Dr Doom & #39;S Gloom-Laden Prophecies

Recently Mumbai was host to Marc Faber, aka Dr Doom, the fund manager and famous bear from Hong Kong. His Gloom, Boom and Doom report has a major fan following, and his lecture in Mumbai told us why he commands such respect.

Dr Faber's forte is economic history, and his presentation at a reception organised by Enam Securities was a superbly erudite performance, peppered with a wide range of examples drawn from hundreds of years of economic and stock market history.

Faber believes that the US, and perhaps the world market, is recovering from "history's largest financial mania". This was a technology driven boom, bringing with it the ills of all such booms. These include an overestimation of demand and underestimation of supply, competition from new technologies, a rapid rate of obsolescence, excessive valuations, and falling cost of capital.

The problem with investing in technology stocks, says Faber, is that the pioneering companies are not usually the ones that survive and prosper. For instance, many US stocks which were the leaders in the period 1966-73 bit the dust in the next three years.

While companies like IBM survived, their stocks underperformed the index. What's more, the speed of penetration of technology is getting faster all the time. For instance, while it took 45 years for electricity to reach 25 per cent of the US population, it took the internet about 5 years. For companies, the product cycle is getting more and more compressed.

In other words, the cycle from starting a company to taking it public to reaching a growth plateau has become much shorter, and companies producing new products remain very profitable for only a short length of time. The accelerated pace of change is true of countries as well.

The UK doubled per capita income in 58 years, between 1780 to 1838. The US did it in 47 years, from 1839 to 1886. Japan took 33 years, South Korea in 11 years, and China did it in 9 years, from 1987 to 1996. But was the recent boom in the US a result of money flowing into the US attracted by superior technology and returns? Or was it the money flows themselves that caused the above-average investment and growth?

The answer to this question will determine what happens to money flows in the US. If it is merely the flow of money that was behind the boom, then any shift in sentiment by investors would result in money flowing out of the US, which would lead to a massive slump.

But there is little doubt that huge foreign flows have helped sustain a massive current account deficit in the US. As usual, Faber cites figures to prove his point: in 1982 15.4 per cent of Treasury issues were owned by foreigners, by the first quarter of 1999 that percentage had increased to 34.4 per cent.

Faber also points to massive over-investment in technology, and does not predict a speedy return to normalcy. Moreover, the US boom was funded by an explosion of debt. From 1994 to 2000, the gross domestic product of the US grew by US$2.7 trillion.

However, corporate and consumer debts were up by US$4.8 trillion and financial debt up by US$4.1 trillion. Other economists too have pointed to the fact that it is only the confidence of the American consumer that was holding up the US economy, after massive over-capacity in the information technology industries led to investment demand falling off a cliff.

Once the wave of layoffs and mounting unemployment dents consumer confidence, as seems to have happened after the September 11 attacks, a deep recession is a certainty. But the professor of doom and gloom is extremely bullish on China. China's competitiveness in manufacturing is an established fact, as shown from its rising market share in US, European and Japanese imports.

And China is going up the value chain---for example, Chinese electronics exports as a percentage of total exports has increased from around 13 per cent in 1996 to over 17 per cent in 2000. Moreover, Chinese exports are increasing at the cost of Southeast Asian countries. The Asian tigers may never be the same again.

What about India? Dr Faber is extremely bullish about the Indian software sector, pointing out that its cost advantages will ensure its success. But that bullishness also has a dark side, a side that he left unsaid.

The assumption is, and it's a very valid assumption, that the Indian manufacturing sector is no great shakes. The implication is that we'll have a vibrant service sector, catering to foreigners, a few competitive manufacturing firms, and great inequality.

Faber is known to have advised investors to take advantage of China's growth outside China, for example by buying into hotels in southeast Asia, because they could cater to a large number of Chinese tourists in the coming years. That's probably why he recommends buying real estate in Indian tourist resorts as well. It is not a pretty picture, nor is it an economically or politically viable one.