When I worked for an investment bank during the dotcom boom, I recall in early 2000 publishing a bearish note on a leading European semiconductor company, which like all tech stocks was on a ludicrous earnings and revenue multiple. It was a top down, reality check piece of research, which asked a simple question: what future market share is the current valuation implicitly assuming? It turned out that even on the most bullish assumptions of consumer device growth, they would have to capture just about 100% of the market to remotely justify their market value, and in a competitive market that was never going to happen. We presented that note to some of the leading global investment institutions who held the stock, and with few exceptions, despite the compelling simplicity of the argument, they retained their bullish stance. Within weeks the Nasdaq crash had started, and within a couple of years that stock had joined the 90% club. The fact is that those highly qualified and paid investment professionals were guilty of informational bias, of subconsciously filtering out information that ran counter to their prejudices. They were emotionally involved in investments that had long flattered their performance, and it is a trap most investors fall into.

It’s hard to be strictly rational and dispassionate, but the most crucial investment discipline is to reality check anything you read or hear. Take China for example; if Chinese exports kept growing at the rate evident until the end of 2007, they would account for all global merchandise exports by about 2015 (same for FDI; China would soak up 90% of all global foreign investment if you extrapolated recent trends). It was never realistically going to happen, which is partly why I’ve taken a very bearish stance on the the stuttering Chinese economic model (I’d be a seller of even 5% GDP growth next year). Aggregate bank asset growth is another easy ready reckoner; banks collectively can’t grow assets faster than GDP for any sustained length of time, and the disparity in recent years was a clear warning of a looming financial correction. Long term aggregate equity earnings and dividends are similarly constrained by underlying economic growth.

Mark Hulbert recently analysed the returns of the three most long-term bearish investment letters, and found they had lost 60% this year. Similarly with Peter Schiff, who is CNBC’s resident bear when Nouriel Roubini actually has to teach a class, down 40%. These are guys who were preaching systemic collapse for years if not decades, and when the perfect storm roared ashore, they did worse than the most gullible long-only mutual fund manager. Why? I don’t know their detailed portfolios, but I’d bet that they were all long gold and short the dollar. Permabears and Goldbugs believe the dollar deserves to go down to punish America’s excesses, it’s emotional, not rational with them. They think gold is a currency, not just another commodity subject to demand destruction.

It’s the same informational bias that afflicts all those not possessed of a strictly rational, agnostic view of markets. On 11 April I wrote in The Fed goes Bust, the Dollar Goes Up ‘the dollar is poised to surprise against consensus and bounce strongly over the next few months; I’m long far quarter $/Euro’. And on 2 May in Goldbugs get Squashed: ‘At the time I suggested selling, which I did by shorting the June future at just over $1000, as gold seemed the most extreme manifestation of a general commodity mania, driven by huge speculative flows (much of it retail via ETFs) into the complex as a dollar hedge…I know an overcrowded momentum trade when I see one.’ Those were high-probability, low risk trades, based on an appreciation of market fundamentals. Now, I note that physical buying of gold, particularly in the Mid-East and India, is rising strongly again, and that the dollar move looks technically overextended and likely to reverse sharply in a likely sustained rally for risk assets, which means the balance of probabilities is shifting again. I read recently that a key advisor to Barack Obama, when asked how he stayed so cool, stated: ‘he works out every possible scenario in his head before anything happens, so I’ve never seen him actually surprised by events.’ If he wasn’t President-elect, sounds like he’d make a great investor.

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America, Bank, Barack Obama, China, Federal Reserve System, India, Investment Bank, mania, Mark Hulbert, Market Commentary, Nasdaq 100, Peter Schiff, semiconductor, USD