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Eureka Report special issue, June 2008

Bear markets Why they start, how they end

By Patrick O’Leary and Charles Macek

Foreword by Alan Kohler Bear Markets • Eureka Report special issue 

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Foreword, by Eureka Report publisher Alan Kohler Successful investing is not about getting a lucky profit every now and again, it’s about consistent successful negotiation of the markets day after day, year after year. As we roll towards the new financial year Australian investors face one of the most uncertain periods we have witnessed in a long time. Awakening from the shock of a dreadful quarter in the three months to March 2008, investors must now deal with rising inflation, rising energy prices and higher interests rates … it’s bearish! So how tough is it going to be and, more importantly, how will you make money in the year ahead? To get to the heart of the issue we’ve asked two worldly wise market professionals – Charles Macek and Patrick O’Leary – to put this year’s

events in historical perspective. We’ve asked them specifically to give us a history of bear markets: how they start, how they evolve and, most importantly, how they end. Charles Macek is today on the boards of Telstra and Wesfarmers but he is best known to Australian investors as the man behind the success of County NatWest in Australia. Patrick O’Leary, a former head of investment strategy at County NatWest Investment Managers, is able not just to write about the last major bear market of the 1970s – he recalls working with a stockbroking firm in London at the time. It’s that exceptional blend of working knowledge and analytic ability that makes this Eureka Report special issue a great read … and an important part of your investment strategy in the year ahead.

Bulls, bubbles, busts and bears By Patrick O’Leary and Charles Macek

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went forever smoothly upwards, all investors would be rich and never have to work. It would always be irrational to take profits by selling and it would also be foolish to be out of the market at any time. On the contrary, it would be crazy not to borrow as much as possible to magnify the guaranteed available investment returns. F ASSET prices

The reality is all these encouraging conclusions are false simply because they are based on a false premise: prices just don’t keep rising. We can’t ever all be rich through investing in securities or real estate or works of art, because asset prices can never climb all the way to the sky. Prices in an open market are set by buyers and sellers – and whether they rise or fall depends on whichever group is more powerful at any given time. Their respective tactics and their confidence in the future will always fluctuate with events, so market prices move in erratic swings and never in straight lines – either up or down – for very long. “Cycles Rule OK” should be scrawled on the walls of every stock exchange and real estate agent and financial adviser in the world. But we are human, so in the good times we project rising trends into the unknown future. We also extrapolate present disaster into the distant future during a market slump. We just don’t think naturally in terms of the cycles that make up the real world. Let’s try to dissect three historic episodes that have come to be seen as classical bear markets. We will look for similarities and differences between them and try to come to some conclusions about how those bear markets begin life, how they develop and grow and how they die away. We’ll try to focus on what makes market events work the way they do, and on what lessons might be drawn from the past. Most importantly perhaps, we’ll try to apply what we learn to the present situation, and propose some signposts that may be helpful in telling us what lies ahead. Bear Markets • Eureka Report special issue 

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Bulls: The vindication of good fortune FOR MOST of its course – which may take many years – a bull market can be justified by the steady improvement in economic and commercial conditions. Despite the setbacks caused by wars and recessions as well as natural disasters, it must be accepted that those conditions have generally improved for most of the century just past, which helps to explain why market prices have trended broadly upwards for most of that time. Over the very long term, however, we must also accept that the consistently falling purchasing power of money has also contributed largely, and perhaps overwhelmingly, to the impressive upward trend of such inflation-hedging assets as real estate and equities. But we are more concerned here with the shorter-run market patterns of rising and falling prices, which respond to the moods induced by more immediate economic fluctuations. When things are going well inflation may be falling or steady, interest rates are bearably low, capital is abundant and profits are healthy and growing, while the policy environment is predictably sympathetic to business. The competing claims of capital and labour are being carefully managed and the balanced economy is functioning smoothly to satisfy the reasonable needs of the society at large. Economic growth is neither too hot nor too cold, but is keeping pace with the growth of the population and its total productivity. Trade is open and efficient and capital and people can move freely. Competition is healthy and productive new ideas are being financed and adopted by a profitable private sector. And in the background, all’s well with the world. Under these ideal conditions national wealth grows smoothly, at about the same long-term rate as GDP, and is widely distributed through the mechanism of relative prices and the tax system in a socially acceptable way. The claims on that compounding wealth, represented by the financial securities that are traded in open markets, will become more intrinsically valuable as time goes by, for as long as those favourable conditions last. Bulls are thoroughly rational creatures under such ideal conditions and they only become dangerously unstable when maddened by the application of leverage and uncontrolled money-lust. The signs of mania are normally less obvious to the herd than to the outsider. Cash becomes trash. Any setbacks are greeted as unexpected opportunities to buy, and as cash is exhausted more and more credit is used. As the fear of loss is banished, it makes clear sense to use borrowed money to make even more. If there are no quantity or price restrictions on borrowing, and if the lenders become heedless of risk themselves, buyers will force prices ever higher as potential sellers are overwhelmed

Bear Markets • Eureka Report special issue 

After a while the intrinsic value of what’s being traded in such feverish conditions becomes merely its market value: a thing is worth whatever the market will pay for it. Traditional touchstones of value – such as dividend yields and price/ earnings multiples, the relationship of stock earnings yields to bond yields, the cash backing of share prices and, at the broadest level, the ratio of the whole market’s capitalisation to gross domestic product – none of these conceptual anchors means anything any more, because Things Have Changed and the resulting New Paradigm has made them old-fashioned. This is where momentum comes in. The bullish process becomes self-feeding. Any fool can see that the line of least resistance lies upwards. All news is interpreted as favourable and is immediately built into prices, whose consequent rise is then taken as confirming that interpretation. Anything that fails to confirm universal optimism is argued away or ignored. And as this increasingly debt-financed frenzy continues, the rate of “wealth” creation rises well beyond what the economy’s own growth rate can truly provide; in other words, that market wealth becomes illusory. In our rational moments we accept that we are not all fated to be rich by simply playing a no-risk game. Most of us also understand that we must take risks to increase our capital – nothing ventured, nothing gained – and that our rewards, if they come, are proportional to those risks. But it’s striking how universally and deeply we can delude ourselves about the colossal size and certainty of the rewards we deserve, and about the negligible size of the risks we have to take, when a persistent strongly rising price trend is built up during a bull market. Our limitless extrapolation makes us more and more incurably optimistic as we forget about the pain of the preceding downturn. Once we’re clear of our previous losses we become even keener to redouble our bullish bets. The bovine mentality of the herd takes over as individual judgment is suspended. Don’t think – just buy! Everybody else does! No safety if you stand aside! United we charge, and the dissenters get trampled … When value and price have parted company like this, under the influence of euphoria and leverage, the bull market has become unsustainable and has become a bubble. It rises gloriously above the colourless landscape of fundamentals as it inflates and provides the quickest and most evanescent gains of the whole cycle. But when this glowing and fragile creature ruptures, as it must when reality intrudes upon it, we have a bust, a crash that makes the headlines and usually changes the market mood from manic to depressive overnight as it happens so fast that it traps almost every helpless player into a loss-making position.

