Leithner Letter No. 4
26 April 2000

I’m going to put two quotes on the screen and ask you if this was an honest mistake on the part of the White House, or if the speechwriters had no sense of history. The first quote is, “The economy is fundamentally sound.” Herbert Hoover [uttered that memorable sentence in] 1929. And here is George W. Bush today, “The fundamentals of our economy are sound.” Is this an honest mistake by White House speechwriters, who must know the difference or similarities in this case?

Brian Williams interviews historian Robert Dallek
CNBC’s The News with Brian Williams (30 July 2002)

Mr President, I am put up here to speak a kindly word for the solvent and the damned; or, as the more advanced thinkers say, for the Rotten Rich.

H.L. Mencken to Franklin D. Roosevelt
The Gridiron Club, Washington (7 December 1934)

Janus Looks in the Mirror

The Dow Jones Industrial Average, “the Dow,” is the most recognised and widely reported indicator of “performance” on the New York Stock Exchange. The Dow tracks changes in the aggregate price of 30 of the NYSE’s most important and heavily-traded industrial stocks. Nasdaq, America’s second-largest exchange, is an electronic market run by the National Association of Securities Dealers and consists disproportionately in “technology” companies. The Nasdaq Composite Index tracks the price movement of all stocks traded on the Nasdaq. The Standard & Poor’s 500 is an index of 500 large stocks which are traded on the NYSE, Nasdaq and the American Stock Exchange (which is America’s third most active market and is comprised largely of small- and mid-sized companies).

On Friday 14 April (the wee hours of Saturday 15 April in Australia) the Dow decreased 618 points (5.7%), from 10,924 to 10306; the Nasdaq Composite fell 355 (9.7%), from 3,676 to 3,321; and the S&P 500 dropped 84 (5.8%), from 1,441 to 1,357. In absolute (as opposed to percentage) terms these three decreases are collectively among the biggest ever recorded on a single day. For this reason, and also because changes in the All Ordinaries Index are roughly correlated with changes in its American counterparts, these events received extensive coverage in Australian tabloid newspapers over the weekend of 15-16 April and on Monday the 17th.

This coverage, alas, told us much more about Australian tabloid journalists and mass circulation newspapers than it did about the events in the U.S. which were purportedly being described and analysed. I take at face value little of what I read about business, investments and finance in newspapers and magazines. I also accept without careful consideration even less of what I hear on radio and television – and run as fast as my legs can carry me from “tips” and the babble which pervades investment chat sites on the Internet. Events in Wall Street on 14 April provides a good case study.

The Misleading Atmosphere of Crisis

Australian newspaper reports of the day’s events sought to convey a crisis-laden atmosphere which poses grave and imminent dangers to stock owners. Brisbane’s Sunday Mail of 16 April, for example, under the front-page headline ‘BLOODBATH’ (set out in 4cm letters, the same size used to announce the fall of Singapore in 1942, JFK’s assassination in 1963 and the prime minister’s dismissal in 1975), stated that “Australian investors are expected to lose up to $18 billion [in] the aftershocks from Wall Street’s most spectacular crash. ...” It added that “United States markets plummeted by a staggering $US1 trillion in just seven hours” and that “it was the largest sum of money ever lost in a single day.” Feature articles emphasised that “massive plunges” in markets had occurred, that “indexes [had] suffered record-breaking falls” and that “most stocks were battered.”

Similarly, the front page lead of Sydney’s Sunday Telegraph repeated that “Wall St investors lost a staggering $US1 trillion ($A1.7 trillion) in just seven hours as the stock market suffered its biggest crash ever,” and concluded that “trading on the Australian Stock Exchange is expected to be frantic tomorrow as equally terrified Australian investors try to get out of their high-tech holdings.” Less hyperbolic – but not in all instances more insightful – coverage appeared on Monday the 17th in the broadsheet Australian and the specialist Australian Financial Review.

