How we’ve prepared for the next bust

Chris Leithner

Leithner & Company Ltd

My two most recent wires (Recessions usually crush shares – but investors can always reduce their ravages, 31 October and How low could stocks go in 2023? 14 November) established six key conclusions: 

  1. Investors can’t accurately predict the timing, still less the duration or severity, of recessions. Nor, it’s hardly worth adding, can central bankers and economists.
  2. Downturns in the U.S. cause equities to fall – not just there, but also here in Australia.
  3. As measured by their current Cyclically-Adjusted PE (CAPE) ratios, Australian stocks are moderately and American ones are greatly overvalued.
  4. Equities in these countries typically suffer their most punishing losses when recession and overvaluation occur simultaneously.
  5. Both in the short and long terms, a diversified (“60/40”) portfolio of stocks and bonds greatly mitigates recessions’ harmful effects upon investors’ returns.
  6. Whether or not a recession occurs and given their high current CAPEs, the prospective returns of stocks in Australia and the U.S. over the next ten years are mediocre – and a 60/40 portfolio is likely to outperform.  

It’s vital to emphasise: nobody can reliably predict when the next recession will commence. Yet surveys of American economic forecasters (which date from 1970) indicate that they’re presently more convinced than they’ve ever been of a downturn during the next year. And on 18 November, America’s largest and hitherto most bullish bank capitulated and made a recession in 2023 its base case.

“If we do have a downturn next year,” said JPMorgan Chase, “it will be the most well-telegraphed recession in modern memory.” And, I add, if we don’t then it’ll be forecasters’ biggest blunder since their collective inability to detect the GFC until after it had already erupted.

Reliably unreliable “experts” reckon that a recession is nigh. How is Leithner & Company responding to equities’ current overvaluation and preparing for the economy’s – and stock markets’ – next downturn? 

On 18 February 1995, The New York Times quoted Warren Buffett: “if Fed Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, I wouldn't change a thing (Berkshire Hathaway does).” Similarly, even if Leithner & Co. knew whether a recession is going to occur next year, we wouldn’t change what we’ve done since 1999: intensely research the businesses that interest us, buy their shares when they become cheap relative to our conservative valuation, and maintain a conservative allocation to bonds and the like.

As a result, our attitude towards recessions differs fundamentally from the crowd’s. Downturns can reduce the prices of stocks to bargain levels; we prefer to buy shares at such prices; consequently, we don’t fear – indeed, we welcome – downturns. Our conception of recession also distinguishes us from the herd’s. Recessions per se aren’t harmful: it’s the artificial boom that produces the genuine bust that does the damage (see in particular Australia’s bogus boom).

 The hangover, in other words, isn’t the problem to be avoided at all costs: it’s the binge that caused the hangover. The problem isn’t the “high” rates of interest that have appeared this year: it’s the extraordinarily low and patently artificial rates that central banks imposed during and maintained long after the GFC. And inflation per se isn’t the problem: the trouble is the high and rising government expenditure and aggressive monetary policy that creates it (see also Why inflation is and will remain high).

In this crucial sense, recessions can have salutary effects: they usually damage and sometimes destroy the “conventional wisdom” which inflated the boom and bull market which created the bust and bear market. This article elaborates this crucial idea. Using as an example the bull market and Dot Com Bubble of the mid-1990s to the early-2000s, which was the most egregious period of equity overvaluation in American history, it shows that “what everybody knows” at the height of a boom simply isn’t so.

How has Leithner & Co. prepared for the next downturn? We’ve identified the parallels between the Dot Com Bubble and today’s “climate investment euphoria.” Both rest upon unsound (I’m tempted to say “unsustainable”!) foundations. As we did 20 years ago, so we’re doing today: steering clear.

An Enduring Lesson about Ephemeral Conventional Wisdom

Although it dates from the early-19th century, the phrase “conventional wisdom” is often credited to the economist John Kenneth Galbraith. “It will be convenient,” he wrote in The Affluent Society (Houghton Mifflin, 1958), “to have a name for the ideas which are esteemed at any time for their acceptability … I shall refer to these ideas henceforth as the conventional wisdom.”

In its previous usage, conventional wisdom was a synonym of “commonplace knowledge.” Galbraith narrowed its meaning to those beliefs which buttress the authority, prestige and self-esteem of leading members of society (or those who imagine themselves to be) – and which buttress their ability to disparage, ignore or resist inconvenient facts that diminish or threaten their authority and influence.

Conventional wisdom’s economic, financial and investment aspects, adds Maggie Mahar in Bull! A History of the Boom and Bust, 1982-2004 (HarperBusiness, 2004), are “grounded in ... a particular time and place.” Although it’s as fickle as fashion, “conventional wisdom masquerades as eternal truth. And we accept it as such. The consensus provides ... conviction and a sense of community.” That others believe what we profess bolsters our confidence that our beliefs are correct – and that people who doubt or reject what we uphold are certainly incorrect, probably suspect and (these days) even immoral and reprobate. 

Utterly alien and subversive to conventional wisdom and consensus is Benjamin Graham’s maxim: “you are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” That’s why the herd and its shepherds abhor independent analysis – and ignore or ostracise independent thinkers.

