Rational Fools

“If you measure your success by the apoplectic state in which you leave your readers, at least those of us who might naively suppose that reason is the path to Truth, then you have met the challenge!” An old friend, long afflicted

By the Daily ReckoningThe reader was reacting to part two of what has become a trilogy on the role of reason – both in investing and the rest of life.

Rationalism is held up as a god. Reason is worshipped as not merely a source of truth, but the only source. The Internet, the most recent and perhaps most marvelous handiwork of this god, is regarded by many as the crown of rational creation. The Internet, or so the creed goes, allows everything of importance to be digitized, reduced to binary signals, plus or minus, black or white, and spread over the entire world. Its evangelicals have proclaimed it the solution to all the world’s ills – from material shortcomings to moral ones. Glory halllelujah and amen.

These Internet evangelists have created what Tor Norretranders calls “an advanced illusion” that has rearranged the entire world to rationalize their own desires. It is salvation they seek…salvation from a real world that requires real work and real virtue…a world in which people make a lot of mistakes and spend a lot of time and money before any major advance is made…a world in which limits of all sorts, from interest rates to marriage vows, restrain activity and cut short fantasy.

The Internet, with its promise of unlimited financial growth without real investment or genuine sacrifice…and it’s promise of easy sex without cardinal sin…and wealth without work or larceny – the Internet is one of the greatest promises of a New Era since the time of Christ.

And yet, as Norretranders tells us: “The ability of consciousness to assimilate the world has been seriously overestimated by our scientific culture.”

One of the great prophets of the Internet Age’s Hyper- Turbo-Logic was a great mathematician named David Hilbert. On September 9, 1930, Hilbert made a speech in Konigsberg, in which he summarized the case for an unlimited faith in human logic and rational thinking. He ended the speech with a rousing declaration: Wur mussen wissen. Wir werden wissen. (We must know; we shall know.)

The speech was recorded and still exists. If you listen carefully, according to his biographer, you can hear him give a sly laugh at the end. He knew it was a joke after all.

Poor Kurt Godel. He took it all too seriously. At the end of his life, as I told you yesterday, he believed people were trying to poison him. So he starved himself to death. The Cartesian logic that had made his career sparkle, tarnished his death. He thought people were trying to poison him; therefore they were.

Positivism – the hollow philosophical notion that only things that can be proven logically or experientially matter – could not help him. Maybe people were trying to poison him. He couldn’t prove they weren’t. Reason could not produce the truth he needed, and his intuition failed him.

Intuition, reason and even instinct all fail at times. The rabbit I ran over last weekend would be alive today if he had abandoned his instinctive reactions. He should have done the rational thing – and simply run across the road, rather than trying to fake out 1 1/2-ton automobile traveling at 50 mph.

Humans could have figured it out. We could have calculated the momentum of the automobile and its trajectory and avoided stepping in front of it.

Few people in the early 19th century were better at this sort of calculation than Napoleon Bonaparte. He was an artillery officer with a gift for mathematics and politics. I mention him because, in terms of logical power, not to mention persuasive rhetoric, Napoleon and Adolf Hitler, both stand out. Both were very good at rational discourse and logical argument.

And this month, June, marks the anniversary of the beginning of their most important campaigns – in which both men decided to invade Russia, Napoleon in June, 1812 and Adolph in June, 1941.

We humans flatter ourselves. Endowed with the power to reason, we believe ourselves superior to the rest of the animal kingdom. But every dog, horse, rat and cow that saw Napoleon’s grand armee or Hitler’s Wermacht pass must have had better sense. Even a field mouse might be said to have been better programmed than a field marshal. Scurrying to safety as the troops passed…did these lowly, furry rodents foresee that they would later gnaw at the bones of fallen soldiers, or at the frostbitten fingers of sleeping ones?

What a wonderful world…where the brightest, though not necessarily the best, that mankind can produce fall into the biggest traps!

“The mind is merely the heart’s dupe,” as La Rochefoucauld put it. The poor man had a wife who was always late. So he kept a pad of paper and a pencil in a special little cabinet he had installed at the bottom of the stairwell. As he waited for his wife to descend, he would scribble his little insights and aphorisms.

Hitler and Bonaparte were duped by their heart’s desires. Their minds went to work producing the rationales with which they could convince themselves and their generals to undertake campaigns of such momumental stupidity that even the crows must have laughed at them.

Are today’s Internet True Believers any different? They believe they have reasoned their way to the truth about this new innovation. They believe that those who cannot see it are just backwards, retrograde, Luddites. And there is no way to prove that they are wrong. Only the God knows. And only the future tells.

But if not reason, what?

Mark Hulbert’s 20-year study of investment advisors produced a curious conclusion. No specific approach to investing – neither fundamentalism, chartism, nor vegetarianism – produced an unequivocal advantage. But there was a clear, hard-to-measure, advantage from discipline. Whatever approach you decided upon, you were better off if you stuck with it – even through periods in which it didn’t work.

Why? Because, otherwise, an investor had only his powers of reason and logic to guide him. This, in effect, left him at the mercy of his emotions. He became the kind of investor who buys the hottest stocks in the hottest sectors at their hottest moment – an approach that is almost always a disaster.

It was far better to choose a time-tested technique and follow it mechanically, slavishly. As Hulbert commented several times, whenever an advisor departed from his own rules, the results were almost always bad.

Beyond investments – rules, habits, traditions, and custom govern our behavior. It may be rational to kill someone who gets in your way. It may even be a good idea, for which your friends and neighbors will thank you. But it is not customary. It may seem reasonable, at the time, to take someone else’s money…or sleep with his wife…or to bear false witness against him – but again, there are rules against these things which you contravene at your peril. These rules are not the product of reason. They are the product of evolution…and recognized, intuitively if not explicitly, for many generations.