This tabloid coverage, considered as a whole, is misleading: indeed, several of its individual claims are patently false. When we observe tumult on the stock exchange (which, thanks to blanket media coverage, Americans, Australians, Britons and Canadians do virtually every day), we risk drawing erroneous conclusions. According to The Wall Street Journal Interactive Edition, approximately 1.2 billion shares changed hands on the NYSE on 14 April. But by my (admittedly crude) calculations there are approximately 240 billion shares registered on that exchange. In what was described as a selling frenzy, fewer than one-half of one percent of those shares actually changed hands. (Daily turnover of 1.2 billion shares on the NYSE, by the way, is not dramatically greater than that prevailing since the beginning of the year). As in New York, so too in London, Toronto and Sydney: from one day to the next, and from week to week and month to month, most investments stay invested.

Second, it is misleading to talk about “a rush to get out of the market.” Tabloid and some broadsheet coverage gave the strong impression that trades conducted in Wall Street on 14 April consisted solely in one party – sellers. A moment’s reflection, however, tells us that it takes two to tango: a transaction requires a buyer as well as a seller; and every stock which is sold must also be bought. Further, for every person who wishes to exchange a share of X Ltd for some amount of cash, there exists another person who is prepared to exchange that amount of cash for the share. And for every person who wishes to “exit the market” at some price there must also exist another who wishes to “enter the market” at that price. Indeed, at the end of a day’s trading, regardless of the change in the Dow or other index, “the market” contains the same number of shares (ignoring new issues of shares and companies’ repurchase of their own shares) that it did at the opening bell. At the close of trade, then, it has neither shrunk nor grown and the “exits” are perfectly matched by the “entries.”

It is therefore misleading to assert that on a particular date market participants “made” or “lost” a particular amount of money. This assertion misconceives the nature of market prices. Prices are ratios at which money is exchanged for titles, goods or services: they are neither arbiters nor indicators of intrinsic value. This assertion also confuses “paper” gains and losses and changes in sentiment on the one hand with commensurate increases and decreases in real wealth on the other. Finally, this assertion claims knowledge that one cannot easily possess, i.e., the prices at which those who told their shares in X Ltd on 14 April originally bought those shares. It is entirely possible – indeed., likely – that significant numbers of that day’s sellers did so at prices greater than their purchase price.

The False Air of Certainty

Financial journalists,’ “market experts’” and commentators’ analyses of the events on Wall Street on 14 April – like their analyses of financial markets on most other days – convey a false sense of certainty. A prominent syndicated columnist provides a good example. In his 16 April column, which appeared in both The Sunday Mail and The Sunday Telegraph, he stated categorically that “the good times are over. This is the bust in the crazy Internet and high-tech boom we were always going to have. Just in case the point has not been made crystal clear: the boom is over. Not postponed. Not interrupted by the ‘pause’ that refreshes. Bust. Well and truly shattered. What happened overnight on Wall Street [spells] the end of the unique combination of factors and forces that made the 1990s such a glorious decade. ...” In a separate article in The Sunday Telegraph, this columnist stated flatly that “most tech stocks are worthless.”

Statements such as these are thinly-disguised predictions; and the success rate of predictions about financial matters is abysmally low. Moreover, financial journalists’, “market experts’” and commentators’ explanations are post hoc and typically ad hoc attempts to summarise and rationalise very large numbers of actions undertaken by individual human beings. Each of these actions is complex and stems from different motivations; and considered as a whole, they are too complex for the human brain to grasp. Bloomberg columnist Caroline Baum hit the nail on the head: “to try and explain why markets do what they do on any given day is a Herculean effort. There are so many moving parts that it is almost impossible to quantify the short- and long-run shifts in the supply of and demand for a particular currency, commodity or financial instrument.” In short, there is no single, collective reason which prompts investors and speculators to buy and sell on any given day; and there is no collective “market mood” or psyche. Accordingly, we simply do not know what “the market” will do tomorrow, the next day, next week or next month. Anyone to possesses the pretence to this knowledge does not inform others; rather, he simply deludes himself.

The Obsession with Prices and Projections

Finally, most financial journalists, “analysts” and commentators obsess about market indices and the prices of individual securities. With some exceptions, they also babble incessantly about revenue and profit projections, future developments in technology, interest rates and other macro phenomena. Their implicit definition of investment return is therefore the increase in a security’s market price, and they usually take little or no interest in dividends and companies’ actual (as opposed to projected) operations. Most importantly, very seldom if ever do they set out assumptions, evidence and patterns of reasoning which yield conclusions about a particular security’s intrinsic value.

