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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Investors need to know when they are in a this situationLAST CHANCE: SECOND CASCADE In three of the last centurys Triple Waterfalls, investors had a chance to sell into the rally at the end of the First Cascade at relatively modest cost. Indeed, in 1930 the stock market rallied so strongly that it briefly touched 1929 levels before entering the Second Cascade. Similarly, the Nikkei rallied to 34,000 from 29,000 in 1990, and Nasdaq rallied to 4200 from 3480 in 2001. The Second Cascade is the stage at which the first signs of the major flaws underlying Shared Mistake are revealed:. Stocks cannot go up when theres a depression on. 1974. Many of the Nifty Fifty stocks have entered terminal declines: They are not growth stocks immune to the economic cycle, theyre overpriced cyclical stocks with serious competitive problems. 1983. For inflation hedge assets, the plunge gains speed as Paul Volcker shows adamantine determination to crush inflation, even at the cost of record-high interest rates and a deep recession: Monetarism is proving to be, in fact, the right medicine for the disease of inflation. 1990. The Nikkei enters a terrifying decline as it slowly registers on all but the most solipsistic Japanese theorists that Japan is not an island that can set its own valuations forever. For many of the biggest stocks in Tokyo, including many of the biggest banks, what has begun is hari-kari in slow motion. 2001. Investor sticker shock: The truth in techs, as in so many of the Nifty Fifty stocks, is that they are falsely labeled growth stocks. In fact theyre actually capital goods cyclical stocks, and as such, they can have big losses, and they certainly are not worth big multiples. Moreover, the boom in private equity and IPO financing has created huge overcapacity among suppliers. It turns out those telecom companies do not have unlimited deep pockets. Who will buy all this gear? The S&Ms are less in evidence, but they keep reassuring the dwindling ranks of the faithful that stocks are coming back once the economy recovers or when the next El Nio causes another crop failure or when another Arab-Israeli war produces another boycott or when Volcker is forced to resign, or whatever. But their pronouncements no longer carry much weight, and they are now being openly attacked by skeptics who had been lying low during the Fanaticism period. Conflicts of interest about their performance begin to emerge. The stage is being set for catastrophe. LONG-TERM COLLAPSE: THIRD CASCADE This is the long, grinding collapse that finishes the process. It takes more than a decade before the asset class reaches its final bottom (or final resting place, if you will). Stocks didnt trade at lower yields than bonds until the mid-1950s. The Nifty Fifty stocks as a group underperformed the stock market throughout the 1980s. Japans stock indices keep hitting new lows 13 years after their market peaked. Gold and silver trade for small fractions of their prices of two decades ago. Oil stocks only bottomed out in their percentage weighting in the S&P at 3.4 percent 17 years after they peaked at nearly 30 percent. RECOGNIZING A TRIPLE WATERFALL IN TIME TO PROTECT YOURSELF Since Triple Waterfalls are the most dangerous of market phenomena, investors need to know when they are in a Triple Waterfall situation, as compared with one of the less ferocious bears. Triple Waterfalls have their own defining characteristics. That so many have been stunned by the extent of the collapse in technology and telecom stocks shows how few have made any serious study of market history. Its not as if theres a shortage of investment professionals: The number of graduating Chartered Financial Analysts breaks records each year (with growth particularly strong among foreign students). Its not that readable books on previous crashes do not exist. To name a few: A Short History of Financial Euphoria, by John Kenneth Galbraith; Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay; and Manias, Panics, and Crashes: A History of Financial Crises, by Charles Kindleberger. Its not as if the chart patterns arent attention-getters. Sir John Templeton, one of the wisest of investors, observed: The four most dangerous words in investing are Its different this time. He had retired from active investing to devote himself to his foundation, but reemerged during the late stages of the Nasdaq mania to proclaim that it was the biggest financial insanity of all time. Given such an astounding opportunity, he felt honor-bound to get reinvolved. He shorted dot-com stocks, making an additional $90 million for the foundation. The lesson is that each generation must make its own mistakes, as if nothing in previous history were relevant. But you need not share in the worst financial experiences of your own generation. Opt out. Triple Waterfalls are different from other kinds of market enthusiasms, because, by involving and infecting society at large, they transcend the stock market. The Baby Bear collapse in 1987 was a correction within the financial community and financial system. The public at large was only vaguely aware that the stock market was getting expensive and the dollar was in trouble. The economy was not derailed by the crash, although global stock market leadership did shift from the United States to Japana shift that would prove disastrous for the Japanese, because it set the stage for their Triple Waterfallwhich would never have occurred had the Bank of Japan not been forced into massive reflation after the crash. Two factors differentiate Triple Waterfalls from ordinary