The Conventional Wisdom of the Dot Com Era

What was the conventional wisdom that spawned the Dot Com Bubble of the 1990s? What, in short, did “everybody know”? In essence, it comprised four convictions:

  1. Technological innovations that came to fruition during the 1990s (“the internet”) “changed everything” more profoundly and rapidly than previous innovations such as railways, telegraph, aviation, radio and television.
  2. The internet greatly increased (a) the economy’s productivity and (b) its overall profitability – and particularly the profitability of companies at the heart of the revolution.
  3. Investors would gain handsomely by purchasing the stocks of companies that (a) created the internet’s hardware and software; (b) built, owned and/or operated fibre-optic and other networks; and (c) harnessed the digital technology and the internet to revolutionise the “old economy.”
  4. In particular, and because these stocks would certainly rise, their purchase price didn’t matter. Traditional methods and measures of valuation, in other words, had become obsolete.

From the mid-1990s, the average person might reasonably have regarded Premise #1 as plausible. The internet was becoming ubiquitous and enabling people, cheaply and quickly, to do things that they couldn’t do hitherto. And “tech stocks” were certainly skyrocketing – as one’s irksome next-door neighbour or idiot nephew was constantly reminding everybody. Mr and Ms Average Person increasingly tended to conclude: “if others are apparently getting rich, why can’t I? Why shouldn’t I?”

The mainstream media accelerated the bandwagon. Interviewers were mostly credulous, usually superficial and very seldom sceptical. “Experts” greatly outnumbered sceptics. Further, evangelists were typically granted “soft” interviews whilst non-enthusiasts received tougher questions and even hostile and mocking treatment.

 Hence the vicious cycle of mutual reinforcement: “everybody knew” that tech stocks would continue to rise rapidly because the media said so; and the media said so because “everybody” knew it!

A quarter-century later, reviewing my files, notes and clippings from that time, it remains striking how pervasive – and untested with logic and evidence – the conventional wisdom had become. Among internet and tech enthusiasts, confidence became arrogance. Any scepticism received a combination of condescension and pity. “You just don’t get it” was the most civil reply (others weren’t so polite). 

Yet Mahar astutely adds that “conventional wisdom rarely stands the test of time ... When tested against empirical data extending over decades, the popular wisdom of any era tends to fall apart. This is especially true in financial markets.”

And never in financial markets was it truer than from the mid-1990s until the early-2000s. For brevity, I’ll concentrate upon Premise #2. Overturning it also disproves Premises #3-4. 

The New Economy’s “Productivity Miracle”

Every era’s conventional wisdom has its torchbearers, and Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve System (1987-2006), ranked among the most powerful enthusiasts of the conventional wisdom that formed during the Dot Com Bubble. On 14 July 1997, Bloomberg announced that he had converted to the cause: “the staunch conservative who once personified industrial-era economic thinking has turned into the avant-garde advocate of the New Economy.”

What Bloomberg dubbed “Alan Greenspan’s Brave New World” stemmed from his newfound conviction that that the U.S. was undergoing “a productivity revolution not seen since early in the 20th century.” Workers, he was certain, were producing more goods and services per hour worked. The Bureau of Labor Statistics (a government agency whose widely-respected statisticians had compiled these data since 1947) reckoned that the growth of productivity was mired at 1-2% per annum. No matter: Greenspan reckoned that “statistical distortions are underestimating efficiency gains.”  

Indeed, “the suspected productivity payoff is also making Greenspan more sanguine about the rising stock market ... When he raised his famous concern last December about whether stocks were in the grip of ‘irrational exuberance,’ the Fed chief was worried that corporate profits couldn’t keep pace and that a steep correction might ensue. But (profit) margins have been rising smartly – faster than Greenspan can ever recall. His only explanation: ‘productivity.’”

Then came the real eyebrow-raiser: “so confident is Greenspan of his argument that he has required researchers (at the Fed) to make a secondary productivity measure by ‘zeroing out’ any industry sector – such as health care – where statistics show falling productivity ... In this cost-cutting era, he can’t fathom any sector becoming less efficient.”

In effect, Greenspan ordered his minions to deform the data so that they confirmed his preconceptions. It’s akin to shooting an arrow, painting a ring around where it lands and then exclaiming “we’ve hit the target!”

As long as equities levitated, the New Economy’s evangelists remained unassailable. Not long after Greenspan’s conversion, his underlings compiled data purportedly showing that productivity had grown at double the rate that had allegedly prevailed from 1973 to 1995. But in March 2000 the Dot Com Bubble began to burst – and during the next year reality forced enthusiasts drastically to revise their rosy numbers. “Overestimates of computer software sales and consumer spending” had inflated previous estimates of productivity, reported Jeff Madrick (“Tarnished New Economy Loses More Luster,” The New York Times, 30 August 2001). Indeed, by then it had become clear just “how thin the new-economy thinking has been all along. Those (efficiency) gains turn out mostly to have been the product of counting error.”

Anticipating these revisions, research by James Medoff, an economist at Harvard, published in Grant’s Interest Rate Observer on 26 May 2001, concluded that the only real gains of productivity were limited to the computer industry. And even there, the industry’s predilection for creative accounting made it difficult to be sure.

