THE GLOOM, BOOM & DOOM REPORT

ISSN 1017-1371 A PUBLICATION OF MARC FABER LIMITED FEBRUARY 5, 2007

Perpetual Debt Super-cycle, or Apocalypse Now?

INTRODUCTION overbullish market conditions current bull market, which began in

My attention was caught recently by
some comments made by John
Hussman, along with the figure below
(www.hussmanfunds.com), which
displays a monthly chart of the S&P
Index going back to 1994 with a set
of “Bollinger bands” that form an
envelope around the 20-month
moving average. In his December 18,
2006 weekly market comment,
Hussman noted that “over the last 10
weeks or so, the market has reflected
overvalued, overbought, and
overbullish conditions (a
combination that has historically
been associated with market returns
below Treasury bill yields, on average
— though not in every instance)”.
Commenting on Figure 1, he admits
that Bollinger bands don’t provide
very useful buy or sell signals.
However, he thinks that there is an
“important regularity that shouldn’t
be missed”.
[emphasis added].
As can be seen from Figure 1,
each time the stock market advance
matured, which began in 1994, the
20-month moving average was
touched. This occurred in 1998 and
again in 1999 before the market’s top
in March 2000. Also, since 2005, the
moving average was touched three
times (in April and October 2005,
and in June 2006). Now, consider
three points. The current bull market
is one of the longest on record and
the second longest on record without
a 10% correction. As Steve Leuthold
(www.leutholdgroup.com) shows, the
Figure 1 S&P 500, 1994–2006 with Bollinger Bands
October 2002, has already exceeded
the post-World War II norm by 12
months (see Figure 2). Moreover, the
current bull market’s magnitude
matches the post-World War II
median (see Figure 3). So, both
magnitude and length would support
Hussman’s contention that the
advance is rather mature. (The
economic recovery that began in
November 2001 — now more than
five years old — would also seem to
be rather mature by historical
standards.) Finally, the S&P 500
hasn’t experienced a 2% correction
since July 13, 2006, when the latest
rally got under way. According to Jim

Once the market has enjoyed a

mature advance (not just an initial
rally from a low, but an extended
advance that has continued for
some time, even if it turns out to
have further to go), a move to the
upper Bollinger band is almost
invariably followed at a later date
by a consolidation or a decline to
a lower level… Stated simply, it’s
never a good idea to buy the upper
band in a mature market advance
(which is where we are now). The
market seldom “runs away” for
long, and you generally have a
better entry opportunity later.
That tendency is behind the
relative poor short-term market
returns that emerge, on average,
from the combination of Source: www.hussmanfunds.com
overvalued, overbought, and
 Bianco, this is the second-longest
rallying period without a 2%
correction since 1964; only in 1995
did we have a longer rally without a
2% correction. However, it should be
noted that the 1995 rally came from a
rather depressed level (the S&P 500
touched the lower envelope of the
Bollinger band, whereas the current
advance since July 13, 2006
originated from the 20-month
moving average and not from the
lower envelope of the Bollinger band
— see Figure 1).
In a more recent market comment
(December 26, 2006), John Hussman
elaborated on the “overbullish”
condition of the market. According
to him, the quarterly poll of money
managers by the Russell Investment
Group, which was published in
December, showed “a fairly stunning
86% of advisors bullish for the
coming year”. About 13% of money
managers polled expected a flat
market or a decline of less than 10%,
and just 1% expected a decline of
more than 10%. Hussman wrote:
…in the latest poll of 80 analysts
by Business Week, 89% of the
analysts are bullish (18% of which
expect positive returns but below
the prevailing T-bill yield), 8%
are slightly bearish — expecting a
decline of less than 10%, and just
Figure 2 Already an Extended Bull Market: Duration
Source: Steve Leuthold, www.leutholdgroup.com
2 The Gloom, Boom & Doom Report
3 of the analysts expect a decline
of 10% or greater. Evidently,
there’s not a lot of “buying
power” available from converting
that tiny pool of remaining bears,
but there’s a lot of room
available in the bearish column
in order to populate a more
typical divergence of opinion.
The last time we saw this much
bullishness was at the start of
2001, which preceded an awful
2-year period for stocks [emphasis
added].
The prevailing extremely positive
sentiment for equities is also evident
from the polling of clients at the
Global Insight Day, held by Morgan
Stanley in Europe in early January.
Gerard Minack, the Morgan Stanley
economist based in Sydney, noted
that “one of the concerns I have for
financial markets this year is simply
that the consensus seems so solidly
positioned for a Goldilocks world”.
Figure 4 shows the preferred assets for
2007; not surprisingly, equities were
the overwhelming favourite. (Note
the low reading for bonds.)
In mid-November 2006, I met
with Robert Prechter (Elliott Wave
Financial Forecast) in New Orleans.
He told me that his sentiment
readings were then, from a contrarian
point of view, more bearish than just
Figure 3 Already an Extended Bull Market: Magnitude
Source: Steve Leuthold, www.leutholdgroup.com
before the crash in 1987. A chart
showing the 60-day moving average
of bears, as reported by the Daily
Sentiment Index Survey, revealed
just 12% bears; whereas readings for
this gauge, going back to before the
1987 crash, showed that such a low
reading was unprecedented. Figures
near 20% bears were the most
extreme ever recorded. Therefore, his
view was that, from a contrarian
interpretation, a very serious
correction or crash should be
expected.
Well, since then, the stock
market has continued to rally and
may continue to do so for a while
longer. But, combining the mature
advance of the bull market both in
terms of duration and magnitude (see
Figures 2 and 3), the present
overbought condition of the market
(indicated by the S&P touching the
upper envelope of the Bollinger
band), investors’ extremely bullish
sentiment, and the recent heavy
insider selling, it would seem to me
that a more favourable entry point
than we have currently will shortly
present itself. Since the upper
envelope of the Bollinger band now
stands at 1435, and the moving
average (the middle line, which is
periodically touched) at 1327 (while
the lower band is at just 1207), a
more meaningful correction of at
February 2007
 least 5–10% could get under way at
Figure 4 Best Asset Class for 2007 any time. The bigger issue in my
mind, however, is whether the
coming correction should be bought
aggressively (which is what investors
should have done last June/July) or
whether it will be the harbinger of
worse to come.

