Profiting from Bubbles: 'Grab Marshmallows'

What's an Investor to Do?

[But] as long as the music is playing, you've got to get up and dance.

--Former Citigroup CEO Chuck Prince

Perplexed by a stock market that (inexplicably?) is once again on the rise -- along with all manner of commodities (oil, gold, silver, etc.)?

That, despite at best conflicting economic signals (continuing weak employment numbers, constricted lending, soft housing, etc.).

You shouldn't be.

Behind the scenes, the Federal Reserve has signalled its ongoing commitment to print money as a way to stimulate the economy, via a mechanism euphemistically labelled "quantitative easing."

"Grabbing Marshmallows"

So how should investors play such an environment?

If you have the stomach, take Barry Ritholtz's advice (my paraphrase):

When the Fed adds even more gasoline to the conflagration, [investors] should grab some some marshmallows and sticks and head over to the boy scout jamboree campfire.

--Barry Ritholtz, "Do You Wanna Be Right, or Do You Wanna Make Money?"

Note to the intrepid: the trick is not waiting around for the embers.

Jeremy Grantham, Animal Spirits, and "Bubble Business"

"Don't Just Stand There -- Buy Something!"

Some people wait for a new episode of a favorite TV series (Seinfeld, The Sopranos).

Others for a new album from a favorite artist.

I look forward to Jeremy Grantham's latest quarterly newsletter. Seriously.

The man's honest, brilliantly insightful -- and a great writer, to boot:

Greenspan was lucky enough to inherit Volcker’s good work, and that gave him a base from which he could launch or blow a huge equity bubble; he also had the advantage that the country’s balance sheet was in excellent shape. Even Bernanke inherited a reasonably solid position from which to fund a second bailout. But a third time? It is hard to work out where the resources would come from to resuscitate the economy if a real shock were to be delivered by another collapse of a major asset class.

--Jeremy Grantham, "Playing With Fire"; GMO Q1 2010 Newsletter

Subscribing to the notion that the "bigger the bubble, the more damaging the bust," what is Grantham's antidote?

"We had better hope that something lucky turns up to break the speculative spirit."

Bubble Dynamics

Here We Go Again?

While early investors savor their gains and see their money multiply, those still on the sidelines must consign themselves to earning less than nothing on their savings.

At first, it's easy for prudent savers and investors to tune out the "siren call" of the hot market du jour, and "just say no."

But eventually, you feel like a chump sitting on the sidelines while everyone else is partying.

And if you're someone who actually needs to earn a return on your money -- like a retiree -- you really have no choice but to take more risk.

So, you hold your nose and join in.

Today's stock market?

Well, yes.

But it also describes the dynamics underlying the housing bubble, and the last stock market bubble in the '90's.

Who's ultimately responsible for creating a (promiscuously) easy money environment that creates such perverse incentives?

The Federal Reserve.

Who benefits? Banks and wanton risk-takers.

Who loses? Everyone else.

New Bubble, Same as the Old Bubble?

Be Careful What You Wish For

Recession-Plagued Nation Demands New Bubble to Invest In
--headline, The Onion (7/14/2008)

Like many readers, I'm delighted that my decimated (and much too modest) stock portfolio is showing signs of recovery.

On the other hand, I'm leery that the gains are for real.

As I see it, first came the 90's stock market bubble, fueled by Internet mania. Then came the housing bubble, engineered (or not) to counteract the effects of the punctured stock market bubble.

And now . . . exactly what?

The makings of another stock market bubble, to speed recovery from the housing bust?

I don't make stock market calls -- staying on top of the housing market is hard enough.

However, it's hard to escape the fact that better-than-expected corporate earnings -- supposedly the fuel behind the market's 40% pop since March -- are characterized by two things: 1) they're good only in comparison to previously lowered estimates; and 2) most companies are making money -- or losing less -- thanks to cost-cutting rather than top-line (revenue) growth.

To me, neither of those make for the underpinnings of a sustained, new bull market.

Or, maybe I'm just a spoilsport.