Rogue Missives - Thursday, December 12, 1996

Rogue Missives

ROGUE ARCHIVES

Thursday, December 12, 1996

Meltdown or Meander?
The current cover story in NEWSWEEK magazine carries the tag line: "How to Invest. How Not to Panic." The story deals with the advent of 401(K) policies, and the way in which a flood of novice investors into the stock changes the market. Of course, putting the word "panic" on the cover may not be the best recipe for helping people stay calm. It's a little bit too easy, if you're unsure of yourself, to read "Don't panic!" as just another way of saying "Panic now!"

The financial press tends not to use the word "panic," preferring instead "anxiety" or "concern." But the coverage of the stock market over the past two days has been, once again, exemplary in its use of histrionic language and lack of historical context and its willingness to see chaos lurking around every corner. And investors themselves have not been overly impressive, seizing on fragmentary rumors and whispers as reasons to sell.

Reuters, for example, talked of blue-chips taking a "steep dive" and portrayed them as "shaken by a sell-off in bonds." (It's not clear whether this means that the stocks themselves were emotionally upset, though I suppose you never know.) Bonds, meanwhile, were described as suffering a "meltdown" in the morning, while the dollar "dropped sharply."

Now, to be sure, the reporters responsible for this language would undoubtedly insist that they were just being objective, reporting events as they occurred. But every act of inclusion is also an act of exclusion. Every frame you place around a story---the only way a story can be told---ensures that some information gets counted as important while other information is discarded as irrelevant. And the use of words like "meltdown" and "sharply" embeds the day's events in a larger narrative of a jumpy and unpredictable market on the verge of a potential crash. It makes, after all, for a better story that way.

As David Gardner argued in THE FOOL's Portfolio Report yesterday, a 1% decline in the value of the market---which was what yesterday's drop amounted to---is both historically common and mathematically insignificant. In almost any other context it would be regarded as practically unnoticeable. But so much attention is levied on the market everyday---and especially of late---that the potentially irrelevant ends up instead freighted with meaning.

In a sense, though, the anxiety that the press is finding is not entirely of its own creation, even if there is no way to disentangle the reporting of a mood from the perpetuation of that mood. Investors do seem particularly focused on the short-term, particularly uninterested in the fundamentals, either of the economy as a whole or of the market as it currently stands. And this climate lends itself, necessarily, to rumors, since they feed on uncertainty. It also lends itself, one suspects, to a kind of frenzied buying, as with Intel over the last couple of days. (Though that isn't to say that Intel is overpriced.)

The most interesting thing about these two days, though, has been the degree to which the stock market's behavior has illustrated the degree to which there really is only one global market for capital, a market of which bonds, currencies, mortgages, and equities are all part. What it hasn't illustrated, though, is the way in which the relationship between the different parts of that global market are meant to work.

The drop in equity prices was spurred by the drop in bond prices, which in turn was sparked by an article in THE WALL STREET JOURNAL that suggested that the Japanese appetite for U.S. debt might be diminishing, which would mean that they would be buying fewer bonds in the future than they have in the past. The article quoted Goldman Sachs vice chair Robert Hormats to the effect that the Japanese would begin slowing their purchases of bonds, and that this was "the Achilles' heel" of the bond and equity markets.

Foreign investors purchased a remarkable three-quarters of U.S. government securities issued in the past year, and Japanese purchases of these securities in October were especially large. The JOURNAL depicted these purchases as part of a concerted campaign to devalue the yen, and quoted a Finance Ministry official as saying that the need for further devaluation had disappeared.

Yet most analysts seem skeptical that any major change in Japanese behavior is in the offing. Today, Secretary of the Treasury Robert Rubin told a class at the Kennedy School that he had no doubts about the market for U.S. debt as long as the yield on U.S. bonds continued to offer value to investors. And economist Julian Jessop of Nikko Europe told Reuters, "The long-term trend is that Japanese investors will continue to build up their holdings overseas because they need the return. The return on JGBs (Japanese government bonds) is under 2.5 percent and that's not enough."

