Monday, June 04, 2007

6/4 A Tale of Two Cognitions, Bull and Bear

June 4 (Econotech FHPN)--I added the last phrase to the quote below from my May 31 article link to help make the point in today's first section.

“Financial Leverage May Boost Global Economic Growth,” Bloomberg headline, June 4, 2007

“The global economy, led by China, India and other emerging markets, is in arguably its strongest five-year boom in history, in terms of sheer scale, scope and speed, and unfortunately also of financial leveraged speculation.” Econotech, May 31, 2007

“It was the best of times, it was the worst of times.” “Tale of Two Cities,” Charles Dickens, 1859

Unprecedented Both Global Growth and Speculation May Cause Cognitive Dissonance for Market Analysts

“Basically, cognitive dissonance is a state of tension that occurs whenever an individual simultaneously holds two cognitions (ideas, attitudes, beliefs, opinions) that are psychologically inconsistent. Stated differently, two cognitions are dissonant if, when considered alone, the opposite of one follows from the other. Because the occurrence of cognitive dissonance is unpleasant, people are motivated to reduce it;” “The Social Animal, 8th ed,” pg 182, Elliot Aronson, 1999 [bold emphasis in original]

In the 2002-07 global market cycle, both the global real economy and global leveraged speculation are very strong, in fact both are at record levels.

Perhaps to unconsciously minimize cognitive dissonance, permabulls (Wall Street) constantly emphasize the former, the unprecedented growth of the global economy, while permabears (common on the Internet) continually analyze the latter, the unsustainability of huge global speculation using debt.

However, both are different views or frames of the same seamless overall reality, and thus need to be simultaneously kept in mind in order to optimize investment results.

Two Monday Morning "Heads-Up" Charts, China's Shanghai Composite and U.S. 10-year Treasury Bond Prices

In the attached chart (left click once for better viewing), courtesy of, since China's stock market peaked on May 29, the more well-known Shanghai Composite is now down -15.3%, the newer CSI 300 -15.7% The index closed on its 50-day moving average for the first time since the beginning of Sep 2006.

So far global markets have shrugged off this equity market correction in China, the strongest global equity market this year. Global equity markets are making new highs, as if money is flowing out of China into the U.S., Germany (the strongest developed equity market this year), Japan (the latter two showing somewhat less anemic economic growth than has been the norm until recently), and elsewhere.

Wall Street has offered up the usual rationalizations for this lack of concern, such as China's stock market is small, its correction is overdue and won't impact China’s economy, the U.S. economy is re-accelerating after a weak first quarter, corporate profit growth remains strong, etc.

These are all plausible sounding, except if/when a correction in China or elsewhere were to become more serious. Then you may hear a different set of stories. For now, it's too early to dismiss China’s ongoing correction as something not to be concerned about more globally.

Second, the rise in U.S. 10-year bond yield to approaching 5% is starting to get a little worrisome for stocks, see attached Treasury bond price chart, courtesy of, left click once to expand for better viewing.

To use an out-of-season metaphor, this rise in yields, decline in Treasury bond prices, can create small subsurface cracks in the global markets’ ice (i.e. support levels of bullish psychology) that can widen and give way, with a loud bang, more suddenly than may seem obvious right now on the surface, especially given the huge amount of leveraged deals which are driving global markets, and the fragility of the real estate mortgage market, especially with ARMs resets.

Challenge to Private Equity: Innovation, Not Cost-Cutting, Drives Economic Growth, Living Standards, Asset Values

“"We're in two different industries," says Ted Schlein, a venture capitalist at the Silicon Valley firm Kleiner Perkins. "We recruit. We help companies sell product. We do business development. [Private equity] is not an industry that can talk about creating ten million jobs."” “Raising taxes on VCs,” Adam Lashinsky, Fortune magazine, May 16

I have my own long-standing criticisms of overly opportunistic venture capital as the major focus in the U.S. of a business model for innovation, but I agree with the above vc quote with respect to private equity.

Huge confusion is caused by the fact that Wall Street and the mainstream media, in their self-interest, would have you believe that immense leveraged financial speculation, especially by private equity, is helping to drive the global economy, e.g. the Bloomberg headline at the beginning of this article which makes very explicit the implicit assumption of much mainstrean financial coverage.

One "enlightened" form of this argument, sometimes favored by economists and vc/technology types, is that financial speculative excesses, bubbles, are a necessary evil, so to speak, a small price to pay in order to incentivize and drive innovation and strong economic growth.

Rather, I believe that the exact opposite is the more accurate view, that not only are huge financial speculative excesses unnecessary and harmful, but also that the immense growth in the global real economy, led by China and India, is what is allowing huge global speculation, what I consistently call return on leveraged legal looting (ROLLL), to essentially skim off record unearned speculative income. (For elaboration, see my long Dec 19 article, "World Needs Better "Face of American Capitalism" than Private Equity," link.)

The paper “wealth effect” on economic growth of rampant asset/debt bubbles, concentrated at the very top of the income/wealth pyramid, can only support cancerous or parasitic speculation to some limit, though no one seems to have any idea how long that may be.

In the economists' infamous "long run," ROLLL can not support global valuations that are currently based on an extended future period of strong, low-inflation growth. E.g., there is a very large but still only finite number of m&a restructurings that can be done that emphasize cost-cutting, outsourcing, layoffs, speed-up, health care and pension looting, etc., let alone that make business and economic, or even financial and political, sense.

A couple of decades ago, economists finally figured out what entrepreneurs have always instinctively known, i.e. that innovation and real productivity (not working more hours for less money, since 1972 real median weekly earnings are down -15% in an unprecedented shift in American history) is what drives long-term growth in the real economy, living standards and asset valuations. (Hence my web site's tag line, "Finance Innovators, Not Speculators" link.)

Unless and until private equity, which is on pace to smash last year's record, makes the case that it is driving innovation and real productivity, it is an exercise in unjustly enriching a very few, including the corporate CEO’s who have unavoidable legal conflicts of interest in making buy-out deals on their own behalf, and even worse, tremendously distorting incentives for the allocation of scarce corporate resources, especially human talent, and developing markets capital (which is funding unprecedented U.S. current account deficits driven by paper "wealth effects").

In other words, concretely, what innovative, useful products, services, processes, etc., is private equity creating better than had been done before? I've never read or heard of one, so far.