Thanksgiving finds us supremely grateful for having lived in the time and place that we have, and despite how exasperating the Market has been of late, feeling blessed to have spent a working life in the Great Game of Buy Low and Sell High. (I am quite certain that habitual gratitude all but surely enhances one’s mental and physical health.) We can and should count our blessings every day, especially if our gratitude has an Object (can one really be grateful toward no one in particular?), but designating a day to do so publicly and communally is a not bad idea.
Public and communal expression has taken an unexpected turn of late with the Occupy Wall Street (OWS) movement. It iss tempting to dismiss what is probably best understood as its participants’ infantile reaction to that reality of life that their cosseted upbringings apparently shielded them from, that life is not fair. However, there is a sense in which they do have a point, and it is a point worth exploring. I had initially expected OWS to last until about the time when wintry weather puts an end to that season when NYC is a glorious place to visit, but something is sustaining it as more than a collective tantrum of variously clueless and hapless crybabies. Part of it is money, funding that has been funneled in to keep the narrative alive and growing (where is the outcry about “Astroturf” grassroots that greeted the TEA Party, is if some Doctor Evil in Denver or Pittsburgh or Wichita was fronting thousands of people the expense of showing up at a protest?) That narrative is the sense of class divide that is about the only identifiable theme that can be divined from the whole OWS exercise, that there is this evil 1% and then there are the rest of us. Trace back the money flows that have kept it going and I am sure that much of it comes from sources that could fairly be classed under the 1%.
As if there really was a 1%! Whoever wants to foster this notion that 99% of us have common cause against the kulaks, I mean, fat cats, going probably stands to benefit from this artificial construct and the divisiveness it entails. There is no 1%. Just as has been well documented with respect to both top and bottom income deciles, many who are in the top 1% of earners this year were not there a few years ago and will not be there indefinitely. I know this because I have lived it, having been at or very near the top 1% in years like 1988, 1999 or 2006 and not far from the poverty line in some years since (and probably below the median based on earned income of late, net worth being a totally different measure). This 1% that is the object of OWS’s umbrage does not exist as such.
Where I think the outrage of OWS might be on to something is that life’s inherent unfairness has gotten at least a bit out of hand, and there is indeed a culprit. It’s just that identifying the culprit by either a being a top earner or a part of a particular industry is way off the mark. The OWS crowd is not the first crop of young people to find that life in the world can be understood as a bunch of games, that those games tend to be rigged in someone’s favor, and that someone is not them. There is nothing new about those who have political power trying to stack the odds of enterprise in their favor. Advantage tends to accumulate in ways that harden the lines we call Class, unless or until the discontinuities of history disrupt them. There hasn’t been much truly disruptive history in the US in the past sixty five years (as most people who have ever lived would reckon disruption), so the power to distort probable outcomes to benefit of a favored few has accumulated way beyond what most of us reckon as fair. It is quite likely that the rising tide of debt fueled prosperity that marked the late decades of the 20th Century substantially mitigated this, but all that ended when the music stopped in mid 2007, and now we get to live through a protracted and and bitterly disputed adjustment period.
Wall Street is a convenient target because the banks got bailed out whether they asked for it or not (as if we had a choice but to throw money at the problem and hope the panic subsided) and their compensation is so public and “winner take most”. Left unsaid is that most people who work “on Wall Street”, which is to say in banking or investing, are not earning anything like in that 1%, and many of the beneficiaries of a system that has become too politically rigged for its own good have nothing to do with Wall Street or even commercial enterprise. It is a problem not of unbridled, free market capitalism, as if such a thing ever existed for more than a fleeting moment, but of political machinations that produce crony capitalism and similar corruptions that favor the well-connected. “Capitalism” as practiced of late, where lobbying, campaign contributions, revolving doors between government and industry jobs and who you knew in school, has produced outcomes (i.e., paydays) that are increasingly difficult to defend. OWS has staying power because while in most respects they couldn’t have their collective head any further up their collective arse, they have given voice to what millions of others have sensed about how the Game of Life seems to have gotten too rigged for its own good. It’s just that owing to the misinformation that was included in what they were scandalously duped into thinking was an education (and even more scandalously duped into borrowing money to pay for), they are unable to accurately identify the perpetrators. The message resonates anyway because it is intuitively obviously that if the corruption in the system isn’t rooted out or at least dialed down, the whole thing will eventually break down and hurt us all. (The fable about goose that laid the golden eggs comes to mind here.)
Indeed, it is no small irony that said perpetrators are no doubt the source of that funds that allowed the days of rage to linger into months of incoherence. A narrative which fosters class division is useful to those who own or influence the seats of power as long as it misdirects anger and weakens potential rivals. To the degree they are successful in the year ahead, the political change necessary for genuine economic recovery will be at risk. I don’t believe that a preponderance of voters will fall for the lie that one party is “for the 1%” and the other looks out for the rest of us, but the introduction of this phony narrative can’t help but add to political uncertainty in the months ahead.
About fifteen years ago, a thought came to me that had a certain prophetic feel. At that time I was working with a lot of other men who all had sons the same age as mine or a little younger. They were not quite teenagers. It occurred to me that in their time, when they reached manhood, that our society would no longer be riven by race the way it was a generation ago, so much as that Class would emerge as a great divider. That has not come to pass in the stark sense recognizable in, say, Edwardian England, but absent some change from recent trends, we seem to heading in that direction. We should not be so foolish as to imagine that we can create truly “level playing fields”, let alone equality of outcome, but there are risks attendant with a failure to check the power of the politically well connection to stack odds in their favor to the perceived detriment of practically everyone else. The corruptions that have accrued in recent years will have to be addressed by political change. OWS is kinda, sorta onto something, they just don’t have a clue that the real perpetrators are the ones who have been picking up the tab for all their months long party.
Monday, November 28, 2011
Friday, October 28, 2011
The Dueling Errors of Optimism and Pessimism
So it looks like our concluding remark of the previous edition, anticipating the “utter.. rout (of) those who bet against the resiliency of the US economy”, is turning out to be more on target than we could have imagined. The Euro crisis seems to have been bundled into an appropriate haz-mat container, strapped to Doc Brown’s flux capacitor and transported to some indeterminate point in the future, and the economy has once again displayed its ability to shrug off manifold toxins and keep stumbling along. Investors of the bearish persuasion, who seemed totally in control in the opening moments of Q3, have indeed been utterly routed. Unless a really plausible competing narrative develops in the next few weeks (keep an eye on the Congressional spending cuts tax force), my sense is that all those managers who got under-invested over the course of Q2 will be chasing performance into the New Year. Once again, optimism has paid off splendidly.
It is that matter of optics (how we choose to look at things), that difference between optimism and pessimism, that is perplexing us today. We find ourselves torn between the two. Our economy is at once marvelously resilient and debilitated by a host of maladies, mostly parasitic in nature. It is “early” with respect to a Bull Market in the generational sense, but perhaps getting late in the game in a more tactical, cyclical sense (i.e., 2.5 years off the bottom). I would suggest that coping with this conundrum comes down to recognizing the inherent errors in these two perspectives. Of late, the error of the pessimist has been to underestimate the resiliency of our economy and the body politic. Optimists have prevailed because the error of this pessimism has been revealed in the decent sales and earnings of large swathes of corporate America and the ability of European leaders to dance the dance of forestalling the fitful entropy that has been their lot since time immemorial. But this takes nothing away from an equally troubling error on the part of the optimist, to underestimate the impediments to economic growth that will be dealt with, to the short term detriment of economic growth, over the next decade and beyond. So while it just now paid off to discount pessimistic notions, we disregard the optimist’s error at perhaps an even greater peril (especially if our objective is absolute as opposed to relative returns).
The optimist’s error disregards the inevitable undoing of what has been called the 1950 Moment, that point in time when U.S. stood astride the rest of the world with the only industrial base that had not been bombed halfway back to the Stone Age. This allowed us to have policies that built around a compact between Big Business and Big Labor, to grow government spending faster than the economy and borrow against the future in the expectation that our wealth would continue to grow inexorably. It worked splendidly for two decades and we could almost get away with it for another, but our relative stature as it stood at mid century was, indeed, only a moment. The 1970s precipitated a recognition of global competition that rendered that industrial policy obsolete, and the 1980s were all about the undoing of Big Labor and, in the private economy, the Bismarckian notion of defined benefit pensions. It took a couple of decades, but with a very few notable exceptions (i.e., Big Three automakers, and look how that turned out) it was a remarkably successful transformation. We continued to be a big, strong country, a generous people growing steadily richer, and could still afford many indulgences, especially on the public sector side of the economy. Or so it seemed, as with the passage of time the sense of entitlement and largesse, helped along not so much by incomes as by net worths rooted in home equity and 401(k) balances, outstripped the actual wealth generating capability of the economy.
We need to be very mindful that 2008 induced a discontinuity that like the c. 1974 realization that we had to re-tool and reorient in order to compete in a global economy will require at least a decade of painful, contentious adjustment. It is not as if we, as a people, have suddenly been impoverished. We are still in the aggregate a rich and resourceful people. It’s just that just that many millions of us are not as wealthy as 2006 made it seem, and millions more will be coming to that realization as the great post-Crash adjustment rolls on. The disconnect that has become too unsustainable to ignore is between the discipline of the private sector over the past two decades versus the obfuscation and lack of accountability of the public sector spending. In terms of how this plays out over the next decade or so, I am inclined to optimism. It’s the getting there a day at a time that will wear on us as investors. There will be the political theatrics, as defenders of the status quo decry the heartlessness of those who are just looking for a little accountability and perhaps a bit of cost/benefit analysis. The larger issue, though, will be that the necessary right-sizing or even dismantling of presently bloated public sector enterprises will be a persistent drag on GDP growth (both the G in C+I+G and some of the C as head counts are reduced and pensions evolve in the direction that the private sector started down thirty years ago).
It has been said that history doesn’t repeat itself but often rhymes. To the extent that 2008 rhymed with 1974, we would do well to recognize that while profit opportunities abounded, it wasn’t until 1982 that the Bull Market became recognizable, and even that was a fleeting event. Even the election in 1980 of the sort of president many of us are wishing and praying for today did not really work its way into equity valuations (at near record lows in 1982) until his stay in office was nearly over. This was in large part because the cure (Volcker’s medicine for inflation) was painful and protracted. The cure for the massive disconnect between how we manage the wealth generating part of our economy and how we manage the wealth redistributing part of the economy will be at least as painful and probably a lot more fractious. It will involve millions of households having to re-invent themselves economically. People seem to be figuring this out, as seen in the increased savings rate. It is going to take a couple of election cycles at least to come to terms with large and in some case spectacularly corrupt institutions before the economic drag (i.e., their stakeholders coming to terms with a diminished call on the collective wealth) runs its course. It will happen throughout government, at all levels, and nowhere will it be more apparent than in what we call Education. From the dubious benefits of Head Start to the $1T scandal that is student loans, and at all points in between, this money sucker has failed us. Its reform is absolutely necessary, in terms of both fiscal solvency and renewing our economic competitiveness in a world that will only get more so. Getting there will take most of the rest of our lives, and it will hurt.
Pessimists have just paid a heavy price for not allowing for their inherent optical bias. Optimists, which would seem to include the vast preponderance of successful investors, would do well to not disregard the consequences of even the most positive developments over the next several years. History might not repeat, but it tends to echo. 2008 was a moment a lot like 1974. If history is echoing the way I suspect it is, we have years to go before this generational Bull Market feels like a Bull Market for more than a few fleeting moments at a time (moments that will prove to be good times to raise cash in anticipation of the next time the pessimists slip the leash).
