Recognising bubbles
27 July 2001
Over the past two days, two reports were made in the local media relating to losses made by the Government of Singapore Investment Corporation (GIC) in technology-related investments.
Yesterday, The Straits Times reported that the GIC has cut its stake in poorly performing Portuguese telecom company Sonae.com. It took a loss estimated at about 3.42 million euros, or about S$5.41 million. The GIC sold 450,000 shares on 11 July, reducing its shareholding to 1.8 percent. The GIC had bought a 3 precent stake when shares of Sonae.com -- the parent company of Portugal's third biggest wireless operator -- was floated last June at 10 euros apiece.
Today, The Straits Times reported that the GIC has trimmed its stake in money-losing Satyam Infoway, India's second biggest Internet service provider, by 0.44 percentage point to 4.64 percent. The GIC had paid US$36 for each share in June last year. American Depository Receipts (ADRs) of Satyam Infoway were quoted at US$1.82 on Nasdaq on Wednesday. Each Satyam Infoway share represents four ADRs.
What is interesting about both cases is that the GIC appeared to have made the investments in June last year, soon after the high-tech bubble burst but before the correction had run anywhere near its full course. Whether or not the GIC had been caught in the earlier phase of the bubble is not clear from these reports, but it is quite obvious that it went back into the technology sector much too soon. The GIC seems to have failed to appreciate the extent of the overvaluation of high-tech stocks, the difficulty of making a profit in the Internet and telecom sectors, or both.
Of course, the problem with bubbles is that if they were so easy to recognise, they wouldn't be created in the first place. Intelligence does not render one immune to being caught in a bubble. No one seriously believes that the GIC investment officers are unintelligent. Rather, what is needed is an objective and sceptical mind. This must be coupled with moral courage to face the social pressures of being different from other investors.
The ability to strike an independent investment stance is possibly a somewhat more difficult task in the GIC, given its government pedigree. Government organisations are, after all, notorious for making decisions by committee. While the GIC is not exactly a government department, the same political consideration -- that is, avoidance of taxpayers' wrathh -- applies.
Bubbles usually arise insidiously. The initial premise for a bubble often seems reasonable. For example, in the case of the Internet bubble, the basic premise for the supposed profitability of dot.coms was that they could generate traffic to their sites, which in turn allows them to attract advertisement money. What is often neglected is consideration of the sustainability of the premise. There is enough advertisement money to support one Yahoo!, but by the time Yahoo!-wannabes started appearing all over cyberspace, the initial business model had become part of the Internet investment mindset and investors failed to re-evaluate its continued viability.
That same sort of mental fixation is occurring in another area: the US dollar. For some time now, many economists have warned that the strong US dollar is weighing down US exports while promoting imports, resulting in persistent current account deficits. In the International Monetary Fund's World Economic Outlook report in May 2001, it opined that a gradual depreciation of the US dollar is likely, but warned that an abrupt adjustment in the US dollar exchange rate remains a possibility. Such an adjustment could lead to substantial dislocations in the global economy and disruptions in US and world financial markets. It repeated this warning in its annual International Capital Markets report, released earlier this month.
The latest to voice concern over the strength of the US dollar and its effect on the US current account is former Federal Reserve chairman Paul Volcker. "The huge and growing external deficits are a real cause for concern," Volcker told a US Senate Banking subcommittee hearing on 25 July. "They are imbalances in the national economy and the world economy that cannot be sustained." Volcker called for "some strengthening of the euro and the yen relative to the dollar".
At the same hearing on the same day, former US Treasury secretary Robert Rubin voiced the same concern about the US current account deficit. Now chairman of Citigroup Inc's executive committee, Rubin said that a continued deficit might cause international investors to lose confidence in the dollar and US economy.
However, most analysts in the US remain remarkably sanguine about the current account deficit. In a commentary on 13 July for Bloomberg, Caroline Baum wrote that as far as current account deficits are concerned, "they are sustainable until they aren't". She added: "Folks have been wailing about the current account for a few years now, even as it doubled as a share of GDP." Baum writes mainly on the US economy, and might therefore not be sufficiently familiar with the characteristics of financial mania like the Internet bubble or the stock market bull run of the roaring 20s, both of which lasted a few years before crashing with disastrous results. Otherwise, she would undoubtedly be less inclined to dismiss a warning merely because the feared event has not transpired.
On 26 July, William Pesek Jr, also writing for Bloomberg, commented that the US needs foreign capital to finance the current account deficit, thus the need for a strong US dollar to maintain investor confidence. But this is circular reasoning. In the first place, if the dollar were weaker, the deficit would be smaller or non-existent, and there would be less or no need for foreign capital to finance it.
Irwin Kellner, writing for CBS MarketWatch on 24 July, was more balanced, mentioning the pros and cons of the strong US dollar. Nevertheless, he, too, ultimately believed in a strong US dollar, stating that "the pluses far outweigh the minuses" without explaining why, and implicitly downplaying the importance of the current account deficit without assessing its sustainability.
Perhaps, the real problem here is that all the above commentators just happen to be proud and patriotic Americans who root for the US dollar even when the fundamentals do not support it. The problem is, pride and patriotism are emotions. The presence of emotions leads to bias. They do not promote the "objective and sceptical mind" that is needed to avoid a bubble mentality. And a bubble is exactly what seems to be have formed in the US dollar.
Disclaimer: The commentaries posted here represent the opinions of the author at the time of posting and should not be taken as investment advice. Readers who wish to take any investment action based on information obtained from this site should seek appropriate advice from a qualified financial adviser.