The Contrarians Have a Doomsday Chat

by Nick Paumgarten

Three eloquent bears gathered for breakfast on Dec. 15 in an executive dining room atop the Morgan Stanley Dean Witter building in Times Square. The three bears were Barton Biggs, Morgan Stanleys chief global strategist; James Grant, editor of Grants Interest Rate Observer; and Alan Abelson, the editor of Barrons.

The Observer had invited them there to discuss the art of being wrong. As perhaps the most visible, articulate and persistent pessimists during the long bull market of the 90s, they have refined the act of simultaneously holding fast and eating crow.

It was 8 A.M. Morgan Stanley was serving breakfast. Hours before, the transit workers strike had been averted, and Mr. Grant had closed the latest edition of his biweekly newsletter. He was so bushed, he ordered iced tea for breakfast. As the host, Mr. Biggs sat at the head of the table with Mr. Grant on his right and Mr. Abelson on his left.

Soon they were joined by a fourth, Henry Blodget, Internet analyst at Merrill Lynch & Company. As the guy who triumphantly predicted the huge spike in the stock price of Amazon.com Inc. one year ago, he has become the face of the Internet stock boom. He is in many ways the embodiment of the weird new science that has so flummoxed Messrs. Biggs, Grant and Abelson: that of ascribing huge valuations to companies that dont make money. Essentially, Mr. Blodget is an Internet bull. The Observer had invited him as a foil.

Mr. Abelson: Hello, Henry. Do you feel like a foil?

Mr. Grant: He just feels rich.

Mr. Blodget (sitting down): Ive been able to take advantage of my lucky advice.

Mr. Grant: Theres a piece of news.

Mr. Biggs: Are we going to talk about the stock market or the Internet or what?

Mr. Abelson: Do you know anything about the stock market, Jim?

Mr. Grant: No. This reminds me of a fellow who was a compulsive gambler. He was so compulsive and so unlucky that his bookie began to take pity on him. He was betting on basketball games. He bet on the N.C.A.A.s and lost every single round of the tournament. Finally he was down to his last five bucks, and he lost that. The guy went to his bookie and said, "I cant pay you." The bookie said, "Well, basketball doesnt seem to be working. Why dont you take a shot on hockey?" And the guy said, "Hockey? What do I know about hockey?"

So, the stock market.

The Observer: Does it matter whether one is right or wrong?

Mr. Abelson: Its better to be right. Theres no question. But we all can in one way or another justify our existence, because somebody has to be wrong, or else how would you know whos right? One of these years were going to be right. Basically, our function is to piss in the wind. Somebody should be standing here pointing out that maybe things are getting out of hand, maybe things are not as rosy as they seem. But I certainly would rather have been right. In other words, I wish the Dow was at 500.

Mr. Grant: Somebody once asked me, "If you had to do it over again, would you have been bullish?" And the only thing I could say was, Yes!

[laughter]

Mr. Biggs: Im a little different from them. Like a lot of people my age, Im bearish and cautious, but Im running a money management firm. The trick really is to survive through this period where we have been too cautious on the markets, but to remain flexible enough so you dont take such extreme positions with real money that you get wiped out.

Mr. Abelson: Theres a difference between emphasizing risk and forecasting the market. I mean, I think both Jim and I have written continually about bullish things. It tends to get lost, but we do. It isnt as if we think people should head off for the South Seas and forget about investing.

Mr. Grant: Its not as if people with a skeptical cast of mind cant get through the day. Its not about being bearish as much as it is about being contrary, about having a sort of creative dyslexia about the world and about not accepting it, you know, when J.P. Morgan comes out and says, "Buy Amazon," you say, "Huh? Is that right?"

Mr. Blodget: The question Id ask is, over the past few years, in retrospect, is there something you missed in the analysis that now makes you feel like you made the wrong call? Not necessarily because of what the market has done.

Mr. Abelson: Its the wrong call, though, Henry, because of what the market has done.

Mr. Blodget: But you have to go back to the decision point. I have in mind something that Bob Rubin said when he was Treasury Secretary: "Just because the outcome is different from what you predict doesnt mean that the decision was wrong, based on the information you had at the time."

Mr. Biggs: I made the wrong call, but a lot of the bears in general, the people who are cautious, the wrong call theyve made is about the Internet and the dimensions and the speed of the Internet. Basically, these people have been right about the 80 percent of the market that is the old-economy stocks, which have been going down for a year and a half now. But I think we way underestimated the impact of the Internet.

Mr. Abelson: I think what we all underestimated was how valuable losses are. We didnt realize that losing money was a way to get rich.

