marc faber, interesting fellow..

  1. 2,154 Posts.
    Selectivity will be the Key
    Marc Faber

    I want you to visualize on top of the earth a gigantic flat bowl about three times the size of the earth, perched on a very large bamboo pole, which is continuously supplied with fresh water from a huge tap and is controlled by the world’s central bankers. Under what economists might call “equilibrium” (which does not exist in the real world), the water (money) would continuously overflow from the bowl evenly unto the earth and, therefore, economies around the world would expand and all asset classes would appreciate at about the same rate. However, the bowl being so large, relative to the flexible bamboo pole on which it is perched, is highly unstable and will lean towards one or the other side depending on which side of the pole investors lean on. If, collectively, investors are bullish about America, they will lean against the bamboo pole in such a way as to let the water (money) overflow into the direction of the American continent. If they are optimistic about the NASDAQ, the bowl will be tilt and overflow into the high tech, telecommunication, media, and biotech sector, and so on. In short, the direction of the overflowing water will depend on the expectations of investors, which in turn can be manipulated by opinion leaders, the media, analysts, strategists, politicians and economists.
    Or think of the investment community at large as being very powerful due to its total size – similar to a herd of elephants – but not very sophisticated when it comes to financial matters. The elephants, being rather docile animals, will listen to the commands they receive from their mahouts (keepers). When the mahouts tell them to do something they will obey, and so, with their strength and weight, they can bend the gigantic bamboo pole for quite some time in the one or the other direction. The mahouts aren’t particularly sophisticated either – in our case, a group consisting of fund managers, stock brokers, economists, strategists and so on - but they have a keen interest to boost the productivity of their elephants and making as much money out of them as possible. Therefore, from time to time, they will give them new instructions as to which side of the bamboo pole they should lean on. This is only natural, because the mahouts’ salaries depend on the performance of the elephants and on the volume of business they do. Each time the elephants receive new instructions, the gigantic water bowl perched on the bamboo pole overflows into a different region, industrial sector, or another asset class altogether. The point is simply this: As long as the water bowl is continuously refilled with water coming from the water tap, which is controlled by central banks, and as long as the perch is buffeted around by the elephants, which are driven by the mahouts, there will always be some assets that will appreciate while others lose their momentum, depending on which side the water bowl is leaning towards. Therefore, there will always be major investment themes under the present monetary system, which sees to it that the water tap continues to supply the bowl with water – or, in our case, with paper money. So, what really frustrates investors is not a lack of investment opportunities, but their inability to accurately anticipate the direction of flow from the gigantic bowl.

