By Victor Niederhoffer Laurel Kenner
John Wiley & Sons ISBN: 0-471-44306-9
Chapter One THE MEME
A curious piece of news comes to us from Rio de Janeiro. Madness, an epidemic of madness, which may be compared to that contagious madness which attacked the people of Europe in the Middle Ages, is at this moment raging in the Province of Sao Paulo. The frightened inhabitants are leaving their houses, deserting their villages, abandoning their land, saying that they are pursued, possessed, governed like human cattle by invisible, though tangible, beings, a species of vampire, which feed on their life while they are asleep. -Guy de Maupassant, "The Horla"
July 18, 1996: What a beautiful century! As the beginning of the third millennium nears, America is looking forward to continued peace and growing prosperity. Communism has been discredited, and the Cold War is over. World trade is opening up. We're starting to spend money on goods and ideas, rather than multibillion-dollar schemes of mutually assured destruction. The federal budget has a surplus for the first time in decades. Interest rates are at half the level of 15 years ago. Productivity and earnings are rising, and unemployment and inflation are negligible, something thought impossible just a few years ago. The computer is transforming work and home life. Revolutions in biotechnology and high-speed communications are under way. Parents can reasonably expect their newborns to live to age 100 andbeyond. Almost 50 million people are using the Internet. Many investors are becoming rich from investing in technology, and entrepreneurs are finding it easy to raise money for new ventures. Millions of people are more comfortable financially than they have ever been before. The standard of living is better than ever. People are optimistic about improving their lot in life. The future seems promising indeed.
I turn on CNBC to hear the financial news. One of my technology stocks is up 15 points! I call my broker to sell half my shares. Now I can pay my kids' tuition bills. Federal Reserve Chairman Alan Greenspan comes on the air. He says that remarkable technological breakthroughs in microchips and software are boosting productivity. He doesn't see any reason that the economy's growth should not continue for the foreseeable future. The Dow is up 120. I salute his image on the TV screen, I hardly know why, except his words give me great pleasure.
The TV anchor then begins an interview with one of the bearish money managers who has been short the market since 1987. The manager launches into a familiar speech: "Market valuations are ridiculously high ... dividend yields aren't what they were in the 1950s and early 1960s ... the Dow has already risen almost 9 percent so far this year, enough for an average year, after rising 33 percent in 1995." Indeed, with dividends reinvested, it has returned 1,200 percent since the end of 1979. But he sounds a little desperate, as well he might, given that so many who had bet against the market beginning in 1987 have gone belly up. He makes no mention of the decline in interest rates, or the doubling of earnings retention rates, or the fact that buybacks are now running equivalent to dividend payouts. Nor did he provide evidence that stocks must go down after going up at more than the average rate. If only he would take out a pencil and envelope, he could see that after a rise, the chances of another rise the next year are 53 percent versus 52 percent after a decline and that the average move after a rise is slightly greater than after a decline.
December 6, 1996: I turn on the 6 A.M. business news when I wake up. Catastrophe has struck. Last night, after the U.S. markets closed, Greenspan suggested that investors are "irrationally exuberant." Markets are diving in Asia and Europe.
A sudden shiver of agony runs through me. The chairman is like the father of the market. If the market were to heed his words, if it were to start worrying that he might punish it by requiring more margin, it might fall beneath his big heels.
His words, taken alone, do not seem too foreboding. He was not even addressing Congress. It was just an after-dinner speech at the American Enterprise Institute on the history of monetary policy. I pull up the quote on the Internet:
Where do we draw the line on what prices matter? Certainly prices of goods and services now being produced-our basic measure of inflation-matter. But what about future prices or more importantly, prices of claims on future goods and services, like equities, real estate or other earning assets? Is stability of these prices essential to the stability of the economy?
Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation on the past. But how do we know when irrational exuberance has unduly escalated asset values, when they become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? [Emphasis added.]
... Evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.
