Man Without Qualities

Sunday, June 22, 2003

Bubble Buddies

New York Times financial reporter Daniel Altman writes today that the United States economy's fundamentals are so strong that the Fed should forget about stimulation and concentrate on dishing out some parental discipline:

A cut of at least a quarter-point seems virtually certain in the target for the federal funds rate, and a half-point reduction is possible. But there's little reason for so much more easing of monetary policy. Several economists are convinced that the economy is at a turning point, and ready for a strong second half of the year. News from the corporate sector has ranged from static to positive, and surveys of executives are reporting greater optimism. Prices for goods and services are starting to rise. The only thing that can derail the recovery now, they all say, is a big shock: another terrorist attack, another spate of accounting scandals, or something else that the bearish gods haven't already tried. If that's true, why cut rates now? With the economy potentially on an upswing, cutting rates would only add unnecessary fuel to the fire. ... At this moment, however, the economy needs investors who are more concerned with the long term — the period during which the economy's fundamental strengths will have time to show through. A gentle chastising of the myopic investors, accompanied by an explanation, might help to shift the markets' focus. That way, unnecessary disappointments might be less likely in the future.

Unlike the Times, I don't remember seeing chastising of the myopic investors as among the tasks delegated by Congress to the Fed - and, frankly, I would not want to be a Fed board member explaining to Congress that this had been my motivation for any particular action I had taken with my federal governmental power. Indeed, it is seriously debatable whether a confession to such a motivation would constitute grounds for removal of a member of the Federal Reserve Board. But it is certainly not debatable that the above passage from Mr. Altman's article is utterly inconsistent with Paul Krugman's bizarre and essentially unsupported dismissal of the recent rise in stock prices as a mere "bubble:"

Bulls think it says the economy is about to take off. But I think it's a sign that America is still blowing bubbles ...[I]t's hard to find any real news to justify the market's leap. Instead, investors seem to be buying stocks because they are rising — which is pretty much the definition of a bubble. ... We're still waiting. Oil prices are off their prewar highs, but they're still higher than they were last fall. Consumers seem to be spending a bit more, but we're talking about fractions of a percent. And businesses are still more interested in cutting costs and laying off workers than buying new capital goods. There have been some pieces of good news — a not-too-bad manufacturing survey here, a pretty good housing-starts number there. But there has also been bad news, especially regarding employment. Payrolls are still contracting; since the U.S. economy has to create 80,000 jobs a month just to keep up with a growing working-age population, the already miserable job market continues to get worse.

So, which is it? Are the economy's fundamentals so strong that the Fed should be weirdly focusing on "chastising" investors while eschewing stimulus efforts? Or, as Herr Doktorprofessor so imperiously contends from the rarified, evidence-free air of Ostelfenbeinturm, is the national economic news essentially disastrous across the board with the recent rise in stock prices just another catastrophe for which compensation will need to be made after the inevitable bubble bursting?

Of course, neither of these Times views of the economy makes any sense at all. These views are cartoons, excerpts, perhaps, from a particularly daffy Sponge Bob Square Pants episode bubbling up on the pages of the Bikini Bottom Gazette, the newspaper of record for zany fish. Herr Doktorprofessor is ideally cast as the ever-sour, gloomy and intellectually dishonest Squidward - to whom Herr Doktorprofessor bears more than a passing resemblance - while the ridiculously optimistic Mr. Altman fills the Sponge Bob role. Contrary to Herr Doktorprofessor's rant, the stock markets' rise is supported by plenty of evidence. Contrary to Mr. Altman's nutty suggestion, that evidence of future prosperity is not so overwhelming that the Fed should set aside efforts to shore up the economy with another rate cut, essentially in favor of nothing more than playing with investors' minds.

