back . June 03 update

Mania and Markets

by Roger Bourke White Jr., copyright February 2003

Introduction

(Note: This section was written in February 2003. Keep this in mind as I discuss various events. For instance, Bush’s “Mission Accomplished” speech happened in May 2003.)

This next section is on business and business thinking.

The goal of this section is to give you, the writer, some alternatives to the cliches and stereotypes about business and businesspeople that infest much of popular literature.

The goal is to give you some ways of writing about business that don't employ dark conspiracies, greedy businesspeople, and corruption making the world go round. They allow businesspeople to look more heroic and the world they operate in to look a lot less certain. And, just as important, these ideas are about how masses of people -- the market place -- will think, and change thinking, when reacting to novel and interesting events when they splash upon the world.

This section is written as investment advice because that was how these ideas originally formulated in my mind. I was working on predicting the future. I've gotten better at this forecasting business over the years, but another benefit of the effort has come in developing better and more believable storylines about business.

What I'm attempting to do in this section is lay out patterns I see and then assess the implications of them.

The starting place for spotting business patterns is to look upon current events as taking place in a continuum. If one can identify the continuum properly, the unfolding becomes more predictable.

This section starts with one of my early trend-predicting hypotheses: My “Mania and Markets Hypothesis”. This hypothesis follows in the tradition of my “Tattoos and T-Shirts” essay as a way of explaining how humans will treat a changing situation.

Mania and Markets

In looking for an investable pattern, I see these as examples of a mania transforming into a bust.

What is a Mania

A mania is when a person or people get excited -- so excited that they start doing things impulsively. Another way of saying impulsively is to say they are doing things rationally, but with a rationality based on a different set of premises than those that are used in non-mania times. An example of this changing 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.

Manias take time to develop. So they become most pronounced and easily identified for investing purposes when the mania is linked to an "end" or a "beginning" that is clearly seen 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 70's and were resolved fairly quickly. The resolution took place so early because real estate developers needed 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. The 1929 stock bubble, as best I can determine, 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. The timing of such a "non-event driven" mania is hard to predict, so it is hard to base investing on it. "Event driven" mania, on the other hand, has some strong predictive value.

Mania Evolution: Noisy "Doom and Gloom", quiet investing

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 the potential disasters bandied about by the media. They 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 being scared, become more willing to invest in them.

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. 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."

The name commonly used in the West for the pocket-size edition of Mao Tse-Tung’s Quotations from Chairman Mao

In the five years leading up to the Hong Kong turnover, there was a building boom taking place from Calcutta to Vancouver in anticipation of this Hong Kong diaspora, and this 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 with offices, and the construction companies and banks that speculated on those offices being filled by Hong Kong exiles suffered first and worst. That was the start of the "Asian Flu" of 1998.

As discussed in the last chapter, 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 there would be massive stoppages of all sorts.

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 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.

When the Bubble Bursts, you can't go back

The third 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 is the 1989 Japan stock bubble that Japan is still trying to recover from.

Whatever was swept up by the old bubble will stay crashed for at least a decade -- don't look for bargains in the tailspin as the bubble bursts. The next mania will prey on a different concern, and the next bubble will form in some other sector of the economy.

What can we learn from these examples?

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. Actions based on the 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. Hong Kong and Y2K both allowed plenty of time for mania thinking and actions to establish, whereas Pearl Harbor and 9/11 are examples of equally exciting events that allowed no time for mania to develop (although there was plenty of mania thinking going on at the time of both of these events that was related to other events).

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 cover up 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 at least 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.

That's it. That's the "Mania and Markets Model” I hypothesize. Now let’s talk about what's happening in 2003 that may be "mania driven".

Major Crisis

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, it's a mania marker as well. In my thinking, the Iraq War will represent "closure" on the mania that the 9/11 Disaster brought into being, and thus end that mania.

Are we in a 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.

So, 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 is that low interest rates are holding this market 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 of it. With time, the mania has become focused on Bush's saber rattling (War on Terrorism) and on the Iraq Crisis in particular. This is the doom and gloom element.

Now that the mania is 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.

When the Iraq Crisis resolves, the mania will end. 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 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 appliances 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.

In other words, just as it seemed to be safe to get back into the investing waters. ... <queue: Theme song from Jaws>

June 03 update

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!

Viewed from the mania model:

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 on 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 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 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.

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.

December 11 update

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.

This outlook on manias and business shows up directly in my novel The Honeycomb Comet, is in the background in many of my other stories, and is the heart of my Cyreenik Says section on White World.

 

-- The End --

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