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Blood in the Street

2002-07-10 20:19:52+00 by TC 15 comments

I'm talking about the Blood on Wall Street of course. I just renewed my subscription to The Wall Street Journal after letting it lapse for the last two years and while I can't say we are at the bottom of the market I think the "Irrational Exuberance" has been crushed and then some. Corporate scandals have investors making "no confidence" decisions about all companies in all sectors. Time for me to start researching which companies to put my faith and money into because this is America

[ related topics: Business Todd Gemmell Current Events Currency ]

comments in ascending chronological order (reverse):

#Comment made: 2002-07-10 21:22:21+00 by: Dan Lyke

Accept, for a moment, that, corrected for economic growth and inflation, the stock market is a zero sum game. The size of an economy is related to its population, but more closely related to how efficiently the necessities are provided. Rough back of the envelope calculation: If food and the food distribution network aren't getting more efficient, the economy ain't growing.

So pick a number for how much more efficient food production and distribution has gotten since, say, 1994. Look at the increase in size of your favorite companies since then. Doing some gross hand-waving, and modulo some small, if the company under discussion has grown, another company has shrunk.

Compare the gains in the stock market since 1994. Note that if we've corrected for "irrational exhuberance", then any gains left over that number for food production and distribution are because someone is lying.

Arnold Kling wrote yesterday:

Take WorldCom. They are on the verge of bankruptcy. Had they not committed accounting fraud, my best guess is that today they would be...on the verge of bankruptcy.

Go look at those lists of companies on the market claiming to be winners. Remember that once we've normalized as above, for every dollar gained there has to have been one lost. So there are two things at work here:

  1. The first is what happens when the Motley Fool algorithm (try to buy the front-runners in cycles) gets applied to the macroeconomic view, ie: irrational exhuberance.
  2. The second is the artificial inflation of stock price because of people trying to keep up with that false vision of economic growth (Rant about compensating your execs via stock rather than based on earnings elided 'cause every pundit with 20/20 hindsight is screaming this right now...).

We might be done with #1, I don't think we're done with #2 yet.

#Comment made: 2002-07-11 00:43:09+00 by: meuon

As some point the reality of simple cash flow accounting catches up with everyone and everything.

#Comment made: 2002-07-11 10:50:40+00 by: pharm

Economic transactions are not a zero sum game.

#Comment made: 2002-07-11 14:04:46+00 by: Dan Lyke

Agreed: Economic transactions aren't a zero sum game. Entities become more productive. But economic endeavour is either applied to survival or to luxuries. If the amount applied to survival isn't changing, then the exchange is one set of luxuries for another. The luxuries might become cheaper to manufacture, but then it's the less efficient luxury manufacturers who are losing.

#Comment made: 2002-07-11 16:15:11+00 by: Dan Lyke

I realized that a critical passage of my first rant up there got deleted in the editing, a bit which allowed for increased efficiency as the other tool to economic growth. But even with that the point remains largely the same; Dow to 8000, NASDAQ to 1200, then we're closer to economic reality and a little further from Ponzi scheme.

#Comment made: 2002-07-11 16:48:50+00 by: TC

OOOhh someone's spoilin fer a fight. k dammit I wish had a bit more time but let's get the ball rollin.

Accept, for a moment, that, corrected for economic growth and inflation, the stock market is a zero sum game. The size of an economy is related to its population, but more closely related to how efficiently the necessities are provided. Rough back of the envelope calculation: If food and the food distribution network aren't getting more efficient, the economy ain't growing.

#1 As Phram pointed out "Economic transactions are not a zero sum game"
#2 "size of an economy is related to its population" yes related and linked but it's not even a direct corollary or China's ecconomy would be five times ours
#3efficiency and demand are very important but not even close to the whole model.
#4 in your food distribution example you seem to cite the efficiency is the only way to grow it? False. Increased in demand, Increased profitability(not from efficiency gain), bigger global market share come to mind as other ways.
#5 my main point of the post is that very good companies are being punished because of the bad apples in their sectors. I believe in owning parts of companies you know something about and believe in and now is a good time to start figuring out who those guys are.

