Repent! The End is Coming! ...Real soon now! ...Really!
The ending of eras generates a lot of excitement in human thinking. The excitement can be spawned by often-repeated end of world announcements by religious leaders, or brought on by the ending or beginning of eras as defined by calendars. Or they can be a reaction to a large, surprising and scary event that a community feels must be reacted to. A relatively new category is end of the world announcements by science leaders.
This chapter will briefly look at the obvious craziness that some people engage in when they choose to believe the end of the “world as we know it” is coming. But it will concentrate on another effect that is also powerful but more subtle. This other effect leads to what I call a Mania and Markets condition.
Mania and Markets is important because it reveals patterns in how people treat money and industry in response to an end of world mentality. All this combines to affect how we live. Mania and Markets is not as obvious as goat sacrificing when it comes to blatant end of world celebrating, but it is an important pattern in human thinking.
Mania and Markets is about finance and predicting. Many people make predictions about how stock markets and other financial markets will move. And, yes, in this section I'm adding myself to the list.
History records that end of the world celebrations happen a lot in human history. When this end of the world is coming belief catches hold, the believers radically change their day-to-day activities. One style of change that catches historians' attention is a switch to “party like there's no tomorrow” mentality. Another common style of change is to prepare to hole-up, wait out the disaster, and come out again to rebuild the world after the old world passes away.
Here are a couple of End of the World examples:
The alternative to celebrating the end is hunkering down. The backyard fallout shelters of the Cold War era are an example of this mentality. More contemporary is equipping a survivalist shelter deep in the wilderness as a place to wait out the coming apocalypse -- zombie or otherwise.
Whether celebrating or hunkering down, these rituals are expensive: The people engaging in them spend a lot of money; likewise their time and attention are swallowed up as they plan for this big event. Since the event being prepared for routinely doesn't happen, they are goat sacrificing.
Upon closer examination of these end-of-world times, partying and hunkering aren't the only actions taking place that are emotion-loaded. There are many people making what should be cool-headed business decisions based on hot-blooded emotions, and these results, like the partying and hunkering down, are also expensive. What these people invest in doesn’t work out as they expected. It fails to deliver.
When these Mania and Markets patterns are real and strong, they can explain some long-term trends in two specific situations:
(One of the other fascinating things about human thinking is how fast something such as Y2K turns into an almost completely forgotten non-event after it passes.)
The following three events I will be discussing in more detail later in this chapter. I have particular interest in them because I was on hand watching and doing a lot of head-scratching as they progressed.
These are examples of the pattern I will be discussing: The pattern of a mania transforming into a bust.
The usual definition for mania is a mental illness condition marked by periods of great excitement, euphoria, delusions, and over-activity. For our purposes in this section, mania is when a person or community gets excited - so excited that people start doing things impulsively. Another way of saying impulsively is to say that in their own minds they are doing things rationally, but the rationality is based on a different set of premises than those used in non-mania times - cool-headed times.
An example of this change of premises was the New Economy concept that surfaced in 1998 and ‘99 to explain the stratospheric Dot-Com stock valuations. If you believed in the New Economy concept during those two years, the stratospheric P/E ratios (price-to-earnings ratios) of that era were rational. The form of mania I am talking about in this section happens frequently. The people engaging in it are not insane, but they are capable of making big mistakes in judgment, and as history shows us, they do.
Manias take time to develop. They become most pronounced and easily identified when the mania is linked to an “end” or a “beginning” that is clearly seen coming a long distance in the future.
In the case of the Hong Kong turnover and the end of the century, the ending date was well known at least a decade before the event occurred. In the case of Hong Kong, the negotiations for its fate took place in the 1970's and were resolved fairly quickly. The resolution took place so early because real estate developers badly wanted some certainty in their calculations for buildings and mortgages, and the British government obliged them by opening the subject with China.
Not all manias are tightly linked to a beginning or ending event, rather some are linked to a scary surprise. 9-11 is a classic and will likely remain the Mona Lisa of Big Scary Surprises throughout this century. This lead to the War on Terror in all its many and expensive facets. Less obvious, but a pattern I see, is it also lead to the asset bubbles of the 2000's which brought on the Great Recession starting in 2007.