It is that matter of optics (how we choose to look at things), that difference between optimism and pessimism, that is perplexing us today. We find ourselves torn between the two. Our economy is at once marvelously resilient and debilitated by a host of maladies, mostly parasitic in nature. It is “early” with respect to a Bull Market in the generational sense, but perhaps getting late in the game in a more tactical, cyclical sense (i.e., 2.5 years off the bottom). I would suggest that coping with this conundrum comes down to recognizing the inherent errors in these two perspectives. Of late, the error of the pessimist has been to underestimate the resiliency of our economy and the body politic. Optimists have prevailed because the error of this pessimism has been revealed in the decent sales and earnings of large swathes of corporate America and the ability of European leaders to dance the dance of forestalling the fitful entropy that has been their lot since time immemorial. But this takes nothing away from an equally troubling error on the part of the optimist, to underestimate the impediments to economic growth that will be dealt with, to the short term detriment of economic growth, over the next decade and beyond. So while it just now paid off to discount pessimistic notions, we disregard the optimist’s error at perhaps an even greater peril (especially if our objective is absolute as opposed to relative returns).
The optimist’s error disregards the inevitable undoing of what has been called the 1950 Moment, that point in time when U.S. stood astride the rest of the world with the only industrial base that had not been bombed halfway back to the Stone Age. This allowed us to have policies that built around a compact between Big Business and Big Labor, to grow government spending faster than the economy and borrow against the future in the expectation that our wealth would continue to grow inexorably. It worked splendidly for two decades and we could almost get away with it for another, but our relative stature as it stood at mid century was, indeed, only a moment. The 1970s precipitated a recognition of global competition that rendered that industrial policy obsolete, and the 1980s were all about the undoing of Big Labor and, in the private economy, the Bismarckian notion of defined benefit pensions. It took a couple of decades, but with a very few notable exceptions (i.e., Big Three automakers, and look how that turned out) it was a remarkably successful transformation. We continued to be a big, strong country, a generous people growing steadily richer, and could still afford many indulgences, especially on the public sector side of the economy. Or so it seemed, as with the passage of time the sense of entitlement and largesse, helped along not so much by incomes as by net worths rooted in home equity and 401(k) balances, outstripped the actual wealth generating capability of the economy.
We need to be very mindful that 2008 induced a discontinuity that like the c. 1974 realization that we had to re-tool and reorient in order to compete in a global economy will require at least a decade of painful, contentious adjustment. It is not as if we, as a people, have suddenly been impoverished. We are still in the aggregate a rich and resourceful people. It’s just that just that many millions of us are not as wealthy as 2006 made it seem, and millions more will be coming to that realization as the great post-Crash adjustment rolls on. The disconnect that has become too unsustainable to ignore is between the discipline of the private sector over the past two decades versus the obfuscation and lack of accountability of the public sector spending. In terms of how this plays out over the next decade or so, I am inclined to optimism. It’s the getting there a day at a time that will wear on us as investors. There will be the political theatrics, as defenders of the status quo decry the heartlessness of those who are just looking for a little accountability and perhaps a bit of cost/benefit analysis. The larger issue, though, will be that the necessary right-sizing or even dismantling of presently bloated public sector enterprises will be a persistent drag on GDP growth (both the G in C+I+G and some of the C as head counts are reduced and pensions evolve in the direction that the private sector started down thirty years ago).
It has been said that history doesn’t repeat itself but often rhymes. To the extent that 2008 rhymed with 1974, we would do well to recognize that while profit opportunities abounded, it wasn’t until 1982 that the Bull Market became recognizable, and even that was a fleeting event. Even the election in 1980 of the sort of president many of us are wishing and praying for today did not really work its way into equity valuations (at near record lows in 1982) until his stay in office was nearly over. This was in large part because the cure (Volcker’s medicine for inflation) was painful and protracted. The cure for the massive disconnect between how we manage the wealth generating part of our economy and how we manage the wealth redistributing part of the economy will be at least as painful and probably a lot more fractious. It will involve millions of households having to re-invent themselves economically. People seem to be figuring this out, as seen in the increased savings rate. It is going to take a couple of election cycles at least to come to terms with large and in some case spectacularly corrupt institutions before the economic drag (i.e., their stakeholders coming to terms with a diminished call on the collective wealth) runs its course. It will happen throughout government, at all levels, and nowhere will it be more apparent than in what we call Education. From the dubious benefits of Head Start to the $1T scandal that is student loans, and at all points in between, this money sucker has failed us. Its reform is absolutely necessary, in terms of both fiscal solvency and renewing our economic competitiveness in a world that will only get more so. Getting there will take most of the rest of our lives, and it will hurt.
Pessimists have just paid a heavy price for not allowing for their inherent optical bias. Optimists, which would seem to include the vast preponderance of successful investors, would do well to not disregard the consequences of even the most positive developments over the next several years. History might not repeat, but it tends to echo. 2008 was a moment a lot like 1974. If history is echoing the way I suspect it is, we have years to go before this generational Bull Market feels like a Bull Market for more than a few fleeting moments at a time (moments that will prove to be good times to raise cash in anticipation of the next time the pessimists slip the leash).
Friday, October 14, 2011
Why the Bull Market Just Resumed
What a difference a new page on the calendar seems to have made! The Market ended Q3 11 with a bad case of the dry heaves, and the persistence of that mal de mer through dozen or so trading hours of Q4 and was eerily familiar. So was the broad, relentless advance that has since followed. (It’s like “we’ve seen this movie before, but can’t remember when.") The VIX has turned back into a wasting asset, and maybe gold has, too. So what happened? Two things: it became apparent that Greece is not going be like Lehman Brothers, and it got way too obvious that the US economy, while far from vibrant, is a whole lot more resilient than we were giving it credit for.
Considering the damage done to the life savings of so many mid-and-upper income households since May, and the sheer ugliness of the political spectacle that kicked that wealth destruction into high gear in August, one would think that some kind of “wealth effect” would have registered in retail sales and other such economic indicators. Even those of us not wedded to a doom & gloom narrative figured that consumers were supposed to take stock of their straightened circumstances and dial their spending down. Instead, we were inundated with data from the likes of auto makers, Costco, Nordstrom and and plethora of other retailers that showed nothing of the sort. Far from rolling over and dying, the economy seems to be picking up a little steam. Not as much as it needs to, but definitely contra what you would think happens when portfolios take the hit that we just went through. Perhaps a reconsideration of the “wealth effect” (WE) is in order.
The WE recognizes that households will spend not just as a function of income but of perceived wealth. Households that accumulate financial assets, even in the form of retirement plans or home equity, come to regard those assets as a source of income, if only prospectively. Having enough “to get over the finish line” is important, if only subconsciously, to all be the most profligate or obtuse householders, and they will save (divert income from present consumption) or dis-save (run up credit card or home equity debt) accordingly. When assets have been been amassed, are rising in value and, importantly, households expect that increase to continue, households might rationally spend more than their current incomes. This was the hallmark of the Tech Bubble years, when “home equity as ATM” and “my 401k going up 20% forever” defined the spirit of the moment. The WE also mattered when the fallacy in the logic (inexorable double digit returns) melded with the evaporation of portfolio values. It mattered again in 2008, when the Bear Market of a lifetime took hold and the Housing Bubble was ruptured.. But this time, we get a -20% whack coupled with a heightened sense of futility in terms of being able to secure a decent return “for the duration”, and so far, hardly a ripple. What happened?
I think the most important conclusion is that the WE is a lot like opium, a real kick for a first time user, but subsequent doses have to be a lot higher. In the latter half of the Nineties, the economy really was goosed but all those folks who for the first time in their lives looked at the value of their nest eggs and the rate they seemed to be growing and assumed they could spend 100%+ of income and still be set for life. For many of them, based on the data at hand, that was a rational choice. Then when it swung the other way after Y2K, the error of overspending (i.e., borrowing against assets and future cash flows) had to be corrected, which meant discretionary spending got throttled back until at least some balance sheet repair could be effected.
What’s different about 2011 in terms of how the WE would register is that spending already got dialed way down (three years ago already) and really didn’t get dialed back up. The diversion of income from spending to balance sheet repair (i.e., paying down credit card balances) didn’t have to happen because not many of the households who do that have had the time or the means to bumble down that path again. The trading down at retail, the eating out less often, that hit with a bang when Panic and the recession took hold might have reversed a little, but only a little. We also haven’t see a lot of lay-offs, because most companies got themselves in pretty lean shape already. So this time, there really wasn’t a lot of potential energy (think of the way thunderstorms build up) for the WE to dissipate. What’s more, it is quite likely that whatever damping effect it was having in August and September was being more than offset by the “getting back to normal” within industries that took a cautious tack following the supply chain disruption that was the earthquake in Japan. The resolution of that uncertainty seems to have counted for more in terms of economic activity than the fact that investors were reminded, once again, of the inherent folly of presuming upon the future.
We have just been reminded that the economy is a very resilient beast. It is sick, seemingly weighed down by an inexorably growing mass of parasites, but it has an amazingly strong constitution. However far away it is from optimal health, it is further than we think from being at death’s door. This certainly does not mean we can take its continued viability for granted. Indeed, vitality will not become evident until there is at least a prospect of a change in regulatory regime and a diminution of uncertainty with respect to how the fruits of enterprise will be taxed. While the substantive changes that would restore our economic to vibrancy will happen over the course of years if not decades, I am quite optimistic that once the Market gets even a little conviction about this as a probable outcome, it will begin to anticipate it.
The other big change since 9/30 seems to be the emergence of a big boot to kick the can that is the Euro problem way down the road. This problem, that well-intentioned but flawed concept of a single currency among disparate, sovereign states, will not be going away, but it can go dormant for a while. And more to the point, its flaws now exposed, it can be rendered less of a threat than we have all imagined it to be. Here is where the comparison of Greece with Lehman kicks in. The demise of those banks three years ago was a shock almost no one saw coming. It mattered a lot that up until July 2007, only a very few sharpies had questioned the perspicacity of the AAA ratings that had become the implicit guarantor of so much highly leveraged regulatory capital. Or that practically no one had considered the unintended consequences of applying “mark to market” rules to assets that for all intents and purposes were not meant to be liquid (i.e., held to maturity). It was all such a surprise, fraught with potential outcomes that even the most experienced of us could only imagine. “Shock and awe” was real, not merely a metaphor.
So, a year before it happened, who knew that LEH would end up unable to meet its obligations? Conversely, who hasn’t known for years that Greece is a deadbeat nation? Insofar as it has been nearly eight years since it was revealed that Greece lied to get into the EU, it is hard to believe that there is a creditor out there who has not done all they can to mitigate an eventual default (or quasi default in the form of a “haircut”). 2008 was like a forest with a lot of dead wood lying about, having accumulated for years, and the idea of a lightening strike having only occurred to a few cranks (or talked to death for so long we quit thinking about it). The situation in Europe may also fairly evoke a lot of dead wood, but lightening has been in the air for years already, and a whole lot of scrambling has gone on to create firebreaks and otherwise push the combustible matter into neatly separated piles.