#Comment made: 2002-07-11 19:29:34+00 by: Dan Lyke

#1 I said "stock market" not "economic transactions". Yes, this is modulo 2-3%, which, given what people have been expecting of the market for the past few years, is less than epsilon.

#2 China is an example of that food to luxuries ratio.

#3 Long term they tend to dominate. The current corrections are an example of that.

#4 Increased demand, especially in food, comes from increased population or larger market share. Larger market share implies someone else has lower market share.

#5 Yep, and they'll keep getting punished for a while, and we don't know which ones they are. Or at least I don't. I can take some guesses based on how they compensate their executive teams, and how viable their business models, and I might do that, but I expect that the DJIA and the NASDAQ still have some room to fall.

#Comment made: 2002-07-11 22:21:04+00 by: TC

#1 ok so are you talking about the US stock market or just the DJIA? or all stock markets globally? Your describing a closed system so am I correct in assuming you are talking about ALL markets?

#2 So when a new market emerges your saying no wealth is created that it is just redistribution? Cellphones come to China so equity is drained out of companies that produce rice to fuel the nokias of the future??

#3 yup agree on that but if you try to simply to just those two things it will bite you in the ass over and over.

#4 factors outside the current market or new market emerges which consumes existing market goods

#5 Unhun Quest just found out they are under SEC investigation. My cash is still parked on the sidelines but I am seriously looking for survivors as we watch various corps approach crush depth.

#Comment made: 2002-07-11 23:39:16+00 by: Dan Lyke

Todd, let's say you're a subsistence level farmer. All of your working day is dedicated to staying alive. Someone invents rigid horse collars, all of a sudden the portion of your day dedicated to staying alive halves, and you can spend the other half on luxuries. Maybe floors in your shanty. Maybe time to pick grubs out of your food. Whatever.

Now let's say you're us. You could probably get away with spending, say, 5% of your daily earnings on food. Heck, it's probably a lot less than that. So you've got 95% of your time to spend on leisure. Someone makes food distribution 25% more efficient, you've got 96%, five more minutes a day, to spend on something other than survival.

Now it's true that what we spend it on we don't think of as leisure, we think of 4 walls and a floor as a necessity, heck, we think of cars as necessities, but everything beyond 1800 calories a day and enough warmth to stave off hypothermia is a luxury.

So, can we make luxuries more efficient? Yep. We can make the portion of our day dedicated to having a car, eating better food, extending our life beyond our reproductive years, having computers so we can keep in touch with people across the continent, whatever, more efficient. But the fact is that in each case we're exchanging one set of luxuries for another.

The portion of our life spent on luxuries will not change. What those luxuries are, the quantity of those extras, all that stuff may grow, but we're not going to be dedicating substantially less of our lives to subsistence.

This is what I mean when I say that the economy has room to grow only a little faster than population.

What we saw in the late '90s was every company on the planet acting as though they were going to double the economy. So, short of convincing me that I need to work 16 hours a day, how were they going to get more of my time spent working towards luxuries? The only thing they could do is to force someone else to use less of my time working towards luxuries.

That's the zero sum. Yes, we can make an individual human more productive, but at some point that human is spending essentially all their working time on luxuries, and the only way companies can compete is by taking a larger share of that time. Yes, technologies will increase. Companies which used to have 10% of that time will be able to deliver the same product on 5% of that time. But they're all fighting for a portion of my work time.

Now we could argue that the inflation that keeps those products at a constant dollar amount as a company doubles its efficiency and goes from 10% to 5% of my working hours is economic growth. And that's great, that's what most economists reckon, but we shouldn't forget that those companies are fighting for portions of leisure hours, and our sanity checks on what a company is really worth should be tempered by that consideration.