The growing resemblance of the New York Times newsroom to Bikini Bottom is made all the more apparent from the evidence presented in the present case that neither Herr Doktorprofessor nor Gretchen Morgenson, writing in a third Times article on topics closely related to those of the Krugman and Altman screeds, seems to have the slightest idea of what to look for to ascertain whether a "bubble" has arisen. Consider this passage from the Nutty Herr Doktorprofessor:

Does the collective wisdom of the investor class perceive an imminent, vigorous recovery that is invisible in the data? The market isn't always right. ... What's clear, however, is that investors' big move back into the market has been driven not by careful comparison of returns, but by the fact that stocks are rising — and the fear that if you don't buy stocks, you'll miss out on a good thing. The new bull market isn't forecasting anything; it's just feeding on itself.

Even assuming his premises arguendo, does it follow that a market is being driven by the fact that stocks are rising if the market is not being driven by a careful comparison of returns? Of course not. Even if investors are misreading the future it simply does not follow that they are relying on a "greater fool" movement in the markets or the fact that markets are rising. Further, while Herr Doktorprofessor doesn't explain what he means by a market rise being "driven," if his point is that most investors participating in the recent rise in the market are individuals who are not researching their investments, then that state of affairs is completely consistent with efficient markets, best financial principles and current theory. Indeed, it is a fundamental conclusion of modern portfolio theory (no matter what version of the efficient market hypothesis is selected: strong, medium or weak) that ordinary, individual investors have no comparative advantage in themselves evaluating the value of investments relative to professionals - and therefore should not bother engaging in personal "research" of stocks, presumably "research" constituting whatever it is Herr Doktorprofessor means by a careful comparison of returns. But even if Herr Doktorprofessor is using the term careful comparison of returns to mean constructing a market-basket portfolio consistent with modern portfolio theory he is way off base - for the simple reason that mere failure to abide by modern portfolio theory does not mean an investor is counting on "greater fool" effects. Most professionally managed funds explicitly or implicitly reject the stronger forms of modern portfolio theory - but they are certainly not counting on "greater fools."

Perhaps Herr Doktorprofessor is suggesting that investors should be allocating their investments more into bonds - rather than stocks. But if that is what he means, the point would seem to be a special case of asserting that investors are not abiding by modern portfolio theory. And, in any event, he owes his readers an explanation as to why he believes that they should be tying up their money in debt instruments where many interest rates are at historic lows and default risk on many bonds are high (As one of Ms. Morgenson's sources says: [W]e know most states and local municipalities are bust; and there are lots of problems.)

Gretchen Morgenson seems at least as confused as Herr Doktorprofessor. As Don Luskin adroitly and correctly demonstrates, she is determined to suggest that the markets are bubbling, and she is not about to let the failure of her contacts and sources to support her predetermined position stand in her way. But what do her contacts and sources say?

Well, there's this:

[A]mateurs are not the only ones who are bullish. The most recent Investors Intelligence survey shows that 60.2 percent of investment newsletter writers are bullish, while 16.1 percent are negative. That is the lowest bearish reading since before the crash of Oct. 19, 1987.

And this:

"From an equity standpoint, we are seeing clients dip their toes into the water. They are not jumping in, not diving in," said Jamie Wanless, the director of retail operations at Strong Investments, a mutual fund company in Milwaukee with $45 billion under management.

But, most tellingly, there is this: Even as investors begin to embrace more risk in their portfolios, almost no one expects a return to the anything-goes mentality that ruled during the bubble.

So Ms. Morgenson has actually made some of those anecdotal evidence calls I pointed out in my prior post that Herr Doktorprofessor should have made and could have made. But her sources didn't tell her that investors seem to be buying stocks because they are rising — which is pretty much the definition of a bubble - as Herr Doktorprofessor asserted. Instead, her contacts tell her the opposite! They tell her that almost no one expects a return to the anything-goes mentality that ruled during the bubble!

Yet Ms. Morgenson does not just come out and conclude that there is in fact little evidence that the recent rise in stock prices corresponds to a bubble - any more than Mr. Altman does. Instead, she stretches and tries to bubble as much as she can. After citing to general rises in the major stock indices, she retreats: Portfolio managers point to several pockets in the market where stocks are behaving a lot as they did in 1999. Cute, but there are often "pockets" of the market that seem to be running strong - the existence of such "pockets" doesn't suggest the existence a bubble or that general appreciation is somehow ill-founded. Perhaps for Ms. Morgenson or Mr. Altman to expressly point out the inconsistency between their research and conclusions and Herr Doktorprofessor's silly rant would be too obvious a prick to Herr Doktorprofessor. "No, you can't pop him! He's not just a bubble!" they each seem to say, "He's a bubble buddy! He's my friend, and I love him!"