    The problem with major investment opportunities is that investors have as little imagination as our elephants and are conditioned to listen only to the instructions they receive from the likes of CNBC, Wall Street and the government propaganda machine. As a result, the major investment themes are only obvious to the majority of investors long after they have emerged and only once the bowl has been leaning and overflowing to one side for quite some time and, in the process, has led to a bull market in a particular sector. Not surprisingly, we find that the largest flow of money into an asset class such as stocks, bonds, real estate or commodities will then occur when just about everybody has fully understood the new investment theme, which will inevitably also coincide with that sector’s peak in popularity and top in prices.
    There then follows a further complication in the equation of money flowing from the bowl into a particular sector of the economy. In a market economy, the central bankers control the water (or money) tap above the large bowl. The mahouts, in turn, control, to a large extend, the actions of their elephants. But neither of them can control what the money flows will do once they reach the earth. Sure, as the bowl leans on one side, the money pouring down on to one sector of the economy will badly inflate that sector for a while. But, then some smart people – some of them honest, some of them less honest (I am thinking here of those analysts and corporate executives who, while continuing to paint a glowing picture about their companies, sell out of their own positions) – will notice the huge valuation differences between the inflated sector and the depressed sectors, and will begin to sell the inflated sector and move their money into the depressed, or relatively depressed, sectors of the economy or investment universe. Thus, while the money flows will continue to pour into the now recognized major investment theme or as was recently the case into the “new economy”, the flow of money will no longer boost prices in the major investment theme, but will instead leak into other sectors of the investment universe. This process will initially go totally unnoticed to the mahouts and their elephants, which, as I mentioned, are not the most enlightened crowd. Eventually, however, the public realizes that it has been misled by the cheerleaders of the boom and the protagonists of the major investment theme and that no matter how heavily they lean against the bamboo pole or how much money pours down on their favorite investment theme, the money leakage into other sectors of the economy and investment universe will simply overwhelm the supply of money originating from the central banks and the steeply leaning bowl. This depresses the favorite investment theme while at the same time boosting the depressed sectors to which the money is now not only leaking but flooding.
    When the mahouts and their elephants finally recognize that, however much money they pour at one sector of the market, it will no longer rise but, instead, will fall, a major shift takes place. The mahouts force their elephants to take a new position around the bamboo pole, which in turn shifts the downpour of money into a new asset class, which, as just explained, has already begun to appreciate, due to the money leakage referred to above. As a side note, I regard the money leakage problem as the crux of the problem central banks face when they try to support a market or influence economic activity with monetary measures. Central bankers can regulate the quantity of money pouring into the bowl, but fortunately for all of us, given their intellect and their adherence to economic sophism, the market mechanism will control its ultimate direction.
    The point to understand is that major investment themes simply are not obvious when they are their most attractive and promise the highest returns with the lowest risk – that is, when at their nascence. When they become obvious to everyone, they are usually already in the final stage of euphoria, which inevitably ends the way we experienced with the high tech sector over the last two years. I have looked at all the major investment themes of the last 30 years, including gold, oil and gas, and foreign currencies in the 1970s, Japanese stocks in the 1980s, emerging markets between 1985 and 1997, and US equities in the 1990s, and have found that in each case investors were extremely slow to recognize the emergence of a new major theme. At the same time, they were extremely slow – to their detriment - to understand that from time to time the rules of the investment game change requiring them to abandon the obvious investment theme and move into a totally new sector. A good example of the inability of the investment community to spot the emergence of a major new trend is the price movements of the emerging Asian markets between 1985 and 1997. The big move in the Asian markets occurred between 1985 and 1990. But, by 1990 the party in Asia was almost over, and from 1994 the losses started to pile up, as by then all Asian markets with the exception of Hong Kong had topped out. In US dollar terms, the markets of South Korea, Taiwan, Indonesia and India all peaked out between 1989 and 1991, while Malaysia, Thailand and the Philippines made their top in 1994. But foreign investors hardly invested in Asia in the years 1985 to 1990, but then piled into Asia in the early 1990s and right up to the 1997 crisis with many institutions having at the time more money in Asia than in the US.
    In fact, I would make two additional observations regarding major investment themes. When the investment community is fascinated by a major investment theme, outstanding opportunities arise outside the sphere of the major investment that theme.
    This is so, because when everybody’s attention is focused on one sector of the market, an under-valuation must take place in the sectors of the market to which nobody is paying any attention. In other words, the greater the mania in one sector of the market or in one stock market in the world, the more likely it is that there are numerous neglected asset classes elsewhere that offer a huge appreciation potential. This is one of the cardinal rules of investing, and will always work for the patient long-term investor. My second observation with respect to major investment themes relates to the following. Whereas we have seen that a major investment theme which is accepted by the majority of investors leads inevitably to an over-valuation of the theme sector and to an under-valuation elsewhere in the investment universe, the timing of the leakage from the popular and expensive sector into the neglected sector of the investment universe is difficult, if not impossible, to predict. A popular sector, such as Japan in the late 1980s or the US market in the late 1990s, can captivate the imagination of the investment community for far longer than one might think, even after the prices of such a theme may have peaked out, as we are now seeing with the renewed speculation in high tech stocks.

    Still, I believe that we are at a very crucial juncture in the financial markets. Bonds have most likely reached a secular top. Interest rates will rise in the next few years – possibly far more than what investors now expect as commodity prices have made a secular low, following their more than 20 years bear markets and as the Fed will print money as if there was no tomorrow. In addition, I believe the present stock market rally in the US will shortly run out of steam – possibly between now and January of 2003 and thereafter, we will likely move into a trading range and eventually make new lows – maybe only in 2004 or 2005! Emerging markets should do better next year as in Eastern Europe there is a convergence play while in Asia a modest but enduring recovery is taking shape. Finally, the Fed’s easy monetary policies will ensure that gold will regain its proper place in the investment universe by rising significantly.

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