The Roaring Twenties (1920's) leading to the Great Depression is another example of this kind of mania. The first scary surprise in this case was the long duration of WWI. The world was expecting a quick war - six weeks to six months - with an exciting victory and few casualties. Having a four year long carnage-fest was not in anyone's playbook! And the social revolutions which started up in the third and fourth years deepened the surprise. For Germany, Russia, Austria, and Turkey the fighting and surprises didn't end in 1918, instead revolutions continued in full force. Socialism, Fascism, Communism, and many others that are less well known today rose out of this chaos... This hadn't happened before, ever! What was a person to do?
In America and Western Europe the continuing surprise was prosperity. Thanks to mass production new products and services, such as affordable automobiles, were being offered on never-before-seen scales. This lead to all sorts of new prosperities. Although there was a lot of prosperity, what it would mean to people, and how it would change their lives, was not well understood. There were lots of surprises. One example was the many places and people that participated in the change, but did not feel like they were getting their share of the prosperity. Many farmers, for instance, were having a hard time with all the change. They were going in to debt to buy new machinery to produce more, but the prices they were selling their crops for were erratic and on the average falling.
The 1929 stock bubble was the tail end of a combination of post-WWI euphoria and the euphoria of a domestic lifestyle revolution caused by the mass acceptance of autos and electrically-driven consumer appliances such as refrigerators and washing machines.
Unlike event manias, the timing of the scary manias is hard to predict.
In the case of an event-linked mania, as the community approaches the “exciting event”, there will be a lot of high profile doom and gloom sentiments expressed by the community. In modern times, this will show up as lots of media coverage about the potential disasters. The media will pony up pundits who describe worst-case scenarios in lurid detail. But quietly, underneath the flashy doom and gloom of the media pundits, there will be many people who see opportunities, and rather than becoming scared they become more willing to invest in them. They will take more risks than they would in non-mania times. (The doom and gloom side is not necessary, however; and hosting the Olympics is a happy occasion that also brings on a mania for the hosting city.)
In the case of the Hong Kong turnover of 1997, the lurid doom and gloom concerned how people and businesses would be treated under Beijing's Communist regime. The classic specter of the pre-turnover era was that the Red Army would come marching in, with Little Red Books in hand, nationalize everything, and “reeducate” the entrepreneurs who had built up Hong Kong by sending them to live peasant lives in small, remote villages throughout China. Meanwhile, the quiet investors were investing in buildings located everywhere around the Pacific Rim except in Hong Kong. The logic was, “When Hong Kong is turned over to China there will be an exodus from Hong Kong of the brightest and best people. These people will leave and want to set up shop somewhere else on the Pacific Rim. If I have a modern building available, they will set up here, in my new building.”
In the five years leading up to the Hong Kong turnover, there was a building boom taking place from Kolkata (Calcutta) to Vancouver in anticipation of this Hong Kong diaspora. The boom drove up property values, which increased the loan money available from banks. When the Hong Kong turnover happened quietly and with no mass exodus, the rest of South and East Asia found itself overbuilt. Construction companies and banks that speculated on those office buildings being filled by Hong Kong exiles suffered first and worst. That was the start of the Asian Flu of 1998. This was a recession that started with construction companies and property developers in Thailand announcing they were in financial trouble (no one was filling the newly built office skyscrapers), and from there it spread to all kinds of businesses in South, Southeast and East Asia. This recession hit me, personally. I had to leave a teaching job in Korea because the recession was shrinking the number of students who wanted English lessons.
The mania brought on by the end of the millennium in America was known as the Y2K Crisis. Here, the high profile worry was about computers failing as internal clocks wrapped from 99 to 00. The doom and gloom pundits made predictions that airplanes would fall from the skies, ships would crash into docks, and massive stoppages of all sorts would occur.
While the doom and gloomers were getting all the talk show attention, the quiet investment was going into Internet and telecommunications startups. During 1999, there was talk of two economies: an Old Economy tied to the traditional business rules and the New Economy that was going to be playing out with different business rules. When the millennia passed without a terrifying incident, it took a few months for investors to snap out of it and realize that the old rules really did apply to the New Economy companies, too. As that realization hit, the stock market and the economy tanked: the Dot-Com Bubble.
