Change the Subject!

The melt-up continues. We see in the WSJ the Sherlockian insight that strong earnings just might be “baked into stock prices”. You think? Everywhere we look, we see indicates that the economy was much more resilient than we gave it credit for, that rumors of its demise had been greatly exaggerated. For example, what ever became of that wave of mortgage defaults that was going to set off by re-sets? That this tsunami hasn’t let loose is not just because it has turned out that many of the scheduled re-sets of adjustable mortgages have actually lowered payments. It also has to do with the likelihood that the idiot speculators who indulged in that government sponsored insanity are long gone. The flippers who took that mania to its apex in 2006 either quit showing up about three years ago or started walking away from their losses two years ago. It was speculators who blew the last bit of air into that balloon, and speculators don’t tend to sit and wait, hoping for some kind of uptick to bail them out of their heavily leveraged investment. It is relatively easy to stop throwing good money after bad on a speculation (as opposed to the home in which one resides; one has to live somewhere and pay for it somehow), so we got a flush of defaults not long after the great real estate bubble started to lose air. This was then extrapolated into the inscrutable future and correlated with expected interest rates. Wrong on all counts. Real estate will be a tough way for non-astute investors to make money (as opposed to that rising tide that lifted so many boats for a couple of generations) but it is not dragging us down the way so many smart guys said it would.

Which brings us back to the melt-up. Its not just the marginally astute trying to eke out returns on their still shriveled (relative to the plan, five or ten years ago) retirement stakes. It’s the disappointed, painfully flummoxed Bears. There has clearly been a ton of money bet that the world should have more or less ended by about now, or at least that signs of the end would be clearly in sight. If the short side of things is part of what you do, not much of that has been working lately. A few stocks are trading down, but that’s always the case. More generally, they can trade ‘em down but they can’t keep ‘em down. The Bears will get some kind of respite some time this year, especially if stock prices keep melting up right into the earnings season, but it won’t be enough, especially on a heartburn adjusted basis, to have made it worth their while.

Of course, we have been treated to assurances that the Market is applauding the signing into law of “health care reform” (Typing these words reminds me of what someone said about how “holy”, “Roman” or an “empire” the “Holy Roman Empire” was NOT.) This is to be expected, especially as one takes stock of the all out effort underway for the last two weeks to change the subject. They came out blazing. Shortly after Mr. Bart Stupak took his place in the ashcan of history (“right over there, sir, next to Neville Chamberlain.”) we started getting a full throated Chicago style charm offensive. From the talking heads at the media outlets that still register blips in the ratings down to blog trolls who seemed to have been in hiding for the past few months, we got what was supposed to pass for an end zone dance. We also got what seems to have been yet another campaign to demonize anyone who speaks up in opposition to Fearless Leader. We are supposed to be scandalized that when a country so large and diverse gets worked up about something so ultimately personal, a few yahoos show up and express themselves in ways that cross the line out there somewhere between spirited and vile. I think that we should be surprised, maybe even concerned about testosterone deficiency, if in this polity of 310,000,000 souls, we did not have at least 31 or even 310 whose utterances managed to gross us all out. A couple of broken windows, which for all we know might have been done by disgruntled Obamanauts (like in Denver last year), is somehow the equivalent of Kristallnacht? How odd, that despite big cash offers for hard evidence, the only perp in custody was uttering his vile threats against a Republican. And how surprised should we be that the same weekend that the Commander in Chief takes off to “support the troops” and wax censorious with yet another erstwhile ally, the Feds decide to drop the hammer on a bunch of crazies? Again, in a great big country like ours, we should be surprised if there were not dozens of cells like the one just busted up in Michigan, any one of which might dragged down to headquarters when it gets so bad that the chief needs to show that he is still in charge, or his claque wants to create the illusion that its not much different than in 1910, when anarchists’ bombs were going off almost every week.