Mr. Grant: Its the irrelevance of valuation in general. Its not just that no known model of valuation seems relevant to the Internet. Its that the old-economy stocks are also immune to valuation. There are increasing numbers of stocks with decent balance sheets and fine prospects for profitability that are selling for just four, five, six times earnings.

Mr. Biggs: But the question is, do they really have fine prospects of profitability? I think the Internet is changing the world and that its impact on the profitability of industrial America is going to be staggering. I dont think anyone has any idea what the Internet is going to do, but you know that its very deflationary, and that it is crushing the profits in a lot of sectors in the economy.

Mr. Grant: Its crushing profits particularly in the Internet sector, dont you think?

[laughter]

Mr. Biggs: Yeah, its crushing profits in both sectors. Ford announced theyre going to take $3 billion out of their costs by buying parts through the Internet and that the entire automobile industry is gonna take out some incredible number, like $60 billion or $80 billion. Thats coming out of someones elses profits, out of businesses that already exist. And thats why an auto parts supplier like Federal Mogul that looks incredibly cheap, a really good company selling at a discount to book valuethats why valuing it is irrelevant, because you have no idea what Federal Moguls profitability is going to be.

Mr. Grant: So how can you invest not knowing anything about valuation?

Mr. Biggs: Its hard.

Mr. Grant: You just described the perfect case for Treasury bills.

Mr. Biggs: Mmm 

Mr. Abelson: If we extrapolate from what Barton said, theres not going to be an economy, and that isnt going to work very well.

Mr. Biggs: Of course theres going to be an economy. How is there not going to be an economy?

Mr. Abelson: If you kill profit margins through all production, I dont see how youre going to sustain an economy.

Mr. Biggs: You may not kill Ford and General Motors

Mr. Abelson: Just the people that supply them, yes.

Mr. Biggs: Its creative destruction. Youre just taking out an inefficient layer of infrastructure.

Mr. Abelson: Inefficiency is in the eye of the beholder.

Asking Henry

Mr. Grant: In the case of an Amazon, Henry, how do you know how high is too high? Given the uncharted waters of valuation, what is the right price for Amazon?

Mr. Blodget: I dont know. I think in valuing these stocks, you can only come to very vague, fuzzy conclusions. You have to go out several years and ask yourself what is the real opportunity here? Usually the mistake is in being too conservative.

Mr. Abelson: You want a recent analogy for this market? Go to Japan in the late 80s. The same arguments were made then as are made now: that its different.

Mr. Blodget: I dont necessarily think this is different. But I do think its always important to ask whether it might be different. If youre paid to manage large sums of money, if you decide that right now it is no different and we are five days away from becoming another Japan

Mr. Abelson: Id say three days.

Mr. Blodget: Well, if we are in fact three years away from that, in those three years it wont matter, because if youre on the sidelines when the market triples, you will have lost your job before you are proven right.

Mr. Grant: Its always different. If it werent, the historians would have all the money, whereas in fact they have so little of it. And yet there are aspects to every market that are eternal because markets are all about people in crowds, and people in crowds tend to repeat patterns of behavior.

Mr. Blodget: And they tend to go too far both ways.

Mr. Abelson: If you manage money, you have to take a different attitude. If someone calls a plumber in, the plumber may not like the architecture, but he has to fix the leak. People pay Barton and Henry to manage their money. Jim and I arent restrained by having someone elses pot of money.

The Observer: Then do you feel restrained, Barton?

Mr. Biggs: No, not really. But look at Warren Buffett. Buffetts just as bearish as we are, so he tries to be amusing about it.

Mr. Abelson: Its the last refuge of scoundrels.

Mr. Biggs: Its a defense mechanism.

The End Is Where

Mr. Biggs: So, Alan, is it going to be secular [i.e., very long] or cyclical?

Mr. Abelson: No question, weve had a secular bull market, so well have a secular bear market. Of course. Symmetry is everything.

Mr. Biggs: That is an important comment.

Mr. Abelson: Just witness the interconnectedness of it all. Weve never had so much exposure to the stock market. The 401(k) revolutionized an awful lot of things. We havent been through a bear market with this particular phenomenon. Itll be interesting to see. We may not be having breakfast here. And, Henry, I doubt your office will still exist.

Mr. Biggs: If Alans right and the crash is secular rather than cyclical, the intellectual bears are gonna get crushed too.

Mr. Abelson: Theyre the first to be crucified.

Mr. Biggs: To look at Japan is instructive. The Bank of Japan people I talk to say that Greenspan six or eight months ago sent over a couple people and really did an intensive study on the Bank of Japans actions. They looked at what happened in the late 80s and early 90s, and that poor old Governor [Yasushi] Mieno [former governor of the Bank of Japan] who finally pricked the bubble ended up being indicted as an economic criminal by the Diet.

