Recollections of the Greatest Market Bubble Ever…
More and more professional money managers recognize the overvaluation of the
US market but cynically go along for the ride. They all are convinced that
the market needs a "trigger" to stop the mutual fund flows that have led to
current record valuations. It might be useful to look at other greater
bubbles in history in this regard.
Memories of the Souk al Manakh by Frank Veneroso
How large can a bubble grow before it bursts? Farther than you think. And
there need not be a fatal pinprick that makes it burst. And when it bursts,
the crash that ensues can be deeper and more discontinuous than you could
ever imagine.
In May of 1982, while the bear market in US stocks was in its deepest
throes, and the epic bear market in US bonds was still completing its base,
I was called to advise on the greatest stock market bubble of all time---the
Souk al Manakh in the Persian Gulf. Kuwait had had an organized stock market
for some time. The great wealth created in Kuwait by the rise in the oil
price in the 1970's led to seemingly endless appreciation in Kuwaiti stocks.
In the Arab states in those days, only sheiks could grant corporate
charters, and only corporations could become publicly traded companies. The
royal family of Kuwait did not freely grant corporate charters for companies
that might become vehicles for stock speculation, so there was a shortage of
stocks to trade. This shortage and the new unparalleled wealth that was
looking for vehicles of speculation gave rise to an over the counter market
in Kuwait city where shares in companies domiciled elsewhere in the
Gulf---principally Bahrain and the United Arab Emirates---were traded.
Housed in a converted air-conditioned parking garage, this market was known
as the Souk al Manakh---the camel market.
I was asked at the time by the government of the United Arab Emirates to
advise on the creation of a stock exchange in the Emirates. Great fortunes
were being made in shares of companies domiciled in the Emirates at the
time. Why not bring all this wonderful new stock market activity home?
For six weeks I worked out of an office in the UAE central bank in Abu
Dhabi. The city was modern, laid out along a crescent beach at the end of a
promontory into the Gulf. The central bank was a modern glass building
behind severe cement columns that met in graceful Moorish arches. From a
great glass window of this modern building, I could see along a turquoise
backwater old tanned fisherman working on brightly painted ancient fishing
dhows that were beached on the blinding sands. The Sheik of Abu Dhabi was
the richest man in the world then. Only a few decades earlier his brother,
the former ruler, was afraid to walk the streets of what was then a small
sandy seaside fishing village for fear of his creditors.
Being a macro oriented, top-down man, I set about to see how great a supply
of stocks had been made available for trading on a formal market in the UAE.
The results were simply unbelievable. The market capitalization of the
Kuwait exchange and the Souk al Manakh combined ranked third in the world,
behind the US and Japan. It was greater than that of the UK with all its
foreign listed companies. How could this be? I asked, for both
geographically and economically speaking, these few countries---Kuwait,
Bahrain, and the Emirates (the former Trucial States under British
domination)---were only postage stamps of sand on the globe. Oil had brought
wealth to these small countries but their combined economies were still very
small compared to those of the US or Japan or the UK. More striking was the
fact that most of the visible wealth was not reflected in these companies.
The rulers of these sheikdoms owned the oil wealth. The hugely expensive
real estate was privately held, as were the extremely lucrative import
franchises. What assets and income underpinned these multi-billion dollar
market caps?
We did a bottoms up study to find out. In Bahrain, a financial center, there
were banks, seemingly of substance. There was a raft of companies that made
cement and clinker. These companies were domiciled in five former Trucial
states whose names you never heard of that, alas, had no oil. There was a
company or two that imported sheep and goats for slaughter. And then there
was a handful of other companies whose principal activities were not at all
obvious.
The Sheik of Abu Dubai was the richest man in the world at the time and the
Ruler of Dubai was also quite well to do. The five other sheiks who had no
oil were poor cousins. For founders shares these oil poor sheiks granted
charters for corporations that could be traded on the Souk al Manakh. I can
remember driving one day to a small derelict town that was the capital of
one of these oil poor sheikdoms to analyze a company with a high flying
stock on Kuwait's OTC market. For the life of me, on the balance sheet of
this company I could find no assets of any kind. It dawned on me that,
behind most of this third ranking stock market cap in the world, there were
only a few cement and clinker plants, a slaughter house or two, and quite a
few shell games.