THE BULLISH CASE

In my opinion, the most compelling

case for asset markets to continue to
do well (corrections aside) is laid out
by the Bank Credit Analyst (BCA) in
Source: Gerard Minack, Morgan Stanley its special year-end issue entitled
“OUTLOOK 2007 — Another Year
of Riding the Liquidity Wave”
(www.BCAresearch.com). In this
issue, the editors of the BCA focus on
“global excess liquidity” and the
Figure 5 Relative Profit Margins: S&P 500 Sectors, 1995–2006 “debt supercycle”, arguing that there
is “no sign that we have reached the
limits of domestic indebtedness in the
U.S., or by extension, other
economies” (see also below).
The weakest case for the US stock
market to continue to do well rests
on the belief that record profit
margins are here to stay, that
valuations are low, and that the US is
a knowledge-based economy. As I
pointed out in last month’s report
(see GBD report of January 3, 2007,
entitled “Irreparable Cracks in the
Financial System”), the energy and
financial sectors provided 50% of the
recent profit growth and, because of
their low P/Es, these sectors pulled
Source: Ed Yardeni, www.yardeni.com down the S&P 500 Index P/E more
than is usually perceived. I may add
that profit margins in the materials
and energy sectors have increased
since 2002 by far more than the S&P
500 Industrial Composite’s profit
Figure 6 Corporate Profits and Wages, 1990–2007 margins (see Figure 5). Obviously,
these two sectors have little to do
with a knowledge-based economy or
US Corp. Profits the outsourcing of production and
services. That aside, countries such as
Finland, Sweden, Denmark,
Germany, France, Switzerland, Japan,
Singapore, and so on, are just as
Wages as Share of US
much knowledge-based economies as
Corp. Revenues is the US (if not more). Moreover, as
I have discussed in the past, one of
the reasons US corporate profits have
Source: Bridgewater Associates soared is that wages as a share of
corporate revenues have declined

February 2007 The Gloom, Boom & Doom Report 3

 sharply since 2001 (see Figure 6)
along with interest rates — thus
reducing the cost of capital.
Concerning the current corporate
earnings boom and record profit
margins, I should like to introduce a
heretic thought! Security analysis
courses will emphasise the careful
analysis of corporations and
industries with the view that rising
corporate profits will drive
companies’ shares higher. But very
little analysis has gone into the
impact of rising stock and other asset
markets on corporate profits. In an
increasingly “financial economy”
driven by the debt super-cycle, I
suppose that “excess liquidity”
leading to rising stock prices is similar
to an aphrodisiac and turbo-charged
profits. In any event, it will be
interesting to see how corporate
profits behave once asset markets
decline. If recent weakness in the
housing market is any guidance, the
S&P 500 record profit margins could
shrink much faster than the bullish
camp expects!
But, as indicated above, there are
grounds for being positive if one
believes that the “debt super-cycle”
will continue to expand. However,
there are numerous issues to consider
Figure 7 The Diminishing Impact of Debt Growth on the Economy, 1966–2015
Source: Barry B. Bannister, Stifel Nocolaus
4 The Gloom, Boom & Doom Report
when discussing the “debt super-
cycle”. The first and most obvious
one is at what point the limits of
indebtedness are reached. They were
certainly not reached at 200% of US
GDP and may still be manageable at
330% of GDP. But who knows
whether these limits will be reached
at 350% — or 1000% — of GDP?
One point needs to be clear. Just
as copper prices were hitting all-time
highs in April 2006, GaveKal
Research, which then called for a
drop in copper prices, made a valid
point: the higher an asset market
moves, the more money is required to
sustain its advance. In other words, if
a debt super-cycle drives asset
markets and the economy, credit
must expand at an accelerating rate
(see also under “The Bearish Case”,
below). Barry Bannister, an analyst
and historian at Stifel Nicolaus, who
has been right on the mark with his
recent positive call on grain prices
(bbbannister@stifel.com), published
in early 2003 a report entitled “Zero
Hour 2015: Diminishing Returns
from New Debt, and the Inevitability
of a U.S. Inflation Cycle” in which
he produced a figure showing the
diminishing returns from each $1 of
new debt in the US economy (see
Figure 7). At the time, Barry noted
that “incremental debt is steadily
losing its ability to generate new
GDP, and reaches zero in the year
2015”, and that the inevitability of
higher inflation rates would benefit
hard asset companies and companies
serving the commodity industries
such as machinery, engineering firms,
and oil servicing companies. I might
add that just because the trend-line
points to 2015 as the “zero hour”,
that hour could approach much
sooner (see also “The Bearish Case”).
A second issue that is important
to understand is that, whereas the
debt super-cycle is highly conducive
to asset bubbles, there is a
continuous rotation of assets that
are inflating and those that are
deflating. Easy money and
continuous debt growth didn’t
prevent the Florida land boom of the
1920s collapsing in 1926. Nor could
the Fed’s ultra-expansionary
monetary policies, which have led to
extremely rapid credit growth over
the last six years, prevent the high-
tech debacle. So, even if we give the
benefit of the doubt to the debt
super-cycle protagonists, who will
argue that “there are no signs that we
have reached the limits of domestic
February 2007
indebtedness in the US, or by
extension, in other economies”, the
selection of the correct asset class
will still be crucial in order to
capitalise on the debt super-cycle (a
point that the Bank Credit Analyst
also makes). If a particular market
becomes glutted, even rapid
monetary expansion and credit
growth won’t prevent prices in that
market from deflating — at least in
real terms. Huge price increases for
commodities in the 1970s led to
overproduction. Therefore, even as
the debt super-cycle gained
momentum in the 1980s and 1990s,
commodity prices trended down after
1980 in nominal terms (see Figure 8)
and in real terms after 1974 (see
Figure 9). However, it should be
noted that had the debt super-cycle
not been in place in the 1980s and
1990s, commodity prices in nominal
terms would have deflated far more
than they did (see Figure 10). In fact,
I suppose that without the
Figure 8 Reuters/CRB Continuous Futures Index, 1956–2006
Source: Ron Griess, www.thechartstore.com
February 2007
“inflationary” impact of total debt
expanding from 140% of GDP in
1980 to 260% in 2000, commodities
would have declined by about as
much as they did in real terms —
down 80% (see Figure 10). Also, I
suppose that without this colossal
debt expansion, from 1980 the world
would have been not just in a dis-
inflationary environment, but in a
deflationary one (declining CPI).
The point is simply this: if the debt
super-cycle continues to accelerate,
the conclusion that all asset prices
will increase is far from certain. Even
far less certain is that all asset classes
(stocks, bonds, commodities, real
estate, etc.) will increase in real
terms. (“Real terms” would have to
be defined, since core CPI figures
don’t seem to reflect the reality of
paper money’s loss of purchasing
power.)
The last point that a responsible
citizen should consider is that the
longer the debt super-cycle remains
in place, the worse the eventual
outcome will be. If we define a debt
super-cycle as a long period during
which credit growth far exceeds
nominal GDP growth (see Figure 10)
and Barry Bannister’s “zero hour”, it
should be clear that there is a point
at which easy monetary policies and
debt growth becomes totally
ineffective (see Figure 7). When that
point is reached, all the world’s
printing presses cannot lift real
economic activity. Hyperinflation,
accompanied by economic
depression, social unrest, and war,
then follows. It’s not exactly a very
desirable option, but it would seem to
me that it is one that market
participants are perfectly happy to
accept.
As has been the case for the last
few years, in a moment of weakness
Alan Abelson, the author of the
scathing “Up and Down Wall Street”
column in Barron’s, invited me to
participate in this year’s Barron’s
The Gloom, Boom & Doom Report 5
 Figure 9 Reuters/CRB Continuous Futures Index (adjusted for inflation using the Consumer Price Index –
all items), 1956–2006

