In 2001, there was a fairly easy way to stoke my anger. All one needed to do was to contend in my presence that the economy would rebound toward the end of the year "when the Fed rate cuts kicked in."
OK, maybe anger is a pretty strong word. "Contempt" wasn't it, either, but perhaps that's closer. The chattering class on TV and in print seemed monolithic in the belief that an economic rebound would come soon because, well, that's just how the economy responds to a lower cost of funds.
Of course, this didn't happen. The same chattering class then contended that one of the reasons it did not was the surprise terrorist attacks on the U.S. in Sept. 2001. As much as one would be a complete fool to deny this had substantial impact on millions of Americans' outlook and economic condition, it also became its form of "big bath accounting." Sept. 11 became a convenient repository for excuses varying from missed revenue targets to job losses to the Los Angeles Clippers' losing record However, everyone knows that the Clippers lost because they quite simply stunk, and yet, many were willing to believe that the largest component of economic malaise was structural, not attitudinal.
Stoking an extinguished fire
Lower rates weren't enticing companies to spend, because the biggest way that the "efficiency gains" of the 1990s affected the economy was by helping corporations efficiently deploy more bad investment capital more quickly than in any point in the history of mankind. Think about it. Lucent (NYSE:LU), Corning (NYSE:GLW), and a host of others had shuttered factories in the preceding year; was a rate cut going to convince them that this was a good time to go out and build another one? Investors spent billions building out the infrastructures for Global Crossing (NASDAQ:GLBC) and Exodus, both of which were on their ways to bankruptcy. Exodus got bought out by Cable & Wireless (NYSE:CWP) basically in exchange for assuming expenses, and it was still way too high of a price. And yet a rate cut was going to spur investment. For what?
These companies weren't alone, nor was their industry -- though telecommunications may well have been the worst hit as a result of its being the worst overbuilder. But there the heads were, saying, "Nine months, nine months, nine months." As if steering an economy as complex as ours were just that simple.
We could dwell on just how wrong the pundits were, but why bother? It's now three years later, and once again the received knowledge on the state of the economy comes fast and furious. "No new bull market has ever started with valuations as high as this," and " the added jobs and rising demand show that the economy is definitively improving" are different sides of the same coin. Each is an example of received knowledge dumbed down to its lowest common denominator. Certainly, each has an element of truth to it, but both are such simplifications that they may even prove dangerous. Certainly, both can't be true. And yet, people invest on these sorts of truths all of the time.
It doesn't even have to be macroeconomic in scope. Remember how the Internet would change everything? Remember how people bought not only the garbage businessless dot-com companies, but also bid up Cisco (NASDAQ:CSCO) and Juniper (NASDAQ:JNPR) to absurd levels? This happened in no small part because the knowledge of a coming revolution convinced people that they could count on growth to the sky. It's nothing new. The same thing happened in the car industry, where 98% of all companies ever founded in the U.S. failed. It happened in railroads, it's happened with airlines. Air travel has in fact "changed everything," but that doesn't mean that the airline business was necessarily a good one, category breakers like Southwest Airlines (NYSE:LUV) notwithstanding.
Knowledge like this can even be company-specific. A few years ago, people could not be more excited about the drug pipelines at Merck (NYSE:MRK). These days most pundits believe that the same company's prospects are relatively weak, and its stock has been hammered hard. On what basis were most of the "strong pipeline" determinations made in the first place? Could it be that because some people who were in the know said, "strong" that the polity simply fell into place? Or was it a case of Merck's performance at the time being so strong that people simply couldn't imagine a shift downward?
Common knowledge is useless
Companies begin to perform well as investments at the exact moment when the community is most negative about them, which is precisely why the things that are generally believed to be true are (generally speaking) not of much help if you're trying to beat the market. And this is the case even if they are true.
For example, there is a general belief that the Federal Reserve will not raise interest rates until after the presidential election this fall, regardless of any signs that there is speculative excess in any number of sectors. As such, people ask the question what they'll need to do after November to retrench themselves for a dropping stock market, since "rising interest rates equal a diminished demand for equities." Which is, at its core, a true statement, but it doesn't take the infinite complexity of millions of individual decisions and expectations into account. Nor does it take into account the simple fact that the national economy holds truck for no man. Should it (or the market) elect to fall precipitously earlier than November, there's not much that the folks in charge can do about it. Not just these folks, but any folks. A slavish devotion to the general expectation in this case may be extremely expensive, or it may not be. But the core belief that the Fed can control either is simply erroneous.
What other pieces of general knowledge are out there? What are the general beliefs on outsourcing, for example? Or on whether or not China is the biggest opportunity for investors? Or whether or not the housing market is in a bubble? You know the generally accepted answers, respectively: bad, yes, and not at all (or absolutely).
Obviously, it doesn't make any sense to ignore such things. If you're considering buying a homebuilder like NVR (NYSE:NVR) because it's "cheap" at nine times earnings, it would behoove you to try to determine how the current homebuilding market compares to what it has been historically. But beware the pat answer. That which has happened in the past may not have much relevance for the future. Nor, actually does "nine times earnings equals 'cheap,'" because as we've seen, even with this particular company, earnings only matter if they are retained or deployed to the benefit of the shareholder.
The answer here is simple: View the "obvious truth" with skepticism, particularly when it comes to putting your money on the line. China may grow to the sky, but it doesn't mean that -- just like investors in the Internet, railroads, canals, broadcasting, and a host of other things -- people can't lose their shirts.
Fool on!
Bill Mann, TMFOtter on the Fool Discussion Boards
Is it just me, or is the NBA, even in the playoffs, completely unwatchable? Bill Mann owns none of the stocks mentioned in this story. Ready to dig deeper? Consider a free trial to Mathew Emmert's Motley Fool Income Investor. The Motley Fool is investors writing for investors.