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Bears: The vindication of misfortune A CRASH may give way to a less spectacular but more extended bear market, during which prices fall consistently and relentlessly, over a long succession of months – often years – always making lower lows and feebler highs until even the optimists capitulate into despair as their losses become intolerable. Our own preferred definition of a bear market specifies it as being that extended condition of declining market prices that forces even long-term investors to take financial losses. Every bull market is eventually succeeded by a bear market, and vice versa. But not all bull markets terminate in a bubble, and not all bear markets are born from a bust. However, every destructive bust in the history of investment has been spawned in a bubble. As most modern central bankers complain when the system they brood over is melting down in a crisis, it’s a lot easier to identify a bust than the bubble that always precedes it. Most central bankers are human themselves and so are capable of just as much optimistic self-delusion about market conditions as the rest of us. This being so, they will almost always over-react to the busts and under-react to the bubbles that gave them birth, and in doing so they will inadvertently help to perpetuate the unbreakable cycle of boom, bubble, bust and bear. The bear market is a perfectly normal reaction to a worsening of conditions in the real world. And conditions will get worse if they can no longer improve, according to Stein’s Law (Herbert Stein was an adviser to President Richard Nixon. He decreed that things that can’t go on forever, don’t.) Interest rates can’t fall forever. Profits can’t become infinite any more than could wages. Policies will never be infallible, and the world will turn. The fairest economy will eventually become unbalanced and value will drain away from the price of its assets as these things happen. And as the fundamental underpinnings deteriorate it gets harder to meet expectations and even harder to exceed them, so that disappointment sets in as negative surprises keep popping up. When inflation stops falling it begins to rise and interest rates tend to follow. The debt that supported energetic consumption and economic growth becomes onerous and eats into household incomes and corporate profits. Leverage that helped to turbocharge portfolio returns now becomes a millstone for investors too, and the assets that had earlier provided the lenders with their collateral start falling in value. What had become a virtuous circle of positive feedbacks during the bull stage now works in reverse during the intensifying bear phase, to become increasingly vicious, reverberating between the real economy and its financial markets. Confidence degenerates as reality returns. And as expectations come back to earth, any price rallies are gratefully sold while the deepening declines are ignored by the chastened optimists.

Bear Markets • Eureka Report special issue 

There is therefore a real difference between a mere correction in a bull market and a proper bear market. A correction is a hiccup in the long advance during which sentiment changes very little – it runs counter to the main trend of prices, and many people take advantage of the quick drop to pick up the temporary “bargains”. Brief dips and rallies that run against the main trend of prices are the bread and butter of short-term traders who believe that they have special abilities to profit from timing these cyclical deviations; during a bull market they will buy the dips, and they will sell the rallies that punctuate every bear market. Long-term investors are better advised to concentrate on riding the trend and leaving the short counter-cycles alone if they want to contain their risks. A bear market, by contrast, occurs when the actual trend of prices points relentlessly downwards, and when the countertrend bullish rallies are progressively weaker, shorter and less frequent as time passes. It takes a long time for a trend to develop and become visible and bear markets, like their bull counterparts, take a long time to run their course. About a third of the dozen bear markets since the last world war have lasted for more than 18 months, and they occur about every five years. Although a consensus is lacking when it comes to defining their intensity, most investment lexicons require a decline of at least 20% from the previous bull market peak before a phase can be called a bear market. More importantly, the recovery from the bottom to the previous high point usually takes a good two years, although this too is highly variable. Some slumps of 20% or more have been dramatically quick: the October 1987 market crash spawned a 100-day bear market in the US but lasted only half as long in Australia but it, too, took more than two years to recover. Others are enormously extended and occur in several stages, like the three-year Millennium Decline from 2000, which started with the American “tech wreck” and continued via the September 2001 terrorist attacks, recession, corporate scandals and the wars in Afghanistan and Iraq. The tremendous 1929–1932 bear market in America was also reinforced by policy mistakes, widespread bank failures and a deflationary depression that spread around the developed world and the market took until the 1950s – a quarter of a century – before it exceeded its 1929 peak again. And the great bear market in Japanese equities, which has been rumbling on since the beginning of 1990, is still not spent after 18 years. The present situation has many of the ingredients required to make a historic genuine multi-stage bear market. But history never guarantees repetition, and we will leave the reader to decide whether today’s conditions mark the start of something far worse or prove a mild and short interruption to prosperity.

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Three defining bear markets EVEN BY the most stringent definitions of scale and duration, there have been literally hundreds of bear markets during the past centuries, in currencies, shares, bonds, property, commodities of all kinds, and most recently in derivatives and their “engineered” confections like credit-default swaps and collateralised debt obligations and various asset-backed securities. By some counts there have been two dozen notable bear markets in American shares alone since 1900. Some of these episodes will be familiar to modern readers, either because they happened in living memory or because their savagery has made them the stuff of legend. The enormous speculative booms and busts of 18th century Europe, which typically accompanied the economic expansions and financial experimentations of the time, fall into that former category. During the 1720s, John Law’s Mississippi Company in France and Robert Harley’s South Seas Company in England, both of which were designed to convert a large part of the national debt into equity, spawned unprecedented trading exuberance, which then turned into ruinous market busts that destroyed public investment confidence for a generation. The Dutch trading mania in tulip bulbs 80 years earlier had likewise caused widespread debt defaults and public distress when it collapsed. Each of those episodes wiped out more than 95% of the capital of those speculators who had bought at the top, and yet each of the preceding enthusiasms had earlier been sensibly founded. The attempted monetisation of government debt in Revolutionary France in the late 1790s, through the public issue of so-called “Assignats”, was an early experiment, which also went badly wrong, in originating and distributing assetbacked securities. Rather than backing those new interestbearing notes with sub-prime mortgages like modern American investment banks, the French Republic secured its Assignats on the collateral of newly confiscated church property and in the process created inflation in the cost of living that destroyed the currency and the economy. The value of those securities was annihilated by the turn of the century, and so was the purchasing power of any French personal savings that were not held in tangible assets. Many more recent bear markets have been every bit as extravagant, but have led their malignant lives in greater obscurity, either because they occurred in exotic places or because they were too obvious to be noticed. The relentless decline in the US dollar, the reserve currency of the whole world, is a case in point. It has lost close to 95% of its purchasing power since 1913, a decline, incidentally, which has been one of the major propellants of the long-term rise in nominal American share prices. While on this subject we should always bear in mind that the performance of share prices is usually, and misleadingly, expressed in terms of their “home currency”, which is assumed to be stable. The Zimbabwe stockmarket index rose in 2007 by 12,000% in local currency terms, making it the top-performing

