This a good post by someone else on a different forum:
"Subject: ASSET-BASED VS. INCOME-BASED WEALTH
Date: Tue, Jan 5, 1999 4:28 PM
From: <A HREF="aol://3548:LSkin4">LSkin4</A>
Message-id: <19990105162801.21430.00007063@ng-fp1.aol.com>
ASSET-BASED VS. INCOME-BASED WEALTH
America's recently discovered infatuation with the stock market has created a
new generation of wealth, based on the size of numerous stock portfolios, held
either directly or indirectly through retirement plans. We have recently
witnessed an extension of consumer spending and consumer confidence, based
solely on the public's PERCEPTION that its newfound wealth remains secure,
will increase indefinitely, and faces no threat in the foreseeable future.
There are numerous examples of perceived wealth, based on recently inflated
asset bases, which create an illusion of endless prosperity. The public's
widespread participation in the stock market in the 1920s and 1960s are two
examples. The inflation of agricultural assets (land), following the explosion
in wheat and soybean prices in the early 1970s, led to a boom-bust cycle for
American farmers. The inflation of oil-based assets, which permeated the
"oil patch" during the late 1970s, led to a widespread perception of
prosperity, followed by a bust that wiped out every major bank in the state of
Texas. Just as the stock market "prosperity" of the 1920s and 1960s faded when
the markets declined, the "Ag Bubble" prosperity of the early '70s went busted
when beans collapsed, and the oil-based prosperity collapsed with falling oil
prices, the current stock market "wealth effect" will evaporate with a
bear market. There is no doubt about this, even among bulls. The exact TIMING
of such an event remains the elusive, open-ended question which prompts debate
and recrimination among market participants.
THE KEY POINT IS THIS: ONCE A "BUBBLE" HAS BEEN IDENTIFIED, IT SHOULD BE
AVOIDED. Gold was identified as a bubble at $600 per ounce. It went straight
to $852 before it collapsed. That was 19 years ago. It's 290 today. Soybeans
in 1973 reached "bubble" status at $10 per bushel. It went to $13, and hasn't
seen those prices ever since. Everyone KNOWS what oil looked like at $28 -
"bubble" - but it went to $40 before it collapsed. At $40, "everyone"
forecast $100. Today, it's $12. The Japanese stock market was recognized as a
classic "bubble" in 1987 as it was passing through 28,000. It made almost
40,000 a year and a half later, with "everyone" looking for 50,000. Today,
eleven years later, it is flirting with 13,000. WHO CARES ABOUT PLAYING THE
LAST FEW INNINGS?
The British have traditionally measured "wealth" by the investment INCOME
generated, rather than by the valuation of assets. If economic activity is
accompanied by the generation of INCOME, it tends to be more sustainable. When
economic activity is accompanied by an inflation of asset values,
"sustainability" is ALWAYS hostage to the retention and expansion of that
asset valuation. In other words, the economy becomes much more vulnerable to
the
effects of asset value DE-flation. The current level of stock prices produces
virtually NO effective yield from dividends. Therefore, when the public's
perception of wealth, in a FALLING market, turns to INCOME support rather than
shrinking asset valuation, the market will fall a long way, in order to reach
some form of "income-based" floor. Where this level might be is anyone's
guess. It's the PSYCHOLOGY of a falling market, which few current
investors understand, that will dictate when and where it finally stops
declining. Downside psychology, once it gets started, is a spectacle to
behold.
Long term investors, as opposed to traders and speculators, ALWAYS rely on an
income floor to sustain them through the cyclical ups and downs in portfolio
values. They NEVER spend their principal. They spend only within the limits of
their investment INCOME. The huge influx of new investors during the 1990s has
come to expect that their asset values will ALWAYS rise, thus, they no longer
require an income floor to their portfolio. They leverage their
assets and spend their principal. The dividend yield on the major market
indices has evaporated to a meaningless number, in favor of a pervasive
conviction that rising prices will indefinitely offset that income deficiency.
In effect, the "Greater Fool Theory" of investing, where buyers merely buy
names without regard to financial analysis, in the firm belief that yet
another buyer will follow them to push prices higher, has captured the
imagination
of Wall Street and Main Street simultaneously.
I have seen this phenomenon on a much smaller scale, several times since 1960.
However, we used to experience periodic bear markets every three or four
years. These "episodes" served as "cleansing mechanisms" which flushed out
excesses BEFORE they became unwieldy and before dangerous "bubbles" in asset
valuation could develop. This time around, the "normal" purging mechanisms
have been short-circuited. Too much time has been spent on the upside and
this has captivated an entire generation of "new" market participants who lack
the experience to understand the dynamics of new found, asset-based wealth.
Consequently, the absolute degree of risk has escalated to unimaginable
levels. The classic signs of "bubble mentality" are clearly present. Some
might say, "Well, everyone already knows it's a bubble, but that doesn't
matter, because it hasn't mattered." So far, they have been correct. BUT, it
always does matter. "They" said the same thing about every bubble in recorded
history, from the modern "bubbles" in gold, soybeans, Japanese stocks, and
oil, to 17th century Dutch tulips and mid-1920s Florida swampland. Nothing
ever really changes. Harry Truman once said, "*the only thing new is the
history you don't know." He was right.
Those of us with a memory choose to pass "bubbles". If we were lucky, we
avoided earlier ones and benefited from the experience of others. OR, we
escaped with only minor bruises from our own brief experience with a previous
bubble. In either case, we are "penalized" by experience from participating in
the terminal phases of a bubble - that most exciting and spectacular phase
that captures the imagination of all the participants - the longs, the
shorts, and the spectators. Of course, today's "new era" guys might have it
right. The bubble could grow larger still. The Fed could blow even more air
into the thing before it pops. Many thought the Japanese bubble would pop in
1987. It had another two years of spectacular insanity before it finally
ended. But, nobody remembers the Japanese bubble heroes of 1988 and 1989. They
don't remember the oil patch heroes or the Arab sheiks who bought gold at
$500 - $800 per ounce. And, they won't remember today's AMZN heroes, or NAZ
momentum players. "Bubble Heroes" ALWAYS become merely ghosts from the past.
The only certainty is the fact that TIME always kills off a bubble. Most
people spend great amounts of intellectual and emotional energy trying to
figure out when, how, and why the thing will eventually pop. Even the bullish
participants KNOW in their guts that the thing will end, eventually. But, they
believe that they alone, will escape in time. Somehow, it never quite happens
the way "they" hope. The poor shorts are always intellectually correct
but usually much too eager, and they get carried out of the game feet first.
Does the bubble break today, next week, or next year? Take a guess, make a
choice, pay your price of admission, and sit back to watch the game. Watch or
play is a personal choice. The final OUTCOME of the game is certain.
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