Today's markets are driven by greed and fear

Peter C. Newman November 10 1997

Today's markets are driven by greed and fear

Peter C. Newman November 10 1997

Today's markets are driven by greed and fear

The Nation’s Business

Peter C. Newman

The stock market is a gambling casino. That used to be the claim, but it no longer applies. Casinos have rules; stock markets don’t. Last week’s roller-coaster ride ought to have imprinted that epiphany into every investor’s brain cells, but it probably won’t. Investors like to believe that there is some connection, however vague, between share prices and the state of the economy.

There was a time when this was true, when people bought common shares in blue-chip companies as a hedge against inflation, which has also vanished, come to think of it. In those days, a sharp twist in the market indexes was a fairly safe forecast of an economic upturn or downturn six months later.

None of that applies today. What runs the markets now is a much simpler formula: half greed and half fear. The bull market, which has been going almost full bore since the last major correction in the fall of 1987, is connected mainly to low interest rates, which preclude most ordinary investors from making a decent return, except in the inherently risky equity market. Treasury bills or GICs now return about two per cent after taxes; you might as well leave the money in your bank savings account. The greed comes into the picture at the corporate level. Stock prices have not only become disconnected from economic trends but, more seriously, from company earnings. One really astonishing aspect of the Bre-X story is that greedy investors drove the stock up to almost $300 a share before the company had any earnings, or even had begun to dig into the mountain of mud that was supposed to be bursting with gold.

What has been driving up stock prices is not corporate earnings or economic prospects but the greed of investors (and the brokers who advise them ) to cut themselves in on a boom that deserved to go bust. The correction that took place last week was long overdue, and it will be the first of many. Unfortunately, it may not leave a residue of enough fear to inspire realistic stock price levels.

One of the few gurus who predicted a market collapse was the late Andy Sarlos in his recently published book Fear, Greed and the End of the Rainbow. The full force of the mutual fund meltdown that he forecast has yet to happen. It will probably come after at least another six months or a year of crazily upward spiralling stock prices, but his thoughts on the market in general, published in Fireworks, his 1993 autobiography, are worth repeating. Sarlos, who died earlier this year, was a key player on Bay Street. During 1977 alone, he drove the stock of HCI, his own financial investment company, up from $6 a share to $17.50, and on Oct. 6 of that year, when HCI announced its profit projections, there were so many buyers that the TSE had to suspend trading for four hours. In 1988, he made a cool

There must be some connection, however ephemeral, between stock prices and corporate and economic performance

$5 million in less than 10 days by flipping a block of Santé Fe shares, when the Reichmann brothers were taking a run at the company.

Sarlos, who was a good friend of mine, was frequently asked how he made so much money on the stock market, mainly by people who didn’t know or remember that he had lost two of the three fortunes he made on Bay Street. “Asking me how and where to invest,” he wrote in his autobiography, “is like asking an opera singer or a parachutist how they practise their trade. The former needs a lifetime of study and devotion to practice; the latter requires nerves of steel and the willingness to take risks. For the stock market you need both. It’s more of an art than a science. John Maynard Keynes, the noted British economist who was also a highly successful investor, once defined the process as ‘anticipating the anticipation of others,’ and

that’s a pretty good rule of thumb to follow.

“In the end, putting your hard-earned money out into the cold, cruel marketplace comes down to a choice of wanting to eat well, or sleep well. I’ve been lucky enough to do both, probably because I’m not really an investor, but a speculator, and I know the odds. The ordinary investor’s chances of winning are no better than those of a casino customer betting against the house. As any seasoned gambler knows, over the long term, the house always wins. The longer you play, the worse your odds become. The successful gambler quits while he’s ahead.” That’s good advice, but I doubt if anybody will take it Most investors will read the wrong message into last week’s market performance. They will view it as merely a hiccup in the market’s long-term climb to heaven.

It’s not. The reason the Dow fell more than seven per cent on one day was that it was far too high, even for this overheated market.

There must, in the end, be some connection, however ephemeral, between stock prices and corporate and economic performance.

One other note of caution: the main reason that last week’s stock slide didn’t develop into a full-scale crash had nothing to do with investors rationally assessing the situation and deciding that what was happening in the pressure-cooker markets of Hong Kong had little connection with the freefall on North American stock exchanges.

The Wall Street exchange is programmed to temporarily halt trading to calm nerves during big sell-offs, and on Monday trading was halted twice. There has been speculation that this further panicked the market, because traders thought that exchange officials had, in effect, deliberately halted trading to prevent the ultimate crash. But a closer study of trading as the Dow index headed due south shows that the automatic fuses probably saved the day by preventing the market from seeking a new bottom. Each time the selling wave was threatening to swamp not just the trading system, but the market as a whole.

Pray for those circuit breakers, the next time around.