The problem was – and today remains – that, in both accounting and economic terms, it’s very difficult to ascertain the value of new technology. “Until it is set to profitable employment, a computer is a piece of furniture. Like a piano, its utility depends on the individual at the keyboard,” James Grant shrewdly noted on 26 May 2000. “He may play ‘The Moonlight Sonata’ or ‘Happy Birthday.’” When Greenspan and his band of New Economists attempted to estimate the value of the New Economy’s hardware, software and infrastructure, they assumed, Grant acidly concluded, “that the U.S. workforce studied at Julliard.” 

Figure 1 plots BLS’s productivity data since their inception. On average since 1947, output per hour has risen at an average rate of 2.2% per year. It’s true that from 1995 to 2001 it rose at an above-average pace of 2.8% per year. But it’s also true that from 1947 to 1975 – a much longer period, and well before the internet – it rose almost as fast (2.7%). Above all, since 2001 productivity has decelerated. Comparing the years before and since 1975, the average rates of growth are 2.7% and 1.8% per year respectively.

Figure 1: U.S. Non-Farm Labour Productivity (Output per Hour), Quarterly Observations and Annualised Rates of Change, 1947-2022

Bluntly, there’s no compelling evidence that the internet and associated technology has increased American workers’ productivity. Nor was there at the time: bur in a mania, nobody permits mere data to dampen their spirits.

Profits during the Dot Com Bubble

For enthusiasts of the New Economy, it was obvious: the more corporate America purchased – the conventional wisdom’s received form of words was “invested in” – IT, the more efficient its workers would become; moreover, this improved efficiency would inexorably beget higher profits. “Trouble is,” Jeremy Grantham, a Boston-based funds manager and sceptic of the New Economy (and especially its astronomical valuations) tartly noted, “productivity can have very little to do with profits.” 

In just two more sentences, he fired a torpedo that struck the New Economy below the waterline: “imagine what would happen if you lay a lot of (fibre-optic) cable, and it turns out to have five times more carrying capacity than before. It’s wonderful for productivity, and devastating for profits” (see “Q&A with Jeremy Grantham,” Business Week, 18 March 2002).

More spending on technology can boost capacity, but increased capacity doesn’t necessarily beget higher profits. Quite the contrary: when businesses sink scores and perhaps hundreds of billions willy-nilly into “technology,” more capacity can quickly becomes excess capacity; and as supply swamps demand, prices – and profits – sag. 

By 1997, that’s precisely what was happening in the New Economy’s hottest sectors. Investors who were eager to buy tech stocks at any price financed the boom of capital spending, and the Fed joined the party by suppressing rates of interest below levels that would have prevailed in unfettered markets. “Investors” reckoned that another chip factory or fibre-optic cable network would provide risk-free return. In reality, it generated return-free risk.

Figure 2: U.S. Corporate Profits Before Tax, Trillions of CPI- and Seasonally-Adjusted $US, Quarterly Observations, Annualised, January 1961-April 2022

Using data collated by the Federal Reserve Bank of St Louis, Figure 2 plots U.S. corporate profits before tax since 1961.

At precisely the time the New Economy’s enthusiasts gushed that (allegedly thanks to the internet) profits were exploding, they were actually sagging.

Expressed in current (September 2022) CPI-adjusted dollars, corporate profits rose from $1.3 trillion in early-1995 to $1.5 trillion in October 1997, and then plunged by almost half – to $1.0 trillion – in October 2001. At that point, profits were lower than they’d been 40 years earlier in the mid-1970s. It’s true that they exploded to $2.7 trillion in October 2006 – and then collapsed to $1.2 trillion in October 2008. It’s also true that since the GFC corporate profits have again vaulted: they rescaled their pre-GFC high in January 2012, fluctuated without trend until 2019, began to sag, fell modestly during the Global Viral Crisis – and skyrocketed above $3.5 trillion in April 2022. 

How much of this has to with the internet? I’d say very little. How much has to do with astronomical quantities of fiscal and monetary dope (“stimulus”) as well as a heaping helping of corporate accounting legerdemain? It’s the subject of another article, but I’d say plenty.

In the late-1990s, enthusiasts of the New Economy were as attentive as Mister Magoo to the true state of corporate profitability. But James Grant knew that something was afoot. “Presented with the financial means to build the extra semiconductor fabricating plant or the marginal personal-computer manufacturing plant, the world’s high-tech manufacturers have not hesitated,” he noted (“The Bulls Stand Corrected,” The New York Times, 29 October 1997). “A huge expansion of manufacturing capacity is under way ... The result is a boom in productive capacity – and a collapse in prices of memory chips and personal computers, the most basic commodities of the information age.” Returns on these mammoth investments, in other words, were often scant. 

No matter: at the same time that fundamentals were deteriorating, tech shares zoomed. What could possibly go wrong?

A Leading True Believer and a Less-Prominent Sceptic

According to Mahar, “if Alan Greenspan (was) the father of the bull market of the nineties, then Abby Joseph Cohen … would be its muse.” From 1983 until 1988, she was vice president of investment strategy at Drexel Burnham Lambert. Following the Michael Milken fiasco and subsequent U.S. Department of Justice investigation that triggered the firm’s demise, she joined Goldman Sachs (as a vice president and co-chair of the Investment Policy Committee) in 1990, was named a managing director in 1996 and a partner in 1998.

