“There’s one born every minute,” said P.T. Barnum. And yet, near the peak of a bull market, the one-per-minute estimate seems low. Everyone seems to be a fool.
“Things change,” notes Richard Russellin today’s commentary. “A year ago the following four Internet stocks were considered the blue chips of the net, the stocks you could buy and put away for the kids. They were AOL, AMZN, YHOO and CMGI. I added together the peak prices for the four, and it came to 621. At latest count the current price of the four adds up to 249. That’s a decline of 59% from the highs… Reality has come to the Internet, and it’s still coming.”
“What am I trying to prove? I’m trying to prove that it’s tough to make money in a bear market, even when you buy the most glamorous stocks in the hottest group. Of course, buying the most popular stocks in the hottest and most hyped groups is always a study of the `greater fool’ thesis. And if you buy the hot stocks and the hot group and then you run out of greater fools, well horror of horrors, you wake up to find that it’s YOU who are the greater fool.”
The idea of the greater fool concept is that no matter what price you pay for a stock, there is usually someone willing to pay a higher price. In a bull market – that is, a time of rising expectations and rising euphoria – there are plenty of fools, both great and small. But eventually, the greatest fool of all steps into the market. In the case of the Dow, the world’s biggest fool was a buyer on January 14, 2000. Since then, the fools have seen some shrinkage in their net worths. Four times, the Dow has rallied. And each time, the rally stalled at a lower point.
But as Mark Twain put it, “I may be a fool. But I am God’s fool. And all His works deserve respect.”
By all measures, the Dow at 11,722, was overpriced. Nobel prize-winning economist, James Tobin, developed something known as “q” to determine just how overpriced the market was. The idea is simple. A company should be worth what it would cost to replace it. This is something we think about in private business acquisitions. Instead of buying a company, we ask ourselves, what would it cost to recreate it?
The market price of a stock should be the equivalent of its replacement cost. The q ratio, which has the market price as the numerator of a fraction and the replacement cost as the denominator, should, therefore, be 1.
Andrew Smithers, a London investment advisor, and Stephen Wright, an economist at Cambridge, have written a book, “Valuing Wall Street: Protecting Wealth in Turbulent Markets.” In it, they applied the concept of q to the entire stock market, and discovered that this market was and still is far higher now than either before the crash of ’29 or the bear market of ’73-’74. In fact, were the market to follow the pattern of post-’29, the Dow would have to fall below 2,000. If it merely follows the example of the ’73-’74 bear market, it would fall below 4,000.
Either way, the dividends were so meager, and the threat of capital losses so great, that buying on January 14th – as, by the grace of God, I pointed out back then – had to be a foolish thing to do. And yet, God created plenty of fools ready, willing and eager to do so.
“There are three aspects to the human character,” says my friend Francois, a man so out-of-step with modernity that he lives in a house in the Paris suburbs without a phone or central heating. “There is the rational aspect, the aesthetic aspect, and the spiritual aspect. But these days, people only consider one of them.”
He refers to man’s sense of reason. We are all rationalists now. Every one of the investors who bought the hottest stocks at their moments of most intense molecular activity – Amazon at 113 in December or the Dow on January 14th at 11,722 – had a reasonable explanation: “These are ‘must own’ stocks for the New Era.” … “I’m a long-term, buy- and-hold investor. I don’t care if they go down in the short run.” … “Everyone’s buying them. I heard someone on CNBC say Amazon was underpriced.” (As reported here, someone calling himself an analyst and drawing a salary from a large brokerage thought Amazon should be trading at $125!)
All of these rationalizations were “reasonable.” And who knows, the Dow could have gone higher. And Amazon may yet hit $125. But reason might just as well have driven an investor to an opposite conclusion: that the stocks were too expensive.
“I don’t know what you see in that church service,” complained my son Will, 21, after joining us last weekend at the church in Bourg Archambault. “You stand up. You sit down. You chant. What’s the point?”
Neither Will’s aesthetic sensibilities, nor his spiritual ones, were moved by the little Catholic service. He got no sense of exaltation, no connection to supernatural powers, no hint of God’s purpose or His designs. No religious rush. The whole service might as well have been in a foreign language – which, of course, it was. Maybe had we gone to St. Peters, he would have been impressed by the gilt and frescoes – but in little Bourg Archambault there was not even that.
The ability to reason peaks in the late teens and early 20s. These are also the years in which people are most unreasonable. Everything is subjected to rational criticism. Going to church makes no sense to Will. It is neither entertaining, nor productive. It is not a reasonable thing to do.