This is all political theatre, and it continues to go badly for the statists. The bill just passed settles about as much as the Compromises of 1850 did, which is to say that probably the most enduring thing it has done is to scandalize an awful lot of normally placid and apolitical people. Who among us is holding his breath for that “once it passes, the people are going to love it” groundswell? Other than that not insubstantial segment of society that was already in favor of “spreading it around” (i.e, they already vote the Parasite slate), such “love” is not going to be forthcoming. A center-right country has been goaded slightly more so. The Pied Piper’s tune has turned tinny and annoying. The more the Change horn blows, the more we wish he would just go away. A few more bad laws will be passed in the next few months, but those laws will be like so many barnacles on a very big ship whale that was already pretty encrusted, yet sometimes manages to knock a few off. The debate/theatre we just lived through (which, by the way, was over a bill that was supposed to be “on my desk” in time for the late summer recess) amply demonstrated that said leviathan still has a pulse. This means that however dreadful the last few years have been, we are still a few adverse developments at least away from it no longer being the world’s leading “mattress” for capital.

Banana Scented Madness

This year we get March Madness times three: the college hoops free-for-all, an apparent suicide pact among Democrats now lurching towards a grisly culmination, and an astounding run-up in the Market that was finally interrupted on Friday. The Final Four, whoever it ends up being once the upset-prone bacchanalia that is the NCAA tournament has provided its now customary seasonal diversion, will be ancient history by the time “pennant race” finds its way back into the lexicon of the sports minded. Not so the other brouhaha that has been going on now for a little over a year. Even if they get the votes and the President were to sign it into law by Easter, the Democrats will have lost, and lost badly. Protestations to the contrary notwithstanding, Americans care about “process” at least as much as “substance” if by process one or more of the principals is doing grave damage to the Constitution he or she has sworn to defend. Obviously, one need not be a Constitutional scholar to intuit that we have reached this pass. Anyone who was brought up with even a smidgen of civic education and whose natural faculty for reason has not been short circuited by the deconstructionist tropes of what passes for higher education simply knows that Americans don’t do it this way. Millions of normally apolitical Americans have been jolted by what they take to be a whiff of banana. Not banana as in a party leadership that has gone bananas. That ship sailed some time ago. No, with the latest flurry of procedural innovation, such as what we have seen described as Demon Pass, one gets a distinct sense of once-great-republic being prodded onto that slippery slope that leads to banana republic.

This will not fly. The insularity of the progressive faction, replete with its ritualized reinforcement of the delusional caricatures by which it perceives the “unenlightened” masses it purports to lead, just might have proved fatal this time around. One senses a disconnect with reality that grows more palpable with each passing week. They chose an issue that is deeply personal at some point in almost everyone’s life, and against the backdrop of an unremittingly miserable track record (what has government ever done as well as it promised it could?) proposed to exacerbate an already crippling debt burden that is will be waiting for our descendants. It is hard to imagine what else they could have done to evoke an even stronger visceral reaction against their machinations. Having taken it this far, and so badly mangled what even the most cynical of us understand to be "the way its done" in America, the most successful experiment in ordered liberty ever, the signing into law of this so-called reform would be the exact opposite of “settling the matter”. Anyone who stills holds to the notion of American exceptionalism, which I suspect is still a large enough slice to swing elections in all but the (as the Brits would put it) rottenest of districts, has been scandalized by “process” that smacks of coup, as in bald-faced disregard for Constitutional norms. On that visceral level that gets patriots up out of their easy chairs and out into the street, it is ultimately more scary-making than whatever the “substance” of the yet unseen bill might do the doctor-patient relationship come that unknown but inevitable day when it really, really matters to each and every one of us. They have turned the people against them, a people whom history has shown to be normally placid but furious when stirred (ask the Germans). Many years will have to pass before their successors will be able to work this kind of mischief again.

Perhaps there is a bit of this meager silver lining in why the Market has been so inexorably strong of late, but not necessarily. That string of up-days-in-a-row for the Dow that ended on Friday was highly unnatural. Normal short term action can be understood as little more than “noise”, some of which is random (as in regression) and some not so random (as in helped along by the actions of speculators who have, or believe they have, the ability to exacerbate short term trends to their own advantage). It is most unusual to see equity markets go for more than about three days in either direction without some kind of roughly commensurate regression. The strength we have see since early February, and especially since March 1, has been less about future prospects than it has been about desperation. Investors would like to see some kind of pull-back, but there is increasing anxiety that the opportunity to buy at more reasonable prices might not be forthcoming. People want to “buy the dips”, and what constitutes a “dip” has been greatly diminished of late.