Cohen is remembered as a – and perhaps the – leading proponent of the bull market which commenced soon after the recession of the early-1990s. She was Institutional Investor’s top strategist in 1998 and 1999; by then, she’d developed the reputation as a “perma-bull.” According to Mahar, “if CNBC’s blow-by-blow reporting sent your blood racing, Cohen’s confident composure could settle your nerves … Her genius was that she could make even an irrational market seem perfectly sensible, at least for a time.” In other words, she rode the stampeding bull – until it bucked her.

If the Dot Com Bubble was her making, the Dot Com Bust and GFC were her undoing. After March 2000, as the economy foundered and the stock market (particularly tech stocks) collapsed, she remained bullish. Her reputation suffered further – indeed, it never recovered – when she utterly failed to foresee the GFC. In December 2007, as the most optimistic of 14 major Wall Street forecasters, she predicted that the S&P 500 index would rally to 1,675 in 2008. Instead, it sank as low as 741 by November 2008 – 56% below her prediction. In March 2008, Goldman announced that it had “replaced” (I suspect that’s a euphemism for “sacked”) Cohen as its chief forecaster for the U.S. market.

James Grant began his journalistic career at The Baltimore Sun in 1972, shifted to Barron’s in 1975 and founded Grant's Interest Rate Observer in 1983. Since then, GIRO has appeared fortnightly and his books every few years. 

Grant is perhaps the finest financial writer – and surely one of the most intelligent, independent and forthright assessors of markets – of the past generation. Yet at first GIRO’s success came slowly. As he wrote in Minding Mr Market, “a critic complained that Money of the Mind, my ... history of American finance, was like an account of the interstate highway system written from the point of view of the accidents. The same might be said, both fairly and unfairly, of Grant’s (Interest Rate Observer). Where most observers of the 1980s emphasised the rewards, we dwelt mainly on the risks … We saw not the bull markets of today but the comeuppance of tomorrow.”

GIRO’s scepticism served its readers admirably in the early-2000s. Reviewing Mr Market Miscalculates in The Financial Times (“Profit from Prophesies of Doom,” 24 November 2008), John Authers wrote: “if Grant could see what was happening this clearly … and warn of it in a well-circulated publication, how did the world’s financial regulators fail to avert the crisis before it became deadly, and how did the rest of us continue to make the irrational investing decisions that make Mr Market behave the way he does?”

I append the corollary: why did Cohen, the modeler and forecaster, overlook what Grant (the student of history) saw and foresaw? It wasn’t merely that Cohen was an optimist and Grant a realist. Much more fundamentally, Cohen was an employee of a major financial institution whereas Grant ran his own financial publishing business.

 “Show me the incentives,” Charlie Munger has sagely quipped, and I’ll show you the behaviour.” Career-wise, the independent publisher (Grant) could afford to speak his mind – and the hired hand (Cohen) couldn’t. The consequence is fundamental: in Mahar’s words, “from a business point of view, no (strategist employed by a major institution) on Wall Street has any earthly reason ever to suggest that the market is overpriced.” And so they rarely do.

Cohen Debates Grant

On NewsHour, the flagship news and current affairs program of the U.S. Public Broadcasting System, on 14 February 1997, Cohen and Grant exchanged views about the U.S. economy and stock market. Here’s an extract from the transcript:

COHEN: I think the stock market is doing as well as it is because the economy itself is doing so well. Since 1991 there have been any number of key structural improvements in the U.S. economy and the stock market is reflecting it.

GRANT: (Today) is an age of wonder, so the question is: how can such (the U.S. economy) be priced in the financial markets, and is any price too high? My answer … is an emphatic yes. And I think the price people are paying now is way too high.

COHEN: (Alan) Greenspan did not say (in his “irrational exuberance” address in December 1996) the U.S. market was irrationally priced. What he said was: “how will we know when it is?” And, by the way, he did specifically say that when inflation is low, stock prices do rise. And that happens because the quality of earnings is good. And when inflation is low, there are reasons to believe that economic expansion will continue. So there is rationality behind stock prices rising when the economy’s doing well.

GRANT: If people walk into (a supermarket), they look for low prices. People walking into financial markets paradoxically seem to prefer high prices. And the way you measure price in terms of stocks is: what do you pay for a dollar of what corporations (are earning)? So these people oddly seem to prefer higher (ratios of prices to earnings) in stocks to lower … The act of investing has driven prices up to what I think everyone must concede are extreme.

COMPERE: Do you concede …, Ms Cohen, (that the prices of stocks) are … extreme? Have they been driven up to what everyone says would consider an extreme?

COHEN: No, I will not concede that point. While it is true that prices are at record levels, so too are the underlying fundamentals. And what we like to look at is how those stocks are priced, relative to the earnings being generated by the companies and so on.

In June 1997, Cohen and Grant again crossed swords publicly (see Lawrence Armour, “Can We Talk? What’s Ahead for the Stock Market, the Economy and the Future of Investing: Market Guru Abby Cohen of Goldman Sachs, Perennial Bear Jim Grant and Mutual Fund Dean Shelby Davis Square Off,” Fortune, 9 June 1997).