bull market excesses. The Ideological Superstructure of a Market The first distinguishing characteristic of Triple Waterfalls is the active involvement of the intellectual elitesknown as the clerisyin the building of an ideological superstructure over the markets value systema sand castle destined to be washed away. The clerisy are those within the academic, media, and political communities who are interested in ideas and trends, and eager to communicate their views to others. The presence of the clerisy gives the financial community even greater confidence that its viewpoint is rightbecause all those really smart and really distinguished people who have spent their lives looking down their noses at us as grubby capitalist traders are now saying we are where its at. What the Street denizens are not consideringso great is their delight in being respected and envied by the chattering classesis George Orwells observation about the clerisy: No idea is so crazy and ill-founded that it cannot be believed by an intellectual. The Spirit of a Market Because Triple Waterfalls are collective financial suicides, they are rooted more deeply in human nature than in the ordinary give and take, bull and bear, of financial markets. To a Freudian psychologist, they would have to be manifestations of Thanatosthe love or preoccupation with death, which is generally called the death wish. Thanatos is the opposing emotional force to Eroslove of life, as manifested in the sexual urgethe libido, which is part of the animal spirits of bull markets. Thrill seekers love to take extreme personal riskssuch as parachute jumps, high dives, or using cocaine, heroin, or Ecstasy. What happens in Triple Waterfalls is that a process driven by a form of Eros in the Optimism stage and in the early months of the Faith stage swiftly becomes overlaid with Thanatos, signaling the onset of the Fanati cism stage. In its entry on Eros, the Oxford English Dictionary quotes W. Empsons Gathering Storm: The Freudians regard the death-wish as fundamental, though the clamour of life proceeds from its rival Eros. (Empsons book was published in 1940; Churchill would later title the first volume of his history of World War II The Gathering Storm. His portrayal of the behavior of the allies in the years leading up to the war makes them look as if they had a collective death wish. Since I know of no evidence that Churchill was a Freudian, I assume this was coincidental.) In its entry on Thanatos, the OED quotes a 1935 article in the British Journal of Psychology: Freuds final duality was the division of the mind into two sets of instincts which he termed life instincts and death instincts respectivelyor, if one prefers the Greek names, Eros and Thanatos. Another citation is from Germaine Greer (1970) in the Female Eunuch: Our life-style contains more Thanatos than Eros. (The Nifty Fifty Triple Waterfall was in its Faith stage when her book came out, but I doubt she was making a market forecast.) As Cole Porter wrote of the late stages of the Jazz Age: The world has gone mad today And goods bad today. . . Anything goes. In the Fanaticism stage, the financially erotic keep showing their love by investing more, but they are joined by formerly skeptical market players, whose willingness to bet their futures by buying in at that stage is probably a form of financial death wish. Instinctively they know that they stand to lose their money, but they willingly bet their financial lives in order to be part of a financial form of Felliniesque bacchanalia. Perhaps youre uncomfortable with the notion that Freudian psychology has anything useful to tell us about stock market behavior. Think again. Last years winners of the Nobel Prize in Economics were economic behaviorists, whose work rejects the rational Homo economicus of classical economic theory. Their experiments showed that most people canand dobehave in economically irrational fashion when offered clear-cut choices. (Investment managers who use computer analytics to forecast stock market performance, such as our organization, believe that the stock market can and does behave irrationally; this is contrary to believers in the Efficient Market Hypothesis, who think that it is a waste of time to try to analyze the market because it is, at all times, efficiently priced based on publicly available information. We would argue that anyone who thought Nasdaq at 5000 was an efficient pricesetting medium should not be allowed to manage other peoples money.) Perhaps you want to believe that the market is simply driven by the shifting tides of Fear and Greed. But in Triple Waterfalls, Fear becomes an endangered emotional species, and Greed is glorified. How do Eros and Thanatos relate to Fear and Greed? Answer: Their relationships shift as the mania unfolds. As the life-affirming emotion, Eros drives the animal spirits of the entrepreneurs and risk takers in the early and middle stages of the New Era. But in its climactic phase, it is joined by the dark side of the force of human nature, which comes to join a party that is about to morph into the Dance of Death. Since Death is the end of everything, it announces its arrival on the scene by inducing market players to throw away their rule books and guidebooks and throw themselves into the embrace of the New Economy. The market cannot make that last, orgasmic rush to the top as long as a substantial body of opinion within the marketplace retains a stubborn attachment to the principles of the past. As those belief systems die off, a vacuum is created, and in rushes Thanatos, who will remain in charge for more than a decade. |
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