Another thing to note about mania-generated bubbles, beyond noisy naysayers and quiet investors, is that the post-bubble environment is always different than the pre-bubble environment. In other words, the good old days of the boom aren't coming back in any reasonable investing time frame. Examples of this not-coming-back are numerous. A recent example, known as the Lost Decade, is the 1989 Japan stock bubble that Japan was still working to recover from twenty years later.
This means the next mania will prey on a different concern, and the next bubble will form in some other sector of the economy. In the case of the US, the bubble moved from Dot-Com to the newly invented Collateralized Debt Obligation (CDO) way of financing loans. The mania was called a housing boom, but it was really a mortgage boom.
• Lesson One: Watch for a mania. An event-linked mania will be brought about by an exciting event coming in the future. The intensity of the mania will be proportional to the significance of the event and the time that the mania has to grow - up to about thirty years. As mentioned, a city winning an Olympics bid is a recurring example. Actions based on this kind of mania can show up from a few months to about five years before the event, but these mania actions are based on mania thinking that has been maturing for a longer time. The Hong Kong and Y2K events both allowed plenty of time for mania thinking and actions to establish, whereas WWI and 9-11 are examples of equally exciting events that allowed no time for mania to develop ahead of the event, so the mania came after.
• Lesson Two: The mania will latch on to an incipient bubble of some nature and inflame it into a real bubble. The mania-related actions will be to invest in a project category that, at the beginning of the mania action period, looks like a good investment. As the mania progresses, the investment in this category will become riskier, but the rising values caused by the quiet mania investment actions mask that added risk. These investments don't have to be closely related to the root cause of the mania, and real estate of some sort is a perennial favorite for mania investing.
• Lesson Three: Whatever was swept up by the old bubble will stay crashed for about a decade - don't look for bargains in the tailspin as the bubble bursts. As I said earlier, the next mania will prey on a different concern, and the next bubble will form in some other sector of the economy. Dot-com companies came into their own and prospered late in the 2000's, while the mania turned to mortgages.
That's it. That's the “Mania and Markets Model”.
Starting in late 2002/early 2003, I used this Mania and Markets model to do some predicting about the post-9-11, pre-Iraq war situation. What follows is a real-world example. Please keep in mind that, yes, I am writing what follows in the 2002/3 timeframe, until otherwise noted. My experience and observations will give you a feel for what can go right and go wrong in such predictions. Note that I could predict a crash, and I could predict the center of the bubble forming ahead of the crash, but I could not predict the timing and magnitude. The real crash happened years later and was much bigger than what I predicted or could imagine.
The number one crisis of 2003 is the Iraq War crisis. There is every sign that this crisis will reach some kind of resolution during 2003. So, it's not only a crisis but also a mania marker. In my thinking, the Iraq War will represent “closure” on the mania that the 9-11 Disaster triggered, thus end that mania.
Is there a big mania building in 2003? I think so! It's being built around the Iraq War scare. Unlike the Hong Kong and Y2K examples, this mania has had a short gestation. Bush's saber rattling started in September 2001, so the event has been running only eighteen months, not thirty years. But it makes up for its short duration and unknown ending date by being a very exciting event. The news media are reporting on this constantly, and the whole world is interested in what is going to happen.
Lesson One is in place: We have a mania situation. What about Lesson Two? What investment trend has the mania latched on to? As I look at the news, I see one industry that is clearly in an unnaturally prosperous condition: Real estate, in particular the new housing market.
My experience over the last forty years is that a recession trashes the new housing market. But this trashing hasn't happened in 2001 or 2002. What's holding this market up? Conventional wisdom says that low interest rates are holding it up, but my vote is mania. (Note again, this is an example of quiet investing running contrary to public doom and gloom.)
My prediction based on the “Mania Model” is as follows:
We are currently in a mania period. That period started with the shock of 9-11 and with the expectation that something would happen as a consequence. With time, the mania has become focused on Bush's War on Terrorism and on the Iraq Crisis in particular. This is the doom and gloom element.
Now focused, the mania will end when the Iraq Crisis is solved in some fashion: war is fought, Saddam leaves, or some new crisis takes its place. If the crisis winds down, that means some other crisis has taken its place as a headline maker, and the Iraq Crisis will no longer support a mania. That counts as ending the crisis, and will mark the end of the mania.