 In Grant’s view, prosperity had made investors credulous and lazy: “bull markets ... don’t produce much in the way of vigilance and scepticism. I don’t think the Street is doing as good a job as it might in analysing companies ... A case study in how people forgot to look under the (bonnet) is Centennial Technologies, which had a $1 billion market cap and was the New York Stock Exchange’s top-performing stock in 1996. The former CEO is now in gaol, and the Feds are trying to figure out if any of the sales the company reported were real. This kind of thing happens because, in a (bull market), scepticism doesn’t pay. That being the case, I think you have to expect that many companies are guilty of (exaggerating their) earnings these days.”

Cohen dismissed Grant’s concerns: “we (Goldman Sachs) have just done an exhaustive study that concludes that that the quality of earnings growth is superb. Accounting standards are tougher. The (Financial Accounting Standards Board) has annoyed corporations for years and has forced them to adopt more conservative accounting ... Does this mean there’s no flexibility for companies to do things to their reported earnings? No, but on average the quality of what’s being reported is better now than it has been anytime in my professional lifetime.”

In 2001, Enron and WorldCom plunged into bankruptcy. It subsequently transpired that for years they’d egregiously overstated their earnings. As a result, their auditor, Arthur Anderson – one of the world’s largest multinational corporations and one of the “Big Five” global accounting firms – also collapsed. In 2005, the Federal Home Loan Mortgage Corporation, known as “Freddie Mac,” a government-backed mortgage financing giant, admitted that over the years it had greatly overstated its profits. And in 2008 came the collapse of Lehman Brothers and the bailout (after recording a loss close to $100 billion) of American International Group – and plenty of others.

The irony is gobsmacking: Cohen crowed that “the quality of (earnings) is better now than it has been anytime in my professional lifetime,” yet their actual quality was as bad as at any time in American history. So much for the quality of earnings! So much for the bulls’ “expertise”!

Uncomfortable – for large financial institutions – questions thus arise: did Goldman really conduct an “exhaustive study” – or was it merely disguised marketing?

Most disquieting of all, after a quarter-century has anything really changed? And if you doubt that it has, then why on earth do you ever pay the least bit of attention to upbeat pundits employed by major financial institutions?

Bulls Are Apparently Long “Right” – and then Suddenly and Catastrophically Wrong

By this point, and probably well before, if you’re a bull you’ll probably be protesting: “you’re being grossly unfair to Cohen! Sure, she erred at the apex of the Dot Com Bubble, but she and her bullish mates had been right about the bull market for the better part of a decade. And yes, Grant might have been correct at the top, but he’d been continuously wrong all the way to the top.”

The response is obvious: Cohen and the bulls didn’t make a mere run-of-the-mill “mistake.” Theirs wasn’t the usual misprediction of a company’s or the market’s “forward” earnings: it was an inability to detect what was by far the most egregious overvaluation of equities in U.S. history (see Figure 1 in How low could stocks go in 2023?). They also grossly overestimated corporate earnings and misinterpreted macroeconomic reality.

And just a few years later, she and the bullish consensus failed to foresee the greatest economic and financial crisis since the Great Depression. These weren’t mere “errors” – they were catastrophic blunders that permanently blighted the finances – and thus the futures – of scores of millions of households in the U.S., and millions more around the world.

Cohen’s career demonstrates that it’s easy being a booster, and Grant’s shows that it’s hard being a sceptic. That’s not just because bulls typically greatly outnumber bears; even more importantly, for long periods – years on end – bulls are apparently “right” and bears are seemingly “wrong.” As a result, for years Cohen and the bulls received promotions from their employers, and applause and bouquets from the media and investors (most of whom were actually speculators). In sharp contrast, Grant and the bears got mostly silence and some scorn, boos and brickbats.

The analytical, sceptical bear is often a plodding, unfashionable and above all a slow and “underperforming” tortoise. In contrast, the credulous bulls are typically fashionable, overachieving hares. Then, often very suddenly and unexpectedly, reality rudely reasserts itself: it transpires that all along the bulls had been spectacularly and ignominiously wrong and the bears unquestionably and gloriously right. Over the long run, reason prevails: the tortoise triumphs and the hare fails (see in particular Investors, beware: It’s THAT time of year again! and How the 60/40 portfolio outperforms).

Michael Lewis (“Why James Grant Will Never Become Louis Rukeyser,” Bloomberg, 29 October 2002) elaborated: “for anyone who sets out on a career (in financial media and funds management), there is a very clear incentive to become a bull … The host of “Louis Rukeyser’s Wall Street” (a popular weekly show on PBS TV) has made a fantastically good living for 30 years by ridiculing bearishness in all its forms, and celebrating bullishness in most of its forms.” 

“Even with the Dow falling fast, it is impossible to imagine a bearish version of Louis Rukeyser’s gaudy worldly success. Just as we grossly exaggerate the importance of (bulls), even when those people are dimwits, we grossly diminish the importance of those who say the stock market (will go) down – even when those people are first-rate thinkers.”

“James Grant, for instance. The editor of Grant's Interest Rate Observer is one of the most interesting market analysts alive. Even in a bull market his views are far more stimulating and original than those of most bullish pundits. For going on 15 years he has argued, with wit and clarity, that the U.S. stock market is a house of cards. If there was any justice in the world right now, James Grant would be a household name, feted for his prescience, offered huge sums for his public speeches, perhaps even recognised on occasion by New York taxi drivers.”

Has Climate Hysteria Fomented the Latest Financial Mania?