However orchestrated the campaign to buy U.S. bonds has been, after all, Japanese investors have profited handsomely. The return on JGBs is just 40% of the return on U.S. bonds, making it unlikely that Japanese investors will stay at home. And the relative strength of the U.S. economy next to Europe makes it a more hospitable home for investors in general.

Still, what remains intriguing about all this is the degree to which potential fluctuations in the purchase of U.S. government debt by foreign investors affects the U.S. stock market. It does so, after all, in not always intuitive ways. The dollar, for instance, weakened yesterday as a result of the speculation about Japan and as a result of data showing that the U.S. trade deficit with Japan rose by a third in October. But while a weaker dollar might have been expected to help U.S. companies, particularly those that do a great deal of export business, the market reacted by selling blue-chips. Meanwhile, the dollar's rebound today apparently left no impression on investors, who spent the afternoon selling off all the morning's gains.

All the economic data issued this morning---about inflation, unemployment, and growth---was good, and all the signs are that no interest-rate hike is in the offing, not even to lure more Japanese investors to these shores. But the market, which initially seemed to react positively, ended up either indifferent or unconvinced by the news. Preferring instead to worry about what Alan Greenspan said last Friday or what the Japanese were going to do months from now, institutional investors in particular spent the day yanking the market up and down.

It is one market, to be sure, but everyone inside it has very different ideas about what changes in one part of the market mean for everyone else. And companies have themselves become so integrated into the currency market that there's really no way to isolate them from the vagaries of foreign exchange, no way really to say what it means for anyone---except, perhaps, for Ford and Caterpillar---when the yen strengthens or the real drops. Rumors and speculation move the market in the short term because they're a way of imagining order in a system that is, on a day-to-day basis, necessarily chaotic. There was no meltdown yesterday, no change of historic proportions. In the context of history, it wasn't even a blip.
-- Jim Surowiecki (Surowiecki)

