Buy After the Bubble Bursts.
Most economists will tell you that markets are always ‘efficient’. This means that current prices perfectly reflect all the information out there. It also means that unless you have some special knowledge that no one else is party to, you can’t beat them.
However, in the real world, that’s not how things work. While markets generally work well – or at least, better than any other system for allocating resources – they are sometimes prone to the same flaws and foibles as the humans who run them.
Like any large group, they can believe things that are irrational – or just plain crazy. In recent years, increasing numbers of academics have acknowledged this, and the field of behavioural finance has sprung up. One of its concerns is to look at how we can work out when the market is going mad.
One such expert is Peter Atwater. In his book, Moods and Markets, he looks at how investors can identify when stocks have hit a peak or a trough. It’s well worth reading. It’s also striking just how closely the Greek stock market fits into his model.
At the bottom, it’s the exact opposite. Investors have no idea what will happen next – they are completely incapable of tolerating uncertainty. Indeed, they assume that the worst will always happen. They also become fixated on the short-term, willing to sacrifice any future gains in order to salvage whatever they can.
This attitude doesn’t just apply to investors. It also impacts on how firms run their businesses. During a boom, companies are happy to tolerate complexity and chaos. After all, why bother about the little details when you’re about to make a fortune?
In contrast, during a bust, firms prefer to hoard their cash and keep things simple. This means mothballing projects, changing deals and selling assets. During this phase any source of revenue and cash is pursued. Essentially, they start counting the pennies.
Take the Internet bubble. By 1999, venture capitalists were chucking cash at anyone with a pulse and a plan for a ‘dotcom’ scribbled on the back of a fag packet. As Atwater’s model predicts, people had started to think in a different way.
Analysts started talking about how earnings and cash flow were so “old economy”, and instead talked about “eyeballs” and other “new economy” measures.
However, when the dotcom boom ended the market quickly went to the opposite extreme. Not only did the crash clear out the weak firms, people started ignoring future growth entirely.
This nearly put companies with sensible models out of business. Indeed, you could have picked up firms like Amazon for a fraction of what they are worth now.
As with the tech boom, it relied on some wildly optimistic thinking. The idea was that joining the single currency would lower the risk of investing in Greece. This would boost productivity and enable it to catch up with the other eurozone members.
Downside risks were brushed aside. Investors assumed that if the Greek economy got into trouble, the European Union would bail it out. For its part, Brussels thought that Greece would never need any help. All parties turned a blind eye to the fact that entering a fixed currency meant that it could no longer use its time-honoured technique of devaluation as a way of getting out of economic trouble.
Just as the tech bubble saw the heavy usage of some dodgy accounting tricks, Greece fudged its public accounts to meet the euro entry criteria. Taking the advice of Goldman Sachs, they took part in a complex deal designed to hide the true level of national debt.
For the first few years, things seemed to go according to plan.
Irrationally exuberant investors quickly ensured that interest rates converged with the northern European countries. At one point, Greece was being charged an average of just 0.5% more than Germany to borrow money. This led to a credit boom, funded by European banks, which saw Greek GDP grow by 3.8% each year between 2002 and 2007.
Over the same period, the Athens stock market index doubled in price from 2,627, at the start of 2002, to a peak of 5,310 at the end of October 2007. At the same time, the cost of insurance on Greek ten-year debt was less than 20 basis points (bps). This meant that the markets saw a 0.2% chance of default.
The financial crisis cut off the supply of easy credit. Unable to borrow, both the Greek public and the state were forced to cut back. Investors began to realise that the Greek government could not repay its debts, and bond yields soared. Eventually, Athens defaulted in all but name, with creditors having to accept large haircuts.
Without an independent central bank, the recession turned into a bitter depression, which is still enduring. Unemployment is now 24%, while experts think the peak to trough fall in GDP may end up being as big as 30%.
It’s little wonder the stock market fell by more than 90% from its 2007 peak to a low of 476 in June this year.
At the same time, wealthy Greeks are still putting huge amounts into overseas assets. Indeed, estate agents Savills claim that the number of Greeks searching on the internet for London property has gone up by 50% over the past six months.
As we’ve argued before, London property is expensive and poor value. By choosing overpriced houses, rather than shares or any riskier assets, Greek investors (and others in troubled areas around the world) are showing that they are willing to pay any price for security. As mentioned at the start, this is a classic sign of a market bottom.
Greek shares have already rebounded a fair bit since the euro crisis started to ease. But I suspect the rebound has legs. I’m not saying you should bet your life savings on it, but I think some exposure to the Greek stock market could be very profitable
Matthew Partridge
Contributing Editor, Money Morning
Publisher’s Note: This article originally appeared in MoneyWeek
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