first majestic silver

Asset Bubble Turns Garbage to Gold

July 27, 1998

A house that would barely qualify as a tool shed in some neighborhoods recently sold for $472,000 in Palo Alto.

On the same day, shares of a well-known company listed on the New York Stock Exchange changed hands for 340 times trailing 12-month earnings.

If someone held a gun to your head and ordered you to invest in one or the other, which would you choose?

I suspect most would pick the house, even though it's in a neighborhood with ratty lawns and so-so schools.

I'd probably jump on the stock myself. Admittedly, $140 is a lot to pay for shares of a company that earned just 41 cents in the last twelve months.

But that company is America Online. And while buyers may be lining up six deep to pay half a million dollars for "starter" homes in Palo Alto, they are flocking by the thousands to the stock market every day to bid more than 300 times earnings for AOL.

Which brings us to the cardinal rule for making big money in the midst of an asset bubble: Forget earnings and buy whatever swill the mob of Greater Fools may be clamoring for at the moment.

Of course, that's not the way customer reps are laying it down. They choke down the cynicism, then lob up a concept that at first sounds as novel and enticing as, say, "interactive Monday Night Football."

Here's a plausible script for America Online: "Earnings? Who cares about earnings when a company is generating $4.30 of hard cash per share? Hell, they could buy Disney tomorrow if they needed earnings."

Aren't you glad you asked?

The use of a cash-flow argument suggests how much more sophisticated the sales game has become in recent years. It wasn't too long ago that brokers could incite us to buy stocks like America Online at any price merely by inserting the word "Chinese" into the cold call. As in, "A billion Chinese are going to be connected to the Internet some day. How much do you think Coca-Cola would pay to get its logo in front of them?"

Investors have probably figured out by now that those billion Chinese have got other priorities at the moment. Like surviving the spending collapse that is suffocating the economies of Japan and most of Asia.

Still, you can't blame stockbrokers for hustling their customers. If they didn't do it so very well, huge wads of unspent 401(k) money would be piling up on their desks and bursting the doors of back-office safes.

Nor should we be surprised to find, as the bull market waxes ever more ethereal, that investment theories supporting the purchase of stocks trading for hundreds of times earnings have become commensurately more farfetched.

Here's one that has been making the rounds. It is intended by the feather merchants on Wall Street to negate claims by technical analysts that market "breadth" indicators have been signaling disaster.

Technicians use breadth to measure the internal strength of the stock market. If the bull is healthy, the theory goes, the list of stocks making 12-month highs will expand when the broad averages are hitting new highs, and the list of new lows will shrink.

Conversely, the bull is supposedly in trouble if new highs shrink and new lows expand when the averages move to new records.

In fact, this is exactly what has occurred. Last summer, during a week when the Dow Industrial average was setting all-time highs near 8300, there were a total of 1008 new highs and 68 new lows on the NYSE.

Yet, earlier this month, during a week when the Dow Average was making a new record top a thousand points above last July's, only 388 stocks were hitting new highs, and no fewer than 252 were making new lows.

These statistics are ominous, most technicians would agree. What they imply is that, at current levels, the bull market is little more than smoke-and-mirrors.

But the news media reinforce the illusion that all is well by playing up every new record high notched by the Dow Industrials. Rarely if ever do those stories mention such concerns as market breadth.

One might get the impression the stock market has been red-hot lately. But in reality, it is just a relative handful of stocks that have been driving the highly visible Dow and Nasdaq averages to record levels.

Meanwhile, much broader indices, such as the Russell 2000 and the Wilshire 5000, are languishing well below the record peaks they achieved earlier in the year.

Those who make their living pushing stocks see only a silver lining. They view such divergences as bullish, and hard-sell the theory that the thousands of small-cap stocks that have supposedly been "underperforming" must eventually catch up.

It's a mirage, and a dangerous one. The reality is that the relative handful of large-cap stocks now trading in the ionosphere have been pushed to those levels by money managers who are scared to be in less-liquid stocks when the market finally collapses.

They want to be able to dump stocks in a hurry when the trumpets sound, but I am hard-pressed to imagine who the buyers will be

The Federal Reserve Bank of New York holds the world's largest accumulation of monetary gold.
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