Bear Markets • Eureka Report special issue 

market in the world until adjustment is made for the currency’s collapse. The price of sugar fell by 96% during the dozen years after 1973 to a low of 2.5¢ a pound. Most emerging-market share prices have had phenomenal runs of good and bad conditions; the last major bear market in Peru saw losses of 96% recorded. The Hang Seng index of Hong Kong share prices fell more than 90% in 1973-74. The massive Nikkei 225 index of bluechip Japanese share prices, at its most recent high point, was still 54% below its early-1990 peak value; what had been the second most-capitalised market in the world had fallen by 80% over 13 years to its 2003 low and has yet to recover its former buoyancy even now. More immediately worrying, perhaps, has been the recent performance of the Chinese sharemarket: the Shanghai Composite index has fallen by about 51% since its peak in mid-October 2007. Those who are undyingly enthusiastic about Australia’s continuing export-led prosperity are now betting that this is just one more unimportant example of speculative Oriental froth being blown off, and not another instance (as academic theorists will always insist) of the “efficient” markets telling us something disturbing about the worsening fundamentals. But we can’t perform autopsies on every speculative bust and bear market; we can only observe the tombstones of most of them and pass on. We’ll spend more time putting three familiar episodes under the bright lights to see what can be found out about their birth, growth and death. Perhaps this forensic examination of history may give us some clues about where we now stand.

USA 1929-1932: Wall Street Crash and the Big Bear, Deflation and the Great Depression – euphoria, leverage, panic and fatal policy mistakes Stock prices have reached what looks like a permanently high plateau … – Irving Fisher PhD, Professor of Economics, Yale University, 17 October 1929 While the crash only took place six months ago, I am convinced that we have now passed through the worst … – President Herbert Hoover, May 1, 1930 ALL SERIOUS bear markets require for their gestation a preceding boom of exceptional magnitude, and America after the First World War provided the best imaginable economic nativity for such a boom. The nation had come through the Great War with far fewer casualties or economic damage than Europe and had invested widely in the techniques of industrial mass production, which were now turned towards satisfying the demands of a well-paid and egalitarian civilian market. New transport and network technology was commercialised

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by efficiently managed companies, largely financed by the Wall Street securities houses that had begun to compete successfully with the banks. The demand for motor cars, sewing machines, kitchen whitegoods and all other big-ticket consumer durables was increasingly financed by consumer credit now provided by more the than 1500 finance companies. As has always happened before and since, the financial sector responded strongly to the public demand for such new “breakthrough technologies” by creating its own innovations in credit – and by doing so for both the producer and the consumer. The earlier technology booms in electrification during the 1890s, in railroads and canals in the 1840s and 1820s, and the late-20th century booms in computer and internet technologies, were all similarly financed through private investments in securities markets. The risks involved in commercialising these alluring, untried technologies were spread among a myriad shareholders and bond holders, whose enthusiasm had to be aroused and then inflamed by their expectation of profit. The post-war economy of the Roaring Twenties provided plenty of reasons for their optimism. Consumer spending growth was strong and so was business investment in equipment. The new goods were increasingly affordable. Housing development was surging and investment in real estate, also financed by easy credit, was another new source of wealth. Private investment in non-residential real estate grew by 56% in real terms between 1920 and 1927, concentrated in the burgeoning financial districts of New York and Boston but also in the motor capital of Detroit. Interest rates were kept at low wartime levels to aid the economy’s

Bear Markets • Eureka Report special issue 

reconstruction while domestic demand was let loose; in fact rates were lowered in late 1927 to help the farmers of the drought-stricken mid-West and to ease the manufacturing economy through a flat spot caused by Henry Ford’s retooling for the new A-model car. Inflation remained quiet because of the surge in the underlying productivity growth of labour and capital. Most importantly for the bullish investors and market speculators, credit growth was unrestrained by any effective regulation, and broker loans were widely and cheaply available on margins of 10%. Public participation in the surging securities markets became widespread in the major cities and the successes of investors made headlines. On top of all this, the new investment trusts – financial structures that had been introduced from Britain – were not only allowed to gear their stock portfolios through borrowing, but were also allowed to supercharge their leverage by investing in each other through complex debt and equity cross-holdings. All of this added to securities demand and forced market prices higher, which brought in still more buyers, most of them inexperienced, and many of them operating on borrowed money. The American bull market was now mature, and the bubble fully inflated. The many early doubters who remembered previous panics and recessions had been forced to capitulate and had fallen silent. The dominant academics of the day endorsed the new prosperity as fundamentally sound and permanent, and the regulators basked, having ignored the spectacular credit-fuelled property boom and the consumer splurge. Very few had observed that the debt-burdened financial economy had become dangerously fragile or that