How do you tell your host government that the stock market they want to
bring home is a shell game? I pondered this diplomatic quandary for weeks as
I looked out my office window at those ancient painted dhows in the desert
sun. In the end I mustered the courage to tell the truth. "It is all a
bubble," I told my client-. "And it will burst." To my relief and amazement,
I was greeted, not with displeasure, but with laughter. "You Westerners have
been coming here for five years", they told me, "and to a man you all have
predicted a crash. Don't you understand, there has never been a place on
earth like the Gulf with such unprecedented wealth? You will never
understand that the Gulf market cannot crash."
I had a long time friend in London. His name was Ali. He was one of several
Anglo Arab investment bankers that flourished in London in those years. When
I passed through London on my way back to the US I stopped to tell him about
my trip. Speculation on the Souk al Manakh was financed with a curious type
of informal margin financing by way of post dated checks. So rapid was the
rise in the Gulf market that post dated checks paid an interest rate of 100%
per annum. Ali was financing speculators in this market. He listened and he
smiled.
At the beginning of August I had completed my report for the government of
the UAE. I told them that the market they wanted to organize was a bubble
and that it would crash. Some weeks later I heard from Ali. He called to
thank me for my advice on my recent visit. He had called in all his post
dated checks. "Did you hear what happened to the Souk?", he asked. "No", I
replied. "Well, it topped quietly at mid summer after you left, with no
provocation. One can't quite say it declined or it crashed; it has just
stopped trading."
The Souk al Manakh was the greatest speculative mania of all time. One could
not even speak of valuation. Margin financing reached unimaginable extremes;
one speculator, who had been a customs clerk two years earlier, had at the
peak $14 billion in stocks financed with $14 billion of margin debt. The
people involved believed that the oil rich Gulf was truly a "New Era". It
did not take a trigger to burst this bubble; it simply crested sometime in
the dreadful heat of the Middle East's summer. Its decline was so
discontinuous it cannot be called a crash. There were simply no bids.
The Veneroso Report will be published in the near future. It will cover the
economy, commodities, Asia, and economic issues of the day. If you would
like to receive the inaugural issue, free of charge via e-mail, to determine
if it provides you with the type of informative and useful information that
you would like to receive on a consistent basis, please email with your
request to: macrogold@aol.com
REFLECTIONS ON THE TOKYO STOCKMARKET BUBBLE
June 1,1998 By Marshall Auerback
Marshall Auerback is a partner in Veneroso Associates responsible for fund
management, and a contributor to the emerging markets' group.
It is the view of Veneroso Associates that the US stock market is a classic
asset bubble of historic proportions. This type of financial overshooting
generally goes much further than any rational investor would normally
envisage, thereby inducing suspension of belief in conventional financial
limits. Everyone becomes an adherent to "New Era" thinking, a belief that
"this time it's different." Frank Veneroso was an advisor in the Persian
Gulf in 1982, at the crest of the greatest stock market bubble of all time,
and has written about this in "Memories of the Souk Al-Manakh." I was a
portfolio manager in Tokyo in the late 1980's and witnessed a similarly
spectacular bubble in Japan as well as the aftermath, the effects of which
we are still experiencing globally today. Our shared historical perspective
has enabled us to draw parallels with today's US stock market. I offer these
personal recollections of that time in Japan to give the reader another
point of reference in relation to the current excesses.
There has been much comment in the Western press recently, positing the
notion that America is currently in the midst of a huge stock market bubble.
What has been striking has been the degree to which this notion has been
disparaged in several leading publications, notably the New York Times and
Wall Street Journal. Just two weeks ago, for example, the editorial page of
the Wall Street Journal ran a piece entitled "Let's Burst the 'Bubble'
Theory," by Alan Reynolds, a director of economic research at the Hudson
Institute in Indianapolis.
