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Stock Ideas Top Headlines The Perils of Prediction By Nicholas A. Vardy
Stock Ideas Top Headlines The Perils of Prediction By Nicholas A. Vardy 
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By Tom Dyson In the late 1940s, dozens of new consumer products hit the market, made by companies such as Avon, Xerox, Coca-Cola, and Polaroid. This period marked the beginning of the new American prosperity and consumption... and it triggered a huge bull market in the stocks of the companies that made these products. |
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| The Perils of Prediction By Nicholas A. Vardy |
| Tuesday, 11 December 2007 | |||||||||
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After 15 years of actively following economic developments around the globe, I have developed an almost unconscious habit. Every time I look at a story on the front page of, say, the Financial Times, or any major business publication, I instinctively ask myself: "Could not the exact opposite be true?" Experience has taught me that by the time a story -- investment related or not -- reaches the cover of a magazine -- the trend is likely to be over. We humans have an extraordinary ability to delude ourselves into thinking that we are a lot smarter than we are -- particularly in the world of investment. In fact, the only Nobel Prize winner in Economics was Daniel Kahneman, a non-economist who went to Princeton, who demonstrated successfully the remarkable biases we all have with our psychological decision making processes. With some extraordinary discipline, it is possible to develop an "observing ego" where we can recognize that we are getting too attached to our own particular version of reality -- which allows us to let it go when things don't turn out the way that we expect. That ability, in my view, is the key to the success of top speculators like George Soros. As Soros put it: "The secret to my success is not that I am always right. It is that I recognize when I am wrong." The lesson? The more attached you find yourself to a particular investment idea, the more you should be careful. The Perils of Prediction: The Bookshelf TestYesterday, I spent a few hours browsing in a Manhattan bookstore to take the pulse of today's conventional thinking about business. Books on the rise of China and India are all the rage. There seemed to be more than the usual number of doom and gloom books predicting the inevitable demise of the United States. I could find only one book on Japan and not a single one on Europe or Germany.That's surprising, given that Japan is the #2 economy in the world, Germany is #3, and the European Union's economy is larger than that of the United States. Although there were a couple of books on Google and EBay, I didn't see a single book with the word "e-commerce" in the title. Twenty years ago, the bookshelves bulged with Japan-related titles and 10 years ago the Internet was all the rage.
The Perils of Prediction: Three Contrarian ThemesAs a mental exercise, let's look at three themes in today's financial markets that everyone takes for granted. Then, just for fun, let's assume the exact opposite were true.Theme #1 "The 21st Century Belongs To China"Reality Check: Well, if the 21st century will belong to China, it'll take a lot longer than we thought. As of two weeks ago, China's economy is a whopping 40% (!) smaller than the World Bank had originally thought. And as the air is being let out of the Shanghai stock bubble, it’s becoming apparent that a huge percentage of Chinese companies' profits are from -- you guessed it -- investments in other Chinese bubble stocks. That still says nothing of the bad loans on the books of Chinese banks that make the U.S subprime loan problem look like a rounding error. Two years ago, Price Waterhouse estimated China's bad debts at just about $1 trillion -- before the Chinese government forced it publicly to recant its estimate. Contrarian Prediction: China is the next Soviet UnionFrom the 1930s through the top of the 1950s, the Soviet Union was growing so fast that if economic trends were projected forward, Soviet GNP would pass that of the United States in 1984 -- a year with ominous literary overtones. Sound familiar? With China's economy smaller in real terms than California and Texas combined, you don't need to brush up on your Mandarin just yet.Theme #2 "The U.S. economy and the U.S. dollar are yesterday's news."Reality Check: In what is a classic case of psychological projection -- seeing your own weaknesses in others -- the most strident calls for U.S. decline come from Europe. Yes, the dollar has fallen by more than 40% against the euro -- to just about where it was in 1995 against the euro's predecessor, the German Deutschmark. And what about subprime woes? Relative to the size of the U.S. housing market and to the overall economy, the problem still is much smaller as a percentage of GDP than the S&L crisis (remember that?) was in the 1980s.Also, before you spend too much money upgrading your bunker, recall that the U.S. economy expanded at a 4.9% rate in the third quarter and productivity expanded by the same amount -- reaching the highest level in four years. The federal budget deficit, as a percentage of GDP, is down to 1.2%. And the United States also just regained its crown as the most competitive economy on the planet. Contrarian Prediction: The 21st century will belong to the United States. Given the extraordinary negative sentiment against the United States and the U.S. dollar, the U.S. economy and stock market are probably due to begin a long period of outperformance, led by a rising dollar and a sharp rally in financials. The United States may continue to deteriorate in the housing sector, but the dollar will recover once investors realize that subprime woes notwithstanding -- prospects for the U.S. economy are (yet again, distressingly) very good. Theme #3 "Global markets and commodities are the top investment opportunities as far as the eye can see."Reality Check: This is the toughest one for me, since I really believe this one. But here's some self-inflicted tough love. Commodities are trading at all-time highs and emerging markets now are considered safe havens. In that way, both asset classes are much like technology was seven years ago. Because countries like China use six times as many inputs to produce the same unit of economic output, once developing economies slow down, the air will be let out of the commodity bubble with alarming rapidity.And for all their terrific prospects, emerging markets are a series of booms and busts. The development of the world's most successful emerging market -- the United States -- was no different. As John Paul Smith put it in yesterday's Financial Times: "Even if the secular story is valid, if the price is wrong, stay clear." Contrary Prediction: The rise of emerging markets seems as set in stone as technology was in the 1990s. But just as Cisco was briefly the world's most valuable company in 2000, it's unlikely that we'll be seeing another Chinese company hitting the $1 trillion mark -- as PetroChina did in November -- anytime soon. And there are just too many books out there on how economies that are the size of U.S. states are set to dominate the global economy by 2050. That alone is enough to make me nervous. The Perils of Prediction: The Hard Road AheadIn 1992, Lester Thurow, the Dean of MIT's Business School, published a highly acclaimed book: "Head to Head: The Coming Economic Battle Among Japan, Europe and America." China is covered -- and dismissed -- in two pages. Neither India or the Internet even make it into the index. Fast forward to 2022 -- 15 years from now and the same distance in time that 1992 is to us today.What are the chances of the predictions made by today's crop of business books being any more correct than Lester Thurow's prediction that Europe would dominate the world's economic landscape? There always will be terrific opportunities to make your fortune in the financial marketplace. But it probably isn't the place you're looking right now. Sincerely, Nicholas A. Vardy Editor, The Global Guru P.S. Making money in global markets is all about hitching your financial future to whatever offers you big profits -- no matter where they are on the globe. That's the focus of my monthly investment service Global Stock Investor .
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