The wildfire metaphor (perhaps helped along by what we have been through here in Central Texas this year) is also apt to the question of “contagion” spreading to the US banking system. Like the “toxic” assets of three years ago, I think “contagion” is a bad metaphor, intended to arouse and confuse rather than enlighten. (A lot of money got made buying so-called toxic assets, which were only toxic if you bet your career on an erroneous assumptions about what they were really worth, as opposed to waiting for the fire-sale prices that at least some clever folks were able to get.) In considering just how vulnerable our financial system might be, we should bear in mind that it has been a very long time since the proverbial pendulum started its swing from wretched excess to the opposite extreme. To the extent that the suspect assets and dampened economy are housing related, it has been five years since the party that caused the hangover ended. I reckon that moment to Hurricane Katrina, as I had put a house on the market in Upstate New York (in a time and place where weekenders had been the enthused buyers at the margin) shortly before that national media event. The change in the tone of the real estate market, once that sobering distractor had passed, was palpable. The downturn was yet to become apparent, but the party was definitely over. This means we have had going on five years to not only de-leverage but to see an evolution in that asset category we call mortgage backed securities. Loans made during the boom have either defaulted or been paid down and/or refinanced at rates that are lower than any of us dared to imagine in 2008. Mortgage loans made since 2008 were subject to a degree of rigor that was not present for the four or so years prior to that.
In the mean time, the population continues to grow and evolve in its preferences about where it will live, and the housing stock continues to wear out. My sense is that while it could be decades, if ever, before, “home equity as generator of wealth” is what it seemed to be for H2 of the Twentieth Century, five years is probably enough to wash out a preponderance of the excess. Six or seven just might be enough for us to start to see a few recent, howling headwinds turn into modest tailwinds, economically speaking. The time that “housing bubble and its aftermath” can be seen as a vulnerability has largely passed. In the mean time, expect Earnings Release Season, Q3 11 to utterly rout those who bet against the resiliency of the US economy.
Considering the damage done to the life savings of so many mid-and-upper income households since May, and the sheer ugliness of the political spectacle that kicked that wealth destruction into high gear in August, one would think that some kind of “wealth effect” would have registered in retail sales and other such economic indicators. Even those of us not wedded to a doom & gloom narrative figured that consumers were supposed to take stock of their straightened circumstances and dial their spending down. Instead, we were inundated with data from the likes of auto makers, Costco, Nordstrom and and plethora of other retailers that showed nothing of the sort. Far from rolling over and dying, the economy seems to be picking up a little steam. Not as much as it needs to, but definitely contra what you would think happens when portfolios take the hit that we just went through. Perhaps a reconsideration of the “wealth effect” (WE) is in order.
The WE recognizes that households will spend not just as a function of income but of perceived wealth. Households that accumulate financial assets, even in the form of retirement plans or home equity, come to regard those assets as a source of income, if only prospectively. Having enough “to get over the finish line” is important, if only subconsciously, to all be the most profligate or obtuse householders, and they will save (divert income from present consumption) or dis-save (run up credit card or home equity debt) accordingly. When assets have been been amassed, are rising in value and, importantly, households expect that increase to continue, households might rationally spend more than their current incomes. This was the hallmark of the Tech Bubble years, when “home equity as ATM” and “my 401k going up 20% forever” defined the spirit of the moment. The WE also mattered when the fallacy in the logic (inexorable double digit returns) melded with the evaporation of portfolio values. It mattered again in 2008, when the Bear Market of a lifetime took hold and the Housing Bubble was ruptured.. But this time, we get a -20% whack coupled with a heightened sense of futility in terms of being able to secure a decent return “for the duration”, and so far, hardly a ripple. What happened?
I think the most important conclusion is that the WE is a lot like opium, a real kick for a first time user, but subsequent doses have to be a lot higher. In the latter half of the Nineties, the economy really was goosed but all those folks who for the first time in their lives looked at the value of their nest eggs and the rate they seemed to be growing and assumed they could spend 100%+ of income and still be set for life. For many of them, based on the data at hand, that was a rational choice. Then when it swung the other way after Y2K, the error of overspending (i.e., borrowing against assets and future cash flows) had to be corrected, which meant discretionary spending got throttled back until at least some balance sheet repair could be effected.
What’s different about 2011 in terms of how the WE would register is that spending already got dialed way down (three years ago already) and really didn’t get dialed back up. The diversion of income from spending to balance sheet repair (i.e., paying down credit card balances) didn’t have to happen because not many of the households who do that have had the time or the means to bumble down that path again. The trading down at retail, the eating out less often, that hit with a bang when Panic and the recession took hold might have reversed a little, but only a little. We also haven’t see a lot of lay-offs, because most companies got themselves in pretty lean shape already. So this time, there really wasn’t a lot of potential energy (think of the way thunderstorms build up) for the WE to dissipate. What’s more, it is quite likely that whatever damping effect it was having in August and September was being more than offset by the “getting back to normal” within industries that took a cautious tack following the supply chain disruption that was the earthquake in Japan. The resolution of that uncertainty seems to have counted for more in terms of economic activity than the fact that investors were reminded, once again, of the inherent folly of presuming upon the future.
We have just been reminded that the economy is a very resilient beast. It is sick, seemingly weighed down by an inexorably growing mass of parasites, but it has an amazingly strong constitution. However far away it is from optimal health, it is further than we think from being at death’s door. This certainly does not mean we can take its continued viability for granted. Indeed, vitality will not become evident until there is at least a prospect of a change in regulatory regime and a diminution of uncertainty with respect to how the fruits of enterprise will be taxed. While the substantive changes that would restore our economic to vibrancy will happen over the course of years if not decades, I am quite optimistic that once the Market gets even a little conviction about this as a probable outcome, it will begin to anticipate it.
The other big change since 9/30 seems to be the emergence of a big boot to kick the can that is the Euro problem way down the road. This problem, that well-intentioned but flawed concept of a single currency among disparate, sovereign states, will not be going away, but it can go dormant for a while. And more to the point, its flaws now exposed, it can be rendered less of a threat than we have all imagined it to be. Here is where the comparison of Greece with Lehman kicks in. The demise of those banks three years ago was a shock almost no one saw coming. It mattered a lot that up until July 2007, only a very few sharpies had questioned the perspicacity of the AAA ratings that had become the implicit guarantor of so much highly leveraged regulatory capital. Or that practically no one had considered the unintended consequences of applying “mark to market” rules to assets that for all intents and purposes were not meant to be liquid (i.e., held to maturity). It was all such a surprise, fraught with potential outcomes that even the most experienced of us could only imagine. “Shock and awe” was real, not merely a metaphor.
So, a year before it happened, who knew that LEH would end up unable to meet its obligations? Conversely, who hasn’t known for years that Greece is a deadbeat nation? Insofar as it has been nearly eight years since it was revealed that Greece lied to get into the EU, it is hard to believe that there is a creditor out there who has not done all they can to mitigate an eventual default (or quasi default in the form of a “haircut”). 2008 was like a forest with a lot of dead wood lying about, having accumulated for years, and the idea of a lightening strike having only occurred to a few cranks (or talked to death for so long we quit thinking about it). The situation in Europe may also fairly evoke a lot of dead wood, but lightening has been in the air for years already, and a whole lot of scrambling has gone on to create firebreaks and otherwise push the combustible matter into neatly separated piles.
The wildfire metaphor (perhaps helped along by what we have been through here in Central Texas this year) is also apt to the question of “contagion” spreading to the US banking system. Like the “toxic” assets of three years ago, I think “contagion” is a bad metaphor, intended to arouse and confuse rather than enlighten. (A lot of money got made buying so-called toxic assets, which were only toxic if you bet your career on an erroneous assumptions about what they were really worth, as opposed to waiting for the fire-sale prices that at least some clever folks were able to get.) In considering just how vulnerable our financial system might be, we should bear in mind that it has been a very long time since the proverbial pendulum started its swing from wretched excess to the opposite extreme. To the extent that the suspect assets and dampened economy are housing related, it has been five years since the party that caused the hangover ended. I reckon that moment to Hurricane Katrina, as I had put a house on the market in Upstate New York (in a time and place where weekenders had been the enthused buyers at the margin) shortly before that national media event. The change in the tone of the real estate market, once that sobering distractor had passed, was palpable. The downturn was yet to become apparent, but the party was definitely over. This means we have had going on five years to not only de-leverage but to see an evolution in that asset category we call mortgage backed securities. Loans made during the boom have either defaulted or been paid down and/or refinanced at rates that are lower than any of us dared to imagine in 2008. Mortgage loans made since 2008 were subject to a degree of rigor that was not present for the four or so years prior to that.
In the mean time, the population continues to grow and evolve in its preferences about where it will live, and the housing stock continues to wear out. My sense is that while it could be decades, if ever, before, “home equity as generator of wealth” is what it seemed to be for H2 of the Twentieth Century, five years is probably enough to wash out a preponderance of the excess. Six or seven just might be enough for us to start to see a few recent, howling headwinds turn into modest tailwinds, economically speaking. The time that “housing bubble and its aftermath” can be seen as a vulnerability has largely passed. In the mean time, expect Earnings Release Season, Q3 11 to utterly rout those who bet against the resiliency of the US economy.
Tuesday, September 27, 2011
It's Still A Very Young Bull Market
In the last Musings, we touched on the need to be aware of very long, i.e., generational, wavelength change. This Musings, continues in that vein, albeit in a different way. With the stuff of VIX forcing us to avert our gaze or risk motion sickness, it has been a good time to immerse one’s self in the question of “What Time Is It?” with respect to the Bull Market that began in March 2009. In this edition, we will examine how the early days of this nascent Generational Bull might be similar to its predecessors: the 33+ year Bull Market that lasted from 1974 to 2007 and the only slightly longer one that ran from July 1932 until (take your pick) 1968 or 1973. Owing to the paucity of data in the case of the latter, the comparison of where we might be today is mainly with the Bull Market which more or less defined the bulk of my career (i.e., since 1981). Just don’t miss that the 1932-68 Market strongly resembled the post 1974 Market insofar as it was a three decade affair born out of a devastating washout that completely demoralized all but the most resilient of investors, which is exactly where the financial media would have us believe we are today.
In comparing where we seem to be today and with where the Market was in the years just after 1974, it appears that the sense of futility we are now experiencing is not unlike what the pundits of thirty years ago so called “the death of equities”. In either case, it was a very long time in the making. Both of these “once-in-a-generation” Bear Markets (1973-74 and 2007-09) were preceded few years earlier by gully washers that were fearsome enough in their own right. The Market shed a third of its value in a little over a year circa 1969, and then would take about three years to recover to only about 10% above the 1968 peak. Which on an inflation adjusted basis was less than no gain at all (and why 1968 might be considered the actual generational peak). Akin to the “lost decade” for equities we have lived through, an investor who bought the S&P in 1968 was still underwater in 1982, and on an inflation adjusted, total return basis was not made whole until 1985. By comparison, the bursting of the Tech Bubble a dozen years ago was most notably felt by the NDQ, but in so doing it cut the S&P 500 nearly in half. It would take several years to recover to just a few percentage points above the 2000 peak before commencing the Bear that we will remember as worst ever. (The 1929-32 debacle did not have a similar precursor, as the DJIA rose nearly six-fold between 1921 and 1929 without a perceptible break. However, the decade long demoralization is apparent back then as well. An investor who bought the DJIA near the 1937 recovery peak would still be waiting to break even in 1948.)
Clearly, this is not the first time in the modern, records-get-kept era that equity ownership has been tried, found wanting, and given up on. The massive fund outflows of recent weeks make me think that we have reached a moment of capitulation not unlike 1938 and 1982 (i.e., a few years past the washout that gets remembered). Just as a scintillating rally of rapid decompression in 2009 mirrored 1933-37 and 1975, the recovery, or perhaps the necessary arrival of complete investor capitulation a la 1939 or 1982, is a much more protracted affair.