Source: Ron Griess, www.thechartstore.com

Figure 10 Total Debt-to-GDP, 1960–2006

Source: Bridgewater Associates

6 The Gloom, Boom & Doom Report February 2007

Roundtable, which took place in
early January. The participants are all
very successful investment managers,
analysts, and strategists, and some of
them are worth over a billion dollars.
But do you think that any one of the
American participants touched on —
even just en passant — the problem of
credit growing far more rapidly than
GDP, and of the resulting asset
bubbles? That issue, and the
deepening problems in the Middle
East, weren’t even mentioned.
THE BEARISH CASE
The bullish case based on the debt
super-cycle is easy to explain and easy
to understand. The central bank
pursues expansionary monetary
policies, credit grows, and asset prices
increase. Consumer price inflation
stays low because of globalisation and
productivity improvements. A
Goldilocks economic scenario is in
place! The Goldilocks scenario is in
fact so “obvious” that, as I have
shown above, it is widely accepted by
the investment community. The
bullish sentiment among investors
(see above), low volatility, tight yield
spreads, and the willingness to use
high leverage are all symptoms of the
acceptance of the mantra that “the
good times for asset markets will roll
on” — if not forever, then at least in
2007.
The widespread optimism among
individual and institutional investors
is that much more surprising given
the fact that the high-tech-loaded
Nasdaq 100, where most investors
were positioned in 2000, is still down
by 61% from its high, and that the
S&P measured in Euros is, as of this
January, down by 37% in Euros and
by more than 50% against gold. But
to the average American, a dollar is a
dollar; the concept of dollar weakness
offsetting the gains on his dollar
assets is incomprehensible. The smart
people in the professional financial
community are well aware of this
relationship, but they don’t care
much because their performance is
measured in US dollars or against a
US dollar benchmark. Moreover, for
as long as they can benefit from
investing in foreign equities, bonds,
February 2007
properties, and currencies, they will
remain complacent and optimistic
about the future of asset markets. So,
the bearish case, as opined by people
such as Kurt Richebächer, is
dismissed because “so what, the
markets are rising”!
My friend Jim Walker, the Hong
Kong-based chief economist at CLSA
(www.clsa.com), recently published a
report entitled “Apocalypse Now”. I
met Jim in the 1990s and, in my
view, he is one of the most
accomplished economists I know. He
is also a likable Scotsman, a good and
considerate friend, and a person I
enjoy going out with at night from
time to time. He also happens to be
one of the more courageous people I
know in the investment business, in
that he dares to take career risks by
making unpopular calls that run
against the consensus. Prior to the
1997 Asian crisis, he was — along
with Andrew Sharpe (now at
Redburn Partners, an independent
research broker in London —
andrew.sharpe@redburn.com) — one
of the very few economists who
warned of the impending crisis. The
years preceding the Asian crisis —
and particularly in Hong Kong —
were very similar to the current
environment in the US: growing
current account deficits, wild
property and stock market
speculation, enormous optimism
(although most Asian stock markets
were well below their 1990 or 1994
peaks), and the endless saga about
how the business cycle had been
eliminated. At that time it took great
courage, as it would still today, for an
economist at CLSA who was (and
still is) surrounded by a pack of
hungry and short-term-oriented
salespeople to express a negative view
about Asia. But Jim was able to
defend his negative views and was
eventually proved to have been 100%
on the mark (although, like me at the
time, he may have underestimated
the severity of the crisis). So, when
Jim Walker, who certainly cannot be
labelled as a “perma-bear”, takes a
very negative stance on the economic
prospects of the world, and in
particular of China, I take notice.
This in particular because he himself
admits to having been wrong about
the prospects in 2006, which may
account for the fact that his views are
now largely ignored by the bullish
crowd who are self-contentedly
sleeping the slumber of confidence.
“Apocalypse Now” is a 52-page
document and, therefore, I shall only
be able to touch very superficially on
its, at times, difficult-to-understand
content and Jim’s rather gloomy
predictions. Jim Walker’s principal
reason for recommending caution is
“the strange pattern of behaviour in
sectors and markets that permeate
today’s global economy. Through
Austrian eyes markets appear to be
at one of their most dangerous
junctures in recent financial
history. Global monetary
management is at the heart of our
concerns.” (By Austrian eyes, he
means based on the Austrian School
of Economists.)
What concerns Jim in particular is
that “confidence in global central
banks has never been stronger nor
more misplaced. The Greenspan–
Bernanke Fed has achieved almost
the impossible: the death of risk.
Investors express bearish concerns
but they are 100% invested (in many
instances 200–500% invested). Their
faith in the Fed and its guarantee that
liquidity will flow regardless is at all
time highs — emerging market and
junk bond spreads are testament to
this fact. It has become unfashionable
to be negative, especially on China.
We are confident that these are the
best late-cycle indicators of all.”
To validate his “Austrian” views,
Jim explains that the Austrian
School of Economists has had a much
better record of forecasting business
cycle problems than any other school
of economists. So, whereas John
Maynard Keynes believed in 1927
that “we will not have any more
crashes in our time”, and Irving
Fisher thought a few days before the
October crash in 1929 that “stocks
had reached what looks like a
permanent plateau”, Austrians such
as Friedrich Hayek and Ludwig Van
Mises warned of impending serious
problems. According to Jim, Ludwig
Van Mises exclaimed in 1929, on
being offered a senior post at the then
The Gloom, Boom & Doom Report 7
 largest Austrian bank, Credit
Anstalt: “A great crash is coming,
and I do not want my name in any
way connected with it.” (Two years
later, Credit Anstalt failed along with
thousands of other financial
institutions in the Great Depression.)
The Austrian economists
(including Kurt Richebächer) are,
according to Jim, the most pessimistic
commentators today because of the
way they define “inflation” and how
“inflation” affects relative prices
within the economy: “Inflation is not
about rises in core consumer prices,
the metric on which markets and
most central bankers today are
focused. Rather, inflation is about
the increase in money and credit
aggregates (since credit in its myriad
forms is the final determinant of
malinvestments Austrians have
tended to focus on it and the role
that fractional reserve banking plays
in its creation as the source of
fluctuations in the real economy).”
In other words, as the Austrians
would do, Jim takes no comfort from
the fact that core inflation in the last
few years has been benign. He
believes that excessive money and
credit growth will lead to a
“malinvestment crisis”, particularly in
