Sand Spring Advisors LLC
In the words of Charles Mackay, author of the famous text Extraordinary Popular Delusions and the Madness of Crowds:
"In reading the history of nations, we find that, like individuals, they have their whims and their peculiarities; their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first."In 1980, the object that so captivated the public mind was the omnipresence of inflation, and the brilliant moves higher in gold and silver. Such was the infatuation that Walter Cronkite reported nightly on the gyrations of gold on the CBS network news. In 2000, the Internet and the omnipotence of American business ingenuity clearly have captivated the public imagination in a similar fashion, and most watch Bloomberg television and CNBC with amazed but trusting interest as to the latest high tech stock that has blossomed into a billion-dollar capitalization.
Per the Mackay quote above, investors run after one delusion "till their attention is caught by some new folly more captivating than the first." We started with Planet Hollywood, matured to TheStreet.com, and are now moving through the Ask Jeeves phase of equity investing - each successive wave of IPOs replacing the former in our minds, each successive "story" replacing the last as a bellwether that all is still fine. Those more feint of heart and conservative stick with the big cap names - the Ciscos, the Lucents, and the Intels -- effectively oblivious to the fact that Intel's operating earnings are basically flat to those that they earned back in 1996. Back in the early 1990's Intel actually had sales growth north of 20% per year; while more recently, their sales growth is closer to nil. But none of that matters. It's just that the stock has vaulted from 14 times earnings to over 50 times earnings for no greater reason than "the public believes."
But the anecdotal signs that this "fixation" is reaching saturation are now sprouting up everywhere. Here are three observations that recently struck me. These are no greater or less profound perspectives than any of us could find on any given day anywhere, but all three of these occurrences "hit" me on the same day. The combined effect left me a bit t agog, pondering our society.
First, when I recently took a flight on Continental Airlines, I was amazed to see that the seatback airphones (that hardly anyone ever seems to use) now have a new LCD display showing the DOW and the NASDAQ (displayed as such in big block letters) updated every 5 minutes. Continental for one presumably assumes that people care about this information just as much as they might global news or the weather. The airline has at least taken the time to refit these new-styled phones into their seatbacks.
Then, when I got to my destination, I flipped on the television in my hotel room and was amazed to find a FOX program entitled "Greed is Good." This is obviously a "I Want to Be a Millionaire" look-alike show that offers not just $1 million as a grand prize but $2 million. My immediate reaction: with a title like that, what more explicit manifestation of America's social fixation with wealth can one find?
Then, an amateur fan of thoroughbred horse racing, I decided to log on to the Internet and peruse the prospective colts for that sport of kings' day of kings - the Kentucky Derby, now just a few weeks away. What I found at the Daily Racing Form website was not only the usual assortment of horse racing articles, but a new "stocks" section that was quite extensive. It specifically featured selected sporting and gaming equities. I guess that this just goes hand in hand with the stock ticker that appeared last summer on the Yankee Stadium outfield scoreboard.
In honor of Robert Prechter's recent landmark book The Wave Principal of Human Social Behavior, let us refer to all of the above as "socionomic" manifestations of man's unconscious herding behavior and society's current "fixation" with trading equities. "Get with the program and trade stocks or get left behind" is today's mantra, and with wage growth in America still soft, many otherwise sane individuals may feel that they have no other choice but to do so. If they don't risk their savings trading stocks, then the kids' college education won't get paid for - it's just that simple. So they not only have a subconscious desire to join their friends trading stocks, but there is an actual perceived need to participate in order to survive. And the nice rationalization behind it all is of course: "This is America. Stocks always go up." When listening to today's Abby Joseph Cohen, one is reminded a bit of the din created by the Bruce Bartons and John J. Rascobs of the 1920s who were forever advising on the radio that to sell stocks was to "sell America short," something unpatriotic, and perhaps even unchristian.
The government also promised that day to make further gold available from the U.S. Treasury (conveniently announcing a far greater amount than they actually had available), so while the corner promptly failed, it is reported that half of all businesses in New York City still folded as a result of that day's panic. And it wasn't going to get significantly better in the years that followed. Equities continued to move downward from 1869 onwards until The Panic of 1873 brought several large Wall Street brokerage bankruptcies and the collapse of many ever-so-popular railroad stocks.