Even though I experienced them first hand, I hesitate to compare the years leading up to when the Market finally took off in August 1982 with today. After all, I was in those years that might be described as where the twilight of adolescence is painfully banished by the daunting challenges of matrimony, paternity and, fiscally speaking, still not yet having a pot to piss in, poles apart from today. As a “rookie stock broker” in 1981, I was ill equipped to take the measure of the Market and draw any actionable conclusions. I was, however, extremely in tune with the investing public’s outright disgust with equities. There was money looking to be put to work, but it was the exceptional prospective client who did not say, in so many words, “anything but stocks!”. Money market funds with double digit returns, real estate, oil & gas partnerships (which all came to naught) and maybe municipal bonds (which turned out to provide a prescient few with a fabulous, multi-decade ride), but no stocks. Then there were the gold bugs. Just like today, recent experience had made them look very “right”, as the metal had rocketed six or so fold in the latter part of the Seventies. (Since we can’t begin to value it, I can’t begin to have an opinion on gold, other than that it is likely to be a great speculative vehicle about once in a generation, and that there is no good reason that its latest stint in that mode will end any differently than the 20 year despond which followed its prior day in the sun.)
So as I shift my focus forward and ask what could possibly make the Market go up, given all the structural difficulties we are constantly reminded of, I again recall those late years of the prior, bleak era (1968-82). As it was then, the Bull Market will commence in earnest once the demoralization is complete. That could be right now, or a in a few more years, but just as it was in the Eighties, it won’t be obvious until well after the fact. The Market gave us two great decades because it started from a low and dispirited place, but also because it was on to something. No individual could really see it, but in 1982 the Market “knew”, or started to sense, that ever cheaper computing and telecom would find its way into the cost of practically everything else and make global enterprises with decently managed risks possible. The evidence was also in place for it to perceive that the stultifying menace of Soviet Socialism was dead on its feet, providing a potential for that respite from History which we now remember as the Clinton years. And it also knew, as very few of us would recognize until years later, that a great leader by the name of Reagan was just then taking his place on the big stage. (The hard work and experiences by which he prepared himself for his moment, in stunning contrast to our present leader, were knowable enough, even then.) These were factors that a Market “done going down” in 1982 was able to sense and then overcome that not inconsiderable wall of worry that was the 1980s.
An investor looking ahead for the next decade or two needs to be thinking about similar “stealth potential positives” that, as in the prior era, are probably hiding in plain sight. It has been my experience that as surely as we are unaware of most of what is really going on in the world (the myriad personal dramas that never make the news), we are more aware of the crises and various “bad things” than we are of what might be going right. The “surprising” outcome of so many elections in the past two years is but one indication that our ever vigilant news media doesn’t do a particularly good job of capturing the pulse of public mores and sentiment. So I think this is a particularly good moment to be asking the question, “What could go really right over the next decade or so?” There might not be any answers. It is not beyond the realm of possibilities that terminal decline is upon us, but as those of us who came of age in 1970s (or in the 1930s) can attest, it is not the first time it was easy to suppose as much.
I see political sea change that could make a real difference, but it will be a difference that will play out over a decade and more, and if it is real, the Market will anticipate it. The one area that comes to mind for me as a candidate for circa 2025 pundits wondering about who knew it would change so much would be that vast enterprise we call Education. That would be the process whereby otherwise feral and ignorant little savages get transformed into reasonably productive citizens. Or so it would seem. The reason I single Education out is not just because it is, in the sense I just described, as important as it is if our economy is going to be competitive enough to eventually tame our fiscal morass. Education stands out because as a national enterprise it has experienced colossally bad stewardship over the past generation or so. Alone among critical enterprises, it has had a deteriorating value proposition for the past sixty years at least. Contra what has happened with communications, transport, food and nearly everything else (more and better product at steadily declining real prices), Education is an enterprise that costs more and more but produces less and less (as in recent record low in SAT scores, though it is possible that the reason for that is simply that we invite too many people for whom academic excellence is but a figment of wishful thinking, who should be on a vocational track and/or in rehab, to take the test). The nearest I can get to a similarly failed (i.e., rising instead of falling real cost) would be Medicine, but here at least the quality (previously unimagined improvements in outcomes) makes up for some if not all of the price inflation.
Technology being what it is and having done what it has for almost every other enterprise, and considering what we have learned about the sciences which bear on the process of learning, Education should be a shining star of improving value. Instead, it is the exact opposite. However, I sense that this is well understood, if not quite yet an actionable consensus on any but the most micro of scales. A lot like the way a few prescient folks were seeing what a graphical user interface might do for personal computing, and what personal computing might do for commerce, back in 1982. Too much is at stake for this status quo to persist. Over the next thirty years, that mammoth, value destroying edifice that is Education will be creatively destroyed and supplanted by something that produces a much better outcome (i.e., a competitive workforce) at a much lower cost to families, tax payers, etc. There are probably a couple of other, big slow moving changes in play that will surprise us in the same way. So as tough as it’s been to persevere these past few months, I continue to believe that the decade 2011-20 will end up being less like the one that preceded it than we are presently tempted to believe. And if the leadership manages to get a few things right, the decade after that could be a whole lot more like the last two decades of the Twentieth Century than we now presently dare to believe.
In comparing where we seem to be today and with where the Market was in the years just after 1974, it appears that the sense of futility we are now experiencing is not unlike what the pundits of thirty years ago so called “the death of equities”. In either case, it was a very long time in the making. Both of these “once-in-a-generation” Bear Markets (1973-74 and 2007-09) were preceded few years earlier by gully washers that were fearsome enough in their own right. The Market shed a third of its value in a little over a year circa 1969, and then would take about three years to recover to only about 10% above the 1968 peak. Which on an inflation adjusted basis was less than no gain at all (and why 1968 might be considered the actual generational peak). Akin to the “lost decade” for equities we have lived through, an investor who bought the S&P in 1968 was still underwater in 1982, and on an inflation adjusted, total return basis was not made whole until 1985. By comparison, the bursting of the Tech Bubble a dozen years ago was most notably felt by the NDQ, but in so doing it cut the S&P 500 nearly in half. It would take several years to recover to just a few percentage points above the 2000 peak before commencing the Bear that we will remember as worst ever. (The 1929-32 debacle did not have a similar precursor, as the DJIA rose nearly six-fold between 1921 and 1929 without a perceptible break. However, the decade long demoralization is apparent back then as well. An investor who bought the DJIA near the 1937 recovery peak would still be waiting to break even in 1948.)
Clearly, this is not the first time in the modern, records-get-kept era that equity ownership has been tried, found wanting, and given up on. The massive fund outflows of recent weeks make me think that we have reached a moment of capitulation not unlike 1938 and 1982 (i.e., a few years past the washout that gets remembered). Just as a scintillating rally of rapid decompression in 2009 mirrored 1933-37 and 1975, the recovery, or perhaps the necessary arrival of complete investor capitulation a la 1939 or 1982, is a much more protracted affair.
Even though I experienced them first hand, I hesitate to compare the years leading up to when the Market finally took off in August 1982 with today. After all, I was in those years that might be described as where the twilight of adolescence is painfully banished by the daunting challenges of matrimony, paternity and, fiscally speaking, still not yet having a pot to piss in, poles apart from today. As a “rookie stock broker” in 1981, I was ill equipped to take the measure of the Market and draw any actionable conclusions. I was, however, extremely in tune with the investing public’s outright disgust with equities. There was money looking to be put to work, but it was the exceptional prospective client who did not say, in so many words, “anything but stocks!”. Money market funds with double digit returns, real estate, oil & gas partnerships (which all came to naught) and maybe municipal bonds (which turned out to provide a prescient few with a fabulous, multi-decade ride), but no stocks. Then there were the gold bugs. Just like today, recent experience had made them look very “right”, as the metal had rocketed six or so fold in the latter part of the Seventies. (Since we can’t begin to value it, I can’t begin to have an opinion on gold, other than that it is likely to be a great speculative vehicle about once in a generation, and that there is no good reason that its latest stint in that mode will end any differently than the 20 year despond which followed its prior day in the sun.)
So as I shift my focus forward and ask what could possibly make the Market go up, given all the structural difficulties we are constantly reminded of, I again recall those late years of the prior, bleak era (1968-82). As it was then, the Bull Market will commence in earnest once the demoralization is complete. That could be right now, or a in a few more years, but just as it was in the Eighties, it won’t be obvious until well after the fact. The Market gave us two great decades because it started from a low and dispirited place, but also because it was on to something. No individual could really see it, but in 1982 the Market “knew”, or started to sense, that ever cheaper computing and telecom would find its way into the cost of practically everything else and make global enterprises with decently managed risks possible. The evidence was also in place for it to perceive that the stultifying menace of Soviet Socialism was dead on its feet, providing a potential for that respite from History which we now remember as the Clinton years. And it also knew, as very few of us would recognize until years later, that a great leader by the name of Reagan was just then taking his place on the big stage. (The hard work and experiences by which he prepared himself for his moment, in stunning contrast to our present leader, were knowable enough, even then.) These were factors that a Market “done going down” in 1982 was able to sense and then overcome that not inconsiderable wall of worry that was the 1980s.
An investor looking ahead for the next decade or two needs to be thinking about similar “stealth potential positives” that, as in the prior era, are probably hiding in plain sight. It has been my experience that as surely as we are unaware of most of what is really going on in the world (the myriad personal dramas that never make the news), we are more aware of the crises and various “bad things” than we are of what might be going right. The “surprising” outcome of so many elections in the past two years is but one indication that our ever vigilant news media doesn’t do a particularly good job of capturing the pulse of public mores and sentiment. So I think this is a particularly good moment to be asking the question, “What could go really right over the next decade or so?” There might not be any answers. It is not beyond the realm of possibilities that terminal decline is upon us, but as those of us who came of age in 1970s (or in the 1930s) can attest, it is not the first time it was easy to suppose as much.
I see political sea change that could make a real difference, but it will be a difference that will play out over a decade and more, and if it is real, the Market will anticipate it. The one area that comes to mind for me as a candidate for circa 2025 pundits wondering about who knew it would change so much would be that vast enterprise we call Education. That would be the process whereby otherwise feral and ignorant little savages get transformed into reasonably productive citizens. Or so it would seem. The reason I single Education out is not just because it is, in the sense I just described, as important as it is if our economy is going to be competitive enough to eventually tame our fiscal morass. Education stands out because as a national enterprise it has experienced colossally bad stewardship over the past generation or so. Alone among critical enterprises, it has had a deteriorating value proposition for the past sixty years at least. Contra what has happened with communications, transport, food and nearly everything else (more and better product at steadily declining real prices), Education is an enterprise that costs more and more but produces less and less (as in recent record low in SAT scores, though it is possible that the reason for that is simply that we invite too many people for whom academic excellence is but a figment of wishful thinking, who should be on a vocational track and/or in rehab, to take the test). The nearest I can get to a similarly failed (i.e., rising instead of falling real cost) would be Medicine, but here at least the quality (previously unimagined improvements in outcomes) makes up for some if not all of the price inflation.
Technology being what it is and having done what it has for almost every other enterprise, and considering what we have learned about the sciences which bear on the process of learning, Education should be a shining star of improving value. Instead, it is the exact opposite. However, I sense that this is well understood, if not quite yet an actionable consensus on any but the most micro of scales. A lot like the way a few prescient folks were seeing what a graphical user interface might do for personal computing, and what personal computing might do for commerce, back in 1982. Too much is at stake for this status quo to persist. Over the next thirty years, that mammoth, value destroying edifice that is Education will be creatively destroyed and supplanted by something that produces a much better outcome (i.e., a competitive workforce) at a much lower cost to families, tax payers, etc. There are probably a couple of other, big slow moving changes in play that will surprise us in the same way. So as tough as it’s been to persevere these past few months, I continue to believe that the decade 2011-20 will end up being less like the one that preceded it than we are presently tempted to believe. And if the leadership manages to get a few things right, the decade after that could be a whole lot more like the last two decades of the Twentieth Century than we now presently dare to believe.