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growth in the real economy had in fact peaked during the summer of 1928. Such “funnymentals” were not seen as relevant to stock valuations when RCA, for example, was selling at 73 times its earnings per share, having risen since 1921 from $1.50 to $549 without paying any dividends at all. The inconvenient truth that such investor favourites as General Electric, Maytag, Du Pont, Chrysler and Westinghouse had all tripled in price since 1926, also had no cautionary effect on behaviour. Until, that is, the worsening news about industrial output became more insistent. The index of industrial production published by the Fed fell by 7% in the four months to October 1929. The production of steel, cars and ships was falling steadily. Transport volumes by rail and sea also declined and unsold inventories built up in warehouses. Unemployment began to rise and incomes stalled. The cost of servicing debt went up and profit expectations went down. The capital gains from market trading could no longer pay the interest cost of broker loans. But despite the growing drum-beats of such bad news, the supply of securities continued to grow through new issues and the volume of new broker loans continued to surge to new heights. The actual trigger for the deepening series of market collapses in late October is controversial and probably unimportant, and this remains a central feature of almost all previous and subsequent bear markets. The event that unleashes the hurricane of loss could be the wing-beat of a butterfly, as today’s Chaos Theory would express it, once a system’s tipping-point has been exceeded and it flips into its new state. In complex financial markets, all it takes for the bear to take over from the bull is for raw overconfidence, based on a systematic buildup of implausible New-Paradigm expectations, to be overturned by reality, and for excessive leverage then to collide with falling prices to extinguish the hope of any prompt recovery. If that process of forced liquidation is then compounded, as in the America of the early 1930s, with a series of banking panics and gross policy mistakes, the result can be the sort of great deflationary Depression that then engulfed the nation and spread around the world. There were several strong rallies after the October 1929 crash, which gradually diminished in ferocity as each one failed to return the losses made by the disappointed bulls. Each rally was hailed by the financial commentators as signalling the end of the bear cycle. This is an unfortunately common signpost in all the really serious market declines, the so-called “suckers’ rally” that entices to perdition those whose capital has so far remained intact. The bullish singers of that siren song always have a powerful interest in manufacturing buying demand for their own stock. For that same reason, very few investment practitioners will make a public habit of predicting any kind of correction, and the general public will usually be fully invested at every major top of the price cycle for want of any cautionary contrarian advice. The inevitable bear market that follows will therefore almost always come as a complete surprise and will be confronted first by denial and anger, and then by gradually more hopeless support, until both the will and the means to finance the feeble rallies have vanished.

Bear Markets • Eureka Report special issue 

During the very greatest market declines, such as the 1930s and 1970s debacles, it even becomes “unpatriotic” to predict further pain because such arguments are an affront to those regulators who failed to defuse the risks as they became visible, and an insult to the competence of the experts whose lack of forewarning contributed to the general distress. When the “Un-American Critics of Capitalism” are themselves intimidated into silence by the stampeding bulls the whole herd is doomed. This is what happened during the market meltdown of the 1930s. It has happened many times since. It may even be happening now. The great bull market that occupied the Roaring Twenties ran for 2936 days, from August 24, 1921, to September 7, 1929, and raised share prices by 491% from a starting index level of 63.9. The ensuing epochal Great Bear of 1929 to 1932 lasted for 1035 days and confiscated all the gains made by the previous bull market, falling by 89% to a Dow Jones index level of 41.2, fully 35% below the point at which the 1920s advance had started. The peak of the bull market was not reached again until the mid-1950s, a generation later.

UK 1972-1974: Bretton Woods collapse, OPEC oil price shock, and the Great Inflation THE COLLAPSE of Wall Street during the 1930s and the subsequent deep Depression in America resulted in a long isolationist period during which global trade and activity contracted. The dollar had become suspect and the British Pound had come to replace it as the world’s reserve currency; Britain and Europe generally had been less badly afflicted by the financial speculation and its aftermath. After the Second World War, which once again devastated the Old World more than the New, that situation was again reversed and a new international currency regime enshrining the US dollar as the global linchpin was devised through the Bretton Woods Accord of July 1944. The major trading currencies were pegged to the US dollar while the dollar was itself fixed at a value of $US35 per troy ounce of gold. With governments now unable to manipulate their exchange rates for national advantage, and with the fangs of inflation drawn by the US commitment to exchange gold for a fixed number of dollars on demand, the world entered an era of growing stability and prosperity. Few countries prospered more than the United Kingdom under this regime. Its post-war economy rebounded as reconstruction got under way. Jobs were abundant and there was a boom in incomes and consumption as rationing was eased. As had earlier occurred in 1920s America, the wartime British industrial machine was turned into making goods for the local and export markets. A great demographic boom also took off as popular confidence in a peaceful future grew, and this spilled over into demand for more and larger houses. Once again, the financial sector accommodated the needs of the household sector by providing plentiful credit, and the sharemarket kept pace with the impressive growth in the profits of the productive sector. By the time of the London market’s peak, in May 1972, share prices had more than quadrupled even in real terms, because inflation remained tightly

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contained; and this long ascent had taken place in spite of two sharp corrections, each of about 25%, at the beginning and at the end of the Swinging Sixties decade. All the preconditions for the great local bull market were there. America had taken over the costs of defending the Atlantic Alliance against the threat of communism. Britain had been involved in some small military actions abroad but had not become caught in Korea nor in the ruinous wars in Indochina. The progressive loss of her overseas colonies was balanced by her greater engagement with a reconstructing Europe. The numerous baby boomers were entering the workforce and adding their voracious consumer demand to national sales and profits. The Cold War occasionally interrupted the party atmosphere, but the safe passing of the 1962 Cuba Missile Crisis led to an even greater relief rally in market behaviour; share prices doubled between July 1962 and January 1969. Growing industrial relations problems and tighter fiscal and credit policies laid down by the International Monetary Fund were largely ignored as the financial entrepreneurs in the City’s merchant banks orchestrated debt-funded assetstripping mergers. Share prices doubled again between May 1970 and May 1972. Under the surface, however, things had started to go badly wrong. On August 15, 1971, the world’s stable-currency architecture fell apart overnight when President Richard Nixon pulled the US out of the Bretton Woods Accord, as America could no longer afford to redeem dollars for gold; its simultaneous spending on the Vietnam war and domestic programs had created the biggest budget and current-account deficits in the world’s history. With the dollar’s gold link severed, all other currencies were forced to float against each other in an unexpected burst of international instability. The now “floating” US dollar sank like a stone, creating a burst of inflation that spread abroad like wildfire as global investment capital fled New York. Money was printed everywhere by nations trying to build their financial reserves as the free currency markets fought to find a new equilibrium, and this embedded the inflation even more deeply. In the English social context, the highly organised publicsector and coal-mining unions led the reaction against higher prices and slowing growth by waging industrial warfare against Edward Heath’s Conservative Government. The Government responded with tighter budget and credit controls and a draconian wages and incomes policy. With the domestic economic crisis deepening in Britain throughout 1973, the worst was yet to come. On October 6, 1973, Egypt and Syria attacked Israel on the eve of the Jewish religious holiday of Yom Kippur. In retaliation for America’s support of the Jewish state, the dominant Arab faction within the OPEC oil-exporting group of 12 nations announced an oil embargo 10 days later against the US, its European allies and Japan, and Iran joined them in cutting oil production while raising oil prices by 17% to $3.65 a barrel. Further production cuts of 25% were made the next month and by 1974 the price of oil had quadrupled to $12 a barrel.