Do you think that the recently invented "ticker" was particularly popular during these times? I doubt it. It had come along just in time to deliver nothing but bad news, stocks trading lower for the better part of a decade and effectively sideways for the next quarter century! It has now taken almost 133 years since the ticker tape's original invention for a new round of innovation to bring the market to an airplane seatback or to a pocket pager placed on a luncheon table for occasional review.
Why do I get the feeling that society has once again given itself a new technology of price delivery just in time for that device to once again deliver unwelcome news?
"The desire to belong to and be accepted by the group is particularly powerful in intensely emotional social settings...The less that reality intrudes on the thinking of a group, the stronger is its collective conformity. Dependence most easily substitutes for rigorous reasoning when knowledge is lacking or logic irrelevant. In a realm such as investing, where so few are knowledgeable, or in a realm such as fads and fashion, where logic is inappropriate and the whole point is to impress other people, the tendency toward dependence is pervasive. Trends in such activities are steered not by rational decisions of individual minds but by the peculiar collective sensibilities of the herd."And given such a natural tendency to herd, the great 1960's economist Hyman Minsky, found that economies quite naturally migrate from a "robust structure to a fragile structure, or from a structure that is consistent with stability to one that is conducive to instability. Financial positions evolve from 'hedge' (backed by ample and stable cash flows) to 'speculative' and finally to 'Ponzi' finance, first as expectations about future returns become increasingly optimistic, and later as expectations are disappointed or financial arrangements are disrupted." In other words, the "fixation" with equities starts in society's mind first which, as it builds, causes our economy to become naturally less stable, which in turn leads to disappointment and collapse. When this latter "cleansing" process is temporarily avoided or suppressed (Mr. Greenspan take note), the pressure to move to an ever-more speculative end of the spectrum simply increases. The willingness to "believe" that collapse is impossible simply gets reinforced, and leads to a general willingness to engage in riskier and riskier projects.
Charles Kindleberger in his classic text Manias, Panics, and Crashes would agree. He writes: "A mania starts with a 'displacement' - some event that increases confidence [the Internet, together with Greenspan's Oct 1998 emergency easings]. Optimism sets in. Confident expectations of a steady stream of prosperity and gross profits lead financial institutions to accept liability structures that decrease liquidity, and that in a more sober climate they would have rejected. The rise is under way and may feed upon itself until it constitutes a mania. The action of each individual is rational -- or would be -- were it not for the fact that others are behaving in the same way. If a man is quick enough to get in and out ahead of the others, he may do well, as insiders do, even though the totality does badly…The additional rise above the true capital will only be imaginary. One added to one by any stretch of vulgar arithmetic will never make three and a half. Consequently all fictitious value must be a loss to some person or other, first or last."
Now all of the above discussion is fine. We accept that on a "macro basis" a socionomically driven speculative bubble exists. The anecdotal and scholarly evidence on social herding is everywhere. But can we find more "micro" example to drive home today's silliness? Of course we can - examples are everywhere, and if we suppress our own limbic impulses to conform, they become obvious.
On March 3, 2000 Bill Fleckenstein of Fleckenstein Capital Management pointed out in his daily Siliconinvestor.com commentary that one small company TimeOne has gone from a price of .50 cents to $9 in the last month. Sporting a still modest market capitalization of just $74 million even at its now loftier price, one wonders what this company could possibly have done to deserve a one-month 1800% increase in price. After all, its primary asset as of mid 1999 was a car wash in Murray, Utah!
Well, Fleckenstein's comments intrigued us, so we did a bit of research. Apparently TimeOne actually sold its car-wash business sometime in 1999 so that the company could derive all of its income from the trading of "securities, interest, and dividends." As of September 1999 the company had current assets of just $2.1 million - clearly just a Utah businessman treating his personal assets as a corporation so that he might write-off the office and accounting expenses associated therewith. The company's recent biggest "score" was the sale of a "Montana property lot" that realized a $6,745 gain.
