“Bearish resolve... is snapping like dry tinder thrust against the knee of insanity.”
– Tim Knight
Your editor fondly remembers the first newsletter he ever laid eyes on. It was Strategic Investment, with James Dale Davidson and William Rees-Mogg.
This was back in the mid-1990s or so. I was introduced to SI by the same friend who had a copy of Jim Rogers’ Investment Biker laying around on his dorm room floor. That book, in combination with Davidson and Rees-Mogg’s brilliant letter, stoked a passion for markets that burns to this day.
(As fate would have it, I had a chance to meet Jim Davidson in person 12 years later. We had cocktails in his elegant Buenos Aires apartment, prior to heading out as a foursome for a round of Malbecs and Ojo De Bife. But that’s another story...)
At its height, Strategic Investment was one of the greatest newsletters of all time. I was a subscriber in the peak years – the late 1990s – and could hardly wait to tear open each new issue. When the SI message boards took off, I became a regular poster in a community of well-informed investors and traders. It was a wonderful thing.
And then something truly bizarre happened.
You remember the dot-com bubble, right? Who could forget it? Tech stocks trading at infinite multiples (somehow justified by negative earnings)... the Pets.com sock puppet... new IPOs quadrupling and quintupling in a single day... insane boasts like “We just wasted $1 million on this Super Bowl ad”... manic talk of “eyeball share” and “the new economy”... the Electronic Data Systems “herding cats” commercial, one of the funniest (and most pointless) media spends of all time... and so on.
As the tech mania unfolded, Strategic Investment remained resolutely and intelligently bearish. Picking apart the twisted logic of addle-brained cheerleader analysts became something of a sport – even if it felt like shooting fish in a barrel in the most egregious instances. It was only a matter of time, SI readers were reminded, until the profitless house of cards collapsed in on itself. Gravity (and sanity) would prevail.
But then, at the eleventh hour – perhaps closer to half past midnight – Davidson changed his mind. In a breathtaking pirouette of logic and reasoning, the Strategic Investment stance on the grand dot-com phenomenon morphed from “cynical worldly-wise bear” to “raging dyed-in-the-wool bull.”
As a devoted subscriber, your editor could hardly believe it. All of a sudden, instead of trenchant and biting analysis, the pages of SI were filled with “bizarro” analysis. Scorn turned to praise. Nutty price-to-earnings multiples, so long laughed at, were suddenly somehow justified. The forecasts of a glittering tech utopia, once mocked, were now extolled for their boldness and vision.
As Nassim Taleb quipped in one of his books, “It was as if the Pope had converted to Islam.”
Then Came the Reckoning
With the benefit of hindsight, you can probably guess what happened next.
As far as the doomed dot-com bubble was concerned, Strategic Investment “1.0” turned out to have it exactly right (or close enough to hit the eventual bull’s eye). The new-economy-loving, tech-embracing Strategic Investment “2.0,” however, had gotten it terribly wrong.
For a fleeting period of time, the jury remained out on the dramatic shift. But then the mania ran out of gas. The dot-com juggernaut, fueled as it was by hype, restricted share sales, bogus data points and hot air, eventually collapsed and imploded in a manner that seemed wholly predestined with hindsight.
And as the dot-commers’ fortunes quite literally collapsed, so, too, did the publishing fortunes of one of the greatest newsletters ever. Strategic Investment limped on for another few years after that, but was never the same. Readers were too shell-shocked, perhaps, by the conversion and its jarring conclusion. In time, the letter drew to a quiet close.
So why did it happen? Why did those who saw so early and so clearly – Davidson and Rees-Mogg in this case – decide to turn bullish in the eleventh hour of the mania, hitching SI’s wagon to a bottle rocket in the final stages of fuel burn?
It’s an interesting question, and not one limited to a single letter. Many lose their nerve when a crazy move gets crazy enough, perhaps as a function of human nature. Your editor recalls the great Quantum fund (of Soros and Rogers fame) getting caught out too, in the end... buying tech stocks in the final stretch out of sheer frustration as much as anything.
The episode supports a modest theory, which runs more or less as follows: The relentless rise in worthless dot-com names, nutty as it was, eventually stoked so much peer pressure that being on the sidelines – or, worse yet, standing in opposition to the move – simply became too psychologically painful to bear.
And that, in turn, ushers forth a cruel bon mot. When the last bear throws in the towel, the fat lady clears her throat to sing.
Markets are perverse entities in that rationality only plays a small role in the setting of prices... sometimes a vanishingly small part. Logic, sentiment and emotion are all mixed together (with government meddling as the cherry on top). As pundits seek to justify outcomes they like (i.e. stocks going up), this combination inevitably results in some seriously circular logic.