Thursday, September 15, 2011
Generational Change Hits Home
Something about visiting the locale of one’s youth gets you thinking about things that change over the course of a lifetime. So it was during the week+ we just spent in and around Seattle. It’s always a bit of an effort to square current impressions with memories that probably age more like butter than cheese. When I stop to consider that the time between when I got my driver’s license and today is the same as that between then and 1929, how surprised can I be that so much has changed as much as it has? Back then, a ride on the bus had only recently risen from $0.20 (now $2.50, unless you are among the entitled legions who qualify for a subsidized pass, yet another bit of stealth redistribution which belie the “poverty level” statistics), gasoline as low as $0.26 a gallon. Boeing is no longer the dominant employer it was then, even if it presence and that of the myriad companies that support it is vastly larger. Microsoft, Amazon, Starbucks, Expeditors International and the entire biomedical industry were, at most, just germs of ideas in the minds of a few individuals yet to be heard from. The Pacific Rim was more a geological phenomenon than the vast web of economic interdependence and cultural melding that it has become (a New, better-thought-out-than-the-first-attempt, Greater East Asia Co-Prosperity Sphere?).
It is quite possible that Seattle’s place as a key node in that Pacific Rim economy accounts for what seemed like an economy doing a lot better than I expected. Along with the constant reminders we get that the Western world is teetering on the brink of recession, my expectations were tempered by the prolonged speculative excess in real estate in that region that should have set the stage for a longer than average recovery. The downturn that commenced in 2007 certainly registered in terms of business failures, foreclosures and unemployment, but all that seems to have slipped into the past. The places I visited were not overrun with “House For Sale” signs, in fact one on one rather long walk through neighborhoods overlooking Puget Sound I only saw five such signs, and four of them were “Sold”. Perhaps most of the would be sellers gave up, or the Chinese are buying them, but it sure didn’t look like the aftermath of the bust that was 2008.
Even more striking was a Friday evening visit to downtown of a district known as Ballard, a trendy nightlife destination that a couple of decades ago was as genuinely down and dirty, blue collar industrial as they get. At about the fifth restaurant where we were told that the wait time would be at least an hour and a half for a table for two, I was starting to get those “This is some recession we are having!” thoughts. Once we finally found a place that could seat us right away (at a bench overlooking a patio), I was struck by just how lavishly a mostly younger crowd seemed to be able to amuse themselves. A dozen or so years ago on a similar trip, I was bemused by a hallmark of spendthrift culture I chronicled as “$4 micro-brews”. That (now perfectly normal seeming) marker has evolved into $9 cocktails, which were being consumed along with a plethora of a la carte items all but certain to push the tab into three digits in no time at all. I was also assured by my guest that it is crowded like that most other evenings as well. I went to sleep thinking, sure, there may be something exceptional to account for what seemed like surprising prosperity in this little corner of the world, but even with that said, how shaky can the economy be with so many people out spending like that?
That further reflection that sometimes accompanies a night’s sleep brought me to a somewhat less sanguine conclusion. I couldn’t help wondering if what seemed like indications of prosperity were actually indications of cluelessness. Perhaps despite that terrifying moment of reckoning we went through a couple of years back, there are still large numbers among the up and coming generation that haven’t figured out that they are going to have to save a lot more of their incomes than their parents did. If so, then what was going to be a long, slow economic recovery in any case is going to be very long and slow indeed. Recessions are supposed to be reality checks, catalysts for prudence, temperance and sundry other virtues that tend to undergird prosperity as opposed to decline. We no doubt got a good whiff of that, but I can’t help wondering if, much like that uplift in comity and civic mindedness that followed 9/11/01, it has faded away. Probably not absolutely and across the board, but also probably more so than is conducive to a true and lasting national recovery.
The taproot of this somewhat counter intuitive stance is probably rooted in something that occurred to me at least 25 years ago. That was the observation that other countries, notably Japan and Germany, seemed to be catching up with us, and that many investors were terribly alarmed by this. It was true enough, but it had festered into confusion between relative and absolute position. Fixing on 1945 as a reference point, it seemed pretty obvious that other countries growing faster and so seemingly “catching up with us” was the most natural thing in the world. If one economy starts out bombed halfway to the Stone Age but is even remotely well-led, and the other has the only intact industrial base in the world and, over time, the hubris that goes with that, of course the former is going to grow faster.
Unfortunately, those advantages, the ease with which Americans could obtain the spending power to, in effect, bid against the rest of the world for goods and services (e.g., a union job at an enterprise with few if any competitors, something that in recent years has only existed in the public sector.) came to be thought of as perfectly natural and normal. The absolute level of prosperity has risen amazingly for nearly all of us (outside those benighted regions where autocrats and thugs do their best to discourage the impulses that drive prosperity). With the passage of a half century or so, though, the relative position, those advantages enjoyed by Americans and Europeans that were so conspicuous until well into the Seventies and still very large a decade ago, seem to be withering away at a faster clip. And not just withering. They took a huge haircut during the asset deflation that commenced in earnest in 2007. As with any other enterprise, the dysfunction, the dry rot, the ill-considered ideas that accrue in an economy during eras of scarcely interrupted prosperity don’t seem to matter at all until one day there is a tipping point and they are all that matters. Let’s put the collapse of Lehman Brothers at the epicenter of that tipping point and say that what should have been a wake-up call has had three years to wear off.
It appears more than remotely possible that however obvious that wake up call was for some of us, a plurality of the electorate might have further to go in realizing the true gravity of the situation. (Send a message of discontent like we just saw in NY special election? “Absolutely!” Accept the tough decisions that leaders will have to make without whining, complaining and threatening to vote the bum out of office? “Not if it puts my “rights” at risk!”) Having lived through the Seventies, I don’t see the US economy as beyond cure. They fixed that mess, and this mess is probably still fixable as well, but not without the realization that we can no longer afford to be as profligate (i.e, need to spend less and so a lot smarter) as the great prosperity of the past sixty years made so easy. Hopefully I have taken a tiny, atypical sample and misjudged the mood of a nation. Hopefully the vibrancy I keep seeing that belies doomsayers’ lament that the economy is stalling out is not being fueled by little more than rounds of $9 mojitos being piled onto credit cards. But as long as that’s a not bad metaphor for how the US economy functions (i.e., generously seeing to it that your friends have a good time with no thought as to when it will be paid for), the seriousness we need to undergo a necessary cure just might not be there. As we suffer through the discomfort of having watch wobbles in the the price of PIGS nation bank debt (which is easy enough for a pack of hedge funds to set to wobbling, by the way) swing the market cap of our economy by a major fraction of a $Trillion in a seeming blink of an eye, we should bear in mind that meaningful change also plays out on a wavelength that is generational and beyond.
It is quite possible that Seattle’s place as a key node in that Pacific Rim economy accounts for what seemed like an economy doing a lot better than I expected. Along with the constant reminders we get that the Western world is teetering on the brink of recession, my expectations were tempered by the prolonged speculative excess in real estate in that region that should have set the stage for a longer than average recovery. The downturn that commenced in 2007 certainly registered in terms of business failures, foreclosures and unemployment, but all that seems to have slipped into the past. The places I visited were not overrun with “House For Sale” signs, in fact one on one rather long walk through neighborhoods overlooking Puget Sound I only saw five such signs, and four of them were “Sold”. Perhaps most of the would be sellers gave up, or the Chinese are buying them, but it sure didn’t look like the aftermath of the bust that was 2008.
Even more striking was a Friday evening visit to downtown of a district known as Ballard, a trendy nightlife destination that a couple of decades ago was as genuinely down and dirty, blue collar industrial as they get. At about the fifth restaurant where we were told that the wait time would be at least an hour and a half for a table for two, I was starting to get those “This is some recession we are having!” thoughts. Once we finally found a place that could seat us right away (at a bench overlooking a patio), I was struck by just how lavishly a mostly younger crowd seemed to be able to amuse themselves. A dozen or so years ago on a similar trip, I was bemused by a hallmark of spendthrift culture I chronicled as “$4 micro-brews”. That (now perfectly normal seeming) marker has evolved into $9 cocktails, which were being consumed along with a plethora of a la carte items all but certain to push the tab into three digits in no time at all. I was also assured by my guest that it is crowded like that most other evenings as well. I went to sleep thinking, sure, there may be something exceptional to account for what seemed like surprising prosperity in this little corner of the world, but even with that said, how shaky can the economy be with so many people out spending like that?
That further reflection that sometimes accompanies a night’s sleep brought me to a somewhat less sanguine conclusion. I couldn’t help wondering if what seemed like indications of prosperity were actually indications of cluelessness. Perhaps despite that terrifying moment of reckoning we went through a couple of years back, there are still large numbers among the up and coming generation that haven’t figured out that they are going to have to save a lot more of their incomes than their parents did. If so, then what was going to be a long, slow economic recovery in any case is going to be very long and slow indeed. Recessions are supposed to be reality checks, catalysts for prudence, temperance and sundry other virtues that tend to undergird prosperity as opposed to decline. We no doubt got a good whiff of that, but I can’t help wondering if, much like that uplift in comity and civic mindedness that followed 9/11/01, it has faded away. Probably not absolutely and across the board, but also probably more so than is conducive to a true and lasting national recovery.
The taproot of this somewhat counter intuitive stance is probably rooted in something that occurred to me at least 25 years ago. That was the observation that other countries, notably Japan and Germany, seemed to be catching up with us, and that many investors were terribly alarmed by this. It was true enough, but it had festered into confusion between relative and absolute position. Fixing on 1945 as a reference point, it seemed pretty obvious that other countries growing faster and so seemingly “catching up with us” was the most natural thing in the world. If one economy starts out bombed halfway to the Stone Age but is even remotely well-led, and the other has the only intact industrial base in the world and, over time, the hubris that goes with that, of course the former is going to grow faster.
Unfortunately, those advantages, the ease with which Americans could obtain the spending power to, in effect, bid against the rest of the world for goods and services (e.g., a union job at an enterprise with few if any competitors, something that in recent years has only existed in the public sector.) came to be thought of as perfectly natural and normal. The absolute level of prosperity has risen amazingly for nearly all of us (outside those benighted regions where autocrats and thugs do their best to discourage the impulses that drive prosperity). With the passage of a half century or so, though, the relative position, those advantages enjoyed by Americans and Europeans that were so conspicuous until well into the Seventies and still very large a decade ago, seem to be withering away at a faster clip. And not just withering. They took a huge haircut during the asset deflation that commenced in earnest in 2007. As with any other enterprise, the dysfunction, the dry rot, the ill-considered ideas that accrue in an economy during eras of scarcely interrupted prosperity don’t seem to matter at all until one day there is a tipping point and they are all that matters. Let’s put the collapse of Lehman Brothers at the epicenter of that tipping point and say that what should have been a wake-up call has had three years to wear off.