China and the US. He then quotes
William White BIS Working Paper
No. 2005, April 2006, entitled “Is
Price Stability Enough?” to explain a
point that I have tried to make on
numerous occasions in the past.
Consumer prices stability is no
guarantee whatsoever of the
avoidance of economic crises.
Moreover, in the end, asset inflation
periods are far more destructive than
consumer price inflation periods.
White writes:
The historical record provides
stark evidence that a preceding
period of price stability is not
sufficient to avoid serious
macroeconomic downturns.
Perhaps, the most telling example
is that of the Great Depression in
the United States in the 1930s…
The crucial point is that the
outturn was not preceded by any
noticeable inflation… Rather,
the period was characterized by
8 The Gloom, Boom & Doom Report
rapid technological innovation,
rising productivity, rapid
increases in the prices of equity
and real estate and strong fixed
investments… Still more
recently, attention could be
drawn to the financial crisis in
South East Asia in the late
1990s… Similar to the US and
Japanese cases, these difficulties
were not preceded by any
inflationary excesses but rather
by sharp increases in credit,
asset prices and fixed
investment.
As an aside, I should mention
that at its peak in 1929, the US stock
market sold for just 13 times earnings.
Jim Walker is particularly
concerned about three different, but
in my opinion rather closely
correlated, issues: excessive debt
growth in the US, which led to
malinvestments in the US (first the
Nasdaq bubble and then the housing
boom); malinvestments in China;
and finally, the failure of the Bank of
Japan to move swiftly to normalise
interest rates.
Concerning the excessive credit
growth in the US, Jim expresses
similar views to ours (see the
discussion of the debt super-cycle) by
quoting Friedrich Hayek’s “A Tale by
the Tail”:
If the current level of output and
employment is made to depend on
inflation [As explained above,
inflation, as defined by the
Austrians, is about the increase in
money and credit aggregates —
ed. note], a slowing-down in the
pace of inflation will produce
recessionary symptoms. Moreover,
as the economy becomes adjusted
to a particular rate of inflation,
the rate must itself be
continuously increased if
symptoms of a depression are to
be avoided: to inflate is to have “a
tiger by the tail”. (In the US,
financial and non-financial credit
expanded by $2.8 trillion in 2004,
when the first interest rate
increases took place. In the third
quarter of 2006, total credit grew
at an annual rate of $4.4 trillion.)
This is a very important point. In
order for an “inflating” economy to
just maintain its altitude, the rate of
money and credit growth needs to
be continuously expanded. This
phenomenon is clearly visible from
Figure 7 on page 4. The moment
credit growth no longer expands or,
worse, decelerates, asset prices stall,
decline, or more likely collapse and a
recession becomes unavoidable.
Jim believes that because new
technologies (Nasdaq) and housing
are played out as bubble sectors —
even if the Fed were “to start relaxing
policy and pushing households and
businesses to take on more debt there
is no obvious sector for the bubble to
move into (except private equity,
M&A activity and even bigger
bubbles overseas perhaps?). In order
to do so, interest rates would probably
have to be reduced towards the
previous low as well.”
According to Jim Walker, the
2007 China malinvestment crisis will
come about because China’s depressed
exchange rate attracts too much
capital most of which is speculative —
hoping to benefit from an
appreciation of the currency. But at
the same time it is “distorting: it adds
to domestic demand, particularly
investment, when it is the most
dangerous to do so”. The danger Jim
sees is that corporate profit growth in
China is slowing down at a time when
excessive money and credit growth
(inflation) has, through
malinvestments, produced excessive
capacities in capital goods industries
such as steel, base metal refining, cars,
etc. In fact, Jim explains that profits
are likely to be overstated because of
increasing domestic competition and
likely waning productivity growth.
Moreover, “to suggest that Chinese
profitability is improving in the face of
rapidly rising commodity prices and
rapidly rising labour cost, neither of
which are in dispute, makes no sense”.
Jim also notes that malinvestments
are exacerbated when public sector
agencies play a significant role in the
investment process: “indeed, history
has shown that the public sector
excels at malinvesting”. (This seems
to be particularly true with respect to
warfare.)
February 2007
 Concerning Chinese monetary
policies, Jim anticipates that 2007
will bring about a much tighter
monetary environment than was the
case at the beginning of 2006: “the
slower growth in monetary
aggregates already built in to the
system will produce a surprising
degree of business failures and bad
debts in the Chinese banking system
over the next 2–3 quarters.”
I must stress that Jim Walker
doesn’t expect Chinese GDP growth
to turn negative in 2007. But, based
on his rather negative views about
the US economy (he expects GDP
growth of 1% in both 2007 and
2008), he forecasts growth to slow
down considerably:
Our view of the US economy with
its direct (export) and indirect
(capital flow) effects are now
critical elements in our 5–7%
forecast for China in 2007…
China suffers the same policy
failings as every other country and
it will suffer the same cyclical
fluctuations as any other
capitalistic economy although, in
the early stages of transition to
industrialization, when capital
investment plays a lead role, the
fluctuations are likely to be more
severe than in more mature
economies.
immediate cash holdings are less than
11% of GDP (see Figure 12).
According to Jim, “the lower the
ratio the higher the confidence in the
future and the system’s financial
institutions (ie, the lower
precautionary cash balances)… The
Japanese ratio, following 15 years of
grim deflation, is three times larger
than it was at the beginning of the
1990s.”
Jim believes that, in order to
restore confidence among consumers
in the system, interest rates must
therefore be increased. I have a
slightly different take on this. If the
Bank of Japan were to increase
interest rates meaningfully, it would
at the same time kill the Japanese
bond market and the carry trade, and
increase consumers’ interest income.
At one stroke, this would achieve the
Figure 11 Japan’s Real GDP Growth, 1946–1973
following: move money out of cash
deposits and bonds into equities,
boost confidence, and repatriate
money that was invested overseas
into Japanese equities and properties
(since the bond market would be
declining). However, as Jim believes
— and I agree with him — bold
actions by the Bank of Japan are
unlikely to happen. Therefore, the
Japanese carry trade could one day
unwind for other reasons than bold
interest rate increases in Japan (see
also below).
The most important investment
implications Jim sees if his
“Apocalypse Now” scenario comes to
pass in 2007 are as follows. If, in
Japan, interest rates were to increase
significantly, this would diminish the
attractiveness of the carry trade.
Since the carry trade “is one of the