Why is this? It is first and foremost because we all underestimated the resiliency of the economy. It might not come back strong as those of us who have been around for a few decades reckon strong, but it is coming back stronger than almost everyone expected, and this is reflected in almost everyone’s portfolios. And while it is possible to concoct a dire scenario somewhere way out in the future (hyperinflation, etc.) you just can’t get there, based on the data coming at us each week, within the timeframes that all but a very few investors care about. Over against budget train wrecks ten years from now, we have announcements like what we heard from Boeing late this week. Nobody invested in or just following aerospace companies came to work last Monday thinking in terms of production rate increases for wide body aircraft, but there it was. Indeed, for what seems like forever (but has probably been only six or so quarters), the prime topic on just about every aerospace company conference call has been how companies expect to manage prospective rate decreases. Bear in mind, though, that what is good news for those already invested is bad news for those investment professionals who were still waiting for signs of improvement (i.e., are underinvested). If I were underinvested right now, I would be wondering what the next such “shoe” to drop, probably next week, is going to be. It is easy to imagine an unremitting series of them stretching out well into the misty future. There will probably be some kind of meaningful pullback in the Market sometime this year, perhaps akin to that which marked most of January, perhaps somewhat more so. However inevitable, though, waiting for a pullback can be just as fraught with anxiety if one is underinvested as waiting out a pullback when one is fully invested. Excessive pessimism has begot de facto market bets by professionals who might even know better than to try to time the Market, and their need to unwind that inadvertent bet is why the Market has had such a hard time selling off.

It has also mattered that there is a ton of money that out there that needs a return and is finding it increasingly difficult to find alternatives to equities. Just as pension funds have their assumed rates of return to live up to, so does a burgeoning generation for whom an erstwhile defined contribution plan is now the difference between a comfortable life and base, dependent subsistence. For all but an infinitesimal few, that rate is well north of what banks and money funds are offering. Bonds might have a little more juice in them, but more likely are primed to regress toward some mean that in another few years will have shaken off the specter of deflation. “Dead money” is simply not an option for millions of households. The funny thing is, though, that Markets are the one place where, if only for a while, wishing really can make it so. Markets reflect economic reality over the long haul, but they also take on a Price Reality of their own over lesser periods of time. If enough investors decide that stocks are more or less the only game in town (as last happened a little over a decade ago) there will be a self perpetuating phenomenon, if only for a season. Money is clearly, impatiently, inexorably flowing back into US equities. Stage Two of this rocket has been lit. (Stage One was the decompression, that gasping realization that the world wasn’t ending after all, that commenced just over a year ago.) Unless and until something we’re not even thinking about today derails this migration back in stocks, this Market has a long, fun ride ahead of it.

Pushing Back The Parasite Class

March came in like a lion for small cap value investors. There was a franticness to trading on Monday that had to include a good deal of short covering. It was one of those days that you really had to be there, as in being one of those handful of days in a year that end up generating most of that year’s returns. (Such is the nature of value investing.) Two simple explanations presented themselves. The most fundamental was seen in the latest batch of “big honking premium” bids takeover bids. Similarly, the price offered for a piece of AIG reminded us that even that which had been lumped with “toxic” a very short while ago is worth a lot more to someone in particular than to the rest of us in general. Coupled with yet another snippet of confirmation of recovery among the enablers of Web 2.0 (i.e., global chip sales rose in January, a month which normally sees a decline), this had to make it very uncomfortable to be short any but the most rancid or liquid of situations.

I suspect the speculative crowd also woke up Monday a bit aghast at how the recent Greek drama has played out, but not in the sense of a collective sigh of relief that this tempest-in-a-teapot crisis is being managed away (or at least kicked down the road a few years). No, reading between the headlines, it seems that at least some of the big speculators have gotten the message that the “authorities” have wised up to their game (i.e., using derivatives to simulate/exacerbate volatility in financial instruments, which reflexively undermines the viability of the enterprise, in this instance nation states). It’s about time that someone drew a line in the sand and said “proceed at your (pecuniary) peril”. This does not mean that the authorities will necessarily prevail in dissuading the big speculators who are trying to exploit the flaws in the Euro system, but they seem to have made it clear that they are going to push back. Smart speculators heed the lessons of history, which suggests that while governments don’t always win, they win often enough when they put their mind to it (see attempts to corner gold and silver). My sense is that in a way akin to August 2007, at least some of the smartest and largest hedge funds have recognized this as enough of a sea change to back up and re-group, which would include no small amount of short covering in the small & mid cap parts of the Market.