Mr. Abelson: And well he should have been.

Mr. Biggs: But he was the hero, really.

Mr. Abelson: And I remember you wrote that. Mr. Greenspan is conscious of this.

Mr. Biggs: He is conscious of this.

Mr. Abelson: And dont be surprised if he [Mr. Greenspan] gets indicted.

Mr. Biggs: He wont get indicted because hes never going to take the courageous stand.

Mr. Abelson: Hell get indicted for not taking the courageous stand. I dont think its even a possibility that hes gonna win in this thing.

Mr. Biggs: Really? You dont think so?

Mr. Abelson: No, I dont. Ive thought from the start that the best he can hope for is a footnote as to why the crash took place. And Greenspan will deserve a footnote. I think he had a chance in 1996 to do something. But why he didnt raise margin requirements is beyond me. Just because it hadnt been done since 1974 is hardly a good reason.

The Observer: How do you think the boom will end?

Mr. Abelson: It wont end well. I hope I dont shock you.

Mr. Grant: Its gonna end in 1986. Thats my story and Im sticking to it.

Mr. Abelson: 86 was actually a very nice bear market.

Mr. Grant: Hey, Barton, can you buy me another iced tea?

Mr. Biggs: Absolutely. Press that little button right there.

Mr. Grant: This is a bull market. Press the button and a guy comes in.

(I Cant Get No) Vindication

The Observer: How would a crash affect your lives?

Mr. Abelson: Not much. I would probably turn bullish too early, like I did in 74.

Mr. Grant: Nothing wrong with that.

Mr. Blodget: Business would slow down quite a lot.

Mr. Abelson: Henry would become a money manager.

Mr. Blodget: After a few years hiatus.

Mr. Abelson: Or a consultant.

Mr. Grant: I dont know whether it would be good or not for my business. It would certainly be good for the journalism.

The Observer: Is a crash something you wish for?

Mr. Biggs: Both of these guys should definitely wish for it. Theyd be vindicated, and its not gonna make a lot of difference to them financially. But for Henry and me it would be an incredibly painful and expensive disaster. We work for financial service companies.

Mr. Abelson: Vindication would be nice. Everybody wants vindication in some sense. But it isnt going to change the fact that were still going to be skeptical.

Mr. Grant: For me, the point is not being personally vindicated. It is no longer being tormented by the sense that two and two dont make four but rather 5 7/8, and tomorrow theyll make 6 1/4. People tell me this new truth with all the certainty of accumulated wealth behind them. Thats whats exasperating. Its the sense that not only valuation but the laws of nature and of compound interest have all changed, and nobody mentioned it. Everybody else found out, but nobody told me. No matter how sure you are of the ancient cycles of boom and bust, no matter how sure you are of the tendency of people in crowds to do the same things at roughly the same moment, no matter how sure you are of those truths, you cant help but wonder if things changed and nobody had the courtesy to say so.

Mr. Biggs: The real truth, if its a secular bear market, not cyclical, is that its gonna take 10 years to get through it. It may even take longer than that.

Mr. Abelson: It could be longer. What was it, 25 years for the market to come back after 1929?

Mr. Biggs: The best that you can hope for is that we have a nice 20 to 25 percent decline, then the market goes dead for three or four years. Thats the best outcome.

Mr. Abelson: The best of the worst.

Mr. Grant: I always say that well know when the bottom is here when CNBC starts showing test patterns. As it is, the world has come to accept that they have to know about the market at every minute. Well, they dont have to know. And, furthermore, when the time comes when one actually has to be interested again, they wont want to hear it. A.J. Liebling, who is the greatest of all, wrote about the Daily News Inquiring Photographer in 1933 who went around asking people in the streets whether theyd read the agate stocks quotes, and they gave the Inquiring Photographer a piece of their minds. They didnt want to hear about it. The market is now ubiquitous.

Mr. Blodget: And that is the reason why valuations are where they are. Its supply and demand. Theres just a greater percentage of global assets in the stock market. And the question is, if we do get a 25 percent correction or a two-year bear market, does that asset allocation shift back? Because if it does, then your scenario of a 7-to-10-year bear market seems totally plausible.

Mr. Biggs: We also have to consider the possibility that we really are having a deflationary boom.

Mr. Abelson: That sounds like joyless sex to me.

-- Ponzi (Bubble.@pop.com), December 25, 1999

Answers

The MD debt accelerator

This condition exists in most of today's economies due to the tax structure- particularly the income tax. Beginning with an economy with substantial numbers unemployed workers, in the midst of an expansion, as in the US, let us examine what happens financially when the private sector hires unemployed workers. In the first instance the worker's income has increased. At the same time net government expenditures decrease as unemployment benefits drop and income tax liabilities begin to accrue, decreasing non government sector net nominal wealth (an accounting identity). Therefore through the hiring of the unemployed aggregate demand increases while net nominal wealth (savings) decreases.