In fact, Jim favours Japan’s

industrialisation roadmap as a proxy
Source: Jim Walker, CLSA
for the kind of violent cyclical
economic swings one should expect
in China (see Figure 11). As can be
seen from this figure, Japan didn’t
experience negative GDP growth Figure 12 Effective Cash Holdings as Percentage of GDP, 1990–2006
between the 1940s and the 1970s, but
it certainly didn’t feel good when
growth was halved, as happened four
times over this period. Jim also
expects the Chinese Yuan to weaken
once Chinese GDP growth slows to
less than 7%.
With respect to Japan, Jim
believes that “in order to secure the
recovery the Bank of Japan must
raise rates”. His reasoning goes as
follows. Japan, the world’s second-
richest economy, has effective cash
holdings equivalent to almost 76% of Source: Jim Walker, CLSA
GDP compared to the US where

February 2007 The Gloom, Boom & Doom Report 9

 largest sources of excess capital in the
global system today” and has been
“instrumental in supplying leveraged
funds for bets on high yield
currencies, commodities, emerging
market debt and fashionable stock
markets”, all these assets would
decline significantly in value. At the
same time, Jim expects the Yen and
Japanese asset prices to increase. He
therefore advises, “sell high yield
currencies, commodity funds,
emerging market debt and fad and
fashion stocks, eg, Chinese banks”.
The expected China
malinvestment crisis will slow the
economy significantly (to a GDP
growth rate of 5–7%), and “any sign
that the economy is slowing below a
7% growth rate would put the skids
under the renminbi… We would
expect the renminbi to move back
above Rmb 8/US$1 perhaps towards
the Rmb 8.2/US$1 mark by the end
of 2008. Commodity prices,
especially for base metals and oil,
would fall sharply… There will be a
cooling in the notion that China
constitutes a ‘core holding’ in
international portfolios.”
The blow-up of the US super-
boom, which Jim believes is more
likely to happen in 2007 “than at any
time in the last fifteen years”, would
have “the most serious consequences
for the region”. Capital flows to Asia
and elsewhere would be cut through
“the twin effects of a declining
current account deficit and the ‘home
bias’ that occurs when a large
domestic economy runs into trouble.
The easy money that seems to be
willing to increasingly buy emerging
market and commodity assets would
dry up immediately (just as it did in
May and June 2006).”
Lower capital flows to China
would exacerbate the effect of the
expected China malinvestment crisis,
lower the demand for commodities,
and diminish risk appetite. US
interest rates would decline, but part
of the interest rate decline in the US
would be offset by risk premium
increases. “But much more
important, compared to interest rates,
nothing destroys liquidity like a
recession. When companies begin to
go bust and non-performing loans rise
10 The Gloom, Boom & Doom Report
in the system banks curtail credit. In
turn, the constant increase in capital
flow that is required to make markets
go up is not forthcoming. Equity
markets fall, even when rates are
falling.”
PERSONAL THOUGHTS
Both the Bank Credit Analyst’s
“Another Year of Riding the
Liquidity Wave” (see “The Bullish
Case”, above) and Jim Walker’s
contrarian “Apocalypse Now” reports
are well-thought-out analyses of the
current global economic and
financial environment. The BCA
study outlines the more likely
outcome in the near future, the
Apocalypse report the certain
eventuality at some point in the
future. But when — this year, next
year, or in five to ten years?
Moreover, unlike Jim Walker, I doubt
that in the event of the apocalyptic
scenario, US GDP growth will
remain at 1% and Chinese growth at
5–7% per annum. If one really thinks
through the combination of rising
interest rates in Japan, the end of the
carry trade, the US economy blowing
up, a Chinese malinvestment crisis,
and collapsing commodity and stock
prices, the perfect cocktail of events
should be in place to bring about a
terrific deflationary depression
around the world where, with the
exception of the highest-quality
bonds (but where are they?) and,
possibly, precious metals, every type
of asset should be avoided.
Depending on one’s investment
strategy, the debt super-cycle or the
apocalypse will make or break one’s
wealth. Under the economic
apocalypse scenario, bonds will do
well in absolute terms (declining
interest rates) and fantastically well
in relative terms (as all other asset
prices collapse, with the possible
exception of precious metals and
farmland).
Under the debt super-cycle
scenario, the worst investments will
be cash and bonds, because paper
money will continue to lose its
purchasing power compared to asset
prices such as real estate,
commodities, stocks, and art at an
accelerating rate, although, as the
BCA pointed out, asset price
inflation will rotate.
There is one point that Jim
Walker makes that I haven’t
mentioned, but which may yield
some clues as to what an investor
should do. According to Jim “one of
the most worrying features in global
central banking today” is that central
bankers don’t want to take
responsibility: “when the US Federal
Reserve, ECB and Bank of Japan talk
about appropriate monetary policies
they do so in a national context. The
Fed has stopped raising rates because
of the US housing market slump; the
ECB has been slow to raise rates
because of sluggish EU growth; and
the Bank of Japan has dragged out
the process of interest rate
normalisation because of the lack of
inflation in Japan.”
But, as Jim explains, in a world
where globalisation is acknowledged
in every speech a central banker
makes, “there is no attempt to
recognise — because that would
mean taking responsibility — the
effects of their national monetary
policies on economies, commodities,
and assets around the world. This is
what makes the current state of
financial markets possibly the most
dangerous in history” (emphasis
added).
But what are the implications of
the unwillingness (and, in some
cases, the inability) of central
bankers to assume responsibility?
Quite simply, it means that if the US
cuts interest rates and takes
“extraordinary measures” in order to
support the housing market and
consumption, the other central
bankers will all, to a larger or smaller
extent, do the same thing and print
money.
So, for one, my view would be
that, at least for now, a mild
apocalyptic scenario may occur in the
“real economy”, but that the “asset
economy” could continue to inflate
— albeit interrupted by severe
corrections and with fewer asset
classes participating (that is, without
housing and industrial commodities).
Under this scenario (some kind of
stagflation), the worst investments
February 2007
would be long-dated bonds (see
Figure 13). Inevitably, the asset Figure 13 Thirty-year T-Bond Yield ($TYX), 1980–2007
inflation will in time also lead to
more consumer price inflation,
because if the debt super-cycle
remains in full force and credit
continues to expand at an
accelerating rate, commodity prices
will have nowhere else to go but up!
(The supply of commodities will
decline relative to the supply of
money and credit.)
Therefore, in a mild apocalyptic
scenario for the real economy, a far
more desirable alternative to long-
term bonds would be to buy short-
dated, high-quality bonds and
Treasury bills. But should investors go
short long-dated US bonds? As a
secular long-term bet, T bonds should
be an excellent short, but in the near
term yields may not rise much as the
US dollar could strengthen somewhat
more and because of the very low Source: www.decisionpoint.com
bullish consensus about bonds (see
Figure 4).
I have one further observation of a depression are to be avoided.” warning signal that commodities
about long-dated bonds. Investors In the December 2006 GBD were likely to peak out in 2006. The
who either sold or avoided bonds in report, entitled “Irreparable Cracks in price of crude oil is down 34% from
1982, when 30-year T bonds were the Financial System”, I suggested its July 2006 high, and the CRB
yielding more than 15%, were totally that some cracks had appeared in the Index is now down 21% from its May
misguided, as they were discounting US sub-prime lending market, in 2006 peak (see Figure 14). (Please
consumer price increases to either households’ liquidity, and in the note that the difference in
accelerate or remain around 13% per performance of some of the asset performance between the Ron Griess
annum (providing a real yield of shufflers and the collapse of the CRB Continuous Futures Index —
about 2% — see Figure 13). Now, Middle Eastern stock markets. But, Figure 8 — and Figure 14 is because
investors who buy 30-year T bonds now we can add to those cracks some Figure 14 is based on the Revised
seem to expect inflation to average at new ones. Since its early January high Reuters/Jefferies CRB Index, which
most 2.5% per annum for the next 30 the Venezuelan stock market is down has a higher energy weighting.)
years — a bold assumption, indeed, 33% within just a few days, and the Unless FRODOR reaccelerates, I
given that, as Jim explained, “central Thai stock market has dropped by would expect the following scenario
bankers do not want to take 15% since mid-December. It is highly for the next three to six months.
responsibility”. probable that the emerging markets, Equities globally will top out shortly
I suppose that a mild apocalyptic which just recently began to stall or and decline in a sharp sell-off.
scenario would equate to stagflation decline (exceptions are Vietnam up Emerging markets will underperform
for the majority of households except, 30% so far in 2006, and China up the US. The dollar rallies as US
perhaps, the asset shufflers. However, between 5% and 27% depending on liquidity shrinks due to far worse
that the latter would continue to the index), are the canary in the coal conditions in the housing market
thrive is far from certain. Why? If mine for global liquidity. Foreign than are perceived, which brings
interest rates were to rise and credit Official Dollar Reserves (FRODOR), about further failures among sub-
growth remained constant and failed which is a reliable indicator of prime lenders.
to expand, not only the economy international liquidity, is still growing Once the US stock market
could remain stagnant but also most at about 15% per annum, but growth declines by 5% from its peak, the Fed
asset markets. After all, Mises is no longer accelerating. (As I will start to cut interest rates and
pointed out that, “as the economy mentioned above, the rate of money embark once again on massive
becomes adjusted to a particular rate and credit growth must continuously liquidity creation in order to protect
of inflation [money and credit growth increase if recession is to be avoided.) its friends on Wall Street. Whether
— ed. note], the rate must itself be When FRODOR growth began to the Fed succeeds at that time in
continuously increased if symptoms decelerate in late 2005, it gave a stabilising the markets will depend on

