The Daily Reckoning PRESENTS: Dr. Marc Faber, searching
for
value... and coming up short.
PAINFUL RESOLUTIONS
by Marc Faber
In an environment of money printing and excessive
liquidity, which leads to strong debt growth and high asset
inflation, real bargains and truly distressed assets could
be a thing of the past until such time as an economic or
financial accident again creates value in one or another
asset class. I mention this because when I look around the
world at equities, bonds, commodities, and real estate, I
find it increasingly difficult to identify assets that meet
my criterion of being "great values" that I would feel
comfortable in just putting aside and waiting to appreciate
substantially at some point in the future.
Moreover, I get the feeling that, with very few exceptions,
most assets will be available at lower prices sometime in
the next few years. Take as an example New Zealand. A few
years ago, assets in New Zealand and the cost of living
there were extremely low because of a depressed N.Z. dollar
and an overbuilt real estate market. But now, with the N.Z.
dollar having doubled in value against the U.S. dollar, I
found on a recent visit to this remote but scenic country
that prices were almost as high as in the United States.
Or consider Sydney. A few years ago, Australia was a real
bargain compared to the United States, but today property
prices in Sydney are as high as, or even higher than, in
New York, and the cost of living is close to that of the
United States - again, partly because of the strength of
the Australian dollar against the U.S. dollar. Therefore,
the dilemma I face is the following.
If we recall colleague Richard Strong's prediction in 1996
that in the future U.S. stocks could be valued as highly as
Japanese stocks were in the late 1980s, I think it is
conceivable that assets such as real estate, equities,
commodities, or even bonds could continue to appreciate and
reach much higher prices than I have been expecting. At the
same time, I am fully aware that not one single credit-
driven asset inflation has ended "harmoniously" and led to
"the best of all possible worlds"; instead, these
inflations have always been followed by a severe bust and
financial crisis, which then erased most, or even all, of
the previous gains.
After recently talking with a large number of investment
professionals, I have the impression that they share an
uneasy feeling about buying assets at present in order to
capture further near-term capital gains, while at the same
time knowing that one day the music will stop. But if we
remember that the most common feature of any mature asset
inflation, mature bull market, or bubble (to put it more
bluntly) is the urge of investors to participate in the
appreciating assets at any cost and with little
appreciation of the risks involved, then we can better
understand the present pressure on the fund management
community to earn superior returns. This is, of course,
particularly true when interest rates are ultra-low, or
even negative in real terms, as is now the case in the
United States.
In this environment, investors rush from safe and liquid
but low-yielding cash into assets that seem to promise far
higher returns, such as stocks, real estate, and
commodities. Needless to say, the monetary policies of the
Fed, which keep interest rates artificially low (negative
in real terms), encourage this preference for higher-risk
assets and are add fuel to the ongoing speculation in
stocks, lower-quality bonds, commodities, real estate, and
foreign exchange. Thus, fund managers are almost forced to
take significant risks and play the momentum game in order
to meet their clients' unrealistically high return
expectations.
Aside from the pressure from clients on fund managers to
fully participate in the asset inflation, there is another
factor that is leading fund managers to be heavily long
every kind of risky asset. A dangerous consensus view has
proliferated among the investment community, which goes as
follows: No matter what happens, the Fed will continue to
ease and keep interest rates lower for longer than might be
appropriate. Therefore, asset prices can only rise; ergo,
let us be long assets since with Alan Greenspan and Ben
Bernanke at the Fed, the downside risk is almost
nonexistent.
In my opinion, this consensus is very dangerous for several
reasons. First, some assets can decline even under easy
monetary policies simply as a result of oversupply. This
was the case for commodities between 1980 and 2001. In
addition, some assets can decline because of a change in
investors' psychology. This was certainly a factor in Japan
post-1989, when Japanese financial institutions and the
public became risk averse and had a preference for cash and
bonds over equities.