So why the sudden jump in the stock price? Well somehow using $2.1 million in total current assets, TimeOne Inc. bought 49% of a private company called SunGlobe Fiber Systems Corporation that is trying to develop a "seamless digital Internet and telephony delivery system throughout Latin America." The March 3 press release by TimeOne claims that this system will be operational by June 2000 and will be used by "major foreign and domestic Tier 1 international carriers."
But my question is this: if SunGlobe (for which a thorough search of the Internet shows no reference whatsoever) actually has such a great product, why would they sell 49% of it to TimeOne? And besides a nice TimeOne press release to lift its stock price, what did the owners of SunGlobe get in return for TimeOne's 49% share of their activities? Presumably cash somewhere short of the total cash TimeOne had on hand last fall of $1.2 million. And yet the market suddenly gives TimeOne a capitalization of $74 million? I'm sorry but this type of rags to riches story just doesn't make any sense. It smells of blatant stock manipulation and a non-savvy public jumping on board without researching what it is that they are buying and at what cost.
Here's another story that is almost as silly. In recent months, a number of small mining companies have decided to "throw in the towel" on their traditional mining and exploration businesses and to completely reformulate their companies. At times this has simply been a legal vehicle to start a new company from within the shell of an old defunct entity, but at times it has been a true burning desire by management to toss out "the baby and the bath water" and to start anew.
Take for example the company Vengold (VENGF), a small Vancouver-based gold mining outfit that has tried to reinvent itself a few times. First in the early 1990s they bought some promising mining properties along the "Guyana Shield" fault line in Venezuela (renaming themselves Vengold from some other name prior to that time). A neighboring property struck substantive quantities of gold and Vengold was hopeful that they would as well. They came up with nada. The stock went from $3 to $18 to $1 in a matter of months.
Then Vengold decided to regroup and buy an investment in a much bigger gold project, Lihir Gold Mines in Papua New Guinea, hopeful that their 12%+ share in one of the richest gold mines in the world would grow in value and potentially perhaps get bought out. But Gold languished at such low levels that the Lihir investment slowly deteriorated. Their investment recently became so painful that Vengold was forced to sell the majority of its Lihir shares just to ensure adequate resources to repay its bank debt. This translates into having previously leveraged up to buy Lihir shares above $35 a share only to resell them closer to $12 and wipe out all of Vengold shareholder equity save 16 cents per share in cash ($21 million given 125 million shares outstanding), and a remaining Lihir investment roughly equal to the company's remaining debt. Indeed, the stock recently sank to trade at a price under 20 cents.
Now, however, management of Vengold has a new plan. Per its December 10 press release, the company has identified "the need for a significant pool of capital targeted at the Internet and e-commerce industry" and has decided that in the future "it will focus on investing its [remaining limited] resources in private Internet related companies." The same press release stated that the company currently held cash and securities "valued in excess of Cdn $70 million" but failed to mention that it was also carrying long term debt equal to about half of this. Basically the company still has cash available to invest of just $20 million or the .16 cents a share that the company was trading at as recently as last September. Not to help matters, their remaining investment in Lihir has slumped in value by another 25% since last fall.
But low and behold, on February 17th Vengold announced that they were going to rename themselves (yet again) Itemus, Inc. and had formed a new board of advisors that they are calling "the National E-Dream Team. " The "dream team" consists of the founders of IdeaPark.com, a former Yorkton Securities tech analyst, the founder of Intrasoft.com, and a former employee of CMGI.
Now I have no idea if any of these fellows are any good or not, but I do know that Vengold/Itemus still only has $20 million in cash and no other immediate new investments. All they have is a new management board and some hopes and dreams. Yet since this latest announcement, the stock has vaulted 500% from .50 cents a share to $2.5 last Friday. Suddenly this company is once again "worth" a market capitalization of $312.5 million, before they have even invested in anything. Now this is ridiculous. Vengold/Itemus is suddenly being valued at almost 75% of the total current value of the Lihir gold mine of which they now only own 5.7% -- just because of a new management board! I for one would take 75% of Lihir over all of Vengold/Itemus any day of the week. For those who care to think in options terms, as I do, it's a simple case of intrinsic value compared to pure time value.
