Common Sense & Investment
An investor's greatest ally in this tough and mean world of finance is common sense – an understanding of the rational behaviour of money, notwithstanding the new eras and paradigms and other such nonsense. The timeless basis of money since, say a few thousand years, is – what is the return on my money? This basic computation is the most efficient judge of the deployment of wealth or capital in any enterprise or undertaking. Implicit in the return on capital are factors like corporate governance, technological edge, an efficient business model, and a number of other factors. Only if you have good management, technology, etc. will you get a good return on your capital. So where does this common sense part come in?
Consider the last two-three years in the stock markets. From 1998 onwards, the prices of companies in the technology sector started appreciating at a faster rate and the initial investors made huge profits. Later, say end-1999 early-2000, the herd seeing these huge profits also decided to join the party. The shills of the finance industry of course joined in the chorus inviting one and all to the party. The arguments at this point, like the new era and new paradigm were faithfully trotted out by the financial quacks, regardless of whether we understood it or not and in fact the more hocus-pocus the word, the more followers it attracted. The 'money would be doubled' we were told, yes doubled is the operative word, in a few weeks to months depending on one's gullibility. Did it appeal to my common sense that we normally get 5-10% return on deposits, 10-30% in business, so how can 100-300%, or even more, be a rational expectation on my investment in a largely untested business area? My common sense should have told me that returns like this are abnormal, more of an exception than the rule. Ponzi schemes are structured along these lines – the initial investors come off very well, but when it collapses, nothing remains.
Fast forward to the present - these same financial quacks are now calling a bottom in the stock market and recommending that you invest in small quantities for the long-term in 'good' companies. My common sense is now suggesting the following:
- If these quacks did not call the top in early 2000, how can they call the bottom now?
- If these quacks were using silly valuation models (eyeballs, hit rates, etc) last year and were wrong, what is the assurance that they have finally learnt anything at all in valuing their 'new era' companies with traditional models?
- If these quacks were asking me to buy CISCO at US$ 70 per share last year and are also telling me to buy at US$ 20 today, do they, in fact, know anything about valuation at all?
- How come the values of the tech stocks have plunged 60-99% and these quacks are still saying this is a good long-term opportunity?
My common sense tells me that these 'advisors' and 'experts' are as clueless today about the dynamics in the financial markets as they were at the start of their careers.
Now let us try to apply common sense to this latest fad of interest rate cuts - "nirvana" for the economy, courtesy Mr. Alan Greenspan and others of his ilk at the central banks globally. The interest rates are lowered so that the cost of borrowing reduces for corporations and consumers. The corporations will now make capital investments which will increase production. The consumers can buy this excess production with cheaper loans and consumer credit. Consider the facts: Industry is reeling under excess capacity and is already heavily in debt, consumer is also heavily in debt and his current income is used to service this old credit, and the economy is slowing as industrial growth numbers prove. Now to the common sense part – does it make sense that industry will borrow cheaper money and add further to its debt and capacity, when existing capacity is not utilized fully? NO! Does it make sense to assume that consumers will borrow more and add to their existing debt burden in a weak job environment with increasing layoffs just because money is cheaper? NO! In case of doubt refer to Japan 1990-today. Hence this rate cutting business is a very futile and desperate move by reckless central bankers and politicians who think they can ban recessions (purging of accumulated rot in an economy) or rather, business cycles! The effects we will see over time!
US technology companies are laying off workers, whom they had paid a lot to hire and train over the last few years. Now common sense suggests that if things will get better in the next six months, why on earth are these companies laying off trained people, only to rehire in 6 months and again spend on training? They are obviously seeing a longer downturn but do not want to say so or Wall street will slaughter their stocks and then the options of the executives will be worth less than toilet paper (if not already)! So if you assume that things won't improve substantially in the US, be careful on the earnings forecasts that are dished out in the media.
Pinank Mehta
E-mail : métier@bol.net.in
28 May 2001
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