It appears more than remotely possible that however obvious that wake up call was for some of us, a plurality of the electorate might have further to go in realizing the true gravity of the situation. (Send a message of discontent like we just saw in NY special election? “Absolutely!” Accept the tough decisions that leaders will have to make without whining, complaining and threatening to vote the bum out of office? “Not if it puts my “rights” at risk!”) Having lived through the Seventies, I don’t see the US economy as beyond cure. They fixed that mess, and this mess is probably still fixable as well, but not without the realization that we can no longer afford to be as profligate (i.e, need to spend less and so a lot smarter) as the great prosperity of the past sixty years made so easy. Hopefully I have taken a tiny, atypical sample and misjudged the mood of a nation. Hopefully the vibrancy I keep seeing that belies doomsayers’ lament that the economy is stalling out is not being fueled by little more than rounds of $9 mojitos being piled onto credit cards. But as long as that’s a not bad metaphor for how the US economy functions (i.e., generously seeing to it that your friends have a good time with no thought as to when it will be paid for), the seriousness we need to undergo a necessary cure just might not be there. As we suffer through the discomfort of having watch wobbles in the the price of PIGS nation bank debt (which is easy enough for a pack of hedge funds to set to wobbling, by the way) swing the market cap of our economy by a major fraction of a $Trillion in a seeming blink of an eye, we should bear in mind that meaningful change also plays out on a wavelength that is generational and beyond.
Wednesday, August 31, 2011
A Nation of Fraidy Cats?
These last few days before the unofficial end of summer find us refreshed by a week-long stay up where Idaho, Montana and Wyoming converge, sublimely grateful to live in such a vast and beautiful country and have the means to explore it. The Market might have been trending better during that week than it had since July 22, but it was still blessed relief to be disconnected from it (Alas, the one time I snuck a peek was in the midst of Friday AM’s opening swoon, which gave a totally misleading depiction of the week’s trend. Better to not look at all when one is supposed to be “vacating”.) This respite afforded the opportunity not only to enjoy one fabulous vista after another and match wits with wily salmonids but also to ponder what seems like the emergence of Alarmism as a fact of life.
As peaceful as our playground was, there was a backdrop of fear that seemed totally out of proportion with objective reality, an uncanny sense that however much progress has been made against perils such as famine and disease, we are an increasingly fearful people. This was prompted by abundant reminders of the dangers of bears and of lightening strikes. Such dangers had to have been there in similar degree when we were out there thirty years ago, but we don’t remember them as such. Even more intrusive was the media event that was Hurricane Irene. Having been in Texas now since shortly before Katrina, I have learned just how imprecise hurricane projections tend to be. The gruesome spectacle as the storm made landfall and quickly degenerated to well below the 74 mph threshold that denotes a hurricane was not the occasional debris pile that the news mongers were able to scrounge up. It was the overbearing manner in which various officials seemed to be fanning fear. (Even the flood related damage that hit Upstate and Western New England was not so out of line with what seemed to happen almost every year when we resided up there.) The whole thing really made me wonder if we have not become a nation of fraidy cats, a people so fearful of imagined outcomes, however improbable, as to be totally paralyzed in the event some objectively dangerous threat emerges. This, coupled with having just lived through an episode of “skittishness-in-the-extreme” in the Market, got me wondering about just how much stomach for adversity we as a people still have. If it has gotten to where every little potential threat alarms us so, how can we expect to live with the risks and uncertainties of ownership (of enterprises, via common stock), let alone confront the actual, genuine disasters that will inevitably occur at some point?
At first blush, it is tempting to suppose that the aforementioned perils (lethal weather and dangerous wildlife) have been a part of human experience forever, and that our seeming inability to respond to them as courageously as our forebears seemed to does not reflect well on us. We can’t really know what past generations were thinking when bad things happened, but the clues we do have do not, by comparison, reflect well on us (e.g., Isaac’s Storm, by Erik Larson, an account of the Galveston hurricane of 1900, based largely on first person accounts.) Further reflection, however, suggests that perhaps the objective peril has indeed evolved. Better engineering and construction have dramatically reduced the objective perils relating to earthquakes and weather. On the other hand, changes in our interface with wildlife has definitely increased the dangers posed by alpha predators such as grizzly bears and cougars. Their numbers have rebounded as habitat has recovered. Vast improvements in both transportation and the technologies that keep one warm and dry in inclement weather mean that there are far more people coming into contact with them. Behavioral changes, both learned and evolved (not unlike how fish seem to be so much smarter than they were in past generations, in some waters I fished, anyway.) no doubt have occurred as well. This is no doubt attributable, at least in part, to that imperative that we co-exist with nature more peaceably than in the past. Less shooting and trapping, more accommodation and protection. This has been, on balance, a wonderful thing, but not without its price. It’s not just that the Internet has made it so that when a hiker gets killed (as has happened since before the first mountain men visited the Rockies) by a bear the whole world can read about it within hours of the discovery. The alpha predators have re-learned that they are indeed the alpha predators of their realm, and so their realms have become objectively more dangerous places.
Not so with the weather. Comparisons of the dangers posed by Irene with those of Katrina were ludicrous (not much of the Eastern seaboard lies below sea level behind a wall of suspect construction). Those of us who have wearied ourselves over the years trying to glean substance out from the hype generated by the news media will quickly find fault there, but the real problem is on this side of the screen. Yes, they have the increasingly hopeless task of competing for “eyeballs”, and have to resort to hysterics to do it, but who over the age of about eight has not figured that out? The problem, what seems like an increased propensity to allow prospective perils to morph into the stuff of panic, is not the fault of successors of William R. Hearst, however strenuously they seem to make it seem that way. My sense is that they (the news media) only do what they do because we (the audience) do what we do, which is lap it up like crazed kittens in a milking parlor.
Two broad, in-our-lifetime trends account for what can only be called a rising tide of credulity. The most obvious of these has been the still accelerating availability of increasingly visual stimuli purporting to be information. Today’s eighty year old was born into a world of newspapers, a weekly newsreel at the movie theater and a radio that just might have been battery operated. Sixty year olds grew up with television, but it probably only had three or four channels. Forty somethings encountered personal computers and perhaps cell phones as they reached adolescence, while thirty year olds can’t remember there not being video games and hundreds of TV channels. Those now twenty probably struggle to imagine life without 24/7 connectivity, as well as to see what point newspapers ever had. Increasingly, unless we choose to opt out or aggressively screen, we are inundated with what purports to be information but ends up being little more than adrenaline provoking stimulus. It seems in this age of ubiquitous connection with the flow of such data, we are overwhelmed, and a part of us likes it that way. There is something neurological going on when such stimuli hits our brains, especially when it is visual (the eye being, as it was said, the window of the soul). The ease and, indeed, lack of objective peril (like famine or disease, for most of us, most of the time), impels us in the direction of something, anything, that will simulate the struggle that for most of our ancestors gave purpose and meaning to life. Propensity to amuse ourselves seems to have devolved into compulsion. Mobile internet is only making it more so.
Making this threat to our sanity (i.e., the ability to see and understand things as they really are) even worse is the endemic innumeracy of our times. (Innumeracy being to matters quantitative what illiteracy is to the ability to read effectively.) There seems to be little or no understanding of orders of magnitude (i.e., the difference between millions and billions), proportion (e.g., the influence of Fox News in a nation of 311MM+, given its top show draws about 2MM viewers) or probability. It is the latter that accounts for the alarmism that characterized Irene, and otherwise seems to rear its wooly head every few months. The projections by the NWS were only sets of probable outcomes. That is the nature of weather forecasting. But since worst case outcomes, however improbable, tend to be the most luridly fascinating, that is what a bored, innumerate herd of data consumers will gravitate toward. We see this inability or unwillingness to assign probabilities to potential outcomes in matters commercial or economic all the time. Considering how the aforementioned technological evolution has been accompanied by what can only be described as educational devolution, we can only expect this propensity to get worse.
All that said, and back to tactical considerations, the mini-Panic of 2011 seems to be wearing off. Regarding its purported substance (the paltry GDP data), it was interesting to note that Thailand, an economy much more attuned to the Japanese production system than ours, actually contracted in Q2. Whether anticipatory or due to actual upsets in the system, there was a pause in large swathes of the global economy due to that earthquake (have you seen a Honda dealer’s lot lately?), but it seems to have passed. We should see a healthy reflation of equity values in the coming weeks. But given what might be called the New Volatility, with no apparent relief in sight, and the unpalatable prospect of more “politics across a worldview divide” (i.e., scant likelihood of compromise), a portfolio realignment in a less aggressive direction sometime in the months ahead is very much on my mind. Something more in line, at least, with Mr. Graham’s recommendation that one should never have less than 25% or more than 75% in common stocks. We could have more to say about this in the future, but for now the main event will be enjoying a reversal of money flows back into “risk-on” type investments.
As peaceful as our playground was, there was a backdrop of fear that seemed totally out of proportion with objective reality, an uncanny sense that however much progress has been made against perils such as famine and disease, we are an increasingly fearful people. This was prompted by abundant reminders of the dangers of bears and of lightening strikes. Such dangers had to have been there in similar degree when we were out there thirty years ago, but we don’t remember them as such. Even more intrusive was the media event that was Hurricane Irene. Having been in Texas now since shortly before Katrina, I have learned just how imprecise hurricane projections tend to be. The gruesome spectacle as the storm made landfall and quickly degenerated to well below the 74 mph threshold that denotes a hurricane was not the occasional debris pile that the news mongers were able to scrounge up. It was the overbearing manner in which various officials seemed to be fanning fear. (Even the flood related damage that hit Upstate and Western New England was not so out of line with what seemed to happen almost every year when we resided up there.) The whole thing really made me wonder if we have not become a nation of fraidy cats, a people so fearful of imagined outcomes, however improbable, as to be totally paralyzed in the event some objectively dangerous threat emerges. This, coupled with having just lived through an episode of “skittishness-in-the-extreme” in the Market, got me wondering about just how much stomach for adversity we as a people still have. If it has gotten to where every little potential threat alarms us so, how can we expect to live with the risks and uncertainties of ownership (of enterprises, via common stock), let alone confront the actual, genuine disasters that will inevitably occur at some point?
At first blush, it is tempting to suppose that the aforementioned perils (lethal weather and dangerous wildlife) have been a part of human experience forever, and that our seeming inability to respond to them as courageously as our forebears seemed to does not reflect well on us. We can’t really know what past generations were thinking when bad things happened, but the clues we do have do not, by comparison, reflect well on us (e.g., Isaac’s Storm, by Erik Larson, an account of the Galveston hurricane of 1900, based largely on first person accounts.) Further reflection, however, suggests that perhaps the objective peril has indeed evolved. Better engineering and construction have dramatically reduced the objective perils relating to earthquakes and weather. On the other hand, changes in our interface with wildlife has definitely increased the dangers posed by alpha predators such as grizzly bears and cougars. Their numbers have rebounded as habitat has recovered. Vast improvements in both transportation and the technologies that keep one warm and dry in inclement weather mean that there are far more people coming into contact with them. Behavioral changes, both learned and evolved (not unlike how fish seem to be so much smarter than they were in past generations, in some waters I fished, anyway.) no doubt have occurred as well. This is no doubt attributable, at least in part, to that imperative that we co-exist with nature more peaceably than in the past. Less shooting and trapping, more accommodation and protection. This has been, on balance, a wonderful thing, but not without its price. It’s not just that the Internet has made it so that when a hiker gets killed (as has happened since before the first mountain men visited the Rockies) by a bear the whole world can read about it within hours of the discovery. The alpha predators have re-learned that they are indeed the alpha predators of their realm, and so their realms have become objectively more dangerous places.
