Section: Dr.

Marc Faber
Published: Thursday, June 13 - 2002 at 11:52 (GMT+4)

Finding new major investment themes

The most frustrating aspect of being a portfolio manager these

days is the lack of long term themes,' wrote recently our friend
Byron Wien of Morgan Stanley. But is this really the case?

The fact is that there is a huge pool of money slashing around the world. This pool increases
in size with the credit expansion and the increase in money supply, for which the central banks
around the world under the guidance of Alan Greenspan are responsible.

And whereas we may debate whether this artificial stimulus by the monetary authorities is
healthy or will lead to further unimaginable problems down the road, the fact remains that this
pool of money in a free market economy and in absence of foreign exchange controls will flow
somewhere and boost economic activity temporary, and lead to inflation or a bull market in
some asset class at least somewhere in the world.

To better understand this process, visualize a gigantic flat bowl, full of water, about three times
the size of the world, standing on top of the earth, perched on a very large bamboo pole, which
is continuously supplied with fresh water that comes from a huge water tap and is controlled by
the world's central bankers. Under what economists might call 'equilibrium' (which does not
exist in the real world), the water would continuously overflow from the bowl evenly unto the
earth and, therefore, economies around the world would expand and all asset classes would
appreciate at about the same rate.

However, the bowl being so large, relative to the flexible bamboo pole, onto which it is perched,
is highly unstable and will lean toward the one or the other side depending on which side of the
pole investors will lean. If collectively, investors are bullish about America, they will lean against
the bamboo pole in such a way as to let the water (money) overflow into the direction of the
American continent.

If they are optimistic about the NASDAQ, the bowl will be tilt to overflow into the high tech,
telecommunication, media, and biotech sector, and so on. In short, the direction of the
overflowing water will depend on the expectations of investors, which in turn can be manipulated
by opinion leaders, the media, analysts, strategists, politicians and economists.

Again think of the investment community at large as being very powerful due to its total size -
similar to a herd of elephants - but not very sophisticated when it comes to financial matters.
The elephants, being rather docile animals will listen to the commands they receive from their
mahouts, and when the keepers tell them to do something they will obey and so, with their
strength and weight, they can bend the gigantic bamboo pole for quite some time in the one or
the other direction.

The mahouts themselves are not particularly sophisticated either - in our case a group consisting
of fund managers, stock brokers, economists, strategists and so on - but they have a keen
interest to boost the productivity of their elephants and to make as much money out of them as
possible and, therefore, they will from time to time give them new instructions, as to which side
of the bamboo pole they should lean on.

Therefore, each time the elephants receive new instructions, the gigantic water bowl perched
on the bamboo pole will overflow into a different region, industrial sector, or another asset class

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 altogether. The point is simply this. As long as the water bowl is continuously refilled with water
coming from the water tap, which is controlled by central banks and as long as the perch is
buffeted around by the elephants, which are driven by the mahouts, there will always be some
assets which will appreciate while other lose their momentum, depending to which side the
water bowl is leaning.

So there will always be major investment themes under the present monetary system, which
sees to it that the water tap continues to supply the bowl with water or in our case with paper
money. What really does frustrate investors is not a lack of investment themes, but their inability
to anticipate with any accuracy toward which side the gigantic water bowl will overflow to.
The problem really with major investment themes is that investors have little imagination and
are only conditioned to listen to the instructions the receive from the likes of CNBC, and the
Wall Street and government propaganda machine. Thus, the result is that major investment
themes are only obvious to the majority of investors long after they have emerged and only
once the bowl has been leaning and overflowing to one side for quite some time, and in the
process led to a bull market in a sector.

Not surprisingly, therefore, do we find that the largest flow of money into an asset class such
as stocks, bonds, real estate or commodities will then occur when just about everybody has
fully understood the new investment theme, which will inevitably also coincide with that sector's
peak in popularity and top in prices. This has to be so, because once all the money pours from
the oversized water-bowl into one sector of the economy, this sector becomes grossly overpriced
relative to other sectors of the economy, which did not come into the benefit of the torrential
money flows.

But here follows another complication. In a market economy, the central bankers control the
water or money tap above the large bowl. The mahouts in turn control to a large extend the
actions of their elephants, but what both of them don't control is what the money flows will do
once they reach the earth. Sure, as the bowl leans on one side, the money pouring down onto
one sector of the economy will badly inflate that sector for a while.

But, then some smart people - some of them honest, some of them less honest (I am thinking
here of some analysts and corporate executives who continued to paint a glowing picture about
their companies, while at the same time sold out of their own positions) - will notice the huge
valuation differences between the inflated sector and the depressed sectors, and therefore,
they will begin to sell the inflated sector and move their money into the depressed or relatively
depressed sectors of the economy or investment universe.

Thus, while the money flows will continue to pour into the now recognized 'major investment
theme' or as was recently the case into the 'new economy', the flow of money will no longer
stay there, but it will leak into other sectors of the investment universe. This process will initially
go totally unnoticed to the mahouts and their elephants, which as I mentioned, is not the most
enlightened crowd.

Eventually, however, the public realizes that it has been misled by the cheerleaders of the boom
and the protagonists of the major investment theme (read Maria Bartiromo, Lawrence Kudlow
and James Cramer to name a few) and that no matter how heavily they lean against the bamboo
pole and no matter how much money pours down on their favorite investment theme, the money
leakage into other sectors of the economy and investment universe simply overwhelms the
supply of money originating from the central banks and the steeply leaning bowl, and therefore,
depresses the favorite investment theme while boosting at the same time the depressed sectors
to which the money is now not only leaking but flooding.

