By DAVID MOON, Moon Capital
March 25, 2001
On October 16, 1987, CNN’s Lou Dobbs and Dan Dorfman were discussing the horrible events on Wall Street that week. The Dow Jones industrial average declined 7 percent that day, and traders were worried. Dorfman tried to put fears at ease. In his almost unimitatable Elmer Fudd style, Dorfman turned to Dobbs and said, Woo, from here, I can tell you the market is going up, up, up.” The next trading day was October 19; the Dow declined another 23 percent.
How could a knowledgeable journalist and longtime market observer have been so wrong? Because of the misunderstanding about cause and effect.
Dorfman believed the stock market had its own karma and the Dow would bounce off bottoms and react to relationships between things like prices and moving average. In reality, the market was an excess in stock pries. Pries were higher than they should have been. A correction can be triggered by all sorts of irrational impetuses, and usually is. But the underlying cause isn’t the trigger – it is the excess that creates the conditions ripe for the correction.
Assume you are driving down Kingston Pike at 90 miles an hour, running red lights, tailgating and weaving in and out of traffic. You are careful to look through the intersections you are about to illegally cross, to make sure there is no cross-traffic. When you run red lights that have traffic, you dodge the cars that are legally proceeding through the intersection. That is, until you hear an old Barry Manilow song on the radio, which captures your attention. Distracted by “looks Like We Made It,” you wreck at the next intersection. Did Manilow or the radio station cause the accident? No, the accident was caused by an excess (your driving) which was logically guaranteed to eventually (an painfully) correct.
Who (or what) caused our current economic slowdown? It wasn’t President Bush talking down the economy. It wasn’t President Clinton ignoring the economy in his final months in office. It wasn’t Federal Reserve Chairman Alan Greenspan driving up interest rates throughout last year. It wasn’t the Justice Departments attacks on Microsoft. It wasn’t Wall Street. The root of all economic slowdowns is an economic excess. Inventories grew faster than consumption. Production outpaces sales. Prices exceed values. We have become somewhat oblivious to inventory excesses because computer-driven inventory control systems make it less likely for inventories to sell beyond an equilibrium level. Better transportation allows for more just-in-time inventory management. But these technological advances do not eliminate the business cycle – they only dampen it.
Less than a year ago, analysts forecast semiconductor demand would grow 30 or 40 percent this year, based on recent demand for chips. Manufacturers built the plants necessary to meet this demand, but the demand is not materializing. A recession in the semiconductor industry ensues. Greenspan could not have prevented it. People will not buy a new cell phone or computer every year, even if they once did. And if those industries are expecting that kind of consumer demand – and are building inventories to meet that demand – an imbalance eventually erupts.
The imbalance may sustain itself for some time, until some unrelated, probably illogical, trigger precipitates a correction – just like Barry Manilow.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).