The Trap of the New Normal

January 4 2017

In many situations, we human beings make estimates by beginning at a start value. Psychologists call this phenomenon anchoring, or the reference-point-effect. I personally prefer the “new normal” syndrome, especially when we are talking about financial markets. The history of financial markets is filled with examples. For instance, the often-praised economist Irving Fisher declared on the onset of the Great Depression that stock prices “reached what looks like a permanently high plateau.” In 2000 something similar happened, when former Fed-chairman Alan Greenspan talked about the “new economy,” an alleged era of low inflation and unprecedented increases in productivity, such that the (greatly overvalued) internet stocks were no bubble, but a rightful reflection of fundamentals. We all know how this ended at the time. Now, shortly after New Year’s Eve, we seem to pay no heed to certain crystal clear danger signals yet again. The astute investor, however, pays close attention.

The “New Normal” of 2017

After Donald Trump clinched his electoral victory, the financial press turned their focus to the US stock market. The Dow Jones breaking through a record 20,000 points was a matter of time. Financial magazine Barron’s even dedicated one of its covers to “Dow 20,000.” The “new normal” of 2017 is a Dow Jones above 20,000 points, without any regard to the underlying value of the companies that form this index. The idea that a president who does not go out of the way of trade wars, but actively pursues them, just like former president Herbert Hoover did in a very similar fashion with his trade wars of the 30’s which turned the depression into a Great Depression with capital “D,” could be positive for the US economy, is difficult to understand. Moreover, Donald Trump is aware of the “big, fat, ugly stock market bubble”, and interest rate hikes seem to erase any hopes on turning the US into the next economic miracle in short run.

There is more to it: elsewhere there are also plenty of danger signals. It is hard to believe that we are actually living in an era in which the CEO of a popular publicly listed company can give a talk about colonizing Mars without having shareholders worry about their investment. All this might be a bit easier to understand if we consider that those same shareholders were prepared to believe the exaggerated promises and disappointing results of this charismatic CEO. This charismatic CEO, the often praised and beloved Elon Musk of Tesla, gets away with it. As long as the bubble continues, he is able to cozy up to his shareholders, blinded by the challenges that are awaiting the company in the short run.

Or take the idea that net earnings no longer count, but that somehow the number of new subscriptions of (non-paying) customers do. I recall that during the dotcom bubble the maxim was “we are losing money on each sale, but make up on volume.” The “old” rules no longer count, according to the modern tendency. But the rules do not change; tendencies do.

In the real estate market we also notice the “new normal.”

In Amsterdam, for example, housing prices experienced double digit increases over the past few years. Housing prices will never go down, “since it is, after all, Amsterdam!” And everybody wants to live in Amsterdam, without any regard to price or price-quality. The idea to pay two hundred thousand dollars for an unsaleable rabbit hole with a skewed foundation is the “new normal” in Holland. The fact that housing prices mostly depend on the availability and cost of financing, and not on the number of expats in a town, organic super markets in the neighborhood, or historical price tendencies, appears to be a intellectual artifact of ancient times.

The “New Normal” Is “The Same Old Song”

This time, too, the new normal is no normal at all, but rather a (temporary) deviation from normal. And this time, too, prices will come down to earth.

The good news for gold investors is the following: given the fact that the stock market is all-decisive for the interest rate decisions of the Federal Reserve (even if they pretend otherwise), the Fed will lower interest rates when the current stock market bubble bursts. With negative returns on equity markets and zero interest rates on bond markets, that shiny barbarous relic (that is, gold) will avenge itself. Gold prices will rise rapidly when returns on capital markets are low or negative.

I am the first to admit that these danger signals have been flashing for some time now. I, among others, have been writing about the overvaluation of stock markets myself. Despite the extreme overvaluation, the stock market has not crashed yet. Does that mean we were wrong?

The answer is a definite “no.” I can tell you whether the probability of a recession or a stock market crash is large or small, I can tell you whether a stock market is under- or overvalued, but I cannot tell you when the herd conforms to the underlying reality. I have never given you bold price targets, and I will never give you bold price targets.

What I can give you for 2017, is the following advice:

  • Patience is rewarded on financial markets.
  • New (and sometimes credible) justifications of extreme price levels (that is, overvaluation) are nothing new and should be met with scepticism.
  • Most investors will, sooner or later, be caught by the current; in contrast, the eventual winners follow their own course and never allow the current to decide where their ship is heading.
  • Act accordingly; avoid being misled by the way how the vast majority of your fellow investors seemingly disregard these important dangers signals.

    I wish you a happy new year, dear reader.

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