Now you cannot fault Vengold management for trying to reinvent themselves -- for continuing to come back off-the-mat so to speak -- but is a new board of advisors really worth this stock trading up from its book value to over ten times book? More importantly, shouldn't the market be laughing (crying) at these folks on the third go-round? After all, every other step this company has made over the past 10-years has only ended in tears. But the market is neither laughing nor crying - they're buying! Vengold has done nothing but disappoint its investors for years, but the company has seemingly found yet another round of investors ever so willing to give them a chance, and to buy into their dream - and to pay 16x available investment capital for the privilege to do so. With such instant gratification in its stock's performance, it is a wonder that every gold mining company is not planning a similar path. Clearly they should. What's the barrier to doing so, besides losing one's pride?
Not only is Vengold and other gold mining companies trying to reinvent themselves as a dot-com entities, but I heard today that JP Morgan is closing its bullion trading operations in New York, leaving a handful of traders to now run that business solely from London. Previously in 1999 they exited the oil and base metals business as well. Now when a big bureaucratic bank decides to get out of the commodity business, you know that in a contrarian fashion, this business is finally due for an upswing. After all, JP Morgan only got into the bullion business in late 1980 - right after that business's peak, and at the same time that Goldman Sachs felt compelled to purchase its commodity subsidiary J Aron.
We believe strongly that a mania does exist. The limbic part of the brain has taken over the investment process, while balance sheets and realistic investment considerations are being pushed to the back burner only for curmudgeons.
All manias end of course, and by definition, they tend to end badly. Bad news may be sloughed off until one day, a piece of news will seemingly be latched upon to signal a turn in psychology. In the 1890's it was the Bank of England warning to Barings to limit its amount of Argentine acceptances. In 1929 it was a Fed rate hike to reverse earlier 1928 rate cuts that had caused unforeseen speculative consequences. All one needs is that final prick, and as well intentioned or as small as that prick may be, it can with time devastate a market that has already reached a mania stage.
We say "with time" because when the prick comes, some may notice it and some intitially may not. To quote from Charles Mackay once more: "Men it has been said, think in herds; they go mad in herds, while they only recover their senses slowly, and one by one." When the New York Comex instituted a "liquidation only" rule together with tapered position limits on the March 1980 silver expiry, prices did not drop at once. Not everyone's lightbulb had been illuminated with the word "bearish," although that certainly turned out to be the case. So too is the current market tempting fate by thumbing its nose at the prospect of several further Fed rate hikes. Historically 6% base rates (a level we are quickly approaching) have been high enough to squash past speculative excess - at least if 1987 U.S. equities or 1989 Japanese equities hold any historical precedent.
Many think Greenspan holds the key to the economy's health and trust that he will not turn that key to derail it. What they fail to understand however is that the social herding mentality, not Greenspan, really holds the key, and that this mentality can change for other reasons besides rates going up - although such may be the excuse that people will focus on.
Already in the past six months we have seen a mild turn in social preferences whereby movies such as The Blair Witch Project and Boiler Room have received popular acclaim. These are not bull market movies like Mary Poppins or The Lion King that both appeared several years in front of final equity highs for their respective eras. Conversely, the recent Disney re-release of a suped-up Fantasia has been met with mediocre reviews that call it "hollow and disappointing," and the recent upbeat King and I remake starring Jody Foster was a disappointment at the box-office relative to its cost of production. For whatever deep-seeded psychological reasons, people are slowly turning from wanting upbeat movies to being ready for downbeat ones. These types of anecdotal socionomic observations argue that -- like most stocks -- equities may already have peaked, or are certainly close to doing so.
The next rate hike may simply be the excuse that pushes society over the edge to recognize what many subconsciously already know is in the offing: a crash. Most still hold a certain fixation with equities, but despite airline seatback LCD displays showing us the latest index levels, that fixation may already be on the wane.
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