Bear Markets • Eureka Report special issue 

The effects of this first oil-price shock were serious everywhere but they hit the British economy like a sledgehammer. Coal stocks had dwindled drastically as the miners’ strike dragged on and the nation, which was close to running out of energy to power its homes and factories, was put onto a three-day working week at the end of 1973. Petrol rationing was imposed. Goods shortages developed. Inflation soared further. Economic growth dropped faster and distress spread into every corner. The elections of early 1974 resulted in an indecisive Labour Party win with the Liberal minority holding the balance of power, and Edward Heath resigned. One week later the new Labour Prime Minister, Harold Wilson, capitulated to the mine workers and awarded them a pay rise of 35%, starting an avalanche of wage claims. Another pay rise of 30% followed a year later. The financial engineers in the City were trapped as asset values collapsed with the sharemarket. As Jim Slater, the founder of Slater Walker Securities, famously answered an interviewer on television at the height of London’s greatest-ever bear market: “Thank you, I sleep like a baby at night … I wake up every hour and cry.” What caused that bear market to end? As with the great debacle of 42 years before in America, it died of sheer exhaustion. It had lasted 956 days and prices had slumped by 73%. Investor capitulation was complete. There were no sellers left to sell. Fortunes had been wiped out in the share, bond and property markets as inflation had raged – and in the end the market had fallen 29% below the point from which the previous exhilarating bull market had started. Great Britain had been humiliated internationally by being forced into the hands of the IMF. And yet within 18 months of that deepest trough the market had rebounded by 177% as the world adapted to higher energy prices. The Arab oil embargo was lifted in March as a fitful peace broke out in the Middle East. The OPEC oil producers had acquired a huge hoard of petrodollars that needed to be invested around the world. And few of the confirmed bears had noticed, during the final year’s debacle, that the first oil from Britain’s own vast North Sea reserves would flow ashore in mid1975, ridding the nation of energy dependence on foreign oil sellers and local coalminers … Cycles Rule OK. The market had risen exponentially, convincing everyone that a new world order of stable prices and rising profitability would last. The deterioration in local and global politics was ignored until market prices could levitate no longer. The old familiar model of fixed exchange rates was shattered and a new model of unstable national competition took over, and wars took their toll as well. Britain’s unbalanced economy was grievously exposed to the unexpected supply shock of OPEC’s use of its oil price weapon. That weapon had been wielded principally at the United States and its collapsing dollar, by which the oil producers made their living, but Britain and its weak government was caught in the crossfire. Soaring inflation then destroyed the paper wealth of the nation – until the cycle turned and the next bull market developed.

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USA 2000-2002: Dot-Com Crash, Millennium Bear, recession and 9/11 terrorist attacks IN COMMON with every other memorable bear market, the long three-part slump that started with the new millennium in America was first nurtured by a lengthy and well-founded economic boom. Nearly 20 years earlier the rampaging inflation of the 1970s had at last been defeated by the brutal monetary tightening of Paul Volcker, arguably the most effective and courageous Federal Reserve chairman in history. In one year from July 1980 he had relentlessly raised short-term interest rates from 9% to 19%. In squeezing the previous speculative excesses out of the financial system and restoring credibility to the dollar, the Volcker policies had provoked a healthy 20% pullback in the broad S&P500 share price index, pushing its dividend yield up to a compelling 6.3% by the middle of 1982. Then the monetary brakes were released and the economy took off. That served as the springboard for the huge secular bull market of the next 18 years. Low and stable inflation, massive technological innovation, the Reagan tax cuts and the “peace dividend” flowing from the economic defeat of the USSR, all combined in a magic pudding of prosperity. And that prosperity was propagated outwards to the rest of the world through a vigorous relaxation of old trade barriers, allowing capital to flow freely between economies, together with goods, services, people and ideas. A new ideological paradigm was embraced, especially in the Anglo-Saxon economies, in which economic rationalism – embodied in the operations of self-regulating free markets – came to replace politically driven regulators. Markets were more efficient in creating wealth and much less fallible than individuals in coming up with solutions.

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A brave new golden world of deregulation and globalised capitalism and democracy had arrived. That unreliable old world of economic and business and market boom-bust cycles had been tamed, and from now on they would be reduced to smooth and predictable trends. This would allow rational longer-term planning by business and reduce commercial risk, in turn raising profitability by permanently cutting costs. It would also help the financing of government by keeping inflation and interest rates lower than usual and by directing a flood of new tax receipts into treasury coffers as corporate profits burgeoned. Overall taxes could be lowered as this happened and economic growth would be permanently raised as the fiscal drag was removed. Best of all, the resulting new worldly paradise of higher growth with lower taxes and interest rates would inevitably spawn the mother of all bull markets in every single asset class available to the investing public. Their homes and share portfolios would be revalued upwards permanently as this happened, with little possibility of relapse. Those many ageing baby boomers who were now contemplating retirement could be assured of a comfortable retirement if they committed themselves to taking an active part in the securities boom. Meanwhile, their growing paper wealth would compensate the working population for the unusually low growth in wage incomes that would flow from outsourcing many low-skilled but highly paid jobs to low-cost countries. The beguiling universal new-age mantra had become “Markets Rule OK”. Unlike the cautionary old mantra about the sovereignty of cycles, which had been carefully hidden from timid investors, this one was scrawled all over the walls of every legislator, regulator, financial adviser, funds manager, broker and lender.

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The markets responded to the new conceptual model as buyers poured in from everywhere and as they geared up for the good times. Naturally, there were cyclical setbacks in share prices as well as in the bond markets from time to time during this period. The enthusiastic trebling of share prices in the five years from August 1982 was briefly punctured by the 1987 market crash and its short, 100-day quasi-bear market – but the technical nature of that crash, driven by wild trading in derivatives, produced few lasting scars on the economy and may even have reinforced fundamental investment sentiment. The newly appointed chairman of the Federal Reserve, Alan Greenspan, helped by flooding the financial system with liquidity, a habit he would find difficult to break during future market crises. Two equally shallow but even shorter corrections – once again salvaged by the Fed – accompanied the second OPEC oil-price shock of late 1990 and the 1998 Russian default, which triggered the spectacular crash of the Long Term Capital Management hedge fund. But the market picked itself up promptly each time and quickly moved to greater heights of price (and of valuation) as official interest rates were helpfully lowered to save Wall Street from itself. By the time the market had truly peaked, in August 2000, the S&P index had risen by an extraordinary 15 times since 1982, and investors were paying a heroic 29 times earnings per share where they had been reluctant to pay a lowly 7.3 times at the trough. What were they thinking? They were reciting the new mantra, with the whole national congregation, and blessing the Fed. But what was happening in the blue-chip heavyweight S&P index was downright conservative compared with the action in the NASDAQ index of technology stocks. During the same 18 years to the August 2000 pinnacle, that index rose by 32 times, more than twice as fast, to a level of 5048 points, even though few stocks paid dividends, and very few indeed made any noticeable profits. Here was a market that existed for the pure hope of capital gains and not for any reasonable expectation of future income from the distribution to shareholders of commercial profits. It was a market that fed on broker loans and rumours of breakthroughs in incomprehensible new technologies that would sweep the world. The many start-up companies in whose future triumphs it speculated were almost invariably financed by Initial Public Offerings of shares that were underwritten and distributed to the public by investment banks and brokers. The cash raised was then spent in commercialising the new idea in ferocious competition with others, so that any eventual investment reward would depend on whether profits arrived before the cash was burnt to a cinder. The fantastic NASDAQ bubble that developed under these conditions was similar in many respects to the earlier bubbles of the 18th century, in that the investing public seldom knew, nor was interested in, what it was buying. The speculation was this time concentrated in the internet, or “dot-com”, stocks that represented the new network technologies of the dawning Golden Age. While it was accepted that the odds of picking a winner were low, the expected payoff for doing so was always thought to be mighty enough to warrant the risk of picking a total loser.

