Monday, April 9, 2007

Are We In Shangri-la or Sangui-la?

Last week’s market action was most telling. For here was a shortened week with a key economic report due out on a day when the markets were closed and just before earnings season begins – an earnings season that by all accounts could easily disappoint to the downside. Yet, despite all this, and despite the fact that the recent failure of predictions to get it even close to right (up or down - Goldman’s earnings, jobs report, for example), the markets still staged a solid performance.

Either the bulls have it right and we are in Shangri-la. Or the bears will be borne out and that we are in Sangui-la.

One thing is for sure: we aren’t in Kansas anymore.

Liquidity, leverage, the forces of the “Misalignment Triangle”, unregulated money, innovation (financial and technological) and Globalization have altered the traditional dynamics of the market. This helps explain, in part, why so many predictions are off the mark. For example, some experts remain stuck in the dogma of a domestic economy, failing to appreciate how the world has changed due to Globalization. Others insist that traditional monetary measures capture the level of liquidity. Yet, they ignore the factors of unregulated money. And so it goes.

All this should argue for greater caution among investors. But bubbles are not periods where caution is the modus operandi for many investors. The greater fool theory is. Buy high to sell higher. And, most definitely, buy the dips.

And who can criticize investors who adhere to such thinking? After all, since early 2003 what has worked better than this? In fact, this morning on CNBC there was a strategist who advocated exactly that – buy the dips. And that seems to be the mantra. It is certainly the mantra of the newly minted “masters of the universe”, a/k/a 20-something hedge funds managers.

What is forgotten and/or ignored is the fact that our world is a highly dynamic place. It is a multi-faceted Hydra whose behavior is erratic and most unpredictable. Yet, too many still believe the past, particularly the recent past, is the best tool to predict the future. And that certainty is the norm. Risk appetites have returned to pre mini correction levels. And credit spreads have barely budged off their historically low levels.

I believe, however, that some investors have been seduced by the elixir of liquidity and leverage and mistake high times for good times. Good times that are both predictable and sustainable. An other-worldly quality to it. Kind of like, well, Shangri-la.

Investment Strategy Implications

Shangri-la is a fictional place described in the 1933 novel "Lost Horizon". It is a book about a mystical, harmonious valley. An earthly paradise where all is good and life exists without consequences.

On the other hand,

Sangui-la is a place where certain investors reside. It is a place where they smoke their liquidity-drenched doobies, listen to Pink Floyd, and get comfortably numb. It is a place where some investors mistake higher prices due to liquidity and leverage with unrequited value.

And a place where some investors mistake for Shangri-la.

No comments: