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Segue into the year 2000…Mesmerized by startling stock market gains the average American was convinced that a ‘new economy’ had been created. The spectacle of overnight billionaires and their extravagant dotcom lifestyles fueled an anxiousness on the part of the average American to become a part of the show. There were those who questioned how profitless Internet companies, fudged financial numbers, and a negative savings rate offered proof that stock market gains would be sustained forever. ‘The piper will one day have to be paid for these stock market excesses’ they claimed. However, most did not listen. Rather, they joined the frenzy, eager for a taste of the excitement.
Today the situation would appear on the surface to be much different: shocked by startling stock market losses the average America investor has been quick to relinquish their new economy beliefs. And yet Americans seem unwilling to exit the stock market stage. While the carnage is evidently piling up, participants still seem reticent to head for the relative safety of the stands. The potential and unlikely glory of the gladiatorial floor has a greater hold on the collective mind…After all, if they or their colleagues fall it is due to Caesar’s machinations and not because they are unfit for the arena.
Part I: Admitting Defeat At The Hand of The Bear
Tiger Management’s Julian Robertson has a long-term track record that is comparable to that of Peter Lynch and Warren Buffett. However, 1 month into the bear market Mr. Robertson’s investment company, which once held $22 billion in assets, folded up shop due to heavy losses. Surprisingly, the astute Robertson claimed ‘There is no point in subjecting our investors to risk in a market which I frankly do not understand.’
Similarly, George Soros, who once ran the largest and most famous hedge fund on the planet, lost roughly 22% ($8 billion in assets) during the first 3 months of the bear market. He folded up his Quantum fund, sidekick Druckmiller quit, and Soros began a value fund (Quantum Endowment Fund).
These two gentleman, who before the bear market were regarded as two of the most astute investment minds of all time, admitted that they made mistakes – they owned up to neglecting the golden rule when investing: the preservation of capital.
By contrast, the average American investor has not owned up to making mistakes. Rather, and thanks in part to their conditioning from the media, the average American investor has owned up to being a victim of the system: some retirees lost everything because Wall Street lied to them, others took a hit because they were enticed to buy stocks on the basis of fraudulent financial numbers, and many more were goaded by politicians into believing that the markets were infallible (i.e. Clinton fighting for stocks to be a part of Social Security Funds).
With this in mind, stories about the great demise of the U.S. investor are severely exaggerated. While there is ample evidence to suggest that some people are dumping equities, there is an equal amount of evidence to suggest that the majority of Americans have blamed others for their misfortunes, and that they still control a stake in the U.S. stock market (ICI, Trimtabs). Furthermore, the evidence is quite clear that Americans do not save much money for proverbial rainy days, have a penchant for debt, and still invest in Wall Street hubris rather than specific companies.
However, whereas the demise of the U.S. investor has been overstated, what has been dramatically understated is exactly how unfit many investors were for the challenges of investing. To be sure, and with surprising nonchalance, the media and Wall Street have gathered that investors made mistakes investing in ‘bubble’ stocks. Yet when the markets rally, if even for 1 day, they are quick to put on a smile, reiterate endlessly that the markets may have hit rock bottom and/or that the U.S. economy may be shielded from another recession. Of course, all this occurs without a word being said about the continuing slide in the quality of corporate debt, deteriorating profit rates, and entrenched accounting irregularities. If investors made the mistake of investing in bubble stocks in the past, exactly what are they doing correctly today? Is it not ironic that few people diligently question exactly when and why the markets went from being in a ‘bubble’ to being undervalued? That the bubble has burst is taken as a truism without auxiliary comments beyond ‘stock prices have fallen’.
The investor is still willing to bask in speculative ignorance. Thus, instead of battling to become a better investor many wait for Bush, Pitt, Greenspan and others to try and clean up the mess: specifically they wait for tax cuts, CEO jail sentences, Fed cuts, and dreamy bottoms and bounces. What they do not do is objectively look in the mirror and surmise that they are still unprepared for battle: that they remain unable to quantify, beyond overly simplistic interest rates models and force fed mantras of capitulation bottoms, exactly when, and if, the bubble suffered its final point of deflation.
In sum, these are the reasons why the majority of Americans are still losing equity – they are afraid of the anonymity and the cult of the mundane which standing on the sidelines implies. Rather than being satisfied with slow and steady gains based on patient observation, they possess a suicidal desire to rush on to the gladiatorial floor without first arming themselves. In some senses, it is almost as if they deserve to lose their money.
Part II Throw Them To The Lions
At first the notion that anyone ‘deserves’ to lose money in the stock markets may seem to be vindictive. However, this could not be further from the truth. Rather, the reason why the word ‘deserve’ is applicable is because investing is a game of skill rather than blind luck. To be sure, those who blindly throw darts should not be expecting to hit the bull’s eye and/or be given a pat on the back when they miss the board completely.
