Barrelling over the falls

Donald Coxe August 13 2001

Barrelling over the falls

Donald Coxe August 13 2001

Barrelling over the falls

Donald Coxe

The Great Technology Bear Market has shocked millions of investors and pushed the global economy towards recession. To veteran market observers, this is just the most recent example of the most dreaded of all financial events, the Triple Waterfall. A Triple Waterfall is the price chart for a collective exercise in human folly, such as the 1929 Crash, the Nifty Fifty Collapse in 1973-1975, the Oil Stock Boom-Bust of 1978-1984, and the Japanese Bubble-Burst of 1982-2001.

Each mania had its own special features, but they have tended to move through eight stages. Here’s how I see them: Stage I: Investment Opinion Shift Financial liquidity expands, thanks to aggressive central bank money creation. Earnings and stocks begin to soar even faster than the few truly bullish forecasters had predicted. At this point, a new breed of pundits with academic credentials emerges, announcing the dawn of a New Era because of a new kind of economy. They legitimize the most enthusiastic of Street profit predictions.

Stage II: Faith

Financial liquidity continues to expand and prices rise more rapidly as more and more buyers rush in. Suddenly, the world is divided into two groups: those getting rich from the roaring bull market, and the envious others who wonder whether it’s too late to get in. The financial community becomes awash with new promoters, new products and new winners. Tales of instant fortunes abound. Youthful forecasters leap from obscurity to stardom as their predictions cause instant leaps in prices. Established investment professionals, relying on time-tested evaluation techniques, lose business and clients to hotshots.

The economy itself changes. Soaring asset prices attract floods of funds for companies in the winning group. They expand their capital investment, convinced that oversupply is impossible.

Stage III: Fanaticism

Liquidity expands even more rapidly, and prices leap to astounding levels. Newly rich abound, building palaces. Because the trend has been so sustained and so powerful, the formerly envious and the formerly embarrassed can no longer stand the pressure; they rush to join the newly rich. Those who had proclaimed the New Era earn fortunes in media appearances, citing the boom as evidence of even greater profits ahead. Established investors counselling caution become endangered species, as Dissent becomes professionally perilous.

Donald Coxe is chairman of Harris Investment Management in Chicago and Toronto-based Jones Heward Investments.

The recent collapse of the bull market for technology stocks echoes the eight-step “Triple Waterfall” pattern of the past

Asset prices reach levels that make financing virtually free for companies. They use the money to increase capital spending to stratospheric levels.

Stage IV: The Top and the First Drop

Central bankers finally act to control liquidity growth. Stock prices are so high that huge inflows are needed merely to prop them up. As liquidity dries up, prices suddenly drop sharply. Capital spending continues at unheard-of rates.

Stage V: Rally

Liquidity shrinks modesdy. The sharp sell-off occurred even though news remained good. The prophets, shills and mountebanks come out in even greater intensity, warning that this is investors’ last chance to buy cheap. They respond. Prices rally, but fail to touch old highs. Capital spending continues at record levels.

Stage VI: The Second Drop

By now, the central bank tightening is taking hold. Liquidity is contracting sharply, forcing liquidation of margin accounts. This comes as bad news begins to appear. Evidence of grossly excessive capital spending emerges. Prices plunge. Each week, some former superstar stock collapses.

Stage VII: The Last Real Rally Frightened central bankers flood the system with liquidity. The financial community rushes to reassure investors. (“This is no time to panic” is frequently heard; question: when have you ever heard Wall Street say, “This is the time to panic”?) A spirited rally comes out of nowhere. New Era barkers emerge from hiding to scream “buy” with something approaching the old gusto. It turns out that Faith has not completely disappeared. Capital spending peaks.

Stage VIII: The Third Leg Down

Despite rising liquidity, asset prices roll over and plunge in response to increasingly terrible news. It becomes apparent that excess capital spending has created a glut that will take years to clear. Collapsed earnings, bankruptcies and asset writedowns become routine. Faith fades into Doubt and then Despair. The process grinds on, usually for years. Brief intervening rallies occur, but they are “dead cat bounces.”

Nasdaq and its kindred have entered Stage VIII. That there are still “New Economy” promoters around suggests it could be a long process. The good news is that to date this has been an industry-specific bear market, like the oil-stock collapse, which didn’t kill the bull market of the 1980s. The overall stock market remains in bull phase.

As Mark Twain said: “History doesn’t repeat itself, but it sure does rhyme.”