If stock prices rise fast enough or far enough, for example, one almost always winds up with some broadly circulated version of the following:
The stock market is going up because the fundamentals are justified. How do we know the fundamentals are justified? Because the stock market is going up.
Funny, too, the way efficient market theory (EMT) actually encourages and enables emotion-driven bubbles. Those who presume that the market is always rational had instant justification for buying dot-com stocks at infinite multiples – and, indeed, have a source of instant justification in future for buying any market at any price. Because, hey, if the market is always rational...
Near the tail end of liquidity driven bubbles (and bear market rallies), this self-serving bit of tautology becomes a giant wooden mallet for true believers to bash bears over the head with. The basic argument is invariably couched in some fashionable thesis or data point du jour, but the underlying thrust of logic (anti-logic?) is the same.
Meanwhile the fur-depleted bears, who grow tired of getting repeatedly bashed, eventually throw in the towel and say “Yes, okay, fine, perhaps you are right... perhaps we missed something... perhaps argument ABC or XYZ, which previously seemed ludicrous, is actually sound,” and so on.
The Verdict of History
And what does market history say about who is right? Unfortunately, history does not speak with one voice on this. To remain resolutely bearish post-1982, for example, would have been a pretty lousy idea. And yet, on the other hand, to have shoved all one’s chips in near the peak of the über-impressive bear market rallies of the 1930s, the 1970s, and other grizzly decades past – not to mention buying dot-com stocks in late 1999 or residential real estate circa 2006 – would have counted as a recipe for disaster.
Your editor sees at least three broad takeaways here:
The market has a documented history of soaring like Icarus, then plummeting back to earth. The investing “herd” has taken many a jaunt to Planet Pangloss, and paid for the experience with a violent return trip. There is all kinds of precedent, especially in bear markets, for soaring rallies and precipitous declines. Key point being, characters saying “it’s a new bull market, prices will double from here” at the very time the rally is peaking would not count as a new phenomenon. Rather, it would count as a very old phenomenon. There is a cast of characters who will always and everywhere say the same thing. Certain forecasters and prognosticators are on record coming to the same conclusions, day in and day out, regardless of dramatic shifts in general conditions. (A certain long-time Forbes columnist comes to mind here.) These people are worse than useless at critical market junctures. While the risk factor is greatly increased upon buying into a heavily extended market rally, their thinking does not adjust one whit. Because history does not truly repeat (but only sometimes rhymes), arguments must be considered on a situational basis. As repeatedly underscored in Reminiscences of a Stock Operator, in times of great uncertaintyone must become a student of general conditions. This means cultivating the ability to assess the underlying soundness and logic of an argument – or otherwise retaining the fleet-footedness of a trader – before buying in to any aggressive market forecast. As Larry Livingston (aka Jesse Livermore) put it: “You have to use your brains and your vision to do this; otherwise my advice would be as idiotic as to tell you to buy cheap and sell dear.”
Et Tu, Grant?
This whole topic sprang to mind thanks to a notable Wall Street Journal op-ed posted over the weekend. In the op-ed piece, titled “From Bear to Bull,” James Grant of Grant’s Interest Rate Observer lays out his case for turning bullish (after long being bearish) on the prospects for economic recovery.
The piece begins with a touch of hemming and hawing. Grant starts by pointing out that “the future is unfathomable,” and reminds readers that great investors primarily seek out compelling values (as opposed to compelling forecasts).
But then Grant goes on to heartily endorse the extremely shallow WSJ summation of his stance: “The deeper the slump, the zippier the recovery.” The gist of this three-inches-deep idea is that hey, things were just really ugly... so historically speaking, that means things should now look really good again soon.
Grant finishes by suggesting that global economic pessimism is too entrenched (even with all manner of fly-by-night junk stocks having led the charge to gains of more than 50%).
I am a big fan of Jim Grant, a witty market historian who has been publishing Grant’s Interest Rate Observer for more than a quarter-century. As with the old (and now defunct) Strategic Investment, I look forward to reading the latest issue of Grant’s the same day it arrives in the post.
And so, on coming across this flimsy bullish argument from such a noted long-time bear – essentially the idea that “the economy will recover quickly because it always has” – I couldn’t help but ask myself: “Did Jim Grant just pull a Jim Davidson? Is this capitulation déjà vu... an eleventh hour turn all over again?”
Or, as Michael Panzner so aptly put it: “Did one of the world’s best known bears just ring the bell at the top of the great dead cat bounce?”
The proof, as they say, will be in the pudding of the next few quarters. Tomorrow we’ll take another look at reasons why the “V-shaped recovery” arguments, now soaring with the borrowed wings of runaway equity prices, may well be little more than postcards from Planet Pangloss.
Justice Litle, Editorial Director,
Taipan Publishing Group