February 2007 The Gloom, Boom & Doom Report 11


Figure 14 Reuters/Jefferies CRB Index ($CRB), 2001–2007
Source: www.decisionpoint.com
Figure 15 Asian Equities, 1988–2006
Sources: CLSA Asia-Pacific Markets and Chris Roberts
a number of factors, including
whether the Japanese Yen carry trade
avoids going into a massive
liquidation. And here I have a
slightly different take on the situation
than Jim Walker. The Yen carry trade
can also end if foreign assets suddenly
start to decline or under-perform
Japanese assets — not just because
Japanese interest rates increase. Since
much of the carry trade is invested in
12 The Gloom, Boom & Doom Report
risky assets, any decline in their value
could violently reverse the trade and
spread like a bushfire through the
asset markets. Whether at that point
massive liquidity creation by all the
central banks (not only the US Fed)
will bring about a strong recovery in
equity prices remains to be seen!
However, it is likely that precious
metals will perform well during this
act of monetary desperation.
INVESTMENT
CONSIDERATIONS
Given the over-bought and over-
bullish position of most equity
markets, my preferred investment for
now is US Treasury bills with a
maturity of three to six months. As
John Hussman said, there is presently
not much buying power left from
converting a tiny pool of bears into
buying equities, but there is a lot of
room available in the bearish column
in order to populate a more typical
divergence of opinion.
While I remain very negative
about the prospects of the US dollar
for the long term, based on FRODOR
not growing at an accelerating rate
and strong money supply growth in
Europe as well, the dollar should hold
at least for now and may even
strengthen somewhat. The problem
with being overly negative about the
US dollar against other currencies is
that they are also fiat currencies. I
don’t agree with Jim Walker’s
negative views concerning the
Chinese Renminbi and I continue to
like Asian currencies.
For investors who need — or wish
— to own equities, I continue to
recommend exposure to Singapore
and Malaysia. Thai stocks are
inexpensive and are supported by
high dividends, but they are unlikely
to perform well for now.
A friend of ours, Chris Roberts, a
technical analyst at CLSA, recently
published a figure showing that Asian
equities have now broken out to new
highs (see Figure 15). Chris expects a
25% correction to get under way
shortly, which will provide a “major
buying opportunity”. From the 2007
lows, the Asian markets should then
advance by more than 100%. If Chris
is right and the BCA debt super-cycle
continues unabated, it would seem to
me that the risk of not owning Asian
equities is higher than having to
endure possibly an intermediate 25%
correction. As a result, I am still long
Asian stocks, although I have
reduced my positions. In the
meantime, Jim Walker thinks that
the companies that will perform best
February 2007
through the next cyclical downturn
“will be the true winners in China Figure 16 S&P 500 Relative to MSCI World, 1990–2006
and Asia. At this stage in the cycle
there is too much liquidity ‘noise’ to
make a reasonable assessment.”
I might add that Chris Roberts
believes in a secular de-rating of the
US stock market compared to the
rest of the world (see Figure 16). As
mentioned above, if a sharp
correction gets under way, I would
expect US equities to outperform the
world for a while by declining less
than other stock markets. Regular
readers of this report will know that I
have been very negative about sub- Sources: CLSA Asia-Pacific Markets and Chris Roberts
prime lenders such as Accredited
Home Lenders (LEND) and New
Homes Financial (NEW). I continue
to maintain this negative view. In
addition, I believe in a higher Figure 17 Broker/Dealer Index – AMEX ($XBD), 2003–2007
vulnerability of brokerage companies.
Buying puts or selling short brokerage
stocks in the period directly ahead
should be considered (see Figure 17).
Kenneth Ng, who has an
accounting background and whom I
met in the mid-1990s when he was a
senior analyst and head of research at
Baring Securities in Bangkok (he
later worked at Macquarie
Securities), now runs an Asian micro
cap value fund, NTAsian Discovery
Fund (Kenneth@ntasset.com), in
which I have invested some money
(the minimum investment is
US$100,000). Kenneth has provided
the following comments about
opportunities in very small
companies in Asia.