These developments explain why portfolios skewed to small cap & Tech (like mine) rose 3-5 times the Dow’s +0.8% on Monday, but they should not obscure a large and more enduring drama that is playing out. As we approach the anniversary of 3/9/09, “How’s that HopeNChange thingy working out for you?” is the gift that keeps on giving. There seems to be much more to it than the hubristic overreaching that Musings recognized very early on (see 3/25/09). It turns out we are looking at much more than hubris begetting inefficacy, which is what I discerned back then. The body politic has been energized by a plurality of the productive class having realized that they are well on their way to being enslaved by a new petty aristocracy. This bad news has been delivered variously, most notably in the reports that government “workers” are now better paid than those in the private sector. At a time when private sector workers were swallowing pay cuts and sweating layoffs, the ranks of government employees making $100K+ were exploding. These “workers” also enjoy vastly greater security in retirement, a security that is funded by a non-negotiable call on what the productive class produces. It is also not so secure, insofar as the shortfall in the pension obligations to public employees is one of the things that the Downturn made worse, to the tune of $1T+.

To the degree that the value of ownership, which is to say, stock prices, is dependent on the long term viability of the host organism (i.e., nation), that a vigorous resistance to the Parasite class has developed is quite encouraging. It may come to pass that the parasite has gotten bigger than the host and will prove impossible to extricate, but at least the host has been made aware and is starting to fight back. A favorable outcome cannot be assured, however. Indeed, it is problematic to handicap the outcome of a struggle where one side is defending something specific and tangible and the other something diffuse and less tangible. In this case, it’s the jobs and sinecures of what the late Irving Kristol termed the “New Class” against the marginal tax rates of a number of the rest of us. It is much easier to mount a hedgehog defense of something like “jobs” and “retirement” than it is roll back something understandable only by metaphor (e.g., the dead hand of the state) and experience (which passes with each generation). Nonetheless, the vanguard of this class having overplayed its hand has had the effect of waking the dead, or at least seemingly dead. The US will not be sleepwalking its way to Euro-inspired decrepitude after all.

That the New Class has evolved from its putative idealism to being all about the welfare of its members and clients should not be surprising. Nor should we be surprised that if uninterrupted the parasite will eventually overwhelm its host. This has been a very long time in coming. I can remember being struck by what seemed like imminent crisis with respect to municipal pension obligations living in New Jersey 20+ years ago. I was struck by how many towns, counties, etc. had contracted with their employees to provide very generous pension benefits. Life expectancies having lengthened as they have, one could easily envision a situation where the rate payers end up supporting several “generations” of retirees at once (twenty years of service leaving 45 years of life expectancy). Somehow, a rising tide of prosperity covered these manifestly irresponsible obligations, but all that came undone in 2007. Private sector workers not only endured pay cuts and lay-offs (and the threat thereof) while their public sector neighbors hunkered down behind their union contracts, they also saw their retirement funds withered. Over the past 25 or so years, defined benefits plans have been replaced by the much more fiscally responsible defined contribution plans and stock option programs in virtually all of the nonunion portions of the economy. So those whose long term financial security is in 401k not only experienced the haircut of a lifetime, they learned that as taxpayers they were on the hook for the gargantuan shortfall to fund public sector defined benefits plans. The boiling point was probably reached when the Administration didn’t bat an eye in extending this “hook” to future generations, i.e., our grandkids.

I continue to think that the host on which all of us, parasites and producers alike, subsist is much more viable than we give it credit for. We are groping our way toward a recovery that is much more essential than mere cyclical upswing. Liberties seem to have been eroded, but we are still the Land of the Free, at least in the sense that we aspire to be free and respond to that which threatens liberty. This could get ugly in the sense that it will amount to an attack on the “jobs” and “security” of a putative protected class, but it does not have to get ugly in the sense of literal blood being spilt. There was a similar rebellion against the New Class thirty years ago. It bought us about 25 years. The Market is figuring out that history is trying to repeat itself.