The Million-Eyed Market
Vanity, vanity…all is vanity…
Vanity is probably responsible for more crack-ups than any other character flaw.
The Greek tragedies almost always follow the same plot. Driven by some sort of vanity, a man challenges the gods. He is then humbled…usually in a gruesome or terrifying way. Prometheus, who stole fire from the gods to give it to human beings, was chained to Mount Olympus where eagles set to work plucking out his entrails. If that wasn’t bad enough, the poor man miraculously recovered every night…so the birds could come back and do it again, over and over, for all eternity.
The mess in Iraq is also largely a result of vanity. The neocons had a plan for the world. No need to ask the world about it, though – they knew better.
Besides, no matter what the foreigners said, the neocons knew that deep down, they all longed to be just like Americans. All the United States had to do was to storm into Baghdad; the kids would line up to get candy…adults would line up to vote and get credit cards.
And now the U.S. army is chained down in Iraq…where terrorists and military contractors devour its innards.
Vanity gets investors into trouble too.
“There is record brokerage margin money out. There is record insider selling in the U.S. since 2000. There is record corporate buyout activity and mergers. Half of all corporate buyouts are for companies that are not profitable! Did you know that?” asks one commentator.
For confirmation, we turn to today’s International Herald Tribune, where we get more details on the sale of Blackstone shares to the public. The article notes that the private equity firm’s founders, Stephen Schwarzman and Peter Peterson, will walk away with $2.3 billion of the $4.7 billion IPO. Peterson is retiring. He earned $213 million last year. So, the $1.88 billion he will get from selling his stake in Blackstone will help supplement his Social Security payments. Even at $213 million in last year’s pay envelope, he must have felt a little light in the wallet. The average pay of 25 top hedge fund managers was more than twice that much last year – $570 million.
But now Schwarzman and Peterson have hit pay dirt…along with the rest of the Blackstone team. The insiders are being taken out by the outsiders.
Let us pause a second to draw breath. We turn our heads upwards to marvel at the monumental vanity…the outrageous arrogance…of these poor outsiders…the retail investors who are buying Blackstone’s shares.
You will recall, dear reader, that every investor needs a certain amount of arrogance. Mr. Market sets a price – taking into account all that is known about an asset. No one knows the future, of course, but Mr. Market has a million eyes…and he sees all that can be seen. He factors the future, as he sees it, as well as the past, into his price.
Then, along comes an investor from Salem or Seattle or Sun City who says to himself: “I think Mr. Market has miscalculated. This share is more valuable than he thinks. It’s going up.”
What audacity! What chutzpah! What arrogance! The investor is making a remarkable wager – that he can outsmart all the rest of the investing public all put together.
But now think about the poor lames who are buying Blackstone shares. Think of the Chinese government. When it comes to capitalism, these guys were born yesterday; they are still pink and soft. Out on the streets of Shanghai, Moms and Pops fresh off the farm line up to open brokerage accounts. And in the boardrooms of the Peoples’ Bank of China, the baby hacks – still wet behind the ears – who guard the people’s money have decided to buy Blackstone shares!
Of course, China is a special case. The billions the Chinese spend on Blackstone is chicken feed to them. They’ve got a trillion more where that came from. They can write it off as cheap tuition – part of the cost of learning how the market system works.
But other investors are merely playing make-believe in Disney World. Money from the IPO will not be used to expand the firm and make it more profitable. Instead, it will go directly into the pockets of the people who know it best. In fact, today’s report tells us that the company is likely to show a loss for several years – because of the cost of the IPO itself. So, the investors who pick up Blackstone shares are betting not only that they can outsmart the entire market, but that they can outsmart Mr. Market’s smartest lieutenants. Schwarzman and Peterson started the firm with $400,000. Twenty years and nearly 200 deals later, it is worth $32 billion. How can an ordinary retail investor hope to put one over on this dynamic duo?
Well…good luck to him.
The real problem is that most investors completely misunderstand what business Wall Street and the City here in London are in. A baker trades his bread for money; but what does a Wall Street financier trade? His expertise is at making money. If he sells you a share of a stock, he must believe that he can make more money selling it to you than holding onto it. His offer to sell must be weighed against the gravity of his professional ability. The heavier his expertise, the more the offer is suspect. In other words, the more able your financial advisor, the more cautious you should be when taking his advice.
Wall Street is fundamentally in the business of selling things it doesn’t want to hold. Blackstone founders held onto their shares for many years, as the company rose to astounding heights. Now, they are selling. Draw your own conclusion, dear reader.
Our conclusion is that the financial industry makes money for itself by unloading investments to the retail public, after they’ve been stripped down as close to the bone as you’ll see outside a video containing a certain “hotel heiress”.
The assets are squeezed, picked over, packaged, marked up, advertised, promoted, and then unloaded at retail prices. Often, the best parts are held off the market for themselves, until the insiders choose a time, place and method of dumping them on the public for the maximum profit.
In other words, the financial industry doesn’t create wealth; it redistributes it – from investors to itself. And now, in the midst of this Great Worldwide Bubble, business has never been better.