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In any case, those risks could be offset, under the academically fashionable Modern Portfolio Theory that now drove investment behaviour. The theory went that you diversified your portfolio and by buying many such risky stocks the hope was that they were all different enough to counterbalance each other’s price behaviour, with the many losers compensating for the few that survived. The reader may notice a similarity here with the motivation that has more lately underlain the purchase, by thoroughly expert and rational professional investors, of corporate junk bonds, sub-prime mortgages and other asset-backed securities. In the Land of Modern Portfolio Theory, diversification of worthless securities and other internal-hedging portfolio techniques can magically create a silk purse out of a sow’s ear. With risk eliminated by the use of such alchemy it then makes complete sense to debtleverage the portfolio to the maximum. The resulting debt-charged bubble in America was then primed to be vaporised, but not by rising inflation or by any precautionary tightening of the regulatory framework within which it had been inflated. Instead, the taper was lit by an ordinary economic downturn in reaction to the furious prior over-investment. The Fed had hesitantly and slowly raised its Funds Rate six times in small steps in a belated attempt to contain the bubbling euphoria and the production side of the economy responded by gradually rolling over. Booming business capital expenditures in the vital new computer and network technologies, grossly accelerated by genuine widespread fears of the “Millennium Bug” thought to be lurking in the operating programs of the world’s computers, suddenly came to an end as the threat was proved overnight to be groundless. The economy contracted mildly and the dot-com sell-off began in March with a 9% crash in NASDAQ prices on the 15th. The blue-chip S&P index peaked 10 days later and followed it downwards as it became clear that the economic cycle had certainly not been conquered and that deregulated markets could work in reverse. Popular disappointment spread during 2000 with the gradual exposure of the model’s flaws – as Warren Buffett remarked, when the tide goes out, you can see who’s been swimming naked – and the market downturn accelerated. Hightechnology scandals and bankruptcies mounted and litigation specialists again became richer than investors. Already-low interest rates and big budget deficits made it difficult for policy to turn confidence around by stimulating the economy. The outgoing Clinton administration was politically hamstrung, as had been the Hoover and Heath governments during the earlier bear markets we’ve examined. And then, when things were already looking seriously delicate, came the totally unexpected shock of the September 2001 terrorist attacks on America, and the inexperienced new Republican administration reacted by taking the nation to war. And that guaranteed the bear market another year of life, to October 2002. The Millennium Bear Market was created by the long preceding low-inflation boom that eventually degenerated, without being discouraged either by the regulators or the academics, into a series of credit-funded bubbles. While these were concentrated in exciting new speculative enterprises

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whose intrinsic value could not be assessed by any ordinary investor, the general euphoria also spilled over into established large-capitalisation companies. The boom ended, as most eventually do, with the cyclic deterioration of the economic environment, and the ensuing bear market was then magnified by the collapse of the bubbles, the exposure of the underlying myths and the effects of unexpected external shocks. In this case the last great bear market of the century lasted for 929 days and forced the broad S&P500 index down by nearly 50%. The loss of wealth was gigantic. At the peak of the preceding bull phase, the market capitalisation of all stocks

listed on the New York Stock Exchange was $US12.9 trillion, while the NASDAQ’s capitalisation added another $US5.4 trillion. By the end of the bear market, on October 9, 2002, the total capitalisation had shrunk to $US7.2 trillion, for an overall loss of about $US9.3 trillion. The speculators in the NASDAQ index lost 78% of their money, more than that lost by British investors in the mid-1970s and nearly as much as had been lost in the 1930s Wall Street bear market. It is still more than 50% below its bull-market peak. Cycles Rule OK.

The present market cycle: Conclusions, consequences, lessons and signposts OUR EXAMINATION has suggested that the bull and bear phases of all past market cycles are historically normal features of open markets. They are neither rare, nor yet predictable enough to be taken for granted. Some of them can be extended in either direction for such a long time that no rigid timing rules can be given for their probable duration; as we said earlier, we are deeply suspicious of statistical formulas that rely on the average length of past episodes as a basis for predicting future turning points. No two cases will be exactly the same because the particular features that animate them, and the background context in which they occur, will necessarily be different. Nor can either phase, up or down, be extrapolated forever. The linked phases will be born, will live, and will eventually die of natural causes and will continue to succeed each other for as long as free markets exist. The surprising result of our examination is that the invariable cyclicality of markets is forgotten by those who invest in them. The present condition is projected into the far future because turning points are not anticipated. We think in straight lines while the world moves erratically. We are constantly surprised by change when it happens, and when we are shocked by what was not expected we react with denial and anger and the whole cavalcade of emotions that accompanies personal loss. Since we are seldom well trained in realism we will always tend to see what we want to see. It’s the existence of market cycles that bestows a rewarding risk premium on volatile long-term assets such as shares, long-dated bonds and property. That risk premium will itself fluctuate as market cycles mature and change shape. Without those varying contributions from the risk premium built into asset prices, investment returns would be lower, as rewards are inextricably tied to risk, which is another way of saying that there can be no free lunch. The trick is to avoid becoming lunch by being trapped on the wrong side of the market cycle. The other depressing result of our historical review is that those who are in a position to advise us will generally tell us what they think we want to hear. The scepticism of the careful contrarian view, which is the only real antidote to the herd

