 3 percent a year in the 1990s. The country created 17 million jobs, driving unemployment down to a 30- year low of 4.1 percent. Recession receded into memory—only eight months in the previous 17 years. As productivity surged, Wall Street gave the economy rave reviews and the Dow Jones industrial average quadrupled over the decade.’
The new paradigm became victim to the same old market forces.
The tech-laden NASDAQ index fell 80%-plus AND there was a memory-refreshing recession that pushed unemployment towards 7%.
In May 2007, Fed Chair Ben Bernanke (with almost the same timing as Irving Fisher) made this comment to the US Congress…
‘We believe the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.’
Well, subprime ended up being more of a wrecking ball than a pendulum swing.
And then came the granddaddy of pendulum swings. The 2017 cryptocurrency craze.
We — or at least those of us who could make no sense out of this madness — watched in wonder at frenzied buying that, by comparison, made Tulip Mania look like an exercise in reasoned thinking.
Which brings us to the present-day market nonsense.
Today’s Stock Market Bubble
In March 2020, the global economy crashes down around our ears. Unemployment rates soar. Squillions of dollars were created out of thin air to patch up the leaks in the credit bubble. Tales of bankrupt and near-bankrupt businesses — small, medium and large — dominate column space in the financial press.
And yet, the US market stages a recovery. One that’s (almost) as steep as its descent.
Once again, we — those of us who watch and wonder at the how and why of all this — are left scratching our heads.
We’re told this nonsense actually makes sense…the market is looking ahead to recovery.
Even the OECD’s more optimistic outlook — based on the single-hit COVID-19 shutdown — has the global economy back where we were in 18 months to two years’ time.
If there’s a second hit, recovery is pushed well into the future.
So how do you make sense of this?
Easy. It’s the same story as all previous episodes of excess…just prior to the pendulum reversing its momentum, there is one almighty push in the opposite direction.
At present the US share market is having its ‘1989 Japanese land value’ moment…a moment in time where there’s a complete disconnect between price and value.
This is the trailing net income differential between Berkshire Hathaway (Warren Buffett and Charlie Munger’s company) compared to five hot tech stocks — Shopify, Spotify, Square, Tesla and Zoom.
Berkshire Hathaway’s income towers over the pancake-like earnings of the hot stocks.
And, for good measure, we should mention that Berkshire Hathaway is sitting on US$137 billion in cash reserves.
In a reasoned, sensible and rational world, you would place a far higher value on Buffett’s business.
But with all rational thinking being temporarily suspended, we get this nonsense.
Those five (highly indebted and earnings light) hot stocks are valued the same as Buffett’s income generating, cash-rich business.
To help you make sense of this nonsense, this is what we know from all previous periods of temporary insanity.
- Bubbles have no bearing whatsoever on underlying economic fundamentals. This is pure, raw emotion on display.
- The higher prices go, the greater the speculative fever…especially if prices push through previous market highs…like the NASDAQ has just done.
- Valuation metrics — P/E ratios, Price/Sales etc — matter for nought when the speculative bit is firmly in the teeth of the punters (and that’s what they are). Valuations only ever becoming relevant AFTER the bubble has burst.
As Benjamin Graham (Buffett’s mentor) famously said:
‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’
Psychology is a powerful driver of short-run market movement.
But, as we’ve seen with all previous episodes when pendulums swing too far, the markets eventually weigh up the value of an asset.
Recognise this current market madness for what it is…absolute nonsense.
Ultimately, the pendulum of the mind will arc back to reasoned thinking and when it does this will become yet another story to tell in the annals of market excesses.