Three eloquent bears gathered for breakfast on Dec. 15 in an executive dining room atop the Morgan Stanley Dean Witter building in Times Square. The three bears were Barton Biggs, Morgan Stanley’s chief global strategist; James Grant, editor of Grant’s Interest Rate Observer ; and Alan Abelson, the editor of Barron’s .
The Observer had invited them there to discuss the art of being wrong. As perhaps the most visible, articulate and persistent pessimists during the long bull market of the 90′s, they have refined the act of simultaneously holding fast and eating crow.
It was 8 A.M. Morgan Stanley was serving breakfast. Hours before, the transit workers strike had been averted, and Mr. Grant had closed the latest edition of his biweekly newsletter. He was so bushed, he ordered iced tea for breakfast. As the host, Mr. Biggs sat at the head of the table with Mr. Grant on his right and Mr. Abelson on his left.
Soon they were joined by a fourth, Henry Blodget, Internet analyst at Merrill Lynch & Company. As the guy who triumphantly predicted the huge spike in the stock price of Amazon.com Inc. one year ago, he has become the face of the Internet stock boom. He is in many ways the embodiment of the weird new science that has so flummoxed Messrs. Biggs, Grant and Abelson: that of ascribing huge valuations to companies that don’t make money. Essentially, Mr. Blodget is an Internet bull. The Observer had invited him as a foil.
Mr. Abelson: Hello, Henry. Do you feel like a foil?
Mr. Grant: He just feels rich.
Mr. Blodget (sitting down) : I’ve been able to take advantage of my lucky advice.
Mr. Grant: There’s a piece of news.
Mr. Biggs: Are we going to talk about the stock market or the Internet or what?
Mr. Abelson: Do you know anything about the stock market, Jim?
Mr. Grant: No. This reminds me of a fellow who was a compulsive gambler. He was so compulsive and so unlucky that his bookie began to take pity on him. He was betting on basketball games. He bet on the N.C.A.A.’s and lost every single round of the tournament. Finally he was down to his last five bucks, and he lost that. The guy went to his bookie and said, “I can’t pay you.” The bookie said, “Well, basketball doesn’t seem to be working. Why don’t you take a shot on hockey?” And the guy said, “Hockey? What do I know about hockey?”
So, the stock market.
The Observer : Does it matter whether one is right or wrong?
Mr. Abelson: It’s better to be right. There’s no question. But we all can in one way or another justify our existence, because somebody has to be wrong, or else how would you know who’s right? One of these years we’re going to be right. Basically, our function is to piss in the wind. Somebody should be standing here pointing out that maybe things are getting out of hand, maybe things are not as rosy as they seem. But I certainly would rather have been right. In other words, I wish the Dow was at 500.
Mr. Grant: Somebody once asked me, “If you had to do it over again, would you have been bullish?” And the only thing I could say was, Yes!
Mr. Biggs: I’m a little different from them. Like a lot of people my age, I’m bearish and cautious, but I’m running a money management firm. The trick really is to survive through this period where we have been too cautious on the markets, but to remain flexible enough so you don’t take such extreme positions with real money that you get wiped out.
Mr. Abelson: There’s a difference between emphasizing risk and forecasting the market. I mean, I think both Jim and I have written continually about bullish things. It tends to get lost, but we do. It isn’t as if we think people should head off for the South Seas and forget about investing.
Mr. Grant: It’s not as if people with a skeptical cast of mind can’t get through the day. It’s not about being bearish as much as it is about being contrary, about having a sort of creative dyslexia about the world and about not accepting it, you know, when J.P. Morgan comes out and says, “Buy Amazon,” you say, “Huh? Is that right?”
Mr. Blodget: The question I’d ask is, over the past few years, in retrospect, is there something you missed in the analysis that now makes you feel like you made the wrong call? Not necessarily because of what the market has done.
Mr. Abelson: It’s the wrong call, though, Henry, because of what the market has done.
Mr. Blodget: But you have to go back to the decision point. I have in mind something that Bob Rubin said when he was Treasury Secretary: “Just because the outcome is different from what you predict doesn’t mean that the decision was wrong, based on the information you had at the time.”
Mr. Biggs: I made the wrong call, but a lot of the bears in general, the people who are cautious, the wrong call they’ve made is about the Internet and the dimensions and the speed of the Internet. Basically, these people have been right about the 80 percent of the market that is the old-economy stocks, which have been going down for a year and a half now. But I think we way underestimated the impact of the Internet.
Mr. Abelson: I think what we all underestimated was how valuable losses are. We didn’t realize that losing money was a way to get rich.