Not so with the weather. Comparisons of the dangers posed by Irene with those of Katrina were ludicrous (not much of the Eastern seaboard lies below sea level behind a wall of suspect construction). Those of us who have wearied ourselves over the years trying to glean substance out from the hype generated by the news media will quickly find fault there, but the real problem is on this side of the screen. Yes, they have the increasingly hopeless task of competing for “eyeballs”, and have to resort to hysterics to do it, but who over the age of about eight has not figured that out? The problem, what seems like an increased propensity to allow prospective perils to morph into the stuff of panic, is not the fault of successors of William R. Hearst, however strenuously they seem to make it seem that way. My sense is that they (the news media) only do what they do because we (the audience) do what we do, which is lap it up like crazed kittens in a milking parlor.
Two broad, in-our-lifetime trends account for what can only be called a rising tide of credulity. The most obvious of these has been the still accelerating availability of increasingly visual stimuli purporting to be information. Today’s eighty year old was born into a world of newspapers, a weekly newsreel at the movie theater and a radio that just might have been battery operated. Sixty year olds grew up with television, but it probably only had three or four channels. Forty somethings encountered personal computers and perhaps cell phones as they reached adolescence, while thirty year olds can’t remember there not being video games and hundreds of TV channels. Those now twenty probably struggle to imagine life without 24/7 connectivity, as well as to see what point newspapers ever had. Increasingly, unless we choose to opt out or aggressively screen, we are inundated with what purports to be information but ends up being little more than adrenaline provoking stimulus. It seems in this age of ubiquitous connection with the flow of such data, we are overwhelmed, and a part of us likes it that way. There is something neurological going on when such stimuli hits our brains, especially when it is visual (the eye being, as it was said, the window of the soul). The ease and, indeed, lack of objective peril (like famine or disease, for most of us, most of the time), impels us in the direction of something, anything, that will simulate the struggle that for most of our ancestors gave purpose and meaning to life. Propensity to amuse ourselves seems to have devolved into compulsion. Mobile internet is only making it more so.
Making this threat to our sanity (i.e., the ability to see and understand things as they really are) even worse is the endemic innumeracy of our times. (Innumeracy being to matters quantitative what illiteracy is to the ability to read effectively.) There seems to be little or no understanding of orders of magnitude (i.e., the difference between millions and billions), proportion (e.g., the influence of Fox News in a nation of 311MM+, given its top show draws about 2MM viewers) or probability. It is the latter that accounts for the alarmism that characterized Irene, and otherwise seems to rear its wooly head every few months. The projections by the NWS were only sets of probable outcomes. That is the nature of weather forecasting. But since worst case outcomes, however improbable, tend to be the most luridly fascinating, that is what a bored, innumerate herd of data consumers will gravitate toward. We see this inability or unwillingness to assign probabilities to potential outcomes in matters commercial or economic all the time. Considering how the aforementioned technological evolution has been accompanied by what can only be described as educational devolution, we can only expect this propensity to get worse.
All that said, and back to tactical considerations, the mini-Panic of 2011 seems to be wearing off. Regarding its purported substance (the paltry GDP data), it was interesting to note that Thailand, an economy much more attuned to the Japanese production system than ours, actually contracted in Q2. Whether anticipatory or due to actual upsets in the system, there was a pause in large swathes of the global economy due to that earthquake (have you seen a Honda dealer’s lot lately?), but it seems to have passed. We should see a healthy reflation of equity values in the coming weeks. But given what might be called the New Volatility, with no apparent relief in sight, and the unpalatable prospect of more “politics across a worldview divide” (i.e., scant likelihood of compromise), a portfolio realignment in a less aggressive direction sometime in the months ahead is very much on my mind. Something more in line, at least, with Mr. Graham’s recommendation that one should never have less than 25% or more than 75% in common stocks. We could have more to say about this in the future, but for now the main event will be enjoying a reversal of money flows back into “risk-on” type investments.
Tuesday, August 9, 2011
When the Beast Slips Its Leash
It looks like we just lived through the mini-Crash of 2011, a correction more or less in line with the -18% (NDQ) swoon that defined the middle months of 2010, but fast forwarded into a much shorter time frame. My assessment in the previous Musings that an underwhelming Debt Ceiling deal would allow the Market to move on seems to be coming to pass, albeit from a much lower level than I expected. That six or so days of stark raving panic I did not see coming. This was probably because I did not consider that that cyborg we call automated trading can slip its leash, especially when compound imponderables crop up during what is supposed to be a slow time of year. The action on August 8 & 9 alone are all the proof anyone should need that automated trading remains untamed beast. This Musings will attempt to offer up a post mortem on what we just lived through.
The Market did not melt down because a rating agency that has not exactly covered itself with glory in recent years officially lowered its opinion of the debt servicing ability of U.S. Nor was it because the Debt Ceiling agreement didn’t accomplish much. Both of these outcomes were all but taken for granted weeks ago. Three factors, in my estimation, account for what just scared the bejeebers out of everyone. The first two emanated from the political process. The sell-off commenced not when the Debt deal was struck but on July 22, when the “grand bargain” talks collapsed. With that event and in the days of high drama that followed, we were reminded of just how divided the primary factions within our government really are. It is a division that runs deeper than ideology. These parties have totally differing understandings of human nature, and of what is the proper relationship between the governed and those who govern should be. Our fiscal situation is not sustainable and must eventually be resolved. We don’t have to get there overnight, but we have to start moving, and to see just how fundamentally divided the two sides are made it much harder to be optimistic about the future.
It is good mental hygiene to resist that nostalgic impulse that compares the trials and oppressions of the present with burnished, if not faded, recollections of the past. Things changes, some for the better, some for worse. In the midst of that gruesome drama, as we watched our so-called leaders plumb what felt like new depths of dysfunction and wished for someone who could lead us out of this fix, an interesting article about the 1986 Budget deal appeared in the WSJ. Perhaps the most striking thing about it was a picture of two of that deal’s principal collaborators, Dan Rostenkowski and Bob Packwood. (Younger readers should go to Google to learn the ignominy which would follow these two at the tail end of their careers.) It was with no small irony that on seeing these faces from the past and reading about how they shepherded a very rancorous process to a conclusion the would ultimately undergird the prosperity that was the 1990s, I found myself wishing that today’s “statesmen” could be more like those two. That’s how far we have seemingly fallen in a moderate fraction of a lifetime. (It should also be remembered, as we go about trying to make sense of the Market’s reaction to political developments, that the liberating agenda set by the 1986 Budget Act was followed a few months later by the Crash of 1987.)
The queasiness induced by daily reminders of just how far apart the dominant factions are was exacerbated by another grim reality we found ourselves forced to notice. I find it pointless to spend too much time thinking about what the federal budget or the growth in GDP are likely to be in the future. The debt ceiling discussion forced this back to our attention, and what we saw was disturbing. Projections of continuing growth in government spending was no surprise, but what struck me were the assumptions about GDP growth. The deficit really can only be tamed if we grow the economy faster than the budget. It seemed doable, for me anyway, until I read that they have been assuming that the US economy can grow at 5% on a sustained basis, and propose to budget accordingly. To realize that the people who have to fix this mess we are in are so unrealistic is beyond disheartening.
The problem is not just that GDP is a big, nebulous, hard to measure construct. It consists of Consumption, Government, Investment and Net Exports (more properly for the US, “minus net Imports”). Its growth needs to be inflation adjusted (by applying a whole other mare’s nest of estimates), and we can only wonder what globalization has done to the math (i.e., If Apple builds a Mac in China and then sells it here, does that count against GDP?) So where is this growth that will eventually make deficits manageable again supposed to come from? We will get a little help from population growth, but that is on the order of 1%. Are we going to consume more (eat more, buy more clothes, watch more movies)? Maybe a little, but that is not much to count on. And might not Consumption be diminished, at least at the margin, to the degree that cutbacks in government programs result in fewer government employees and moderated transfer payments? Invest more in plant and equipment? Only if it is to make stuff the fast growing parts of the world want and haven’t figured out how to make yet. The real rub, the one that sticks in everybody’s craw when they ponder the details of that long road to fiscal sustainability, is how (C+I+G+nE) can grow if heretofore out-of-control growth in G has to be slowed down and probably reversed. I believe that confronted with this data every time the turned on the news, many investors were disheartened not only by just how daunting the task of bringing the deficit under control will be (that was hard to ignore from the get-go) but also by the realization that policy makers are operating under patently unrealistic assumptions like 5% GDP growth.
These factors weighed on the Market all through the late days of the debt deal, what crushed it was an outworking of Man versus Machine. Given the stellar earnings results that were being posted, in what turned out to be a sub par GDP quarter no less, it was quite plausible to expect the Market to trade up once deal was signed. Down eight or so days in a row, the Market seemed primed for a bounce, and when it didn’t, a rush for the exits ensued. When this started, we got reminded, in spades, that the advances in computer automation that have made it so easy to buy or sell securities still constitute something of an untamed beast. This automation has been a good thing, on balance, but it continues to have its moments. The role of “portfolio insurance” in turning October 1987 into an unforgettable episode comes to mind. We seem to have gotten better at keeping this beast under control, on most days under most conditions. Last year’s Flash Crash was an exception. So was this mini-Crash we just rode through. When the buttons got pushed or the algorithms simply started to respond as programmed, there was enough paralyzing uncertainty on the putative “other side of the trade” for things to spin out of control. Throw together the dissonance evoked by the GDP revisions (dissonant with respect to how well the economy seemed to be performing in light of the earnings of 85%+ of the major companies that make it up) with an unprecedented (“So what does it really mean?”) event like the S&P downgrade, and if there is supposed to any human input to that “other side”, it will hesitate. Such hesitation begets price action that begets ominous price declines and so the need for even more assessment. It was a good old fashioned panic kicked into warp drive by automatons that would have been right at home along side the Terminator. It seems to have run its course. The Market is moving on.
The Market did not melt down because a rating agency that has not exactly covered itself with glory in recent years officially lowered its opinion of the debt servicing ability of U.S. Nor was it because the Debt Ceiling agreement didn’t accomplish much. Both of these outcomes were all but taken for granted weeks ago. Three factors, in my estimation, account for what just scared the bejeebers out of everyone. The first two emanated from the political process. The sell-off commenced not when the Debt deal was struck but on July 22, when the “grand bargain” talks collapsed. With that event and in the days of high drama that followed, we were reminded of just how divided the primary factions within our government really are. It is a division that runs deeper than ideology. These parties have totally differing understandings of human nature, and of what is the proper relationship between the governed and those who govern should be. Our fiscal situation is not sustainable and must eventually be resolved. We don’t have to get there overnight, but we have to start moving, and to see just how fundamentally divided the two sides are made it much harder to be optimistic about the future.
It is good mental hygiene to resist that nostalgic impulse that compares the trials and oppressions of the present with burnished, if not faded, recollections of the past. Things changes, some for the better, some for worse. In the midst of that gruesome drama, as we watched our so-called leaders plumb what felt like new depths of dysfunction and wished for someone who could lead us out of this fix, an interesting article about the 1986 Budget deal appeared in the WSJ. Perhaps the most striking thing about it was a picture of two of that deal’s principal collaborators, Dan Rostenkowski and Bob Packwood. (Younger readers should go to Google to learn the ignominy which would follow these two at the tail end of their careers.) It was with no small irony that on seeing these faces from the past and reading about how they shepherded a very rancorous process to a conclusion the would ultimately undergird the prosperity that was the 1990s, I found myself wishing that today’s “statesmen” could be more like those two. That’s how far we have seemingly fallen in a moderate fraction of a lifetime. (It should also be remembered, as we go about trying to make sense of the Market’s reaction to political developments, that the liberating agenda set by the 1986 Budget Act was followed a few months later by the Crash of 1987.)
