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Ignoring the lessons of 1929 The similarities of the lead-up to the great market crash to today's economic environment are obvious. Don't say you weren't warned.
By Bill Fleckenstein
The economic and financial landscape of 2007 bears striking similarities to 1929. Back then, there were large, unregulated pool operators and other insiders constantly muscling the tape in whatever direction they chose. The public, too, was involved, thinking the country was experiencing a new era. Meanwhile, business began deteriorating in the spring of 1929, though the partying in stocks lasted until the fall.
'Only Yesterday'
To give you a flavor of those times, I'd like to quote from Frederick Lewis Allen's "Only Yesterday," which is one of my favorite books about 1929: "Mergers of industrial corporations and of banks were taking place with greater frequency than ever before, prompted not merely by the desire to reduce overhead expenses and avoid the rigors of cut-throat competition, but often by sheer corporate megalomania. And every rumor of a merger or a split-up or an issue of rights was the automatic signal for a leap in the prices of the stocks affected -- until it became altogether too tempting to the managers of many a concern to arrange a split-up or a merger or an issue rights not without a canny eye to their own speculative fortunes."
Obviously, I don't need to point out how similar that is to the practices we are seeing today.
Giant footprints of the funds
Today, too, there are pool operators, in the form of leveraged-buyout (LBO) and hedge funds, both of which borrow money to invest. And, just like their predecessors, who ignored macroeconomic and corporate deterioration, they are partying as never before. In reading the following passage from Allen's 1931 book, you have to remind yourself that it's a portrait not of 2007 but 1929:
"One could indulge in all manner of dubious financial practices with an unruffled conscience so long as prices rose. The Big Bull Market covered a multitude of sins. It was a golden day for the promoter, and his name was legion."
I think that for this current cycle, "promoter" should be changed to "hedge fund."
Macro-myopic Wall Street
Turning to the economy, Allen wrote: "Though the shelves of manufacturing companies and jobbers and retailers were not overloaded, the shelves of the ultimate consumer and the shelves of the distributors of securities were groaning. Trouble was brewing -- not the same sort of trouble which had visited the country in 1921, but trouble nonetheless. Still, however, the cloud in the summer sky looked no bigger than a man's hand."
That's where we are now. The economy continues to deteriorate under the surface. Proof that its engine of strength, the consumer, is faltering? Problems cited by many large retailers, whether that be Wal-Mart Stores, Sears Holdings, Target or various purveyors of specialty goods. And, when The Home Depot lowered expectations last week, it chose the politically incorrect words -- "housing slump" -- to pinpoint the source of its troubles.
Meantime, the stock market is powered by gargantuan speculative forces. With every day and week that passes, speculation becomes that much more intense. I was amazed to find out that trading volume on a recent Thursday in China eclipsed all the rest of Asia combined. Not that trading volume is always a perfect measure of speculative activity, but in this case, I think it probably is.
In this cycle, I don't believe we'll get to the point where the public is back to claiming it's a new era. That was done in the 1998-2000 go-round, and only the real-estate mania saved it from an extraordinary amount of post-stock-bubble pain. The public won't be back -- because its money is tied up in real estate, which will continue to sink.
No magic LBO bullet
Make no mistake about it: The tightening of credit has (and will) radically alter the housing market -- witness the softening of home prices nearly everywhere in the country as inventory builds and sales slow.
The deteriorating economy is a process that has a long way to go, even though Wall Street tries to throw a party every day that bad news does not absolutely pummel it into submission. No amount of hedge-fund and LBO speculation is going to make the average consumer whole again. Thus, I continue to see no way forward other than a recession and, at some point, a dislocation in the stock market.
Until the transient success of speculation comes to an end, I encourage folks to think about that ultimate unraveling -- making sure they can either explain to themselves why it is not very likely or, if they expect events to unfold as I do, have a plan for preparing and/or reacting.
History brings the future home
Finally, although it's impossible to predict the timing, I am certain of one thing: When this unsustainable environment finally ends in tears, people will ask, "How could we have known?" -- when all that would have been required was a little understanding of financial history.
The LBO's and hedge funds are taking money out of the market by taking companies private.
Just in the last year in my own small portfolio I had Freescale Semiconductor go private. Granted, also had Cinergy and Maytag merged into Duke and Whirlpool respectively, which may contribute to market instability as they assimilate their acquisitions (or choke on them, we shall see).
This year I may end up with more cash (and reportable capital gains) if RBS wins over Barclays in their attempt to absorb ABN/AMRO. (Barclays is proposing a stock buyout, they are listed on the NYSE; Royal Bank of Scotland is not traded in the US that I can find; they seem to be proposing a cash buyout).
What we don't have is the bubble mentality of the twenties in radio~autos~white goods run up by the new and novel instruments of consumer credit financing.
Nor do we have the tulip-bulb speculation of the .com 90's.
Indeed, there doesn't seem to any one "hot" area driving this market.
The sky is falling! The Sky is Falling!