Tags: wall street | kool aid | investors | bubble

Beware of Drinking Wall Street's Kool-Aid

By    |   Friday, 17 April 2015 10:07 AM EDT

Most Wall Street strategists estimate the stock market will have a sixth year of gains since bottoming in 2009 as the U.S. economy continues to grow, interest rates remain low globally, oil prices stabilize after plunging since last summer and more people find steady jobs.

With volatility indicating a high degree of investor complacency, I’m very concerned that people aren’t well prepared for the possible consequences of the easy money policies of central banks throughout the world.

To paraphrase a cliché, investors need to make sure they’re not mindlessly drinking the Kool-Aid that over-optimistic Wall Street strategists are handing out.

The phrase “drinking the Kool-Aid” is a morbid reference to the mass suicide by followers of Jim Jones. On his orders, more than 900 members of his Peoples Temple killed themselves in November 1978 by drinking flavored water laced with cyanide.

Obviously, investors don’t face the same lethal perils of docile groupthink but that doesn’t mean they are immune from market declines that destroy years of hard-earned savings and accumulated wealth.

The collapse of two major asset bubbles in the past 15 years hasn’t taught the world’s central banks to act with greater caution in their efforts to stimulate the global economy with easier credit.

When I was an equity research editor at investment bank Lehman Brothers in the past decade, our economists marveled at the strength in consumer spending as households took advantage of historically low interest rates to refinance mortgages or pull equity from their homes.

As early as 2002, we asked how long the refi boom would last, but no one suggested that a housing bubble was forming with major destructive consequences.

Lehman Brothers even bought a mortgage lender, Aurora Loan Services, to help feed the mortgage securitization pipeline for investors who were hungry for yields from borrowers with impaired credit ratings.

As home prices continued to surge and the news abounded with stories of home flipping in Florida, Nevada and California, a few prescient market observers began to warn about the property bubble. I read a book titled “Sell Now!: The End of the Housing Bubble” by former banker John R. Talbott and began to get worried about the trends.

I asked traders and analysts about the possibility of a collapse in home prices, and was met with the same answer: “People always make their mortgage payment before anything else. Home prices never decline.” Former Federal Reserve Chairman Ben S. Bernanke made similar public remarks.

The Kool-Aid was raining down in a torrent, flooding the alleyways and gutters of New York’s financial district.

Another analyst told me he planned to take equity out of his Manhattan apartment and put the proceeds into stocks. I never did follow up with him to see how that turned out. I was cut from Lehman as it pared back research staff – six months before the company collapsed in the biggest bankruptcy of all time.

The fourth-largest investment bank buckled under the weight of its rapidly depreciating mortgage portfolio. The flavored water was laced, after all.  

Overnight, the Lehman stock I had been granted as part of my salary was worthless. “Deferred compensation” took on a whole new meaning for more than 25,000 employees.

At least my last severance check cleared before the bankruptcy filling. Lehman was generous with its severance package, unlike most companies.

Since then, I have been especially attuned to the warnings about growing assets bubbles and wary of euphoric sentiment extolling “this time is different.”

I’ve lived through two significant market declines that destroyed my retirement savings and weakened my employers. (Actually, I remember the 1987 market crash, but I was still in college loading up on student debt.)

These days, I see warnings about bubbles in the energy industry after the collapse of oil prices begins to imperil smaller drillers that loaded up on junk debt to finance hydraulic fracturing operations. About bubbles in technology and biotech industries as profitless start-ups command outsized valuations.

And of course, the bond bubble that will never collapse as long as central banks keep buying government debt or investors seek the tiniest slivers of yield. But central banks aren’t infallible, as they’ve demonstrated repeatedly.

Investors need to question their assumptions persistently and be unafraid to decline the Kool-Aid regardless of how much Wall Street has enhanced its flavor with artificial sweeteners.

As we’ve seen in the past 15 years, caution pays a nice dividend.

About the Author: Rob Williams

Rob Williams is deputy finance editor of Newsmax Finance. He has been a business journalist for more than 20 years, including experience in Budapest and Mexico City. He worked as an editor of equity research at Lehman Brothers Holdings Inc. for eight years.

Follow him on Twitter: @robwilliamsNY

© 2024 Newsmax Finance. All rights reserved.

Investors need to question their assumptions persistently and be unafraid to decline the Kool-Aid regardless of how much Wall Street has enhanced its flavor with artificial sweeteners.
wall street, kool aid, investors, bubble
Friday, 17 April 2015 10:07 AM
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