As someone who witnessed at first hand the inexorable rise of the Japanese
stock market in the late eighties from Tokyo, and its inevitable fall during
the early nineties, I am struck by the many similarities between the current
phenomenon in the United States and the final stages of Tokyo's great bull
market in 1989. Not the least of these parallels was the tendency of the
respectable, mainstream press in Japan to disparage those ignorant Western
"gaijin", who persistently characterized the Japanese equity market as a
bubble of historic proportions.
By 1989, real estate in the Maranouchi district of Tokyo was valued as
expensively as all of the land in the state of California. Most mainstream
stocks on the Tokyo First Section (the equivalent of the S&P 500) traded on
multiples in excess of 60 times. Bank stocks typically traded in excess of
100 times' historic earnings. My favorite was the Industrial Bank of Japan
(IBJ), which I attempted to short at 300 times' earnings, only to be stopped
out later in the year at 400 times' earnings, and watching it peak at 600
times' earnings.
The sociological signs were all apparent as well: Tokyo's restaurants and
nightclubs were full each night until the early hours of the morning (my two
favorites were called "Gold" and "M-za" - they eventually went bust in
1991). Little 750 square foot beach houses in Shimoda (about 2 hours' south
of Tokyo on the Izu Peninsula) were selling in excess of US$500,000, despite
the fact that summer traffic jams usually ensured a comfortable 7 hour
journey along the main motorway back to Tokyo on Sunday evening. Friday
evenings in Roppongi (the hangout of choice for the bond traders of Salomon,
Goldman Sachs, and Morgan Stanley) entailed a fateful decision around
11:00PM - to go home at that time or wait until 4:00AM the next morning. The
reason for this was because the trains stopped running at 11:30. By
midnight, it became virtually impossible for a foreigner to secure a taxi,
since the taxi drivers were all waiting for the drunken Japanese salarymen,
who staggered out of the hostess bars at 1:00 or 2:00 AM, ready to fork out
the $200-$250 cab fare for the hour and a half journey back to Chiba or
Yokohama (all on company expenses of course). Needless to say, none of these
poor foot soldiers of "Japan Inc.", could afford the $1 million plus cost
required to buy a comfortable, family-size home in central Tokyo. We
foreigners found living in Tokyo affordable only because our monthly $5,000
rents were assumed by our respective employers, as part of the lucrative
expatriate package.
In retrospect, it seems easy to say that we were in the midst of one of the
great bubbles of all time. But those of all who questioned the mania at the
time were given the Japanese variant of "this time it's different." Having
quickly bounced back from the 1987 crash (all caused by stupid, panicky
foreigners, we were told at the time), the Japanese genuinely began to
believe in their market's invincibility. Publicly, the Japanese would be
quoted in newspapers, suggesting that they had reached parity with America.
Privately when you met with a few Japanese friends, they would tell you
after a few glasses of sake how they hoped to "bury" the US, and how vastly
superior was their model (sound familiar?). Companies trading at 60 times
earnings would issue warrants with even higher conversion prices and then
swap the proceeds into dollars or Swiss francs (the yen was very strong at
this time), bringing their cost of capital down to virtually zero. A zero
cost of capital does make a company seem fairly formidable, so it was
difficult even for us skeptics to envisage what would ultimately bring down
this Pacific colossus.
Another feature of the economy at that time was the cross-share holding
linkages amongst the various companies. This was particularly important in
relation to the banks, which were able to count their shareholdings in other
companies as part of their Tier II capital reserve requirements. With the
Nikkei powering away to 39,000 (on its way to 44,000 I was told by a
strategist at the end of 1989), this gave the banks enormous unrealized
gains, which padded their reserve ratios, and induced them to go on a
reckless lending spree globally. After all, if you could issue a
warrant/convertible bond issue with an effective yield of 0.5%, it was still
feasible to lend at less than 2% and make money. Given the apparent power of
the banks' respective balance sheets, all of the Japanese financial
institutions were able to undercut their foreign competitors on lending
spreads, leading to a further expansion of their balance sheets and an
exacerbation of the real estate bubble.