The “New Economy” that inflated the Dot Com bubble was largely a sham. It didn’t increase productivity; nor did it boost profitability; and it certainly didn’t render valuation obsolete. Although its cheerleaders were apparently “right” during the boom, the bust proved that they’d actually been catastrophically wrong all along.

With the perspective of a quarter-century, what lessons should we draw from that era? One venture capitalist, who funded start-ups whilst the bubble inflated and lost 90% of his net worth when it burst, remains unrepentant: “nothing important has ever been built without irrational exuberance … You need some of this mania to cause investors to open up their pocketbooks and finance the … railroads or automobile or aerospace industry or whatever. And in this (Dot Com) case, much of the capital invested was lost, but also much of it was invested in a very high throughput backbone for the Internet, and lots of software that works … All that stuff has allowed what we have today, which has changed all our lives … That’s what all this speculative mania built.”

The riposte is obvious: what have these benefits cost? A large percentage of American households – and a majority of poorer ones – haven’t recovered financially from the Dot Com Bubble, GFC and their associated recessions (see America’s permanent recession: Is it coming to Australia?).

Among the Dot Com Bubble’s severest costs has been the loss of memory that paves the way for the next boom – and bust. “For practical purposes,” wrote John Kenneth Galbraith in A Short History of Financial Euphoria (Viking, 1990), “financial memory should be assumed to last, at a maximum, no more than 20 years. This is normally the time it takes for the recollection of one disaster to be erased and for some variant on previous dementia to come forward to capture the financial mind. It is also the time generally required for a new generation to enter the scene, impressed, as had been its predecessors, with its own innovative genius.”

Twenty years after the Dot Com Bubble burst, what “variant on previous dementia” has reappeared? Who are today’s “geniuses”? The parallels of “the internet will change everything” with the “inevitability” and ”imperative” of decarbonisation, intermittent energy, etc., are striking.

It’s Unprecedented!

Just as the “new economy” wasn’t new, “climate change” has always been a constant. Yet “uniformly in all such (financial dementias that create euphorias),” observed Galbraith, “there is the thought that there is something new in the world.” People today are once again succumbing to the same error their forebears repeatedly did: “the circumstances that induce the recurrent lapses into financial dementia have not changed ... since the Tulipomania of 1636-1637.”

More Rhetorical Overkill

The fundamentals of the new economy were fantasies; similarly, today’s central claims about climate are gross distortions and wild exaggerations – which the media again trumpet credulously, thereby intensifying the euphoria in financial markets. The latest examples: “The federal government is ... (positioning) Australia as a clean energy superpower,” gushed a journalist in The Australian (25 November).

On the same day in the same newspaper, the federal Treasurer, Jim Chalmers (“Critical Minerals a Chance to Secure Future, Lead World”), asserted that “critical minerals (like lithium) could be the opportunity of the century ... We want to be setting ourselves up for a boom that lasts and benefits that are shared ...” And on 26-27 November, The Weekend Australian editorialised: “the mining industry is on the cusp of catching the big wave of the next super cycle to produce the rare earths and minerals needed to power a lower emissions world.”

Today’s Rising Costs versus Alleged Benefits in the Distant Future

The internet has clearly bestowed considerable benefits upon society. Equally, these benefits have come at considerable cost – not merely huge financial losses of 20 years ago, but also today’s costs to emotional and psychological well-being of social media, cybercrime, etc.

In particular, the internet’s benefits have been dispersed over billions of people over 30 years or more, whereas its costs were concentrated and, financially at least, mostly incurred “upfront.” Today’s climate investment euphoria’s distribution of costs and benefits is no different.

The alleged benefits of decarbonisation, the global energy transition, etc. – “saving the planet,” Australia becoming a “clean energy superpower” which will unleash a “jobs bonanza” – lie years and even decades in the future. Yet their costs are payable today and are mounting rapidly – and the lower your rung on the ladder of income and wealth, the more you feel the cost. According to The Wall Street Journal (“Europe Pays for Green-Energy Illusions,” 21 November), between September of last year and October of this year “governments across Europe have announced €674 billion ($696 billion) in handouts and subsidies to alleviate the burden of skyrocketing energy prices … This is on top of what of what households and businesses are paying in higher energy bills even after the subsidies.” WSJ’s conclusion defies the conventional wisdom:

It’s impossible to say how much money Europe has wasted on its failed green-energy transition over the past few decades. Estimates for Germany alone start in the hundreds of billions of dollars. (The EU’s) taxpayers shouldn’t be surprised if their total bill to bail out that failed energy transition tops $1 trillion in coming years. When it comes to green energy, the motto is ‘pay, and pay again.’”

And in Australia, “Origin Energy chief executive Frank Calabria has called for honesty about the likely increase in power bills (in his budget speech in October, the Treasurer estimated that prices of electricity and gas would skyrocket 56% and 44%, respectively, over the next two years) from the ‘truly staggering’ scale of transformation required for the energy transition this decade, warning that community support for the task ahead could be lost and the whole effort put at risk” (see “‘Honest Dialogue’ Needed on Costs of Energy Transition: Origin CEO,” The Australian Financial Review, 22 November).

