Once Upon A Time (4/2/01)

Stepan N. Stool, PH&D

Once upon a time there was an economist. And the economist said, "Lo, the stock market is a discounting mechanism." And the people said, "Yea, thou art an economist, wise in the ways of economics. Verily it must be so. Yea, by the well informed and rational decisions of millions of investors, shall we know the future." And so it became that the stock market was anointed a discounting mechanism. 

Another monumental load of crap. Who the hell thinks this stuff up? And why does everyone believe it? We are sheep. We never think about anything that is widely accepted as truth. Like, the market is a discounting mechanism. Or, like, investors are well informed and rational. Even those that are, still usually suck at divining the future.

For example, what the hell was the market discounting at Nads 5100, and Dow 11,700. And what the hell is the Mother Joseph Superior discounting, the New York Times Fiction Bestseller list?

Let Dr. Stool tell you about discounting mechanisms. Back in the 1980's, through the proliferation and advancement of the PC, it first became possible for real estate investors to make wide use of discounted cash flow analysis. The real estate pros at that time made all sorts of nonsensical assumptions in their forecasts, assumptions that simply were not supported by the facts on the ground. In their discounted cash flow analyses, they extrapolated the prior two or three year period of very rapid growth indefinitely into the future. As a result, the greedy, slimy, idiot bankers financed the construction of enough offices, and industrial buildings, and shopping centers, to last for a decade. The developers filled up the buildings by giving tenants lots of free rent. At that price there were plenty of tenants.

Then it came time to pay rent, and suddenly the tenants were gone. And the developers went bust, and the banks went bust, and then we, the freaking people, ended up bailing out the banking system with our tax dollars. As a result of that bailout, which we the freaking people financed and paid for, the real estate market managed to recover in about eight years.

That's what Dr. Stool thinks of the stock market as a discounting mechanism. All of those brilliant genius twenty-somethings and Mother Superiors with their discounted cash flow analyses and fraudulent assumptions have caused this disaster, aided and abetted by the Fed and the easy money policy which fed the bubble. 

And there's not a damn thing anybody, not President Hoover, not the Fed, not lower interest rates, not the stinking rotten Communists in China, can do about it. We have too much galdam capacity in the whole flaming worldwide economy. Sure some of it will find a use in time. But it will still need to be written down. And some of it was obsolete when it was built, and it will always be obsolete, and that must be written off.

There were gigunda liabilities written against those assets that we'll never need. There's not enough income around to pay the creditors. There will never be enough.

So the market is not a discounting function. It is simply a measure of current liquidity, as well as  liquidity and investment preferences. In other words, it is a measure of the stupidity of the masses of which we are all a part. It is a measure of the amount of liquid capital in the economy that bears no relationship whatsoever to the amount of real fixed capital or the level of earnings that fixed capital is capable of producing. The market is not rational. It is irrational. It is simply the flow of hot money. At those times when it appears to be rational, it's an accident, like the stopped clock. Or like the permabulls who looked like geniuses when the market was going up...a cruel accident.

The reason we are in a bear market now is because the irrational insanity went on for as long as it did. In the end we ran out of greater fools. The cause of the bear market wasn't an overly tight Fed. The cause of the bear market was the economic bubble which preceded it. It left us with no choices. Now, we have to pay the piper, because the money is leaving, and it will continue to leave for a long time, long enough for the bloated fixed capital base to shrink down to muscle, and begin returning an adequate return. 

Only this time liquid investment will not return to the markets on a wing and a prayer like it did in the 1990s. Confidence is shattered. It will take a generation to rebuild. And before it can be rebuilt, there will need to be a reason for confidence, some evidence that the profit growth is for real.

This time around it'll be, "SHOW ME THE MONEY, BABEE! We're not coming back for some flimsy promise of future earnings. You're going to have to show us the money." There's not going to be any discounting of future earnings, that's for sure. They will only pay for real earnings they can see and measure, and prove.

So the next time you hear some idiot analyst spouting that nonsense about the market being a discounting mechanism, and that you have to buy stocks before the earnings turn up, just remember Dr. Stool screaming at you, NOT THIS TIME BABEE. Not this time.

Stepan N. Stool, PH &D