Instead, they offer “tips,” prattle and mindlessness. These appeared in abundance over the weekend of 15-16 April. Among the gems: a Sunday Telegraph journalist (16 April) attributed to one expert – let us call him ‘Expert X’ to spare him embarrassment and the possibility that he has been badly misquoted – the view “that there is still potential for growth, even when an individual’s stock price has risen substantially. ‘A stock might have gone from $1 to $5, but then it could still go to $10.’” (This, not incidentally, is the same ‘Expert X’ whom the Australian Financial Review quoted earlier this month with the derisive and rhetorical question: “where would you rather be? In the Old Economy or the telecoms-Internet convergence”?). Barrie Dunstan, it seems to me, is far closer to the mark. As he stated in his AFR column on 17 April: “just because a stock has fallen from $10 to $5 doesn’t make it good value if it never had any intrinsic value.” Other “tips” offered by the gurus in The Sunday Telegraph:

  • Open Telecommunications Ltd. Why? Because it “designs and builds networks and provides value-added services to telcos;”
  • Powerlan Ltd. Why? Because it “is a play on IT outsourcing in the Asia-Pacific Region;”
  • Energy Developments Ltd. Why? Because “there is a lot of upside in a new development, the company’s solid waste-to-energy recycling facility. [and because] there is also blue sky in Energy Developments’ credit holdings.”

Austin Donnelly and Noel Whittaker constitute honourable exceptions to this generalisation. Ironically, their sensible contributions also appeared in The Sunday Telegraph and The Sunday Mail, respectively, on 16 April. Donnelly counselled caution (noting that further falls in the prices of overvalued securities are possible), suggested sensible criteria which investors might use to detect sound companies and emphasised the importance of dividend income in total investment return. And Whittaker reminded his readers to “be aware that when you own shares you own part of a business. Even if the shares in companies like [x, y and z] do fall tomorrow, the companies will still be open for business and making profits. People will still drink beer, do their banking and buy their groceries. There is nothing to be gained by dumping an interest in a good company because the market is having one of its normal slides.” Whittaker also re-affirmed common sense when he stated that “if prices continue to fall next week, regard it not as a disaster but an opportunity to buy quality assets at 10% or 25% less than they were selling for a week ago.”

The Mass Media’s Complicity

Wall Street’s wobble on 14 April illustrated significant shortcomings (from a Graham-and-Buffett value investment perspective) in much – but by no means all – Australian tabloid coverage of financial matters. A key question is whether this coverage is a cause or a consequence of most Australians’ apparently insatiable urge to speculate for the quick buck rather than invest for the long term. This coverage has reflected (and perhaps created) speculators’ euphoria during recent years; and now, in the immediate wake of the wobble, it is reflecting (and perhaps helping to create) a misleading sense of crisis. More generally, many journalists’ and mass media commentators’ misconception of the nature of market prices, their confusion of “paper” gains and losses and changes in sentiment on the one hand with commensurate changes in real wealth on the other – and above all their pretence to knowledge which nobody can possess – has exacerbated the frequency and severity of Mr Market’s) swings from mania to depression.

Further, Australian journalists’ and commentators’ false air of certainty tends to distract attention from the ambiguity (and hence the risk) which inheres in any investment operation. In recent years this unwarranted confidence has therefore lulled speculators into a dangerous sense of complacency with respect to the ease with which returns may be earned and an unduly optimistic expectation that large returns will be earned in the future. Finally, their obsession with “tips”, market indices and the prices of individual securities, their unrelenting babble about projections, technological and other future developments – and their apparent unwillingness to set out assumptions, evidence and patterns of reasoning – has encouraged would-be investors to disparage and abandon careful research of financial statements and, in effect, become momentum speculators. If we wish to assign blame for the recent turmoil on financial markets, then we should take a good, long, hard look in the mirror. But the mass media, as either a cause or reflection of our partiality towards folly, is playing its part too.

Chris Leithner


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