Mr. Grant: It’s the irrelevance of valuation in general. It’s not just that no known model of valuation seems relevant to the Internet. It’s that the old-economy stocks are also immune to valuation. There are increasing numbers of stocks with decent balance sheets and fine prospects for profitability that are selling for just four, five, six times earnings.
Mr. Biggs: But the question is, do they really have fine prospects of profitability? I think the Internet is changing the world and that its impact on the profitability of industrial America is going to be staggering. I don’t think anyone has any idea what the Internet is going to do, but you know that it’s very deflationary, and that it is crushing the profits in a lot of sectors in the economy.
Mr. Grant: It’s crushing profits particularly in the Internet sector, don’t you think?
Mr. Biggs: Yeah, it’s crushing profits in both sectors. Ford announced they’re going to take $3 billion out of their costs by buying parts through the Internet and that the entire automobile industry is gonna take out some incredible number, like $60 billion or $80 billion. That’s coming out of someone’s else’s profits, out of businesses that already exist. And that’s why an auto parts supplier like Federal Mogul that looks incredibly cheap, a really good company selling at a discount to book value–that’s why valuing it is irrelevant, because you have no idea what Federal Mogul’s profitability is going to be.
Mr. Grant: So how can you invest not knowing anything about valuation?
Mr. Biggs: It’s hard.
Mr. Grant: You just described the perfect case for Treasury bills.
Mr. Biggs: Mmm …
Mr. Abelson: If we extrapolate from what Barton said, there’s not going to be an economy, and that isn’t going to work very well.
Mr. Biggs: Of course there’s going to be an economy. How is there not going to be an economy?
Mr. Abelson: If you kill profit margins through all production, I don’t see how you’re going to sustain an economy.
Mr. Biggs: You may not kill Ford and General Motors
Mr. Abelson: Just the people that supply them, yes.
Mr. Biggs: It’s creative destruction. You’re just taking out an inefficient layer of infrastructure.
Mr. Abelson: Inefficiency is in the eye of the beholder.
Mr. Grant: In the case of an Amazon, Henry, how do you know how high is too high? Given the uncharted waters of valuation, what is the right price for Amazon?
Mr. Blodget: I don’t know. I think in valuing these stocks, you can only come to very vague, fuzzy conclusions. You have to go out several years and ask yourself what is the real opportunity here? Usually the mistake is in being too conservative.
Mr. Abelson: You want a recent analogy for this market? Go to Japan in the late 80′s. The same arguments were made then as are made now: that it’s different .
Mr. Blodget: I don’t necessarily think this is different. But I do think it’s always important to ask whether it might be different. If you’re paid to manage large sums of money, if you decide that right now it is no different and we are five days away from becoming another Japan–
Mr. Abelson: I’d say three days.
Mr. Blodget: Well, if we are in fact three years away from that, in those three years it won’t matter, because if you’re on the sidelines when the market triples, you will have lost your job before you are proven right.
Mr. Grant: It’s always different. If it weren’t, the historians would have all the money, whereas in fact they have so little of it. And yet there are aspects to every market that are eternal because markets are all about people in crowds, and people in crowds tend to repeat patterns of behavior.
Mr. Blodget: And they tend to go too far both ways.
Mr. Abelson: If you manage money, you have to take a different attitude. If someone calls a plumber in, the plumber may not like the architecture, but he has to fix the leak. People pay Barton and Henry to manage their money. Jim and I aren’t restrained by having someone else’s pot of money.
The Observer : Then do you feel restrained, Barton?
Mr. Biggs: No, not really. But look at Warren Buffett. Buffett’s just as bearish as we are, so he tries to be amusing about it.
Mr. Abelson: It’s the last refuge of scoundrels.
Mr. Biggs: It’s a defense mechanism.
The End Is Where
Mr. Biggs: So, Alan, is it going to be secular [i.e., very long] or cyclical?
Mr. Abelson: No question, we’ve had a secular bull market, so we’ll have a secular bear market. Of course. Symmetry is everything.
Mr. Biggs: That is an important comment.
Mr. Abelson: Just witness the interconnectedness of it all. We’ve never had so much exposure to the stock market. The 401(k) revolutionized an awful lot of things. We haven’t been through a bear market with this particular phenomenon. It’ll be interesting to see. We may not be having breakfast here. And, Henry, I doubt your office will still exist.
Mr. Biggs: If Alan’s right and the crash is secular rather than cyclical, the intellectual bears are gonna get crushed too.
Mr. Abelson: They’re the first to be crucified.
Mr. Biggs: To look at Japan is instructive. The Bank of Japan people I talk to say that Greenspan six or eight months ago sent over a couple people and really did an intensive study on the Bank of Japan’s actions. They looked at what happened in the late 80′s and early 90′s, and that poor old Governor [Yasushi] Mieno [former governor of the Bank of Japan] who finally pricked the bubble ended up being indicted as an economic criminal by the Diet.