Another distinctive reason why ‘deserve’ factors into the equation rests in the arena of blame. While it is true that Enron and Worldcom were unexpected shocks, prior to their demise they were also nearly junk rated companies searching for needed asset sales to avoid further troubles. Quite frankly, even without the exposure of over-leveraged SPEs (Enron) and massive accounting fraud (Worldcom) these companies could just as easily have failed on their own merits down the pike. The point is, the investor who loses money and accepts losses with the word I (i.e. I didn’t appreciate the amount of outstanding debt or I didn’t think the economy was going to double dip) are certain to become better investors in the future. By contrast, those that blame everyone but themselves (i.e. Enron and Worldcom lied and this is the only reason why I lost money), are certain to win and lose money based solely upon the unpredictability of bulls and bears.
As Buffett has boldly argued, “Be fearful when others are greedy, but greedy only when others are fearful.” Mr. Buffett isn’t suggesting that he wants others to lose money, or that the emotionally unfit deserve poverty. Rather, he is simply offering commentary from the stands – pointing out why the gladiator has fallen, and why he relishes cleaning up the remains…it is a cold hard truth that sometimes in business and investing in order to make money you have to want others not to make money.
Cathartic Ignorance?
If a student doesn’t study for an exam and he fails, does he blame his teacher, the school, or the government? No. The student blames himself. If a vacationer pays a stranger $30 for a box of authentic Cubans on the streets of Havana only to find out that he purchased finely rolled banana leaves does he blame the poverty ridden street person for ripping him off? No. He blames the sucker (himself). Lastly, if a purchasing manager for ABC Computers orders triple the amount of chips from Intel because he had a dream of a big sales rebound does he blame his dreams? No. He blames himself.
Suffice it to say, the vast majority of Americans didn’t study the stock markets before they tossed in their money, they didn’t check what each company was really made of, and they didn’t invest money they had to lose. Rather, they thought they could pass an exam without studying, buy a $200 box of Cubans for $30 from a stranger, and make money simply from dreaming. Question is, should we reward ignorance by instituting government bailouts, initiating fed cuts, and feeling pity? Should we conclude that the markets themselves failed rather than those individuals who dished out money on the nearest rumor and took risks that they simply could not afford?
Does this sound like we are being ‘vindictive’ or simply honest?
Part III: Please Caesar… Spare Me
How many investors play the role of the sucker – the uninformed student, the friendly tourist, and the moronic purchase manager?
Instead of searching for solid companies with clean balance sheets, corporate longevity, and visible pricing power, some opt to endlessly proclaim stock market bottoms and lament over recession. One could argue, quite convincingly we might add, that since the average U.S. stock holder failed miserably as an investor, they have turned into economists (a completely different profession). Now, instead of claiming that Amazon will rule the Internet one day (and this means Amazon $1000 for some reason) they profess that the U.S. economy will recover one day. That one day their falling equity portfolios will rebound. That one day Caesar will rid the lands of the ingenious financial miscreants whose practices paradoxically reveal just how dangerous it is to be a part of the Spectacle. The ‘one day’ they seem to be forgetting, however, is today.
These people are out of touch with reality because reality is too difficult to bear. They are in search of quick answers to complex questions. For instance, one popular slogan is that not since 1939-1941 have the markets dropped 3-years in a row – and whenever the markets have dropped 3-years in a row they have always been higher 5-years later. This picture of history would seem to bode well for the markets going forward, especially if the markets drop this year (3-down years in a row). Yet what is forgotten, or perhaps not recognized at all, is that never before has an entrenched 2-3 year bear market ended with valuations above historical norms. Suffice it to say, those who wish to invest based upon the vagueness of market ‘history’ should, at a minimum, understand that history isn’t about to repeat itself. The hapless investor will not be able to appeal to Caesar that “the markets broke an historical law” should equity prices continue to decline.
Epilogue
From peak to trough almost half of the paper wealth created during the 1982-2000 bull market had been destroyed.
In dollar terms almost $8 Trillion has disappeared from the equity markets over the last 28 months (as of July 02). To put this number into perspective: $8 Trillion could wipe out total consumer credit outstanding almost 5 times over, $8 Trillion is more than 15 times the amount U.S. corporations generated in after tax profits in 2001, and $8 Trillion is equal to ‘annual economic output of Japan, Germany, and Canada combined.’ In sum, $8 Trillion is a stunning amount of money to be destroyed and an amount that will not be magically recovered…
However, beyond all the lost dollars and sense there has been a loss of ‘wealth’ that is immeasurable. What the mauling of the U.S. markets represents is the loss of perspective: that those entertainers risking their lives in the gladiatorial arena are only themselves entertained for a fleeting moment. Then they are impaled.
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