The increase in aggregate demand results in more hiring and therefore additional decreases in net nominal wealth. The effect is accelerating growth and declining rates of profitability until asset prices collapse and the economy crashes due to a lack of net nominal wealth. The symptoms are strong growth, a declining non government savings rate, and decelerating profitability.

Japan in the late 80's stands as an example of how the cycle ends. Note that Japan allowed it budget to go into surplus in the 88-90 period. The US today is still in the accelerator mode. The crash could only be soften by immediate relaxation of fiscal policy, which would also accelerate growth and risk severe upward pressure on prices and wages.

See Wynne Godley's 'The Seven Unsustainable Processes' at http://www.levy.org for an analysis of the current sector imbalances.

http://www.warrenmosler.com

-- Warren Mosler (mosler@gate.net), December 25, 1999.

Thanks for the post. You know, the bear assumption is that people are going to just reject the market like was done in the thirties and that even with low credit rates in the thirties, no one was really responding and starting businesses. Folks are used to seeing the market flip flop and have a long term approach to thier investments. Why assume that people are going to jump off a cliff and freeze up like the japanese? Americans are going to start right up running if the shit hits. The amount of initiative in folks here is very high and this "tony robbins" culture is no going to just lie dead in the water like the 30's folks did because they didnt know how to approach the banks and get a business plan presented and move it. Look, the japs all went inert, the 29 folks did too. That is not going to happen with this present crowd of americans. Factor that in with your analysis.

-- billburke (bburke@rocketmail.com), December 26, 1999.

Yep. Tony Robbins will save the day. ;~)

-- number six (!@!.com), December 26, 1999.

bill -

I have to assume that you're being facetious. You are, aren't you? I mean, you're not seriously positing that the current generation of Americans is made of sterner stuff than the Japanese in 1990 or the folks in 1930, are you?

Consider: the effect on just Silicon Valley of a 25% market correction would be almost catastrophic. The whole compensation system there is based on stock options, and even now during this long bull market, there have been articles in the papers about employees needing psychological counseling due to nearly overwhelming "market anxiety". Thousands of folks are cranking 60-80+ hour weeks based on the dream of getting rich through company stock. Just imagine what it would do to them (and their companies) to have the dream turned to dust by a simple business-cycle correction. There are many others who have literally bet the house (taken out seconds) to finance stock purchases. Neither of these examples qualifies as a "long-term" approach to investing.

Folks nowadays are no more or less hard-working than they've ever been, and frankly Tony Robbins is just Dale Carnegie with more lights and a better sound system. If the market corrects, a whole lot of "money" will vanish into the ether, and it will take a lot of economic activity with it.

You may want to read up a bit more on the reality of the 1929 crash. Might I suggest Galbraith's The Great Crash 1929 for starters?

Rampant speculation. Record trading volumes. Assets bought not because of their value but because the buyer believes he can sell them for more in a day or two, or an hour or two. Welcome to the late 1920s...

-- Mac (sneak@lurk.hid), December 26, 1999.

Hi and thanks for the link. I have spent a lot of time at the gold forums and sites reading. Also, I love the contrarian investor and prudent bear sites. And I do read ableson in the barron paper. But after ingesting that, my own reaction was eventually to see that they are assuming that wipeouts of stock worth and a severe recession or worse will leave us in the stalled state that the citizens of Japan and thirties america gave to themselves. The group mindset was to freeze up and that is japans number one problem now. Thier citizens are not spending and have a general view of resignation. In the thirties, THOSE folks had all previously lived through or heard about many previous bank failures and had NO previous history of stock ups and downs like we have to review. Media will try to make us focus on all the worst, but way too many people here will refuse to just lie down and will approach the banks and the easing of credit that will be offered by the fed in any major downturn and get business plans and projects up and running. Also, the gold freaks are overlooking a few things about all the corners of the BIG boy financial world that support the fiat currency and will not stand for a commodity based power structure ruleing the world. The fiat boys have LONG been playing the chess game of insureing the fiat against the gold system. The game is actually won. Gold will not be king and the euro wont either. Among the many reasons is the fact that the Jews support the dollar and its support of isreal and they are DEEP in the financial business. No matter what the japs and euro guys want, the fiat dollar is king, period, and will still be after any bubble pop. They now realize, after the sept gold leasing rebellion, that THEY will take down the whole world if they try to disrupt the dollar as the currency of the world. They are too late, and are stuck supporting it.

-- billburke (bburke@rocketmail.com), December 27, 1999.