Of course, the mania could end earlier than solving the Iraq Crisis if a credit crunch starts for some other reason, such as a Greenspan announcement that fighting inflation is now a Fed policy, and interest rates will be going up.
When the mania ends, the new housing market will tank because easy money will dry up. Coincident with this drying up, will be a serious readjustment of credit in the US, which will first cause great pain in the construction and finance industries, and then the pain will spread. Scandals comparable to Arthur Anderson (accounting company) will likely be uncovered.
This readjustment will go on for years and will be characterized by the housing market being soft and slow compared to the market of 2001 and 2002, so there is no opportunity to be gained by jumping on early bargains that show up in real estate. Wait at least a year, and more likely two or more, to see a bottom. The contagion will likely spread to the large appliance and auto industries since these are also based on easy credit and consumer confidence - the end of the mania will be marked by a collapse in consumer confidence and general economic malaise.
The Iraq War has and come and gone. The big surprises of the war were its speedy and cheap conclusion and that the main justification for going to war seems to have been bogus: Iraq did not have huge stockpiles of weapons of mass destruction - or any at all!
The mania should be ending. There's a good chance it is, but if Bush is ruthless and adroit, he may succeed in keeping the mania burning for years longer as War on Terrorism. With the mania ending, consumer enthusiasm (AKA confidence) should wane - it's recovery time.
The housing bubble hasn't burst yet, but that's because it's being deliberately sustained by Greenspan and The Fed's actions. Greenspan wants to see housing remain the engine for an upcoming economic recovery, and he's more worried about deflation than inflation, so he's lowering the prime rate again, which is encouraging another round of mortgage activity and pumping more paper wealth into the system. This, in my opinion, is delaying the burst of the housing bubble, and it's going to make it worse.
Other news: Due to severe earnings drops in 2002, the S&P P/E ratio (Standard & Poors Price to Earnings ratio) is still well over 20, which means the stock market is still behaving like we are in optimistic boom times.
Other significant news: The Freddie Mac Scandal. Freddie Mac is a key component in the mortgage industry as it guarantees home mortgages. As of this date, the three top people at Freddie Mac have been summarily dismissed. That's a huge amount of smoke in a critical place at a critical time. I predict this news is the fluttering of the butterfly wings that is going to evolve into a housing hurricane, as in, there are going to be big troubles there.
Remember Lesson Three: When the housing market tanks, the effect will be long-lasting, and it will mark a major change in how the housing industry does business. I don't know the housing industry well enough to predict what kinds of changes are likely, but if it fits post-bubble patterns, there will be lots of consolidations, and it's likely that Freddie Mac and Fannie Mae will be restructured to change their privileged charter positions.
My goodness! That crystal ball was crystal clear! It’s kind of spooky in retrospect. One thing I didn't catch in June 2003 was that Iraq would turn into a long and deep quagmire. That extended the mania. The hangover didn't begin until 2007, and then... whew! I've been surprised at the depth of the bust. Another interesting element is what I called a “housing boom” transformed into a “mortgage boom” as the CDO (Collateralized Debt Obligation), a new financial invention, grew popular.
And finally, the hangover is transforming into our new Worry of the Decade. We are moving from worrying about terrorism to worrying about debt and income distribution. This is an example of “not going back”.
There is a mania in progress as this book is being written. Russia under Vladmir Putin is exhibiting a leadership style I call ruthless leadership. He has been quite successful at it for over a decade now. From military adventures in Georgia (on Russia’s southern border), to Olympic adventures in Socchi, to further military adventures in Crimea and Ukraine, Putin has been shaking up the world. One of the fallouts of his success is an increasingly mania-centered Russian culture. This is affecting markets: quiet, bubbly investing is happening. Although it hasn’t happened yet, I expect a surprising bust when the Putin Era ends. According to the mania and markets model, after the crash Russia won’t be going back - it will be moving on to something new.
This outlook on manias and business shows up directly in my science fiction novel The Honeycomb Comet, it is in the background in many of my other stories, and is the heart of my “Cyreenik Says” section on the White World web site.