Waiting for the End of the World
Ross M. Miller
Miller Risk Advisors
May 17, 2004
The title of this week's commentary is cribbed from an
early Elvis Costello ditty. Poets and songwriters from T.S. Eliot to
Michael Stipe have contemplated the end of the world and so have the
The current series of commentaries began with a
discussion of two battling memes: the inflationary-boom meme and the
it's-all-one-world meme. But there are forces in the financial markets
that are so powerful that referring to them as memes does them a
disservice. These are powerful forces like the winds and the tides. These
forces are fear and greed.
Over the past month, fear has been hard to miss in the
markets. Not merely the fear that higher interest rates will dampen the
recovery, but genuine fear, even primal fear. At the root of this fear is
the sense that things have gotten out of control. As recently as a month
ago, the typical investors that I spoke with seemed confident that the
Bush administration had rigged things so that the stock market would
continue to rise through the elections. The problems in Iraq have
undermined confidence that the present administration is competent to rig
anything, much less something as vast and complex as the U.S. economy.
And, as I have written elsewhere, markets run on confidence. Now the
typical investors that I talk to are scared, plenty scared, and worried
that things are getting out of control.
There is no end of things to worry about if one puts
one's mind to it. No one really knows what is going on inside Fannie Mae
and Freddie Mac, and that likely includes the people who work there. Every deficit that the U.S. could have
(budget, trade, etc.) has been supersized of late. There's
terrorism, China, climate change, bad jobs replacing good, the
overextended consumer, and the housing bubble. Whew! (I have not forgotten
oil--it gets its own commentary next week.) It seems like the U.S. economy
should be dead and buried by now.
In my chosen field of risk management, I have had the
privilege of talking with CEOs about just how much nuclear devastation
would be required to bankrupt their firms, so I have not only contemplated
the ultimate disaster, I have worked through the various scenarios in
excruciating detail. Having done all this, there are three reasons that I
am not anxious. A tad concerned perhaps, but not anxious.
First, history shows that people only rarely anticipate
what will ultimately do them in. Sure, when an "unanticipated"
problem arises one can always find a bureaucrat somewhere in the system
warned about something similar (and usually got all the details wrong),
but then that is what bureaucrats are paid to do. No government or
business could function if it heeded all the memos churned out so that
someone would have his ass covered in the unlikely event that the worst
ever happened. (This assumes that they currently do "function,"
which I admit requires a leap of faith.)
Second, everyone, not just poets and songwriters, seems
to think that the world is ending on a regular basis. I have been
listening to snippets of newscasts from New York's WOR radio station from
the early 1970s. Between Watergate, inflation, Attica, rampant street
crime, streets overflowing with uncollected trash, impended bankruptcy,
etc., etc., one gets the impression that the end was near, if not for the
world, certainly for New York City. Things had gotten so bad that WOR
radio personality and humorist Jean Shepherd suggested that no news be
broadcast by any radio or television station in the country for an entire
month. Of course, those who scooped up Manhattan real estate back then
would go on to realize astronomical gains. Even the stock market turned
out not to be such a bad deal.
Third, when the world ends it will take all the
counterparties with it. A favorite play of the doom and gloom crowd is to
purchase far out-of-the-money put options. However, if things go
sufficiently awry and the financial system actually does collapse, let's
see those bears try to sell or exercise their options. It is one thing to
be right, it is something entirely different to collect on being right.
There is an old saying on the Street that a bull market
climbs a wall of worry. There is a good reason for this. The dance of the
stock market can be broken down into wiggles and hops. (Statisticians call
this combo of wiggles and hops a "jump-diffusion process.") Most
every day, the market wiggles. Even the recent disquieting slides in the
market still qualify as larger wiggles. Hops are rare. The plunge in bond
prices that accompanied the April employment numbers qualifies as a hop.
If you look how the stock market wiggles over a
sufficiently long time, you will notice that the major averages tend to
drift upward. (Statisticians call this drift--well,
"drift"--showing that sometimes they know how to speak ordinary
English.) On the other hand, the hops in the stock market averages are
more likely to be hops down than hops up. Indeed, the largest percentage
moves for the Dow going back to its inception are all crashes.
The mathematical combination of the upward-drifting
wiggles with the rare and horrific downward hops means that each day that
the financial world does not end the market is pushed up a smidgen. (Try
to get a statistician to use the word "smidgen.") A bull market
really does, in a strict mathematical sense, climb a wall of worry.
There is that scene in "It's a Wonderful
Life"--I've got to be careful of my commas now that the Brits have
unleashed the punctuation police on America--where Mr. Potter butters up
George Bailey by noting that they were the only two in Bedford Falls who
kept their heads and bought while everyone else was selling. (Not that
any choice in the matter.) Is this such a time?
Still, the stock market can swoon and give the bears
cause to frolic even without the world ending. Next week, I'll look at
"Black Gold" and the prospects for the wounded bull market in
the face of higher oil prices.
Copyright 2004 by Miller Risk Advisors. Permission
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