Money Manager Nightmare: “How Can I Explain To My Clients That We Had A Third Crash In 15 years?”

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A wealth manager told me last week that some of his elderly clients were now coming into his office, and they’d say, “I’m tired of getting ripped off on my CDs and Treasuries; my kids tell me that I can make 25% a year with stocks. Get me into some stuff that can do that.” How much were they were willing to lose? “Nothing,” they’d say.

They wanted a risk-free 25% return, something that’s readily available nowadays in the stock market, no problem. The S&P is scheduled to hit that point over the next few days. With two month left to go in the year, its gains will certainly exceed 30%. Stocks are no longer at risk of even a mild downdraft. Certainly not of a serious correction. Those belong to the past. They’ve been going up relentlessly, independent of corporate fundamentals or economic data, both of which have been dreary recently.

Which puts him in a quandary. He’s worried that he’ll lose some of his clients if he tried to protect their money. And he is worried that he’ll watch them destroy their nest egg if he follows their wishes.

When he tried to show his institutional clients with graphs and economic reports that there was a mismatch between ballooning stock valuations and reality, he got enormous pushback. No one wanted to hear it. Some people in his network are now refusing to answer his emails. They’ve blocked him out. They’ve blocked out information that is contrary to their beliefs. They’re seeing nothing but unlimited upside without risks. Social pressure is building on industry insiders to conform – or else they’ll be marginalized. We’ve experienced this paradisiacal era before: In early 2007 and in very early 2000 – each time at the cusp of a crash.

Even economists who can somehow manage to see some issues can’t accept that these issues mean anything for stocks. Late last week, Gustavo Reis, a senior international economist at Bank of America, wrote that global activity was ‘less than stellar” and that the data was “mixed.” The US outlook was “particularly foggy.” But he had his spin: “It is better than it looks.” Message: The data is crummy and the outlook is foggy, but stocks will go up.

It certainly has been one heck of a party, thanks to the Fed. How could anyone be crazy enough to want to miss out on this craziness?

Take the IPO market. What a blast we’re having. In October, 33 companies went public and raised over $12 billion. Then there was the Container Store. It has been around since 1978, but in July 2007, at the peak of the prior credit bubble, private-equity firm Leonard Green acquired most of it. On Friday, it was time to unload. That babe doubled on its first day of trading, from its IPO price of $18 a share to over $36. That’s what everyone wants. Not 25% a year, risk free. That’s lame. Any index fund can do that. But 100% in a single day. And yet, the company cranked out a loss last year and still doesn’t know how to make money.

It’s not unique. So far this year, 6 IPOs doubled on their first day, the Wall Street Journal reported. And 41% of the companies that went public had undergone LBOs, during which they’d been loaded up with debt. That debt, most of which continues to exist post-IPO, turns them into precarious structures if the Fed’s zero-interest-rate environment were to dissipate. Now their private-equity owners are unloading at peak valuations.

Then there’s Twitter, the shining star. Its losses are expected to continue to grow. Its IPO price was raised today in the general euphoria to give it a market capitalization of over $15 billion, compared to Facebook’s $16 billion when it went public and flopped. But Facebook is making money. And it’s much larger.

There have been 190 IPOs so far this year that raised nearly $50 billion. The average gain in share price for IPOs so far: 30%. Not bad, given that many happened over the last few months. In 2012, already a hot year, 132 IPOs raised $45 billion.

A new – or rather refurbished – rationalization for tech IPOs is being dragged out of the barn: disrupt. For example, “In a slower-growth environment, the newer names are much more likely to be disruptive,” explained Alan Gayle, senior investment strategist at RidgeWorth Investments. “Disruptive companies are more likely to grow their top line at a fast pace,” he added. The top line – revenues – is the only place apparently where there is room for hope in many IPOs, their bottom line being a hopeless affair for years to come.

And US IPOs of Chinese companies are becoming hot again. These deals are fraught with perils, ownership uncertainties, and a disastrous history. But I’ve already heard it again: this time it’s different. Shares of Qunar, an online travel-bookings service, soared 89% the first day. And shares of China’s Craigslist, 58.com, jumped 42%. Or rather their loosely connected American depositary shares did, because US investors can’t actually own real shares of these companies.

Year to date, 61% of the companies that went public have lost money in the 12 months before their IPO, the highest ratio since 2000 – at the tippy top of the dotcom bubble. It was obvious back then, too. And when all the people who’d planned on getting out when things turned iffy got out, it become a bottomless pit.

Which is what the wealth manager asked: “How can I explain to my clients afterwards that we had a third crash in 15 years?”

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