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ROGUE ARCHIVES

Thursday, December 12, 1996
Meltdown or Meander? The current cover story in NEWSWEEK magazine carries the tag line: "How to Invest. How Not to Panic." The story deals with the advent of 401(K) policies, and the way in which a flood of novice investors into the stock changes the market. Of course, putting the word "panic" on the cover may not be the best recipe for helping people stay calm. It's a little bit too easy, if you're unsure of yourself, to read "Don't panic!" as just another way of saying "Panic now!" The financial press tends not to use the word "panic," preferring instead "anxiety" or "concern." But the coverage of the stock market over the past two days has been, once again, exemplary in its use of histrionic language and lack of historical context and its willingness to see chaos lurking around every corner. And investors themselves have not been overly impressive, seizing on fragmentary rumors and whispers as reasons to sell. Reuters, for example, talked of blue-chips taking a "steep dive" and portrayed them as "shaken by a sell-off in bonds." (It's not clear whether this means that the stocks themselves were emotionally upset, though I suppose you never know.) Bonds, meanwhile, were described as suffering a "meltdown" in the morning, while the dollar "dropped sharply." Now, to be sure, the reporters responsible for this language would undoubtedly insist that they were just being objective, reporting events as they occurred. But every act of inclusion is also an act of exclusion. Every frame you place around a story---the only way a story can be told---ensures that some information gets counted as important while other information is discarded as irrelevant. And the use of words like "meltdown" and "sharply" embeds the day's events in a larger narrative of a jumpy and unpredictable market on the verge of a potential crash. It makes, after all, for a better story that way. As David Gardner argued in THE FOOL's Portfolio Report yesterday, a 1% decline in the value of the market---which was what yesterday's drop amounted to---is both historically common and mathematically insignificant. In almost any other context it would be regarded as practically unnoticeable. But so much attention is levied on the market everyday---and especially of late---that the potentially irrelevant ends up instead freighted with meaning. In a sense, though, the anxiety that the press is finding is not entirely of its own creation, even if there is no way to disentangle the reporting of a mood from the perpetuation of that mood. Investors do seem particularly focused on the short-term, particularly uninterested in the fundamentals, either of the economy as a whole or of the market as it currently stands. And this climate lends itself, necessarily, to rumors, since they feed on uncertainty. It also lends itself, one suspects, to a kind of frenzied buying, as with Intel over the last couple of days. (Though that isn't to say that Intel is overpriced.) The most interesting thing about these two days, though, has been the degree to which the stock market's behavior has illustrated the degree to which there really is only one global market for capital, a market of which bonds, currencies, mortgages, and equities are all part. What it hasn't illustrated, though, is the way in which the relationship between the different parts of that global market are meant to work. The drop in equity prices was spurred by the drop in bond prices, which in turn was sparked by an article in THE WALL STREET JOURNAL that suggested that the Japanese appetite for U.S. debt might be diminishing, which would mean that they would be buying fewer bonds in the future than they have in the past. The article quoted Goldman Sachs vice chair Robert Hormats to the effect that the Japanese would begin slowing their purchases of bonds, and that this was "the Achilles' heel" of the bond and equity markets. Foreign investors purchased a remarkable three-quarters of U.S. government securities issued in the past year, and Japanese purchases of these securities in October were especially large. The JOURNAL depicted these purchases as part of a concerted campaign to devalue the yen, and quoted a Finance Ministry official as saying that the need for further devaluation had disappeared. Yet most analysts seem skeptical that any major change in Japanese behavior is in the offing. Today, Secretary of the Treasury Robert Rubin told a class at the Kennedy School that he had no doubts about the market for U.S. debt as long as the yield on U.S. bonds continued to offer value to investors. And economist Julian Jessop of Nikko Europe told Reuters, "The long-term trend is that Japanese investors will continue to build up their holdings overseas because they need the return. The return on JGBs (Japanese government bonds) is under 2.5 percent and that's not enough." However orchestrated the campaign to buy U.S. bonds has been, after all, Japanese investors have profited handsomely. The return on JGBs is just 40% of the return on U.S. bonds, making it unlikely that Japanese investors will stay at home. And the relative strength of the U.S. economy next to Europe makes it a more hospitable home for investors in general. Still, what remains intriguing about all this is the degree to which potential fluctuations in the purchase of U.S. government debt by foreign investors affects the U.S. stock market. It does so, after all, in not always intuitive ways. The dollar, for instance, weakened yesterday as a result of the speculation about Japan and as a result of data showing that the U.S. trade deficit with Japan rose by a third in October. But while a weaker dollar might have been expected to help U.S. companies, particularly those that do a great deal of export business, the market reacted by selling blue-chips. Meanwhile, the dollar's rebound today apparently left no impression on investors, who spent the afternoon selling off all the morning's gains. All the economic data issued this morning---about inflation, unemployment, and growth---was good, and all the signs are that no interest-rate hike is in the offing, not even to lure more Japanese investors to these shores. But the market, which initially seemed to react positively, ended up either indifferent or unconvinced by the news. Preferring instead to worry about what Alan Greenspan said last Friday or what the Japanese were going to do months from now, institutional investors in particular spent the day yanking the market up and down. It is one market, to be sure, but everyone inside it has very different ideas about what changes in one part of the market mean for everyone else. And companies have themselves become so integrated into the currency market that there's really no way to isolate them from the vagaries of foreign exchange, no way really to say what it means for anyone---except, perhaps, for Ford and Caterpillar---when the yen strengthens or the real drops. Rumors and speculation move the market in the short term because they're a way of imagining order in a system that is, on a day-to-day basis, necessarily chaotic. There was no meltdown yesterday, no change of historic proportions. In the context of history, it wasn't even a blip. -- Jim Surowiecki (Surowiecki)