And yet, as someone once said of a crazy man: “all he had left was his sense of reason.” He could add and subtract. Two plus two still equalled four. But he was insane – beyond the reach of ordinary conversation, like a space probe that overshoots its target and drifts into cosmic nothingness.
We are all God’s fools. We reason. But it is not reason that causes us to buy stocks at crazy prices, or sell them at good prices. It is desire dressed up to sound reasonable. Eventually, desire will give way to fear and that will seem reasonable too.
Your faithful, foolish friend,
Paris, France June 28, 2000
P.S. A few months ago, it seemed reasonable to buy Internet stocks at almost any price. These companies represented the wave of the future. Now they seem to be drowning in the surf. An e-mail message I received recently:
Sites most likely to go belly-up, according to a popular web site: 1 CDNow
*** It was a dull day on Wall Street yesterday, as the pros and cons waited for the Fed to announce its latest discount rate policy. That announcement is expected today. And it is expected to be a declaration of contentment with the status quo.
*** The Dow fell a bit. The status quo is becoming less and less favorable to real economy businesses. After 6 rate hikes, and an oil price above $30, the expense side of business ledgers is beginning to get a little heavy.
*** Kaufman and Broad, for example, the nation’s largest homebuilder warned that earnings will suffer. Transportation stocks have been hit hard.
*** The Nasdaq did no better. The index was down 53 points. Celera dropped again yesterday. After announcing the completion of the genome map, and declaring its intention to give away the product it spent $150 million of investors’ money to create, those self-same investors are asking: “how are you going to make any money?” Answer: no one knows.
*** Amazon bounced a little. But poor Bezos is struggling. “The party is over” said the Lehman Bros. analyst who reported Monday that Amazon was running out of cash. For every dollar in revenues, the company has raised 95 cents from the capital markets. It now has a pile of debt…and still a need for new cash. Even if it could somehow cut back to reduce costs and break even on operations, it still has to service the debt.
*** Where could Amazon raise more money? The Lehman analyst “carefully examines all the potential sources of funds – from banks and junk bonds through converts and equity,” writes Alan Abelson in Barrons, “and finds not one that’s likely to prove hospitable.”
*** Readers may recall that Amazon, though ridiculed and calumnied in these letters, has been the sweetheart of investors for several years. Alas, with the heat of summer, ardent suitors are demanding that the company, so coy for so long, put out or get out.
*** Gold dropped $2. Harry Schultz told me that the Gold Conference, which took place across town at the Inter- Continental Hotel, should have been called the ‘Anti-Gold Conference,” so negative were the attendees.
*** The dollar fell yesterday. Remember, a steep drop in the dollar will mean the end of the whole thing – the bubble…the illusion of wealth…the summer of love…
*** Twenty new IPOs are scheduled for this week. It will be interesting so see how they fare.
*** Certainly something has changed. A few months ago, an entrepreneur could expect phone calls from venture capitalists eager to sponsor him for membership in the public markets. Now, I’m getting calls from entrepreneurs of dot.com companies looking for private financing. “Are you profitable,” I ask. “Not yet,” is the most common reply.
*** But the situation in the venture capital markets is creating some interesting opportunities. Entrepreneurs – fired up by the prospect of easy billions – have started thousands of projects, and now find venture capitalists won’t talk to them. A few of these new projects, by dumb luck as much as anything, are decent businesses. See the advertisement below for how I hope to take advantage of this situation.
*** “I can’t think of any time when two members of the Fed’s Open Market Committee (FOMC) dismissed the Bureau of Labor Statistics (BLS) data as ‘not credible.’ ” says Ray Devoe. The BLS calculates that Average Hourly Earnings were rising at a relatively mild 3.4% annual rate, but says Ray: “in my area of the New Jersey Coast (the Irish Riviera) the local McDonalds has only four of the eight stations manned… because they cannot hire the people needed, even at wages well above the minimum. Anyone who recommends a person who is hired there receives a $100 gift certificate.”
*** Stock options given to executives doubled between 1997 and 1999. Non-option compensation remained the same. Is it any wonder “unlocking shareholder value” is the number one concern of American business leaders?
*** This is the anniversary of the assassination of the Archduke Ferdinand and his wife, Sofia. History, too, takes us in unexpected directions. The Archduke took a wrong turn on his short trip through Sarajevo, one which took him, by chance, within pistol range of his killer. Five years and millions of bodies later, on this very same day, the Treaty of Versailles was signed, formally ending the first world war and preparing the ground for the next one.