Bear Markets • Eureka Report special issue 

stampede, can never be popular. By definition it will always be in the minority and will look cranky and dangerous. It will be even more resented if it turns out, usually too late, to have been right. This reluctance to think and act independently for fear of being isolated is a very human trait; we are fundamentally group-thinking creatures and not rugged individuals as we like to believe. The frequent breakdown of “normal” market bull and bear phases into dangerously irrational bubbles and busts is a totally natural result of this human condition. When our understanding of the “mental model” that formerly justified a particular market trend is threatened by change, we do the only sensible thing available: we assume that others know what’s really going on and we imitate them. We gain comfort from being a part of a greater movement. In supporting the herd we gain its protection and if the herd happens to take us over a metaphorical cliff, at least we don’t fall alone. The great tricks to successful investment arise from those few basic observations. First, remember that nothing is forever. Cycles rule! The objective of an investor is as much to avoid loss as to make gains. From this it follows that no bull party, or bear wake, should be overstayed. To achieve the desirable low-risk entry or exit from the celebrations requires alertness, sober common sense, and a real individual’s capacity to decline yet another drink when the euphoria is becoming uncontrolled. All of these things require a greater maturity of character than specialist technical knowledge. Second, decide if the basic trend of prices is bullish or bearish, and judge whether the trend is sustainable by reference to the underlying fundamentals. A good indication of the trend can be had from a suitably long-term moving average of prices, and its likely stability can be judged from the steadiness of its slope. Determine devoutly to invest with that trend and resist the temptation to trade against it, and do not depart from the trend until it flattens. The short-term deviations, or noisy squiggles, should always be watched if they become extreme, because they can eventually turn the trend if they become intense or frequent enough. The best way to watch the

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deviations while eliminating as much of the “noise” as possible is to construct and superimpose an appropriate short-term moving average over the trend. With practice their contribution to the evolution of the vital trend can be seen and anticipated. Remember that the suckers’ rally in a bear market is always a greater threat to financial wellbeing than the opportunity cost of missing a blow-off top in a bull market. The siren calls must be ignored. Third, be patient. A cycle always comes around again, and every one is rich in the lessons to be absorbed by the observant student. The things that can swing markets into bull and bear phases can often be extracted from a careful study of history but remember that the past can never causally determine the future, but can only shine a light on to it. The present condition of world markets badly needs such historical illumination. In many ways, the disturbing background of dollar weakness, of sharply rising energy and commodity prices and of growing food shortages – and therefore of slowing economic growth and rising inflation – is a reminder of the mid-1970s stagflation. As happened then, governments are now changing, typically towards the political left, after a long period of rightwing conservatism that encouraged profit-seeking and elitist ideologies. Wage claims are building up as the long previous boom exhausted the labour pool. A popular reaction is building strongly against the exporting of jobs to low-cost foreign economies, and against the resulting employment insecurity left behind at home. Public-sector wage claims are becoming especially insistent in the developed economies, including Australia, and this has generally set the tone for past wage breakouts. The notable setback in share and property markets has already begun to have an effect on popular wealth perceptions and is likely to result in second-round effects on consumer behaviour, slowing sales and profits even more. In the case of America, where the present financial crisis erupted through the mortgage and wider credit markets, the scope for policy stimulus is now extremely limited, even more so than in the England of the early 1970s, because US interest rates are already abnormally low and cannot be lowered much further without causing uncontrollable capital flight out of the dollar. On the fiscal side, budget deficits are at record levels both in absolute terms and in proportion to

GDP, blown skywards by the costs of an interminable war in the Middle East and by persistent populist tax cuts. The nation is in unprecedented debt to the rest of the world and its huge trade deficit is adding to its foreign obligations every day. Unemployment is beginning to rise and the distressed average voter, if he can still afford his mortgage, cannot refinance his property any more to supplement his weakening household budget. These are not the conditions from which bull markets are made. They are not, on the strength of any historical analogies, the conditions under which strong bear market rallies can be expected to persist. On the contrary, we now seem to have the makings of a proper old-fashioned economic recession, probably inflationary in nature, which may be superimposed upon an already burst bubble in the housing and asset markets, and associated with a classic “model-change” shock. That shock concerns the possible marginalisation of the New Era Model of securitising debt, which had provided the quite unregulated torrent of liquidity that financed the previous bull markets in shares, real estate and exotic derivatives. The dissipation of credit risk that had been theoretically achieved by transferring it from a conventional lender to a multitude of different investors has now been shown to have spread risk far and wide, in ways that the investors have yet to fathom. Borrowers can no longer trust lenders any more than lenders can trust the system to return their capital, while investors are unable to value their portfolios because the credit markets have seized up. The severity of this shock, because it affects the heart of the global New Era credit architecture, appears to be every bit as deep and as long-lasting as the shocks that brought down the earlier Wall Street and City of London systems in the episodes we have examined. Because of the thoroughness with which the financial world has now been globalised, this shock and its inevitable deleveraging effects on global growth could continue to be propagated outwards from America for a long time to come. We are lucky – once again – in Australia that our links with Greater Asia and the rapidly developing world are now so intricate that we may be spared the worst effects of the shock. But that, at least, is the present view of the herd. We leave the reader to judge.

What are today’s structural differences? To have and to hold, for richer, for poorer may well be fundamental to the blessed estate of marriage but oldfashioned prudence dictates that we should never be wedded to our portfolios. This has now changed. We cleave to our portfolios through thick and thin and we divorce our partners when conditions change. The democratisation of investment and its aggressive marketing point to an important structural change in the dynamics of markets. The natural bull and bear cycle of asset prices needs to

Bear Markets • Eureka Report special issue 

be actively managed if capital is to be nurtured and protected, but “Time in the market matters much more than timing the market”, goes the refrain of today’s financial adviser. For all those people who lack the time-consuming and difficult skills of active portfolio management, this buy-and-hold strategy is naturally extended to passive investment through low-cost index funds that automatically track the selected markets. It permeates almost every insurance and pension plan whose policy allocation to volatile

