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A TALE OF TWO COGNITIONS, BULL AND BEAR
by
Econotech
June 4, 2007
I
added the last phrase to the quote below from my May 31 article link
to help make the point in the first section.
“Financial Leverage May Boost Global Economic Growth,” Bloomberg
headline, June 4, 2007
“The global economy, led by China, India and other emerging markets,
is in arguably its strongest five-year boom in history, in terms of
sheer scale, scope and speed, and unfortunately also of financial
leveraged speculation.” Econotech, May 31, 2007
“It was the best of times, it was the worst of times.” “Tale of
Two Cities,” Charles Dickens, 1859
Unprecedented Both Global Growth and
Speculation May Cause Cognitive Dissonance for Market Analysts
“Basically, cognitive dissonance
is a state of tension that occurs whenever an individual
simultaneously holds two cognitions (ideas, attitudes, beliefs,
opinions) that are psychologically inconsistent. Stated differently,
two cognitions are dissonant if, when considered alone, the opposite
of one follows from the other. Because the occurrence of cognitive
dissonance is unpleasant, people are motivated to reduce it;” “The
Social Animal, 8th ed,” Elliot Aronson, 1999 [bold emphasis in
original]
In the 2002-07 global market cycle, both the global real economy and
global leveraged speculation are very strong, in fact both are at
record levels.
Perhaps to unconsciously minimize cognitive dissonance, bulls (Wall
Street) constantly emphasize the former, the unprecedented growth of
the global economy, while permabears (common on the Internet)
continually analyze the latter, the unsustainability of huge global
speculation using debt.
However, both are different views or frames of the same seamless
overall reality, and thus need to be simultaneously kept in mind in
order to optimize investment results.
Two Monday Morning
"Heads-Up" Charts, China's Shanghai Composite and U.S.
10-year Treasury Bond Prices
In the attached chart (left click once for better viewing), courtesy
of stockcharts.com, since China's stock market peaked on May 29, the
more well-known Shanghai Composite is now down -15.3%, the newer CSI
300 -15.7% The index closed on its 50-day moving average for the first
time since the beginning of Sep 2006.
So far global markets have shrugged off this equity market correction
in China, the strongest global equity market this year. Global equity
markets are making new highs, as if money is flowing out of China into
the U.S., Germany (the strongest developed equity market this year),
Japan (the latter two showing somewhat less anemic economic growth
than has been the norm until recently), and elsewhere.
Wall Street has offered up the usual rationalizations for this lack of
concern, such as China's stock market is small, its correction is
overdue and won't impact China’s economy, the U.S. economy is
re-accelerating after a weak first quarter, corporate profit growth
remains strong, etc.
These are all plausible sounding, except if/when a correction in China
or elsewhere were to become more serious. Then you may hear a
different set of stories. For now, it's too early to dismiss China’s
ongoing correction as something not to be concerned about more
globally.
Second, the rise in U.S. 10-year bond yield to approaching 5% is
starting to get a little worrisome for stocks, see attached Treasury
bond price chart, courtesy of stockcharts.com, left click once to
expand for better viewing.
To use an out-of-season metaphor, this rise in yields, decline in
Treasury bond prices, can create small subsurface cracks in the global
markets’ ice that can widen and give, with a loud bang, more
suddenly than may seems obvious right now on the surface, especially
given the huge amount of leveraged deals which are driving global
markets, and the fragility of the real estate mortgage market,
especially with ARMs resets.
Challenge to Private Equity:
Innovation, Not Cost-Cutting, Drives Economic Growth, Living
Standards, Asset Values
“"We're in two different industries," says Ted Schlein, a
venture capitalist at the Silicon Valley firm Kleiner Perkins.
"We recruit. We help companies sell product. We do business
development. [Private equity] is not an industry that can talk about
creating ten million jobs."” “Raising taxes on VCs,” Adam
Lashinsky, Fortune magazine, May 16
I have my own long-standing criticisms of venture capital as the major
focus in the U.S. of a business model for innovation, but I agree with
the above vc quote with respect to private equity.
Huge confusion is caused by the fact that Wall Street and the
mainstream media, in their self-interest, would have you believe that
immense leveraged financial speculation, especially by private equity,
is helping to drive the global economy, e.g. the Bloomberg headline at
the beginning of this article which makes very explicit the implicit
assumption of much mainstrean financial coverage.
One "enlightened" form of this argument, sometimes favored
by economists and vc/technology types, is that financial speculative
excesses, bubbles, are a necessary evil, so to speak, a small price to
pay in order to incentivize and drive innovation and strong economic
growth.
Rather, I believe that the exact opposite is the more accurate view,
that not only are huge financial speculative excesses unnecessary and
harmful, but also that the immense growth in the global real economy,
led by China and India, is what is allowing huge global speculation,
what I consistently call return on leveraged legal looting (ROLLL), to
essentially skim off record unearned speculative income. (For
elaboration, see my long Dec 19 article, "World Needs Better
"Face of American Capitalism" than Private Equity," link.)
The paper “wealth effect” on economic growth of rampant asset/debt
bubbles, concentrated at the very top of the income/wealth pyramid,
can only support cancerous or parasitic speculation to some limit,
though no one seems to have any idea how long that may be.
In the economists' infamous "long run," ROLLL can not
support global valuations that are currently based on an extended
future period of strong, low-inflation growth. There is a very large
but still only finite number of m&a restructurings that can be
done that emphasize cost-cutting, layoffs, speed-up, health care and
pension looting, etc., let alone that make economic, or even financial
and political, sense.
A couple of decades ago, economists finally figured out what
entrepreneurs have always instinctively known, i.e. that innovation
and real productivity (not working more hours for less money, since
1972 real median weekly earnings are down -15% in an unprecedented
shift in American history) is what drives long-term growth in the real
economy, living standards and asset valuations. (Hence my web site's
tag line, "Finance Innovators, Not Speculators" link.)
Unless and until private equity, which is on pace to smash last year's
record, makes the case that it is driving innovation and real
productivity, it is an exercise in unjustly enriching a very few,
including the corporate CEO’s who have unavoidable legal conflicts
of interest in making buy-out deals on their own behalf, and even
worse, tremendously distorting incentives for the allocation of scare
corporate resources, especially human talent, and developing markets
capital (which is funding unprecedented U.S. current account deficits
driven by paper "wealth effects").
In other words, concretely, what innovative, useful products,
services, processes, etc., is private equity creating better than had
been done before? I've never read or heard of one, so far.
© 2007 Econotech
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