The investment markets teach what life itself teaches – humility. You cannot predict the future. You cannot even understand the present. The best you can do is to stick with the rules, do your best, and as I tell Sophia, echoing the words of Doris Day, “Que sera sera.”

Your faithful, humble servant…

Bill Bonner

Paris, France June 30, 2000

P.S. There are some people in this world who are completely rational. They are brain damaged, and have lost all sense of emotion. I’ll tell you more about these “rational fools” next week.

*** “Profit warnings rained on the market’s parade” yesterday, as one analyst put it. The Dow fell 129 points. Nasdaq stocks dropped 63 points.

*** Nothing very exciting. Qualcomm laid off 200 employees. Goodyear said its quarterly profits would be a third less than anticipated.

*** Up…down…up…down…so it goes. But don’t forget, over the long run all you get out of stocks is what they earn – unless you own enough of the business to use the corporate jet or can take your mistress on a overseas junket and put it on the company credit card. Twenty-five companies confessed that their earnings were not likely to be as great as forecast.

*** Hussman Econometrics, as reported by Richard Russell, calculated that S&P earnings have grown at an average of 5.7% over the last 40 years. Even if the New Era hallucinations were reality – that is, even if the virtual productivity gains became real ones – there is still no reason to think that competition would allow higher rates of profit growth in the future.

*** What happens next? Rather than another decade of 15% per year growth in stock prices, “a more probable outlook,” says Hussman, “is that earnings will grow at a longterm rate of 5.7% annually and that at the end of 10-20 years the price/record earnings mulitiple of stocks will be about 15…stocks will be about 13% below current levels a decade from now. Add in dividends and you’re looking at zero total return over a decade.”

*** It could be worse. The total return from 1965 to 1982 was minus 20%. “If you are interested in longterm returns,” continue the Hussman team, “it is madness to try to squeeze 9% out of a market which is priced to deliver zero.”

*** It may be mad, but it is not unpopular. In this last ‘summer of love’ before harsher days arrive, bullish sentiments still prevail.

*** I am “comfortable” said Merrill Lynch analyst Henry Blodget, with Amazon’s prospects. Blodget believes the big river will finally drift into the land of milk and honey…he thinks Amazon will turn cashflow positive before it runs through half of its $1 billion cash horde. AMZN stock fell 2% yesterday.

*** Dell computer has made between 11 cents and 18 cents a share for the last 9 quarters – eliminating non-operating items. Earnings peaked about 6 months ago. Not a spectacular picture. Yet, as William Fleckenstein points out, Dell is still selling at a P/E of 68.

*** Oil rose slightly yesterday. Gold, however, lost $3.60 – giving up about half Wednesday’s gains. July platinum contracts rose $5.60. Harry Schultz, who’s been watching the platinum market for more than 30 years, says he expects platinum to hit $800 before the end of the year…that is, about a 50% increase from current levels.

*** Martin Spring reports from the Gold Conference: “Egizio Bianchini, rated No.1 gold analyst in the latest Reuters survey, told the Paris conference that world output of newly-mined gold has stopped growing, in fact it’s started contracting. Mine production grew 5.2 per cent in 1997 and 2.4 per cent in 1998, but last year it fell 1.4 per cent. Exploration expenditure is also falling, down from $375 million to $241 million this year. Without replenishment of the reserve base, production will decline.”

*** Salon.com is an “editorially excellent content site for culture and political commentary.” But as with a spate of other dot.coms now frantically trimming costs, Salon has been forced to fire 9% of it’s staff – most of them editorial writers, leaving its editorial product “so ravaged that no one will want to read it anymore.”

*** “Why… was this business started in the first place?” asks a writer on Bloomberg. “So a group of talented writers… could perform like barking seals for a year, or two, while an obscure San Francisco underwriting shop bagged $1.3 million in underwriting fees even as their own clients got hosed? This is the new paradigm? If so, you can have it.”

*** “If you bought the IPOs of Goldman – the premier underwriter in the business today,” the author continues, “you’d be the proud owner of dozens upon dozens of total disasters.” He runs down the list: “eToys [would be] worth 7% of what you paid for it. So would your stock in PlanetRx.com Inc. You’d have taken a 75% haircut on you Webvan Group Inc. stock, on your 1-800-FLOWERS.com Inc., on your NetZero Inc., you Agency.com Inc., your E-loan Inc., and on an on and on and on. And if that’s how you’d have done with the best underwriter in the game, imagine how you’d have fared with any of the rest.”

*** Who knows what the future will hold? “Things are coming down the pike more rapidly than almost anyone can keep track of them,” says Doug Casey, “An ‘unauthorized freelance project’ by some kids working for AOL called Gnutella, apparently allows the free exchange of anything and everything without using servers – the things Cisco makes – and can allow users to search the Web without using today’s search engines – like Yahoo!…Even if the Net and Tech stocks weren’t ridiculously overpriced, the reality of what’s going on would make me loathe to hold them. ”

*** By the way…that article on the plant frankensteins, I mean on agriculture biotechs, that I promised yesterday, from James Passin, didn’t actually get put up until this morning. Oops!

*** The people who write America’s editorial pages, with few exceptions, are even bigger blockheads than the people who read them. I scan them daily, just for the perverse pleasure of being appalled. “The triumph in mapping the human genome,” writes Richard Reeves of UPI syndicate, “was a validation of the role of government…” The private sector has demonstrated its willingness to throw billions of dollars at any harebrained project that comes along. Why take money from sane taxpayers too?