#Comment made: 2002-07-12 00:54:48+00 by: Shawn [edit history]

This is a realization that I have come to myself over the last several years. Although, lacking a real interest in and [college] educated understanding of the economy, I've expressed it in more lay terms:

Take toothbrushes. Once upon a time, a company (doesn't matter who) invented the tooth brush. Wonderful invention and they set out to sell them to everybody. Eventually, they reached all their potential customers - everybody owned toothbrushes (or at least everybody who was going to buy one). What to do now? They had other companies to compete with and they had to keep selling their brushes.

Enter Convincive Marketing (I claim Poetic License). I don't really need bendy, flexing toothbrushes with poiny heads and multi-colored bristles. But try to find a plain, straight toothbrush from the major manufacturers today.

I think this is the fatal flaw of Capitalism (or at least, our implementation of it). It's great for growth. But eventually you reach a point where you can't grow any more. This is normal and should be expected. But we can't accept that. Investors scream bloody murder if their company profits aren't increasing every year - not staying stable, but increasing. There is at least a theoretical limit to how much profits can increase and there very much is a practical effect of approaching that limit.

Business is the horse. The stock market is the [riding] crop. And we're going to whip and whip and whip until long after the poor beast is dead. Then there's going to be hell to pay...

I think what we need is to redefine how we think of the business, the economy and capitalism. I'm still mulling over what the best course of action is but I'm thinking that it has something to do with recognizing - and I mean everybody recognizing - that companies have different phases. At the very least; growth and maintenence. We need to understand that the maintenence phase is worthwhile and valuable. Growth is good, as long as it is reasonable and supported, but then we need to shift focus to maintaining a stable company.

#Comment made: 2002-07-12 11:07:13+00 by: pharm [edit history]

Dan, those "luxuries" you're talking about are just as much part of the economy as the necessities of life; the only difference between a "luxury" and a "necessity" is that people will always pay for the necessities *first* -- this is hardly a surprise since we all need to breath, eat and so on. As far as the economy is concerned though, there's no difference. Increased efficiency isn't just about giving people better/more food (although in some places, having enough of an economy to feed all the people would be a real improvement on the current situation -- see Zimbabwe for a horrible current example).

You write as if having sufficient food it all that counts. That's not to say having enough food isn't important. If you don't have enough food, then getting enough is more important than almost anything else.

In the last analysis, economies are about giving people what they want. You might not agree with their choices, but that's what it's all about. Food is just one of the things which people want, and thus forms one part of the economy.

#Comment made: 2002-07-12 16:16:12+00 by: Dan Lyke

Pharm, you're right. Increased efficiency in all sectors is what allows new products into the market. So, where in the past 7 years have we seen efficiency gains that justify the values companies have been given? Internet companies like Amazon are proving to be no more efficient than neighborhood bookstores, given that both of them are essentially drop-shipping from Ingram. Hell, FedEx and UPS both realize that that's a less efficient distribution model, which is why all the new restrictions and pricing on delivery zones have come about. Wal*Mart is slightly more efficient than KMart, but as we've seen recently, most of the Wal*Mart[Wiki] gains came at the expense of KMart[Wiki], and not from some fundamental opening of new markets.

At some point, money is a stand-in for some baseline of human endeavour. If people don't believe in the ability of human endeavour to back up that money, you get inflation, or you get readjustment of value. In conversations with Todd and Steve back in 2000 I predicted that we'd see inflation, luckily when enough people tried to cash in their chits for human endeavour we saw the value of the chits fall. But we sure didn't see friction in the markets reduced or increased productivity.

#Comment made: 2002-07-14 16:46:08+00 by: pharm

Hey, I've said *nothing* about Wall Street :)

There's a quote which seems appropriate, but I can't remember the source, and I'm probably paraphrasing: "In the short term, the stock market is a voting machine. In the long term, it's a weighing machine."

#Comment made: 2002-07-15 16:44:06+00 by: Dan Lyke

Pharm, I think we're largely in agreement. And there have always been grocers casually slipping a thumb onto the scale. We're just not over believing that there really will be 25 pounds in that head of cabbage by the time we get it home.

#Comment made: 2002-07-15 22:25:49+00 by: Dan Lyke

At least one company is trying to regain trust: via RC3, Coke to report employee compensation via stock options as expenses