Eventually even the mahouts recognize the money leakage problem and, therefore, command
their elephants to take a new position around the bamboo pole, which leads the down-pouring
money to flow into the new asset class, which has begun to outperform.

The point here is to understand that major investment themes are simply not obvious when they

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 are the most attractive and promise the highest returns with the lowest risk - that is at their
nascence. And when they become obvious to everyone they are usually already in the final
stage of euphoria, which inevitably ends the way we experienced with the high tech sector in
the last two years.

I have looked at all the major investment themes of the last 30 years including gold, oil and gas,
and foreign currencies in the 1970s, Japanese stocks in the 1980s, emerging markets between
1985 and 1997, and US equities in the 1990s and found that in each case investors were
extremely slow to recognize the emergence of a new major investment theme.

At the same time they were extremely slow - to their detriment - to understand that from time
to time the rules of the investment game change and that they had to abandon the obvious
investment theme and move into a totally new sector.

I, therefore, warn investors to be extremely cautious when investing in a widely accepted and
highly popular 'major investment theme,' because once it is known to just about every investor
around the world, it is likely to enter the most speculative but also final phase of its bull market
during which, I admit, prices can rise almost vertically, as we have seen in the case of the
NASDAQ.
However, this phase of a bull market of a major investment theme is also fraught with high risks
and always ends in tears once the bubble bursts. In fact, I would make two additional observations
regarding 'major investment themes'. It is when the investment community is fascinated by a
major investment theme that outstanding opportunities arise outside the sphere of the major
investment theme.

This is so, because when everybody's attention is focused on one sector of the market, an
under-valuation must take place in the sectors of the market to which nobody is paying any
attention. In other words, the greater the mania in one sector of the market or in one stock
market in the world, the more likely it is that there are numerous neglected asset classes
elsewhere, which offer a huge appreciation potential.

I think this fact is one of the cardinal rules of investing, which will always work for the patient
long-term investor. A good example of a major investment theme that created an outstanding
opportunity right next to it was the Japanese stock market bubble of the late 1980s. Investors
focused at the time so much on Japanese equities that they missed entirely the greatest bond
market rally in financial history during which yields on Japanese long dated government bonds
fell from over 6% to 1.30% in the 1990s.

What is important to understand is that the water pouring from the large bowl into one sector
of the economy will eventually with as much certainty as night follows day leak into other sectors
and lead in these sectors to sharp bull markets.

The second observation with respect to major investment themes relate to the following.
Whereas we have seen that a major investment theme, which is accepted by the majority of
investors leads inevitably to an over-valuation of the 'theme sector' and an under-valuation
elsewhere in the investment universe, the timing of the water leaking from the popular and
expensive sector into the neglected sector of the investment universe is difficult if not impossible
to predict.

The timing problem is less pronounced when a major investment theme has just gone out of
fashion and when there is no obvious new major theme in the minds of the investing community,
as is the case now, according to Byron Wien. It is in this state of confusion that a new investment
theme is most likely to emerge without too much delay.
Thus, I would argue that from a timing point of view it is precisely then, when there are no
obvious major investment themes in the mind of investors that the opportunities for them are
the most appealing, because in such an environment of general uncertainty the next major
investment themes are born. I would like to emphasize here that both in terms of timing and
magnitude of the forthcoming move the opportunity is greatest for capital gains when there is

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 an absence of major themes in the mind of investors.

I am emphasizing here the absence of a major theme 'in the mind of investors', because in the
real world there is never a lack of major themes. It is just that the investment community does
not perceive that a new major trend is already in the process of fermenting and shaping up. The
problem is that at major turning points or milestones in financial history, the minds of most
investors are like paralyzed, because they simply cannot understand that the rules of the
investment game have radically changed.

Hence the majority of investors will miss the dynamic and powerful first upward move in the
new major theme of the investment universe. I may add that after March 2000 and right up to
now, there were some major investment themes. The most important theme was to stay out of
the NASDAQ or to short it. Another major theme was to avoid the by large market capitalization
stocks weighted S&P 500, which benefited until March 2000 from the process of indexation.

On the long side a major theme was to own small cap and mid cap stocks, which have strongly
out-performed large market capitalization issue over the last two years, and to own the Asian
emerging markets and Russia, which performed far better than the S&P 500. US residential
real estate was another major theme since it has continued to appreciate - at least so far.

Finally, the ownership of gold mining companies and of physical gold was a major theme since
mining companies have risen by more than 100% over the last 12 months, and gold has been
the world's strongest major currency. So, the fact is that there is never a lack of major investment
opportunities - this particularly not when the central banks flood the system with liquidity.

What, however, is lacking when major secular trends do change or when a major bull market
reverses gear - a phase, which is usually characterized by a number of strongly contradictory
trends, which in turn obscure the event - is the comprehension by the investment community
that the cards of the investment game have been completely reshuffled and that a new game
with new rules has begun.

So I think that the next investment theme is about to develop in the asset classes, which have
performed the worst during the American financial bubble - commodities including gold and
silver, basic industries, emerging markets and real estate in emerging markets.

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