What, me worry? This is an Alfred E. Neuman market.
Remember him? The adorable scamp from MAD magazine?
Yesterday, the markets froze up. History stopped. Time stood still.
The Dow barely moved. Nor did the dollar bestir itself. Bonds… gold… commodities – everything lay motionless and quiet, like a wide, frozen river.
You’d think investors had nothing to worry about – or no imagination.
Bush’s dollar-busting budget… the army pinned down in the Mideast… record trade deficits…China’s bubble stock market… rising oil prices… war with Iran… a sudden increase in the yen… rising inflation… bear market in housing. If investors wanted to worry, they’d have plenty to worry about. But near the peak of a bull market in liquidity, worry is the last thing they are wont to do…
“Another general trait that may play a large role in bubbles is ‘disaster myopia,'” writes John Calverley in “Bubbles and How to Survive Them.” Disaster Myopia is the “tendency to ignore major negative events that have a low probability. If we started to think of all the terrible things that could happen, to ourselves or to our investments, we probably could not get out of bed in the morning, let alone buy risky stocks or take on a large mortgage to buy a new house. So the things that happen very rarely we tend to ignore altogether.”
This trait, he goes on, is “linked to a tendency to extrapolate from the recent past, rather than to take a longer view of the history of risk probabilities.”
Mr. Calverley is the chief economist at American Express Bank. We met him a couple of years ago. Then, we both marveled at how worry-free investors seemed to be. But that was in 2005. Little did we realize how utterly sans soucis they could remain two year later.
That is evident from prices. The Dow is at an all-time high. So are other stock markets all over the world, with Chinese stocks at not only a record… but a giddy absurdity – up 200% in the last 18 months. Everything else is up too…
One thing that is down, on the other hand, is the cost of protecting against the disasters that investors don’t see coming. When the sky is clear, the price of umbrellas goes down. So, speculators are able to insure their bets at low cost – giving them the gall, the wherewithal and the encouragement to make even grander bets.
The Bank of Japan lends at less than 1% interest. What’s more, the yen itself has been steadily deteriorating – now, it is at a 15-year low against the European currencies, for example. Seeing no danger, speculators borrow yen… exchange it for dollars… and put their money to work at higher yields. This gamble has been such a steady performer for such a long time that many are the hedge funds and financial firms ready to guarantee – for a low fee – that it never will go wrong. Since the speculator now has not only a marvelous money machine at his disposal… but also a mechanic standing at-the-ready to make sure it never breaks down, he doubles up his bets – which puts even more money at play.
The whole thing is so breathtaking that yesterday we began working on a unified theory for why this credit bubble has been allowed to bubble on for so long…and how so many sensible people in person can act like such dumbbells in public.
We know you are on the edge of your seat, dear reader, waiting for this Darwinian insight. And we promise to reveal the whole thing… later… but for today, we merely marvel at one aspect of this phenomenon:
The surer the profits, the surer the disaster.
Do you see why? The more comfortable the speculators become… the riskier the bets they take.
Yesterday, came news that the BOJ is frozen in time too. No, it said; it would not bend to pressure to raise rates. The bets look surer than ever. And the cost of insurance – puts, swaps, hedges, straddles – is lower than ever. How could anything go wrong? Double up. Raise the stakes. Eventually, there is so much hot money on the table it sets the house on fire.
So far, nothing has gone wrong. And until something goes wrong, nothing will go wrong. Then, when something does go wrong, things are likely to go wrong in a big way.
Right now, the clouds are gathering… and it’s not hard to see what could easily come our way in the next five years: a falling dollar, geopolitical strife, a crumbling housing market – and one of these events could send us into a bonafide financial disaster.