Source: www.decisionpoint.com

February 2007 The Gloom, Boom & Doom Report 13

 Frontier Investing in our Backyard
Kenneth Ng, CEO, NTAsset
NTAsian Discovery Fund (Bloomberg code: NTASIAN KY Equity)
Tel: +662 343 1771; Fax: +662 343 1774; Email: kenneth@ntasset.com; www.ntasset.com

How much would you pay for a
company that is effectively a holding
company of some of the top brand
names in Asia with earnings growth
of 42% and 16% in 2007 and 2008,
respectively, a debt to equity ratio of
20%, and generating an ROE of 24%?
Throw in a healthy dividend also! If
an analyst were to write a research
report on this company, it might look
something like this:
It is noteworthy that the market is
only valuing this portfolio of
companies at 9x FY07 earnings and
1.8x PBV. That would put the
dividend yield also at 4%. The
management of these companies are a
collection of some of the best
entrepreneurs that Asia can offer
today. Against average Asian market
valuations of 15x FY07 earnings and
EPS growth of 11%, you can’t get
deeper value than that. So, what’s the
catch? No catch, except the fact that
most institutional investors are
unlikely to have heard of these
companies, nor is it worth their while
to risk going so far off the
benchmark, because their market
capitalisation is just too small for a
large fund to invest in.
When anyone mentions frontier
investing, three different types come

14 The Gloom, Boom & Doom Report February 2007

to mind: investing in (1) new asset strategies, made popular by Benjamin have to analyse the structure of the
classes; (2) new markets; or (3) stocks Graham, have now outperformed the industry between the sell side and the
that most investors haven’t heard of. market for seven years in a row across buy side.
Investors invest in frontier markets the developed world and for There is no denying that markets
for one reason alone: better returns, companies of all sizes. According to in Asia are better covered now than
because there are fewer bidders for MSCI, its world value index grew they were 20 years ago; on the other
that particular asset class. Fewer 22.2% in 2006 while its growth index hand, if we compare the number of
buyers = less bids = lower pricing. grew by 13.8%. Figure 18 illustrates good-quality analysts now and ten
Some fund managers excel in new how rewarding the returns for small/ years ago (pre-crisis), especially post
asset classes; others love exploring micro cap funds have been over the the consolidation of foreign market
new countries and emerging past six years when measured against players, there are probably fewer
economies. We like looking a little aggregate hedge fund returns as well today. In addition, the structure of
closer to home. However, the as the Russell 2000 index, one of the the research industry has changed
investment philosophy remains the most widely recognised indexes for significantly, with fewer analysts
same, look to seek “value” and invest small cap stocks. catering to a larger number of funds.
where others aren’t looking, for all If we break down the performance Inevitably, with pressure from
the reasons explained in the previous for small/micro cap funds, we find management for sell-side analysts to
paragraph. Is it higher risk? Only if that emerging markets small cap focus on “tier 1” clients, pitching a
you get it wrong. That would seem funds continue to be the most US$100 million market
obvious, but because there are fewer rewarding, returning more than 2–5 capitalisation stock to a US$3 billion
bidders, if you get it wrong, you often times the returns offered by small/ index relative fund is probably not
have no option but to ride it all the micro cap funds in the US, Europe, or going to be much value added,
way down. That’s the main risk in Japan over the past six years (see meaning coverage will continue to
this game. Figure 19). focus on large market cap stocks.
However, if you do get it right, What is the explanation? In order To put some numbers to this, we
the returns can be rewarding. An to see how we can find value in collected some data on the level of
article in the Financial Times recently relatively “mature” (and I’m using coverage in Asia of the top 30 market
concluded that “value” investing this sparingly) emerging markets, we cap stocks against the level of

Figure 18 Twelve-month Rolling Returns, January 2001 – October 2006

200

HFN Small/Micro

HFN Aggregate
150
Russell 2000

100
Percentage

50

-50
May-2001

May-2002

May-2003

May-2004

May-2005

May-2006
Jan-2001

Jan-2002

Jan-2003

Jan-2004

Jan-2005

Jan-2006
Sep-2001

Sep-2002

Sep-2003

Sep-2004

Sep-2005

Sep-2006

Source: Hedgefund.net, a division of Channel Capital Group Inc.