In addition to this tremendous asset inflation, the other striking feature
of the Japanese economic landscape at the time was the relatively low rate
of reported Japanese inflation, which resolutely remained locked in the 2 -
2.5% range. This virtuous cycle of ever rising stock and real estate prices,
coupled with a miniscule cost of capital, looked like it was going to go on
forever. But the music all stopped in late December 1989, when then Bank of
Japan Governor Yasushi Mieno finally raised the official discount rate for
the first time in years. The stock market immediately plunged from 39,000 to
28,000 in four months (pausing very briefly at 34,000 - the Japanese
domestic institutions were told by the Ministry of Finance that this was a
good area to start buying the market again). We then rallied back up to
33,000 by August, leading everyone to assume that the worst was over, and
that the Japanese monetary authorities had expertly deflated the bubble
without causing a major depression. Unfortunately, Saddam Hussein's brief
excursion into Kuwait put paid to that notion, and the Nikkei subsequently
fell again to 20,000 before moderately recovering again by the end of 1990.
Even as the stock market was plunging, the Japanese still didn't realize
that the game was up. Stock syndicates (which often were fronts for Japanese
gangsters - the yakuza - seeking to launder their money), continued to
target certain illiquid issues, hoping to ramp them up, even as the market
around them was crashing. I remember in particular being told of one such
stock, Honshu Paper, which was picked up by the syndicates when it was
trading around 1600 yen - a mere 200 times' earnings to boot. The stock
reached 2400 yen fairly quickly, where I tried to short it. The stock then
rose to 3200, where I was stopped out. It subsequently rose to 5000 yen
(about 700 times' earnings - and, no, it wasn't that great a paper company)
before it went ex-dividend, enabling a few of us hardy speculators to obtain
stock to borrow (if at first you don't succeed…). The stock subsequently
plummeted to 400 yen, which pretty well signaled the end of this type of
speculation in Japan.
Eight years on, the Nikkei is still trading at less than half of its 1989
peak. The Japanese Second Section (the small cap market, roughly equivalent
to the Russell 2000), is back to its 1983 level. IBJ and Sumitomo Bank have
recently issued convertible bonds to overseas' investors in which both were
forced to offer yields in excess of 7%. Real estate prices having been
falling steadily since 1991, and there is no indication of a bottom being
reached just yet.
Yes, the cross-shareholdings, the massive lending to real estate, the margin
debt, after the fact, all of these structural weaknesses were laid bare in
the aftermath of the crash. They were not, however, so readily apparent from
1987-89, when the Japanese confidently dismissed predictions of their
system's demise. Belief in the suspension of conventional financial limits
is very easy to do during a rampant bull market. The weaknesses in the
system do not appear until the liquidity boom ceases. So whilst the
particular symptoms of America's current stock market bubble might differ in
some respects from Japan's in the late eighties, one dominant .psychological
feature does appear common to both: the belief that somehow "it's different
this time" (the New Paradigm), the tendency to dismiss historic and absurdly
high valuations as the moanings of silly Cassandra's who didn't have enough
foresight to get on the bandwagon and who now resent that fact, the endless
displays of hubris, and the concomitant belief in the obvious superiority of
one's economic system. The 1980's were an extraordinary period of growth,
low inflation, and dynamism for the Japanese economy. But look what's
happening now.
The Veneroso Report will be published in the near future. It will cover the
economy, commodities, Asia, and economic issues of the day.
Comments
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, the nation’s fourth largest bank, whose “price discovery” resembled Mr Toad’s Wild Ride, before crashing in Citigroup’s (C) lap. Just remember this, the next time the SEC bans short selling, and an insolvent bank’s market cap jumps $20B overnight - SELL