"But how do we know ...?" It sounds like such an innocent question. By the time the market closed, everything seemed pretty much back to normal. The Dow ended 55 points lower at 6382, a drop of less than 1 percent, after falling as much as 144. But why did our self-confidence change so quickly into timidity? How strange it is that a simple feeling of discomfort-perhaps the irritation of a nervous center, a small disturbance in the imperfect and delicate functions of our mental machinery-can turn the most lighthearted of men into a melancholy one, and make a coward of the bravest.
I walk down to the river near my house to watch the tugboats and barges go by. After walking a short distance in the sun, I suddenly, inexplicably, feel anxious and wretched. I return home immediately to check the stock prices on my monitor. Why am I worried? Is it a phrase that, passing through my memory, has upset my nerves and given me a fit of low spirits? Is it the frown of CNBC's Money Honey as she passes along word of an analyst's downgrade, or is it her new short hairstyle? Everything that surrounds us, everything that we hear without listening, every idea that we meet without clearly distinguishing it, has a rapid, surprising, and inexplicable effect on us and on our organs, and through them on our ideas and on our being.
February 25, 1997: President Bill Clinton has been letting big campaign contributors stay in the Lincoln bedroom! The White House released a list of more than 800 people who stayed overnight in the room where President Lincoln signed the proclamation freeing America's slaves. The guests-including Hollywood moguls and stars-came through with at least $5.4 million in contributions to the Democratic National Committee in 1995 and 1996 alone, according to a computerized study commissioned by CNN. Producer Steven Spielberg donated $336,023, and MCA Chairman Lew Wasserman gave $225,000. The tawdriness is troubling.
March 3, 1997: A crisis is unfolding far away. It seems that cheap Chinese labor is taking away Thailand's share of the electronics export market. The country's fabulous growth has slowed so much that the banks are neck-deep in bad loans to real estate speculators, and a devaluation of the currency-the baht-is probable. The stock exchange temporarily halted trading in bank stocks today. An incomprehensible feeling of disquietude seizes me, as if this news concealed some terrible menace. I walk up and down my hallway, oppressed by a feeling of confusion and irresistible fear.
July 8, 1997: NASA uses the Internet to broadcast images taken by the Pathfinder spacecraft on Mars. An Internet traffic record is set: 46 million hits in one day. These stunning displays of twentieth-century science make my spirit soar.
August 21, 1997: Southeast Asian markets are collapsing before our eyes. Thailand admitted today it had borrowed $23 billion in an unsuccessful attempt to avoid devaluing its currency. Thailand owes a total of $89 billion to foreigners, $40 billion of which comes due within the next year. Indonesia, Malaysia, and the Philippines are in trouble, too. Stocks are toppling, interest rates are soaring, and outside money is fleeing. Malaysian leader Mahathir Mohamed says it's all because Jews are trying to keep Muslims poor.
I have just come from consulting my medical man, for I can no longer sleep. He said my pulse is high and my nerves are highly strung, but that otherwise I exhibited to him no alarming symptoms. He prescribed a regimen of vigorous exercise.
That night, I manage two or three hours of sleep. A nightmare lays hold of me. I feel that I am in bed and asleep ... and I feel also that somebody is coming close to me, looking at me, touching me, getting onto my bed, kneeling on my chest, taking my neck between his hands and squeezing it with all his might to strangle me. I struggle, bound by that terrible powerlessness that paralyzes us in our dreams. Then suddenly, I wake up, shaken and bathed in perspiration.
October 15, 1997: I have made a complete recovery. The Microsoft shares I purchased the day after the "irrational exuberance" speech are up 73 percent.
October 20, 1997: I turn on the news and learn that the Justice Department is accusing Microsoft of violating a court antitrust order. How strange. Microsoft has done more than any company to bring the computer revolution to consumers. Is success now suspect?
About 10 o'clock that evening I go up to my room. As soon as I have entered, I lock and bolt the door. I am frightened-of what?
October 27, 1997: A rolling panic that began in Hong Kong last week has engulfed every stock market in the world. In the United States, exchanges halted trading today after the Dow plunged 550 points. The value investor David Dreman said, "Investors finally realize the market is overpriced."