[Correction: In the Weekend Edition, Short Fuse wrote about the Blackstone deal – and made a minor transcribing error. She wrote: “more than two-thirds of central banks worldwide would rather diversify their foreign currency reserves with bonds rather than U.S. treasuries.”
It should read OTHER than U.S. treasuries.]
The Daily Reckoning
Tuesday, June 12, 2007
Addison Wiggin, reporting from Baltimore…
“Trade wars on the horizon? New legislation that would tax Chinese imports (proposed by Sens. Schumer and Graham) is expected to rear its ugly head this month. The last time this dynamic duo tried to get their bill passed, they proposed a 27.5% tariff on all Chinese goods coming into the U.S.”
To read the rest of the story, see today’s issue of… The 5 Min. Forecast
And further thoughts…
*** Money makes the world go round. Which is why watching money is so entertaining. It is like watching the Three Stooges – it’s one absurd pratfall after another.
While Wall Street redistributes wealth from the novices to the pros – from “weak hands” to strong ones, as the pros themselves put it – corporate America does its own share of redistribution, taking it from the soft hands of retail investors and pensioners and putting it into the calloused paws of elite insiders.
“CEO Compensation Skyrockets,” says an AP headline. Half of America’s top chief executives, those at S&P 500 firms, make more than $8.3 million per year, adds the article.
Of course, we’re perfectly happy for CEOs and Wall Street hustlers to make as much as they want. It’s all part of the public spectacle, as far as we’re concerned.
But we remind readers that the shows change. Sometimes, it’s a gay farce that viewers want to tune in to. Other times, it is a sour tragedy. Sometimes, investors are perfectly happy to pay their hired hands millions; other times, they get stingy and hold back every cent in case they need it. Sometimes too, they rush to buy whatever Wall Street offers them. Other times, the poor stockbrokers wait by silent phones.
The difference lies in the quantity of money. When credit expands, people get a little free and easy with it. They spend and lend recklessly, sure that there will always be more of it. Inevitably, they get too much of a good thing. Soon, people can’t pay their bills…lenders get scared…consumers cut back…investors panic. Then, the whole spectacle changes. No more light-hearted tap-dancing. Instead, viewers want to see the proud protagonists punished. They want to see the powerful humbled and the rich roasted.
How will you know when the playbill changes? Watch the bond market. Bond yields have been rising. This makes it tougher for the housing market to recover and pokes a hole in the huge credit bubble. So far, it is just a tiny puncture. But the hissing sound is probably enough to discourage the Fed from raising rates. And if it grows louder, it could signal the end of the biggest show on earth.
*** In fact, it could all soon be coming to an end, if you believe the stars. “Stand by for trouble in the summer of 2008,” warns financial astrologer Robert Gover.
Gover explains that the opposition of Saturn and Neptune – 180 degrees apart – happens every 76.6 years. This was noticed by the Mayans and portends bad things. The last time it happened was, well…what a surprise, 76.6 years ago! That was in 1932. Now here we are again, sitting on the biggest Bubble ever. “Our monetary system is ready to be blown away,” says Gover.
*** We have gone into exile. Faced with paying more than 100% of our income in taxes, we have fled France for good. Well, we have fled France…whether for good or for ill, we don’t know. Our liver doesn’t feel so good.
The Daily Reckoning PRESENTS: You have probably heard the expression about generals always fighting the last war. Investors, too, tend to invest by looking in the rear-view mirror. In both cases, the consequences are costly. Chris Mayer explains…
FIGHTING THE LAST WAR
British Field Marshal Sir Douglas Haig is an example of the kind of general who is ‘always fighting the last war’. World War I was the first mechanized war. Yet Haig still believed in the frontal assault and the power of cavalry. He discounted the trappings of modern war, such as the effectiveness of the machine gun. Haig’s ideas on warfare were hopelessly out of date.
As historian Geoffrey Norman wrote: “His fantasies of cavalry charges across open country were matched by his insistence on sending infantry against the enemy in neat ranks at a slow walk, to better maintain discipline.” Even against machine guns.
Therefore, when he led the British in the Battle of the Somme, the result was disastrous – nearly 60,000 casualties on the first day. Haig’s army suffered more than 400,000 casualties over a four-month stretch. It was one of the bloodiest battles in history.
Haig, though, seemed completely unrepentant and learned nothing from the experience. As late as 1926 – years after the horror of World War I ended – Haig still clung to old-world notions of warfare. He wrote the following, which I reproduce because it is so unbelievable, so astonishing, that it makes one wonder how the human race ever got as far as it has:
“I believe that the value of the horse and the opportunity for the horse in the future are likely to be as great as ever. Aeroplanes and tanks are only accessories to the men and the horse, and I feel sure that as time goes on you find just as much use for the horse – the well-bred horse – as you have ever done in the past.”
Haig was a fool and it cost Britain the lives of many men, who surely would have gone on to do better things than die in some muddy field in northern France.
The stakes are not so high for you as an investor, of course. Yet the idea of generals fighting the last war is a good metaphor for investors who are slow to realize – or refuse to realize – how the world has changed right before their eyes.