February 2007 The Gloom, Boom & Doom Report 15

 Figure 19 Cumulative Returns for Small/Micro Cap Hedge Funds by Regions in Which They Invest,
January 2001 – October 2006
300

SmCap EM
250
SmCap Global

SmCap US
200 SmCap Europe

SmCap Japan

150
Percentage

100

50

-50
May 1, 2001

May 1, 2002

May 1, 2003

May 1, 2004

May 1, 2005

May 1, 2006
Jan 1, 2001

Jan 1, 2002

Jan 1, 2003

Jan 1, 2004

Jan 1, 2005

Jan 1, 2006
Sep 1, 2001

Sep 1, 2002

Sep 1, 2003

Sep 1, 2004

Sep 1, 2005

Sep 1, 2006
Source: Hedgefund.net, a division of Channel Capital Group Inc.

coverage for 30 stocks with market

capitalisation of US$100 million and Table 1 Level of Coverage for Large and Small Cap Stocks in Asia
lower (see Table 1).
The level of coverage for what I
Big caps Small cap (≤ US$100m)*
would consider “below institutional
investor radar” companies (a market Country % of top 30 stks Avg. no. of % of total % of 30 small Avg. no. of % of total
with coverage analysts/stock mkt cap caps w/coverage analysts/stock mkt cap
capitalisation cut-off derived from
more than a decade of sell-side Hong Kong 100 19 59 0 0 0
experience trying to pitch smaller cap China 90 7 80 7 1 0
companies to buy-side fund India 100 9 86 33 1 0
managers) remains insignificant Indonesia 93 11 79 27 2 2
compared to the top 30 capitalised Korea 93 6 63 13 3 0
stocks. In addition, the analysts that
Malaysia 100 16 79 50 1 1
are looking at the small cap stocks
Philippines 93 5 76 17 1 3
tend to be junior or recent graduates,
coming from mainly local houses, Singapore 97 11 81 47 1 1
implying little in-depth analysis or Taiwan 100 9 57 10 1 1
relatively inaccurate forecast data. Thailand 100 16 69 70 2 2
As a result of this, there can be #1 #2 #3 #1 #2 #3
significant differentials in pricing
with a stock that may have the same * — 30 small caps starting from US$100m market capitalisation and lower were used
growth rate, but where the public #1 — denotes how many of the top 30 stocks have minimum of 1 analyst covering
#2 — denotes average number of analysts covering a top/small cap stock
relations machine isn’t working as #3 — denotes how much of total market capitalisation the top 30 capitalised/30 small cap
well in one company as in another. stock accounts for
As such, a US$100 million company Source: Bloomberg
that is growing at 15% p.a. and

16 The Gloom, Boom & Doom Report February 2007

trading on 5 times earnings could
potentially be in a “value trap”.
However, if it were trading at 10
times earnings, implying a $200
million market capitalisation, it is
suddenly “more investable” and could
trade up to even 12–15 times PER as
it is now liquid enough to attract
larger funds. Of course, a value
investor is a patient investor, but a
little helping hand doesn’t do any
harm, and the management of such
firms are often not that market savvy
and need to be urged into action in
order to increase the profile of their
companies. Quite often the key to
unlocking the value in these
companies isn’t a question of the
fundamentals of the company but,
rather, of increasing market
awareness.
ANATOMY OF INVESTING IN
MICRO CAPS
references are from competitors;
so, where we can, we also tend to
sniff around the competition in
order not only to get a better
understanding of the industry but
also to see how the company is
seen by its competition.
Because of the above factor,
we tend to do a great number of
company visits, as it is pretty
much the only way we are able to
gather information (given the
little coverage from brokerage
houses). In fact, last year, we
clocked up 269 company visits
(most of which were face-to-face
meetings with senior or top
management), and given we held
around 15 stocks in the portfolio
at the end of the year, that’s a hit
rate of 5–6% — lower if you
consider that this list was already
shortlisted from several hundred
stocks screened using our
valuation filters (see Figure 20).
2) Branding: Whether it is B2B or
B2C branding, we tend towards
companies that have built a brand
for their products, if not through
aggressive advertising and
marketing expenditure, then
through longevity. As such,
around 70% of the stocks the fund
holds have strong brands if not in
their products, then in the
company itself. Why the focus on
brand? Partly because Asian
investors don’t tend to put much
value on brands (in the same way
that investors don’t put much
value on research and
development expenditure,
something which we consider to
be an essential component of
building a good brand); as such,
we feel that branded companies,
or those with a strong brand, tend

Our criteria for selection of

investments aren’t significantly
different to investing in larger Figure 20 Number of Company Meetings
companies; however, because any
60
such investments tend to be less 55
diversified and the ability to exit is
50
quite often more limited, we exercise
extreme caution in pulling the trigger
40
on any investments. Our science is 35
33
filtering the markets with our 30
30 28
valuation screens for a list of cheap
23
stocks with fast-growing prospects.
Our art is selecting the ones most 20 16 16
likely to re-rate over the foreseeable 11 12
10 8
future. Our qualitative criteria help
to narrow down our selections 2
further. 0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
1) Management, management,
management: Given the hands- 70
on nature of most entrepreneurs, 59
and given the size of the 60
businesses we tend to invest in, 51
50
this category is by far the single 43
most important factor, and at a 40
guess, its weighting probably 33
accounts for around 60–70% of 30 27
our investment decision. Because 20 19
this is so important for us, we 20
don’t undertake any investment 11
10 6
until we have, at the very least,
talked with management, if not 0
met them eye to eye, or visited Thailand HK/China Malaysia Korea Taiwan India Singapore Philippines Indonesia
the factory. Quite often, the best

February 2007 The Gloom, Boom & Doom Report 17

 to be undervalued in Asia. In
addition, brands tend to be more
resilient in downturns. They tend
to command higher margins,
giving lower operating leverage,
and therefore are better able to
withstand a drop in volumes; they
have a better ability to adjust
pricing to reflect higher costs; and
they have more loyalty among
their customers.
3) Industry: Naturally, the industry
sector, dynamics, competition,
types of business, and so on, are
all important considerations, but
dynamics are significantly
different for different sectors
across Asia, so it is difficult to
generalise for this criterion.
However, earnings predictability
and steady income is a prime focus
for us, given our value and steady
returns orientation, which is
probably why more than 50% of
the companies in the fund are
consumer-related businesses. We
have found that even in the most
competitive of segments, if the
management focus,
determination, and expertise are
there, a company can thrive, so
we don’t tend to rule out any
industry.
4) Corporate governance and
social responsibility: Of course,
this goes back to management.
However, trying to determine
whether the management of a
small cap company will have
corporate governance issues is like
trying to forecast the direction of
the market using astrology.
However, we do tend to find that
socially responsible management
tend to practise better corporate
governance than their peers, so
we don’t focus on social
responsibility just because it’s the
trend!
Finally, we find that if we look at
the fund as an investment company,
it tends to focus our attention even
more. Would we want to be in this
business ourselves (assuming we had
the expertise), or are we buying it
because we think the share price will
go up? Putting some reality in our
investment decision, rather than
looking at purely the share prices,
forces us to consider how viable the
long-term prospects are. As such, we
consider ourselves a partner, rather a
visitor, in all our investments.

THE GLOOM, BOOM & DOOM REPORT

© Marc Faber, 2007
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and consult an independent financial adviser before making any investments or entering into any transaction in relation to any securities
mentioned in this report.

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