Also, even in periods of extremely loose monetary policies,
such as we find in the German hyperinflation period between
1918 and 1923, stocks can sell off. Despite a strongly
rising trend in local currency terms, German stocks had
corrections of 40% in 1918; 10% in 1919; 20% in 1920, 1921,
and 1922; and 30% in 1923. (However, I might add that in
hard currency terms - believe it or not, at that time U.S.
dollars - German stocks declined by more than 98% between
1918 and 1922 due to a collapse of the Reichsmark against
the dollar and other currencies.)
Lastly, the very fact that this view of easy monetary
policies fueling further and never-ending asset inflation
has become so universally accepted and entrenched among
investors should serve as a warning, since it indicates
that the majority of players in the market are already
positioned for the asset inflation to continue for some
time. Additionally, we should not forget that every bubble
has a "hook," which eventually catches the majority of
investors unprepared. The hook can be the notion that the
supply in a property market will remain tight, that the
demand for some products or commodities is unlimited, that
the government will never allow the market to decline - or,
as is now the case, that there is so much liquidity in the
system that prices will never decline except for brief
correction periods within an endlessly rising trend.
Now, combine greed, the urge by the public to capitalize on
the appreciating assets - a necessary evil for many
households in order to sustain their consumption in the
absence of real income gains - the pressure to perform
among investment professionals, and the view that serious
downside risk is nonexistent due to the Fed underwriting
the asset inflation, and you can see why just about every
asset class has been soaring in value! In this situation,
the prudent and value-driven investor has to ask himself
whether it is worth the risk to participate in this renewed
investment mania that has been engineered by the Fed.
In recent reports, I have stressed that the year 2003 was
exceptional in the sense that all asset classes, including
bonds, stocks, real estate, and commodities, rallied - the
exception being the U.S. dollar. On the release of the poor
employment figures on March 5, 2004, we had the same market
action: Everything went up in price, including gold and
bonds, again with the exception of the U.S. dollar.
However, I used to believe that, sometime in 2004, we would
see the beginning of diverging trends in the performance of
different asset classes, since bonds, commodities, and real
estate cannot continuously rally in concert. After all, one
characteristic of a strong secular bull market in one asset
class is the simultaneous occurrence of a bear market in
another asset class. (Inflation cannot be good for bonds.)
The commodities bull market of the 1970s was accompanied by
a vicious bond bear market. The equities and bond bull
markets from the early 1980s were accompanied by a
persistent bear market in commodities, and in the 1990s
stocks of developed Western markets soared, while Japan and
emerging stock markets collapsed. So I was leaning toward
the view that in 2004 some assets would continue to
increase in value, while others, such as bonds, would begin
to fall by the wayside and enter longer-term bear markets.
Upon further consideration, I am now increasingly concerned
that sometime in the near future "everything" could begin
to unravel!
When interest rates rise (and one day they will rise, given
the inflation we have in asset and commodity prices), it is
conceivable that bonds, stocks, commodities, and real
estate will all decline in value at the same time. So
whereas in the past I have had the tendency to dismiss
Robert Prechter and Gary Shilling's deflation scenario as
unlikely, I now feel that the current universal asset
inflation will be followed by a serious bust and asset
deflation, which will kill consumption in the United
States. But when?
I must admit I'm at a loss as to when this bust will occur.
But given the overbought condition of the U.S. stock
market, the extremely high bullish consensus (historically
indicative of market tops), the [until recently]
parabolically rising commodity markets, and the tendency of
markets to defeat central bankers (notably Greenspan,
Bernanke & Co.) who entertain the same erroneous beliefs
that central planners under socialist ideology had, when
they thought that they could plan the best possible
economic outcomes, the bust could come at any time.
It is true that no one can foresee how the endgame of the
current speculative wave will play out and when the bust
will finally occur. But a painful resolution of the current
asset inflation is inevitable, and as certain as night
follows day.
Regards,
Marc Faber,
for The Daily Reckoning