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long-dated financial assets is normally well over 85%. That strategy of staying as fully invested as possible has predictably been embraced by all those intermediaries who purport to serve the ultimate investor because very few of them could justify their big fees and commissions if they retreated defensively to low-yielding riskless cash, no matter what the external conditions might indicate. Their blind steadfast bullishness naturally helps to maintain that gaping disjunction between asset prices and values that almost always opens up, as we’ve seen, as the top of the investment cycle is approached. And their unanimity in applying the buy-and-hold strategy contributes in no small measure to the herd behaviour that always characterises the terminal bubble that signals the onset of the following bear market. This new-age damn-the-torpedoes investment strategy is not a product of the mercenary foolishness of its practitioners, though they invariably get the blame when the cycle turns from bullish to bearish, as it must. On the contrary, it originates in the academic world of database analysis and manipulation, of statistical modelling and its algorithms, of modern game theory and of the straight-line projection of past trends. That world of spreadsheets and normal distributions of portfolio returns has produced an illusion of certainty in future outcomes that had always been lacking in the world of real market behaviour. The future is necessarily bullish because the richest – the most recent – data comes from the long, disinflationary, post-Volcker American boom. And because the models lack the capacity to forecast any bearish turning-points at all, they condemn them as irrelevant. Theoretical support for buy-and-hold strategies is a fundamental structural change, too, in the market dynamics of today. Our observation is that while this may be quite helpful in putting a floor under future bear markets, it is also likely to exaggerate the bubbles that precede them. We’ve already commented on the role of investor leverage and stampedes in the formation of such bubbles in the past – and it may be that the present academic bias towards the upside has, by encouraging such exaggerations, made a major correction inevitable and a serious bear market probable. Given the nature and massive scope of the present American housing-sector collapse, and of its implications for the future provision of securitised global credit, that probability has clearly increased dramatically. Yet again, the recent historical record engraved in the best databases had proved that house prices couldn’t fall, and that it was therefore rational to borrow to the very limit to invest in real estate. Because the home is by far the greatest investment for the American household, the eventual scale of the total lost wealth is now likely to be very much larger than that recorded in the securities markets alone during the dot-com Millennium Bear, and this will be transmitted to the real economy and then to the securities markets through the usual recessionary effects on jobs, incomes and profits. Inevitably that will provide some extraordinary long-term portfolio opportunities in due course, but only for those cautious investors who still have the financial means to seize them at the expense of the majority. As in marriage, the best defence

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against a ruinous divorce is to have a cast-iron pre-nuptial agreement that allows one to finance the next relationship. Three more structural differences in the present situation need to be mentioned before closing. They deserve to be analysed in greater detail but they remain hypothetical for now. The first lies in the likelihood of policy change. The world is turning leftwards now after the long right-wing Thatcher and Reagan free-market ideological interlude reinforced the disinflationary boom fostered by Paul Volcker’s Fed. The cooling of that old boom in the developed world is being accompanied by a persistent great shift of activity to the Asian and Latin American economies. If, as seems likely, the gathering recession in the highly developed economies worsens the situation of voting households even more, we can be confident of a terrific backlash against the present policies – and especially in America, where an inexperienced new president will soon be installed. Banking re-regulation is highly probable in the wake of the present debacle in the credit markets. Protectionism is not out of the question. Both of those things happened after the 1929-32 crash and, as we know, they deepened the ensuing recession into a full-blown depression. With the weak US dollar now in full retreat, the prospect of real capital flight from the world’s reserve currency is once again not completely fanciful. That threat would be greatly strengthened if the popular American mood were to turn against the foreign buyers of domestic assets. The second structural difference lies in the increasingly scary area of climate change. It may of course be another academic miscalculation, like the Millennium Bug that caused such gross and (in retrospect) unnecessary over-investment in computer equipment in the late 1990s. Scientists have been wrong before. But given the accumulating evidence for global climate change and its probable consequences, it’s becoming clear that a vastly costly adaptive effort needs to be made urgently. This will be disruptive, inflationary, and inimical to economic growth. If the effort fails, however, the results are likely to be even more threatening to civilised life. Again, these possible earth-shaking shifts in our present economic structures are unlikely to create much future confidence and will make it hard to get long-lasting bull markets going. Finally, we have to consider the erupting structural change in the world’s raw commodity markets. The globalisation of the world’s economies, which has been one of the most powerful pillars of the New Era boom, is now sending us the bill. The frantic social change and industrialisation of the developing world has pushed the price of all resources through the roof – not only energy prices, but also those of all industrial raw materials and of food. The supplyeffects of climate change have contributed naturally to the price explosions, and these have been magnified by the actions of (highly geared) speculators in the commodities markets. But unlike in the 1970s, the present situation is much more of a demand-side shock, which will not be defused by a peace treaty or by the lifting of a trade embargo. Its inflationary consequences are therefore likely to be more

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long-lasting and may be resolved only gradually, either by a global demand recession or by major breakthroughs in energy and food supplies. The added possibility that we might now be at the very peak of our access to cheap oil makes the supply breakthrough rather unlikely. For the moment, Australia looks well positioned as a defensive market in a potential sea of troubles. The bullish arguments are well-known and basically well-founded. The trade sector is prospering as our resources exports are gobbled up, at ever-higher prices, by our fast-industrialising Asian neighbours. Our rising terms of trade are keeping our massive foreign debt at bay while this continues and so our dollar is rising, keeping inflation a bit lower than it would be otherwise. Capital inflows are strong and our new Government has promised to be fiscally conservative. Unemployment is low and our housing market is not as exposed to the global credit calamity. The company sector is in relatively good shape. Nor

is our banking sector intrinsically vulnerable to the mortgage and derivatives crises that are afflicting the financial sector elsewhere, and it may be fundamentally oversold. At the same time the resources sector has overtaken the previously dominant financials in market weighting, and China and India, where the growth in resources exports is coming from, are hardly slowing at all. Whatever may happen in America and Europe matters a lot less now than it once did; a positive structural change, surely? Of course it is. The only snag is that this is now so thoroughly well known that it’s been long since discounted in market prices. The only possible surprise left on this score is the shock of discovering that Asia may itself not be immune from the erosion of confidence that America is now transmitting around the world. The great tidal cycle of economics may also be changing, and an island like Australia may not be quite so secure if the sea of troubles is now rising.  u

About the authors Patrick O’Leary has worked in the investment industry since 1969. A graduate in philosophy and economics, and then in animal behaviour, he entered stockbroking during the Poseidon mining boom and moved to London after its collapse. The next 20 years were spent in investment research and institutional broking in Australia and overseas. The last decade of his career was spent as head of economics and investment strategy with Charles Macek at County Investment Management in Melbourne.

Bear Markets • Eureka Report special issue 

Charles Macek is a non-executive director of Telstra and a director of Wesfarmers. He has a strong background in economics and has had a long association with the finance and investment industry. His former roles include 16 years as Founding Managing Director and Chief Investment Officer and subsequently Chairman of County Investment Management Ltd.

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Eureka Report special issue, June 2008  

F ASSET prices went forever smoothly upwards, all investors would be rich and never have to work. It would always be irrational to take prof...

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