October 28, 1997: I look up from my desk in the New York City offices of Bloomberg News. Ken Kohn, the New York bureau chief, sitting opposite me, is cackling. "Victor Niederhoffer went under!" he says.
April 30, 1998: The shadow has passed. Jeremy Siegel, the Wharton finance professor, just introduced an expanded edition of his Stocks for the Long Run, showing that stocks have averaged an annual return of 7 percent after inflation for the past two centuries, twice the return on bonds. The Dow has risen 28 percent since that terrible Monday last October, and my Microsoft shares are up 40 percent. I feel cured.
August 31, 1998: In one month, the world has fallen into chaos. More than 250 people were killed when terrorists simultaneously bombed our embassies in Kenya and Tanzania. The Saudi terrorist Osama bin Laden said strikes against the United States would continue "from everywhere." The next day, President Clinton ordered a retaliatory strike against bin Laden in Afghanistan and a nerve gas factory in Sudan-but the strike missed bin Laden, and Sudan insists the factory did not make nerve gas at all, just drugs. People are calling our counterattacks a terrible instance of life imitating art. Just three days earlier, Clinton admitted on television that he had had an "inappropriate relationship" with Monica Lewinsky, a White House intern. A grand jury is investigating whether he lied about it under oath. A new Hollywood hit, Wag the Dog, released just before the attacks, features a U.S. president who declares war to divert attention from a brewing sex scandal.
On top of everything else, Russia devalued its currency last week and defaulted on its debt. In an attempt to clear my mind with fresh air, I went for a walk in Central Park. I turned into a shady path in a little-visited area. A sudden shiver of agony ran through me, and I hastened my steps, frightened without reason. Suddenly it seemed as if I were being followed, that somebody was walking at my heels, close, quite close to me, near enough to touch me. I turned round suddenly, but I was alone. I returned home to find the Dow average had closed down 512 points. In four days, it has lost 12 percent. All the major indexes are down for the year.
September 28, 1998: Some very big hedge funds have lost billions in August and September. One fund, Long-Term Capital Management, had to be bailed out for $3.6 billion by 14 banks after losing all but $400 million of what had been $4.8 billion in net assets. Fear was rampant that the financial system might collapse under the strain if Long-Term failed to meet its obligations. Quantum, Omega, and Tiger suffered stiff losses. The public is scared and is dumping bank stocks. Goldman Sachs, the king of Wall Street, had to cancel its scheduled initial public offering today. Congress is howling to regulate hedge funds. I feel the frightening presence of my nightmares lurking outside my window almost every evening now. It seems to be laughing wickedly.
I went to a dinner at New York University tonight to hear a speech by Arthur Levitt, chairman of the Securities and Exchange Commission (SEC). Levitt said managers are putting out hocus-pocus financial statements with the complicity of their auditors to pump up market capitalization and increase the value of their options. He warned executives to put their houses in order. No more inflated write-offs for restructuring charges, future operating expenses, and "in-process research" to make future earnings look better. No more stashing profits in the cookie jar for a rainy day. No more booking sales before delivery takes place. No more quibbling over how big a lie has to be before it is "material" under Generally Accepted Accounting Principles.
The lawyers and accountants in the room put down their forks and started taking notes.
I suddenly felt a chill in the room. An unearthly voice seemed to be laughing, and I could not escape the feeling that he was mocking Levitt.
May 5, 1999: Was it really a case of Wag the Dog? The U.S. government said it wouldn't contest a lawsuit for damages filed by the Saudi owner of the drug factory we bombed in Sudan last August. I sense the shadow is laughing.
August 2, 1999: Huge accounting frauds are coming to light every week. Bankers Trust has paid $63 million in fines for stealing dormant client funds to cover general expenses. Cendant, Livent, McKesson, Rite Aid, and Sunbeam are embroiled in scandals. Carol J. Loomis, writing in Fortune about the SEC crackdown, said the cascade of cases suggests "great expanses of accounting rot, just waiting to be revealed."
Excerpted from Practical Speculation by Victor Niederhoffer Laurel Kenner Excerpted by permission.
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