Two Views on the Global (ka)Boom

♠ Posted by Emmanuel in at 5/06/2007 03:51:00 AM
The surge in equity markets practically worldwide has spawned suggestions that this liquidity fueled "bubble" is nearing its demise, and the results will be painful. First up is glass half-full sort Bill Fleckenstein on the Dow Jones Industrial Average's winning streak. He compares its streak to 1989 in Japan (!) and 1929 in America (!!):
In any case, after a little checking, I did find an amazing similarity between the last month or so of the rise in Japan that ended on Dec. 29, 1989, and the current advance in the Dow Jones Industrial Average ($INDU) (through April 27): Specifically, the last 32 out of 38 trading days in Tokyo were on the upside, with an initial run with a higher close on 19 out of 21 days, followed by seven out of 11, followed by six for six before about a 40% drop in the course of nine months took place. Recently, from the lows of March 5, the Dow closed higher in four out of six sessions, followed by seven out of 11, followed by 20 out of 22 -- for a grand total of 31 out of 39 days. Now, I am not a big believer in analogs, but if the mind-set in Tokyo back in those days was similar to the mind-set that we're witnessing here today, which, by my reckoning, it is, I guess it's not impossible for that similarity to have some predictive power.

(Another interesting parallel to note, by way of Justin Goepfert at the ever-valuable The last time the Dow had a run of 19 out of 21 days was in July 1929 -- not exactly a great time to buy stocks.)
Simon Derrick at the Bank of New York sees bubbles ripe for a pricking:
The global liquidity boom has notched up several new records this past twenty-four hours: in the face of growing economic and political risks that we have detailed at length in this Update, benchmark indices in Singapore, Malaysia and Indonesia today mirrored the performance of the Dow Jones yesterday in reaching new all time (intraday) highs; and in the currency markets, EUR/JPY has today continued its march into uncharted territory.

Experience suggests that, accompanied by a growing polarisation in view (over the likely longevity of trends), market fervour (and hence risk tolerance) grows at an almost geometric rate as the peak in a boom is approached. Certainly, the NASDAQ put in a staggering quarterly average increase of around 20% through the course of 1999 but it took the index just nine weeks to reach this rate of progress in the first quarter of 2000. This latter achievement notably coincided with breach of the 5,000 level (on March 7th) and this author recalls memories of the associated euphoria, unrestrained optimism and the only question asked of analysts at the time: ‘When will the index hit 6,000?’ Yet, just three weeks later, the index embarked upon a precipitous decent to levels from which it has only recently begun to recover. As such, boom conditions clearly present fertile ground for those with vested interests to formulate growing justification in the relentless ascent of an index whose relationship with traditional market fundamentals has become decidedly fuzzy. Put another way, investors often appear to have the same resistance to booms as moths have to light.
These two gentlemen suggest that bubbly markets go parabolic before popping. Fleckenstein sees a US market increasingly detached from fundamentals. Derrick says P/E ratios of 42 in China make little sense. We'll soon see if they were right.