How long will Western nations sacrifice a bird in the hand (the world’s highest standards of living) in exchange for experts’ and politicians’ pie-in-the-sky and distant promise of two birds in the bush (“saving the planet,” “green energy superpower,” “jobs bonanza”) – while countries that comprise the vast majority of the world’s population increase their consumption of fossil fuels in order to exit from poverty?

Qui Bono?

The Dot Com Bubble enabled a handful of people to become multi-billionaires – and left a trail of financial misery, affecting scores of millions of people, in its wake. Whom does today’s climate investment hyperbole benefit? Galbraith pulled no punches: “the (mania) is protected and sustained by the will of those who are involved, in order to justify the circumstances that are making them rich. And it is equally protected by the will to ignore, exorcise or condemn those who express doubts.” In an interview on 22 November, Satyajit Das referred to crypto-currencies, but his point applies equally to decarbonisation, ESG, EVs, intermittent energy and rare earths: “there is a whole bunch of people who are very skilled in terms of exploiting investors’ desire for rapid riches.”

The Internet Revolution Is Real, but the “Global Energy Transition” and “Net Zero” Are Fantasies

On CNBC’s Squawk Box on 4 October, Jeff Currie (Global Head of Commodities Research at Goldman Sachs), let the cat out of the bag:

Here’s a stat for you … At the end of last year, overall, fossil fuels represented 81% of (the world’s) overall energy consumption (and solar and wind just 3%). Ten years ago, they were at 82. So … you’re talking about … $3.8 trillion of investment in renewables (which has) moved fossil fuel consumption from 82% to 81% of overall energy consumption. But you know, given recent events (in Europe and particularly Ukraine) … that number is (now) likely above 82. So when we think about what those renewables have added … clearly we haven’t made any progress.

The “global energy transition” hasn’t merely been a fantasy: it’s been increasingly – and, if the delusion persists, will become ruinously – expensive. In a comment to Investing in the energy transition (and the companies leading the way), Peter Ralph referred to Currie’s admission: “what can we extrapolate from this?” If a reduction of one percentage point of fossil fuels’ share of the world’s total consumption of energy has cost $3.8 trillion (including subsidies, estimates are as high as $5 trillion), “we have a minimum of another $320 trillion to go.” The International Energy Agency’s estimate of net zero’s total cost globally to 2050 is $130 trillion, the Bank of America’s is at least $150 trillion, BloombergNEF’s New Energy Outlook 2021’s estimate is up to $173 trillion and McKinsey’s is as high as $266 trillion. 

Most recently, on 8 November, Citi released three Global Perspectives & Solutions (“Citi GPS”) reports. One of them, Climate Finance – Mobilizing the Public and Private Sector to Ensure a Just Energy Transition, reckons that “a cumulative total of $125 trillion in capital investment is needed for the global economy to reach net zero by 2050. This translates into $2.6 trillion per annum over the next five years, increasing to $3.6 trillion per annum from 2026-2030. An estimated $600-900 billion was invested in 2020, which is substantially lower than what is needed to limit the negative impacts of climate change …”

At current rates of exchange, Citi’s and IEA’s estimates are approximately $A200 trillion. Given that Australia emits ca. 1.5% of the world’s annual emissions of CO2, its pro rata share of the total, global and cumulative capital expenditure required to achieve “net zero” is at least $A3 trillion. “Net zero by 2050” will thus necessitate capital expenditure in Australia of at least $A100 billion per year, every year for the next 28 years.

Using data compiled by the Australian Bureau of Statistics, Figure 3 plots CPI-adjusted capital expenditure in the electricity, gas, water and waste services sectors. It rose from $198 million in the year to March 1988 to $10.0 billion in the year to June 2022. That’s a compound annual growth rate (CAGR) of 12.2%. During the past decade, however, the CAGR has decelerated to just 4.0%. ABS will likely record in other sectors some of the ca. $100 billion per year (and perhaps much more) of capex that will be required to achieve net zero by 2050. Equally, however, the electricity sector will rank among its major recipients. 

Figure 3:Capital Expenditure, Electricity, Gas, Water and Waste Services, Quarterly Data, Billions of $A, Annualised and CPI-Adjusted

Realistically, and given its current rate of growth, can this sector’s capex immediately skyrocket to an amount that’s several multiples of its current level, and remain at such a level for the better part of 30 years? I strongly doubt it.

Figure 4:Capital Expenditure in Australia, All Sectors, Quarterly Data, Billions of $A,Annualised and CPI-Adjusted

Figure 4 plots Australia’s total CPI-adjusted capital expenditure per year. It’s increased from $77.9 billion in 1988 to $142.4 billion in 2022. That’s a CAGR of 1.8%. It’s true that capex rose by slightly more than $100 billion from the year to March 1999 ($103.3 billion) to the year to March 2013 ($209.6 billion). But this doubling took the better part of 15 years – and was prompted by a mining and energy boom underpinned by China’s rise. And the boom didn’t last. Indeed, it soon sagged: by the year to June 2017, capex fell one-third to $141 billion; since then, it has fluctuated around this level.

It’s reasonable to suppose that the some of the ca. $100 billion or more of capex required per year to achieve net zero by 2050 will render superfluous some that currently occurs. I’ll assume, arbitrarily but simply, that 10% of what occurs today will no longer be required; so that’s “non net zero” capex of (1.0 – 0.1) × $142.4 billion = $128.2 billion. Then add to this amount what’s required to achieve net zero by 2050 – at least $100 billion per year, and perhaps much more, for 28 years. So that’s total capex, beginning immediately, of $128.2 billion + $100 billion = at least $228 billion per year until 2050.

