Speculation gets even loonier!

Contrarian Chronicles12/4/2006 12:00 AM ET

By Bill Fleckenstein

The evidence grows that the unwinding of the asset bubble is liable to be rapid -- and brutal.

While out of the country recently, I did something I haven't done in 20 years. I ignored the markets. I did not read a newspaper. I did not check my e-mail. I did not check my voice mail. I left instructions for my office to call me only if something dramatic transpired. (I wasn't contacted.)

In praise of being unplugged

Why do I bring this up? To make the point that being removed from all information granted me the perspective that's often denied to those in the trenches. Upon my return, it was more clear to me than ever that we are at a speculative zenith of major proportions.

It is truly remarkable how reminiscent the current mindset is of the 1998-2000 stock mania, when every week would see hundreds of upward price-target revisions. Having said that, in my opinion the current psychology amongst so-called professionals is even loonier.

In the previous mania, the bulk of the madness was concentrated in technology concepts, especially Internet-oriented ideas, where a company that boasted a handful of eyeballs viewing its Web site could be worth tens of billions. Today, the insanity is spread out in various different places.

A little freefall for Freescale

Leveraged-buyout madness, for example -- where airlines and semiconductor-equipment fabricators are being leveraged up to go private (prompting dead fish to recommend other companies in those industries, out of the belief that they should be LBO'd as well). Meanwhile, it's worth noting that the bonds of Freescale Semiconductor (FSL, news, msgs) have broken par -- and that after having been lustily sought after when they were originally issued.

Of course, the pinnacle of the lunacy resides in the financial-dark-matter arena, where all forms of financial exotica exist. The latest specimen? A leveraged-up version of the CDO (collateralized debt obligation) known as the CPDO (constant proportion debt obligation). Without going into all the details, this new product supposedly allows for people to get their money back (plus a bit of interest), if its architects are adept at selling more and more premium in the form of credit default insurance (swaps) as the prices go against them. If you think this sounds like a drunken version of portfolio insurance, you would be right. For those who'd like to read more about CPDOs, there is a brilliant primer on the subject in the Nov. 17 issue of Grant's Interest Rate Observer (subscription required).

Long-Term Capital, short-term memory

Turning to another example of folks having lost their minds, a willing crowd now apparently wants to lend $2 billion to hedge fund Citadel Investment Group. I have to ask myself, why would anybody lend money to a hedge fund when it has no assets to claim and its structure thwarts the processes of due diligence and monitoring of one's collateral? Doesn't anyone remember Long-Term Capital Management, which melted down in 1998 and had to be rescued by the Federal Reserve?

When discussing the madness of crowds, it's never possible to predict the outer limits of that madness. Nor is it ever possible to say that the psychology can't get crazier. But in my opinion, the psychology today is about as wild as it can get.

Regrettably, there is no "timing" in that statement. Inflection points -- like tops -- are hard to position oneself around. Change seems to take forever to occur, then happens, seemingly out of the blue. That certainly describes the dollar's serious break, on Nov. 24, for no proximate cause. In all likelihood, it finally sank under the cumulative weight of preceding events, which will be familiar to longtime readers of the Contrarian Chronicles.

Piercing shards 'neath a house of cards

But, whatever "turns" this asset-bubble structure -- and whenever it turns -- the unwinding is going to be brutal, and likely to occur at a rapid clip, given the degree of lunacy on the credit (versus equity) side of the ledger.

And to think that all of this is backed by a thin piece of paper called the dollar, printed at warp speed by the central planners at the Federal Reserve, who brought us the mindless misallocation of capital that created these asset bubbles.

At the time of publication, Bill Fleckenstein did not own or control shares of companies mentioned in this column.