Mr. Abelson: And well he should have been.
Mr. Biggs: But he was the hero, really.
Mr. Abelson: And I remember you wrote that. Mr. Greenspan is conscious of this.
Mr. Biggs: He is conscious of this.
Mr. Abelson: And don’t be surprised if he [Mr. Greenspan] gets indicted.
Mr. Biggs: He won’t get indicted because he’s never going to take the courageous stand.
Mr. Abelson: He’ll get indicted for not taking the courageous stand. I don’t think it’s even a possibility that he’s gonna win in this thing.
Mr. Biggs: Really? You don’t think so?
Mr. Abelson: No, I don’t. I’ve thought from the start that the best he can hope for is a footnote as to why the crash took place. And Greenspan will deserve a footnote. I think he had a chance in 1996 to do something. But why he didn’t raise margin requirements is beyond me. Just because it hadn’t been done since 1974 is hardly a good reason.
The Observer : How do you think the boom will end?
Mr. Abelson: It won’t end well. I hope I don’t shock you.
Mr. Grant: It’s gonna end in 1986. That’s my story and I’m sticking to it.
Mr. Abelson: ’86 was actually a very nice bear market.
Mr. Grant: Hey, Barton, can you buy me another iced tea?
Mr. Biggs: Absolutely. Press that little button right there.
Mr. Grant: This is a bull market. Press the button and a guy comes in.
(I Can’t Get No) Vindication
The Observer : How would a crash affect your lives?
Mr. Abelson: Not much. I would probably turn bullish too early, like I did in ’74.
Mr. Grant: Nothing wrong with that.
Mr. Blodget: Business would slow down quite a lot.
Mr. Abelson: Henry would become a money manager.
Mr. Blodget: After a few years’ hiatus.
Mr. Abelson: Or a consultant.
Mr. Grant: I don’t know whether it would be good or not for my business. It would certainly be good for the journalism.
The Observer : Is a crash something you wish for?
Mr. Biggs: Both of these guys should definitely wish for it. They’d be vindicated, and it’s not gonna make a lot of difference to them financially. But for Henry and me it would be an incredibly painful and expensive disaster. We work for financial service companies.
Mr. Abelson: Vindication would be nice. Everybody wants vindication in some sense. But it isn’t going to change the fact that we’re still going to be skeptical.
Mr. Grant: For me, the point is not being personally vindicated. It is no longer being tormented by the sense that two and two don’t make four but rather 5 7/8, and tomorrow they’ll make 6 1/4. People tell me this new truth with all the certainty of accumulated wealth behind them. That’s what’s exasperating. It’s the sense that not only valuation but the laws of nature and of compound interest have all changed, and nobody mentioned it. Everybody else found out, but nobody told me. No matter how sure you are of the ancient cycles of boom and bust, no matter how sure you are of the tendency of people in crowds to do the same things at roughly the same moment, no matter how sure you are of those truths, you can’t help but wonder if things changed and nobody had the courtesy to say so.
Mr. Biggs: The real truth, if it’s a secular bear market, not cyclical, is that it’s gonna take 10 years to get through it. It may even take longer than that.
Mr. Abelson: It could be longer. What was it, 25 years for the market to come back after 1929?
Mr. Biggs: The best that you can hope for is that we have a nice 20 to 25 percent decline, then the market goes dead for three or four years. That’s the best outcome.
Mr. Abelson: The best of the worst.
Mr. Grant: I always say that we’ll know when the bottom is here when CNBC starts showing test patterns. As it is, the world has come to accept that they have to know about the market at every minute. Well, they don’t have to know. And, furthermore, when the time comes when one actually has to be interested again, they won’t want to hear it. A.J. Liebling, who is the greatest of all, wrote about the Daily News ‘ Inquiring Photographer in 1933 who went around asking people in the streets whether they’d read the agate stocks quotes, and they gave the Inquiring Photographer a piece of their minds. They didn’t want to hear about it. The market is now ubiquitous.
Mr. Blodget: And that is the reason why valuations are where they are. It’s supply and demand. There’s just a greater percentage of global assets in the stock market. And the question is, if we do get a 25 percent correction or a two-year bear market, does that asset allocation shift back? Because if it does, then your scenario of a 7-to-10-year bear market seems totally plausible.
Mr. Biggs: We also have to consider the possibility that we really are having a deflationary boom.
Mr. Abelson: That sounds like joyless sex to me.
Mr. Biggs: Just the opposite. It’s perpetual sex.