COMMON FEATURES OF PREVIOUS INVESTMENT MANIAS AND THE DIFFERENCES TO THE CURRENT INVESTMENT ENVIRONMENT.
A bull market in one asset class was accompanied by a bear market in another important asset class.
Precious metals soared in the 1970s, but bonds collapsed. Equities and bonds rose in the 1980s, but commodities tumbled. In the 1990s, we had rolling bubbles in the emerging markets, but Japanese and Taiwanese equities were in bear markets while commodities continued to perform poorly.

Finally, the last phase of the global high-tech mania (1995–2000) was accompanied by a collapse of the Asian stock markets and Russia, as well as a continuation of the Japanese and commodities bear markets. By the late 1990s, most emerging markets (certainly in Asia) were far lower than they had been between 1990 and 1994. In the 1990s, emerging markets grossly underperformed the US stock market.

Currently, looking at the five most important asset classes — real estate, equities, bonds, commodities, and art (including collectibles) — I am not aware of any asset class that has declined in value since 2002! Maybe realestate has peaked from 2002 and has come down in most parts from 2005 but it is still higher than in 2002. Admittedly, some assets have performed better than others, but in general every sort of asset has risen in price, and this is true everywhere in the world.

In the early phases of all previous investment booms, investors failed to recognise that the “rules of the game” had changed and continued to play the asset class that had been the leader in the previous investment mania. In the 1980s, every increase in gold and silver prices was perceived to be the beginning of a new bull market in precious metals (after silver prices collapsed in January 1980, prices doubled three times between 1980 and 1990 — all within a downtrend), while investors maintained a very sceptical view of bonds. In the early 1990s, investors failed to recognise the emergence of a high-tech sector uptrend, although, as explained above, high-tech stocks were already performing extremely well between 1990 and 1995. Global investors continued to believe in the merits of Asian stocks right to the end and actually stepped up their buying in early 1997!

Similarly, in the current asset inflation, investors have continued to focus on the high-tech bull market and have largely missed out on the huge increase in price of commodities, and of Indian, Latin American, and Russian equities.

At the end of each investment mania, investors believed in some sort of “excess liquidity” that would drive the object of the speculation forever higher. At the end of the 1970s, the “excess liquidity” related to the OPEC surpluses; at the end of the Japanese stock and real estate bull markets, “excess liquidity” centred around the enormous Japanese current account surpluses; during the 1990s emerging markets mania, “excess liquidity” was perceived to come from foreign buying and the Yen carry trade; and at the end of the high-tech boom the investment community believed that “excess liquidity” would come from record mergers and acquisitions, a reallocation of funds from bonds to equities, and easy monetary policies by the Fed (a belief that was fostered by the Mexican and LTCM bailouts and money printing ahead of Y2K).

But as Albert Edwards so eloquently explained in a recent scathing report entitled “Lies, rhubarb, poppycock, bilge, utter nonsense, caravans and liquidity” (see Dresdner Kleinwort Global Strategy Report, January 16, 2007), “liquidity is the hocus pocus of the investment world. It means totally different things to different people but is often cited as being a major driver for buoyant markets”.

Most presciently, Edwards explains that with respect to investment manias, “when markets are rallying but seem expensive, when new issues fly out of the door and when fundamental analysis often appears to fail to explain events, the safe haven for the market commentator is often to rely on the explanation that there is lots of liquidity

What is peculiar to the current investment environment is that liquidity is supposed to come from not just one or two sources, but from everywhere! From OPEC surpluses, from the US Fed and other central banks, from the Asian current account surpluses (excess savings), from the Yen and Swiss Franc carry trade, from the large size of money market funds and bank deposits, from rising asset prices, leverage, and a tidal wave of private equity funds, and from artificially low interest rates. It’s no wonder that, given such beliefs, asset markets are all flying High.
Continued Tomorrow.