Harvey Sawikin suggested that investors today might be like those generals who are always fighting the last war.
Harvey Sawikin runs the Firebird Fund. Firebird has been one of the top-rated funds of the last five years – netting investors a 35% annual return. Dan Amoss (editor of the fine letter Strategic Investment) and I heard Sawikin speak at a recent luncheon put on by the Baltimore CFA Society.
Firebird focuses on the old Soviet Union and Eastern Europe. And those markets have been on fire over the past few years. Anybody who invested in Russia over the last 24 months has done extremely well. Listening to him talk, however, it is pretty clear that Sawikin knows these markets. He’s also been doing this since 1994. So he’s no spring chicken, as the saying goes.
A few points stand out from his talk and I’d like to share them with you here. They speak to the profound changes taking place in the world today, those that rear-view-thinking investors will likely miss.
The first big change is the idea that the U.S. markets will no longer lead other markets. For a time, it was true; as U.S. markets went, so went the rest of the world. However, the facts no longer bear this out.
As The Wall Street Journal recently reported: “During the two-year period that ended in February, correlation between U.S. and other developed markets was 0.63, according to ING Asset Management. That is a big decline from 2003-2005, when they practically moved in lockstep, at 0.93.”
Sawikin’s own boots-on-the-ground experience backs these bloodless statistics. He believes business and growth in overseas markets are robust enough that they are not as dependent on the U.S.
Sawikin opines that the price of oil is one example of the effect of this weaker link. “Why isn’t the price of oil higher?” he asks, given the relatively tight supply and demand for it. Based on his own observations, Sawikin believes the U.S. economy is already in a slowdown. Yet the price of oil is still in the $60s because of the demand from China and India. “The U.S. is not the driver anymore,” he says.
He gave some interesting insight into Russian oil production. Sawikin says the Russians want to increase production, but not at these prices. “They don’t want dollars at the current valuation,” Sawikin notes. “Officials have said so explicitly.” We are at the point where people would rather hold tangible things – such as a barrel of oil, or acre-feet of water or a stretch of timberland – than accept the dollars they can get for them.
Which gets us to the second point: We are all going to have to pay attention to the weakening dollar, which has had a big impact on returns and how markets behave. “We’ve had ideal conditions for dollar alternatives,” Sawikin says. The fall in the dollar is no longer a topic reserved for doomsayers.
Even Warren Buffett, at his last annual meeting, said that the days when Americans could ignore currencies are long gone. “Look at oil going from $30 to $60 and the euro from 83 cents [per dollar] to $1.35,” Buffett said. “So the price of oil for Europeans has gone up very little – 25% versus 100% for us. It’s easy to anchor on your own currency. You’ll have to think more about currency than you have. Around the world, others think about currencies, but the average American hasn’t had to.”
Beyond these points, Sawikin also had many interesting anecdotes on investing in Russia specifically. This is a market that fascinates me, but I am far from pulling the trigger on a Russian investment.
Sawikin talked about traditional measures such as EBITDA. For Russia, his firm has a humorous variation called EBITDAS – which stands for earnings before interest, taxes, depreciation, amortization and stealing. In Russia, investors must consider the impact of thieving managements, which is a unique twist, to say the least.
He also found success investing in nonstrategic markets – such as consumer goods and banking. And he has stayed away from oil, gas and most of the metals, in which Russian oligarchs have muscled out foreign investors. In consumer goods, for example, Sawikin talked about making 75 times his investment on a company that produces vodka. “Selling vodka to Russians and Ukrainians,” Sawikin joked, “that’s a perennial.”
He also talked about the manipulative tactics of some Russian managers. One involved talking down a stock and scaring and insulting investors, thereby pushing the price down so the insiders could buy it. Sawikin calls them “Scooby-Doos,” after the cartoon in which some guy would try to scare the kids away so they wouldn’t find, say, the gold hidden in the old mine. For this reason, Sawikin doesn’t even want to talk to management in some cases. “I don’t even want to hear the misinformation.”
Sawikin did not tip his hand on any specific investment ideas, but I found his perspective valuable nonetheless.
In any case, investors should not emulate Haig’s stubborn insistence on floundering, old-world ideas. Specifically, investors should not discount the importance of overseas markets. Increasingly, investors will want to pay attention to what happens in Moscow or Dubai or other once-backwater markets. More and more in this world of ours, opportunities respect no national boundaries.
for The Daily Reckoning
June 12, 2007
P.S. At this year’s Agora Financial Investment Symposium in Vancouver, British Columbia, I’ll be talking about opportunities found outside the United States…in fact, the topic of the event is “Rim of Fire: Crisis and Opportunity in the New Asian Era.”
Editor’s Note: Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer’s Special Situations and Capital and Crisis – formerly the Fleet Street Letter.
“The winged hound of Zeus, the ravening eagle, coming an unbidden banqueter the whole day long, with savage appetite shall tear your body piecemeal into great rents and feast his fill upon your liver until it is black with gnawing…”
– Aeschylus, Prometheus Bound