And the uproarious shenanigans at the Bikini Bottom Gazette - I mean the New York Times - just go on and on and on! The Times is running yet a fourth article on a variation of the same "there's really no recovery to rally about" meme, this one by Steve Lohr, who produces what is essentially a review of a Harvard Business Review article tricked up as a business news story. Yet again we are informed that various stock indices have risen a good bit recently, and again that there is no good reason for it:

And so it may be that Wall Street has gotten ahead of itself, acting as if an old-fashioned tech rebound were under way. Stock prices on the Nasdaq, where many technology companies are listed, are up roughly 30 percent since March 11. And the Standard & Poor's 500 Information Technology Index is up about 50 percent since hitting a recent low last October. Perhaps the most significant reason to expect only a measured, plodding recovery is the changed attitudes of, and new pressures on, the corporate buyers of information technology — computer hardware, software and services — whose purchasing habits largely control the industry's fate.

After the perfunctory warm up, it's time for the HBR article:

The Harvard Business Review has published an article provocatively titled, "IT Doesn't Matter" .... by Nicholas G. Carr ... argu[ing] that as computer technology becomes more standardized, businesses will have a harder time gaining a competitive edge over their rivals through technology investments. .... But even the essay's critics scarcely make a case for a new technology boom. Paul A. Strassmann, 74, is an elder statesman of the C.I.O. fraternity, having held that title at General Foods, Kraft, Xerox and the Department of Defense, and he remains an executive adviser to NASA. Mr. Strassmann dismisses the Business Review article as "absolute poppycock" because of the "enormous unrealized potential of information technology." The potential is unrealized, according to Mr. Strassmann, mainly because of two decades' worth of mindless technology spending through the 1980's and 1990's. The spending spree, combined with exponential improvements in processing speeds and data storage capacity, has meant companies are often overwhelmed by computing firepower they cannot use efficiently. .... The Business Review article [one critic of the article] added, tended to treat computer hardware and software as if mere transport vehicles for bits — short for binary digits — the lingua franca of information technology. "The competitive advantage you gain from using information technology is not based on storing or moving bits around," he said, "but based on what you do with them." .... Mr. Carr, the author of the Harvard Business Review article, acknowledged that technology, used cleverly, can still give companies an edge in the marketplace. "But my point is that the layer of technology that is customizable, and therefore can give a company a competitive advantage, is getting thinner and thinner," he said. "And technology-based competitive gains won't last as long in the future. I still think my conclusions are true."

What is again striking about this fourth Times article is the loopy insistency of its author on drawing stringent, pessimistic conclusions in the face of much conflicting evidence and many differing opinions. Who is Mr. Lohr to conclude that even the essay's critics scarcely make a case for a new technology boom? This addled conclusion serves as a bootstrap argument supporting Mr. Lohr's assertion that it may be that Wall Street has gotten ahead of itself, acting as if an old-fashioned tech rebound were under way. The arguments advanced by the HBR article's critics may or may not be correct, but they certainly seem adequate to allow a reasonable person to conclude that a case for a new technology boom can indeed be made.

Why does the Times feel the need to rant and second guess the market this way - even to the point of crying "bubble"? Sure, the recent market appreciation and its concomitant prospect of future prosperity is contrary to the Times political inclinations and agenda. But this line of articles is not merely ill-advised flooding the zone where it is far from apparent that a "good story" exists to be flooded. The Times is unleashing a virtual tsunami of presumptuous and tendentious financial reporting in an all-too-obvious area.

It's hard to imagine a less effective way for the sullied, post-Rainesian Grey Lady to reclaim her virginity.

UPDATE: More from Hogberg and Maguire.

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