 Can capex on the scale that developed gradually as a result of the China/mining boom occur immediately and continue every year for the next 28 years? That’s what “net zero by 2050” requires. Hence I strongly doubt that it’ll eventuate. If so, it’ll remain what it is today: a pipe dream.


What’s the conventional wisdom that’s spawned today’s “climate investment euphoria”? What, in short, does “everybody know”? In essence, it comprises five convictions:

  1. “Climate change” entails horrific costs and absolutely no benefits; rising levels of CO2 are its chief or even sole cause.
  2. Burning fossil fuels is the principal cause of rising levels of CO2; using coal, gas and oil imposes huge costs and provides no benefits that “clean” energy cannot also provide – and much less expensively.
  3. “Decarbonisation” is therefore imperative and inevitable.
  4. In Australia, the costs of “net zero” are affordable and its benefits are immense. These benefits include “saving the planet” from a “climate catastrophe,” becoming a “clean energy superpower” and unleashing a “jobs bonanza.”
  5. Investors will gain handsomely by purchasing the stocks of companies at the centre of the “global energy transition.”

The American humourist and writer, Mark Twain, is usually credited with the adage “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Conventional wisdom, as Maggie Mahar observed, is “grounded in ... a particular time and place,” yet it “masquerades as eternal truth. And we accept it as such.” In 1985, Warren Buffett told Newsweek: “you can’t buy what’s popular and do well.” I add a corollary: you can’t succumb to today’s conventional wisdom and emerge unscathed. 

Like the conventional wisdom that inflated the Dot Com Bubble, at some point reality will intrude and people will recognise that each of these five elements of today’s conventional wisdom is highly doubtful or flatly false. Most fundamentally, there simply is no “climate crisis” – and assertions to this effect are the wild exaggerations of blatant hypocrites. There is, however, a “climate policy crisis” in the sense that the proposed “cures” (policies) aren’t merely useless (levels of CO2 will continue to rise regardless) and enormously costly: they’re worse than the disease (a mildly warming climate).

A bust, if it’s like the one that punctured the “New Economy” and Dot Com Bubble, will sweep into the bin like yesterday’s rubbish today’s investors’ delusions euphoria regarding the “global energy transition.” In the meantime, what to do?

During the Dot Com Bubble, Buffett famously avoided tech stocks. In consequence, he initially “underperformed” and received much criticism, but was ultimately vindicated. These days, Leithner & Company is steering clear of the climate investment mania. Like James Grant, we don’t celebrate today’s bull market: we anticipate tomorrow’s comeuppance. We’ve long been sceptics of conventional wisdom. Consequently, over the years we’ve received brickbats – and have twice (Dot Com Bubble and GFC) been vindicated. Time will tell whether our scepticism towards the climate investment euphoria is justified.

Three more quotes from Galbraith’s A Short History of Financial Euphoria encapsulate the gist of our preparations:

  1. “The only remedy (for financial euphoria) … is an enhanced scepticism that would resolutely associate too evident optimism with probable foolishness …” (see also Why you’re probably overconfident – and what you can do about it).
  2. “Let the following be one of the unfailing rules (regarding scaremongering about and attempting to profit from ‘climate change’): there is the possibility, even the likelihood, of self-approving and extravagantly error-prone behaviour …” (see also Investors beware: “Cheap” renewables are very expensive).
  3. “A further rule is that when a mood of excitement pervades a market or surrounds an investment prospect, when there is a claim of unique opportunity based on special foresight, all sensible people should circle the wagons; it is the time for caution” (see also Decarbonisation: A doubter’s guide for conservative investors).

Galbraith’s overriding conclusion is obvious in retrospect. The fanatics of the internet dismissed it during the late-1990s, but by 2003 reality obliged them ruefully to concede it. Today’s climate zealots contemptuously and even angrily deny it. But as reality asserts itself, euphoria abates and they incur crippling losses, I suspect that some of them will finally admit it:

“Fools, as it has long been said, are indeed separated, soon or eventually, from their money. So alas, are those who, responding to a general mood of optimism, are captured by a sense of their own financial acumen. Thus it has been for centuries; thus in the long future it will also be.”

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This blog contains general information and does not take into account your personal objectives, financial situation, needs, etc. Past performance is not an indication of future performance. In other words, Chris Leithner (Managing Director of Leithner & Company Ltd, AFSL 259094, who presents his analyses sincerely and on an “as is” basis) probably doesn’t know you from Adam. Moreover, and whether you know it and like it or not, you’re an adult. So if you rely upon Chris’ analyses, then that’s your choice. And if you then lose or fail to make money, then that’s your choice’s consequence. So don’t complain (least of all to him). If you want somebody to blame, look in the mirror.

Chris Leithner
Managing Director
Leithner & Company Ltd

After concluding an academic career, Chris founded Leithner & Co. in 1999. He is also the author of The Bourgeois Manifesto: The Robinson Crusoe Ethic versus the Distemper of Our Times (2017); The Evil Princes of Martin Place: The Reserve Bank of...

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