The queasiness induced by daily reminders of just how far apart the dominant factions are was exacerbated by another grim reality we found ourselves forced to notice. I find it pointless to spend too much time thinking about what the federal budget or the growth in GDP are likely to be in the future. The debt ceiling discussion forced this back to our attention, and what we saw was disturbing. Projections of continuing growth in government spending was no surprise, but what struck me were the assumptions about GDP growth. The deficit really can only be tamed if we grow the economy faster than the budget. It seemed doable, for me anyway, until I read that they have been assuming that the US economy can grow at 5% on a sustained basis, and propose to budget accordingly. To realize that the people who have to fix this mess we are in are so unrealistic is beyond disheartening.
The problem is not just that GDP is a big, nebulous, hard to measure construct. It consists of Consumption, Government, Investment and Net Exports (more properly for the US, “minus net Imports”). Its growth needs to be inflation adjusted (by applying a whole other mare’s nest of estimates), and we can only wonder what globalization has done to the math (i.e., If Apple builds a Mac in China and then sells it here, does that count against GDP?) So where is this growth that will eventually make deficits manageable again supposed to come from? We will get a little help from population growth, but that is on the order of 1%. Are we going to consume more (eat more, buy more clothes, watch more movies)? Maybe a little, but that is not much to count on. And might not Consumption be diminished, at least at the margin, to the degree that cutbacks in government programs result in fewer government employees and moderated transfer payments? Invest more in plant and equipment? Only if it is to make stuff the fast growing parts of the world want and haven’t figured out how to make yet. The real rub, the one that sticks in everybody’s craw when they ponder the details of that long road to fiscal sustainability, is how (C+I+G+nE) can grow if heretofore out-of-control growth in G has to be slowed down and probably reversed. I believe that confronted with this data every time the turned on the news, many investors were disheartened not only by just how daunting the task of bringing the deficit under control will be (that was hard to ignore from the get-go) but also by the realization that policy makers are operating under patently unrealistic assumptions like 5% GDP growth.
These factors weighed on the Market all through the late days of the debt deal, what crushed it was an outworking of Man versus Machine. Given the stellar earnings results that were being posted, in what turned out to be a sub par GDP quarter no less, it was quite plausible to expect the Market to trade up once deal was signed. Down eight or so days in a row, the Market seemed primed for a bounce, and when it didn’t, a rush for the exits ensued. When this started, we got reminded, in spades, that the advances in computer automation that have made it so easy to buy or sell securities still constitute something of an untamed beast. This automation has been a good thing, on balance, but it continues to have its moments. The role of “portfolio insurance” in turning October 1987 into an unforgettable episode comes to mind. We seem to have gotten better at keeping this beast under control, on most days under most conditions. Last year’s Flash Crash was an exception. So was this mini-Crash we just rode through. When the buttons got pushed or the algorithms simply started to respond as programmed, there was enough paralyzing uncertainty on the putative “other side of the trade” for things to spin out of control. Throw together the dissonance evoked by the GDP revisions (dissonant with respect to how well the economy seemed to be performing in light of the earnings of 85%+ of the major companies that make it up) with an unprecedented (“So what does it really mean?”) event like the S&P downgrade, and if there is supposed to any human input to that “other side”, it will hesitate. Such hesitation begets price action that begets ominous price declines and so the need for even more assessment. It was a good old fashioned panic kicked into warp drive by automatons that would have been right at home along side the Terminator. It seems to have run its course. The Market is moving on.
Thursday, July 28, 2011
Partying Like It's 1999?
As I sat down to start writing this, an hour or so into the trading day, the NASDAQ was down about 2% despite a continuing stream of very encouraging earnings releases from the likes of Boeing and Amazon. A Debt Ceiling Countdown Clock at WSJ Online informed me that we have not quite six days and fifteen hours until something really awful happens, something right up there with Y2K, Carmaggedon, the invasion of Kuwait and the SARS pandemic of 2003. No wait, those weren’t so awful, at least not an in “oops, there goes the present value of the global economy’s future cash flows” sort of way. This “crisis” is probably destined to join those others in the Hall of Shame for Infamously Overhyped Events. It is possible, but not probable in my estimation, that like an avalanche triggered by a single ill-considered snowball, somebody somewhere will feel the need to dump their putatively risk-free assets “before everyone else does”, and the “price signals” thus generated convinces others that there really is a problem and its worse than we think, and then it feeds on itself for a while. Such is the nature of panic. So there is an element of danger in this debt limit impasse, but only if panic takes hold.
This situation is as distasteful as it is because it is so much about short term politics, positioning for next year’s election, at the seeming expense of longer term stakes that are so high. But there is a sense in which we should be grateful for this unseemly display of human nature. Factions within people groups will always disagree, always compete for power and access to resources. We work these differences out through politics. The process is distasteful in the extreme, but considering the alternative, the mobs, assassinations and other sanguinary routines with which most people in most times and places have resolved their differences, it is almost a blessing to have to watch middle-aged men and women go at each other with mere words. This dispute will come to some sort of conclusion in the next few trading days. The Democrats seem to believe that they can make the Republicans look heartless and irresponsible and then get the media to reinforce that message right through the election. As if anyone under the age of about 70 was watching the evening news. The Republicans just want to force the Democrats to have to keep talking about raising taxes, or propose another hike in the debt ceiling, preferably right before the election. Once both sides have decided they have hung something intolerable around the other side’s neck, some compromise will be reached. It will probably constitute and tiny and contingent baby step in the direction of fiscal probity, a long overdue journey that will only get underway in earnest in 2013, but it will be hailed as progress and the Market will move on.
This crisis reminds me of nothing more than a reality show about staging an intervention with some pampered young princess whose credit fueled lifestyle has reached a breaking point. She always seems oblivious to what I, from about age twelve, always thought that any reasonably well educated twelve year old knows, that more money going out than coming in will come to a bad end eventually. There is also that element facing up to how what were once considered luxuries have become necessities or even “rights”. I am optimistic that a plurality at least of voters understand that there will have to be an era of sacrifice, at least a little bit by nearly everyone and a lot by some (i.e., those currently living large on cash flows emanating from that plethora of government programs). They should be able to understand that entitlements conceived a couple of generations ago, when life expectancy was around 58 years and geriatric medicine was mainly palliative, can at some basic level be protected but have to be retooled to the 21st Century. The problem, as always, will be those special interests, whose “sacrifice” (i.e., giving back some of what they have contrived to take from the rest of us) will be acute and possibly life changing. So we will get drama. We will get fear mongering, which we can only hope does not trigger panic (Like the ill-considered “mark-to-market” rules that greased the skids on the way to the brink of catastrophe in 2008, rules that mandate rather than advise with respect to bond ratings are more than a little unsettling at this juncture.)
In the meantime, what’s not to like about this latest batch of earnings releases? Well, some of the action we saw early on, stocks getting crushed for very decent or even outstanding reports, got me thinking about What Time is It? My sense is that in terms of a Bull Market that started in March 2009 and will end at some point to be followed by a 20%+ decline, we are not yet late in the game, but we just might be getting to the late innings. That low water mark is going on 2 1/2 years already. The money at the margin seems to have gotten used to earnings “beats” as a matter of course, and inclined to dump if the “beat” falls short of another construct that seems to have crept back, the “whisper number”. If all this strikes you as faintly familiar, you are not alone. I could not help wondering, especially given the initial reception given some of my Old Tech stocks, if it wasn’t starting to feel like 1999 again. It’s not just the IPO Market back in force, cranking out multi-$B market caps for entities that will probably never turn a profit. No, what the response to the likes of INTC, CYMI and MKSI reminded me of is the way the investing world got starting in April 1998, when New Economy stocks floated as if gravity had been outlawed, and in so doing sucked all the oxygen out of the room for the Old (or, as I liked to put, Real) Economy stocks. This went on for almost two years before reality reasserted itself and valuations of these respective groups reversed course. For a few hours anyway, watching the Market at best yawn at the great results of worthy enterprises while going bananas over yet another dubious social media startup, it was tempting to worry that we were about to go through all that again.
This temptation would prove fleeting. Whatever seemingly orchestrated, trading desk induced “disappointment” at the results of the Old Tech stalwarts was quite short-lived and in some cases (MKSI in particular) no doubt painful for the perpetrators. Investors have not quite taken leave of their senses in the manner we endured through 1999. There is still a realization extant that if Facebook and Linkdin and the rest of their ilk, and even Apple and Google for that matter, are going to realize anything close to their purported potential, they will need Intel continuing to march on what it does so incomparably well. And for that to happen, the likes of ASML and CYMI, athwart that bottleneck in the path denoted by Moore’s Law, are going to have to continue to execute to plan as well. And as they move forward, the likes of MKSI follow right behind. Web 2.0 is most definitely happening, but none of us are truly capable of knowing who the biggest winners will be, and who is going to end up in that vast, teeming herd of also-rans. We can, however, recognize those companies who are key enablers of what the whole world seems to want more of, whose capabilities cannot be replicated and whose valuations are grossly out of synch with any but the most dismal of prospects. Once the data from these earnings releases had time to sink in, the Market at least hinted that it kind of gets this (at least until the Debt Ceiling Countdown got to about seven days), with even dinosaur MSFT shaking off its naysayers.
So what time is it? It’s nowhere near 1999, or even April 1998 for that matter, but it is closer to April 1998 (for Real Economy stocks) than it is to March 2009, i.e., a long ways already from early in the game. There are other factors that make this moment starkly different than what culminated in the Tech Bubble. For starters, the valuations achieved on the way to Y2K were a recognition of how massive and decentralized computing power was going to enable globalization over the next few decades. An Internet based economy has indeed developed, its just not the one the promoters were telling us about 14 or sp years ago. Massive wealth, and not just at the top, was about to be created. That prospect is not exactly gone today, but it is at the very least up against diminution at the margin. Then there is the matter of that national debt and the deficits that caused it. It seems like ancient history today, but in 1998 the Market was loving on federal budget surpluses, with the prospect of more to come (“a shortage of Treasuries, anyone?”). Today’s reality finds a federal deficit unlikely to shrink to even a low-single-digit percentage of GDP unless said GDP starts growing at 5%, and how likely is that?
Finally, in 1998 it had been a very long time since investors had endured a market downturn that wasn’t over and made up for in a matter of months. (Even the Crash of ’87 was over and forgotten, except perhaps for banks and real estate whizzes in the Northeast and the Oil Patch, by mid 1988.) Enough time has passed for the sting that was 2008-09 to fade, but the scars of what probably will be the Bear Market of a lifetime are still very much on our collective psyche. So we can expect the animal spirits to come out and play. And given how long it has now been since the Big Tide turned (that -18% correction last summer notwithstanding), the time has come, in my estimation, to be giving at least as much thought to taking profits and building up for the next rainy day as we give to taking advantage of the momentary buying opportunities that develop when it sure seems like somebody somewhere is trying to trigger a panic.
This situation is as distasteful as it is because it is so much about short term politics, positioning for next year’s election, at the seeming expense of longer term stakes that are so high. But there is a sense in which we should be grateful for this unseemly display of human nature. Factions within people groups will always disagree, always compete for power and access to resources. We work these differences out through politics. The process is distasteful in the extreme, but considering the alternative, the mobs, assassinations and other sanguinary routines with which most people in most times and places have resolved their differences, it is almost a blessing to have to watch middle-aged men and women go at each other with mere words. This dispute will come to some sort of conclusion in the next few trading days. The Democrats seem to believe that they can make the Republicans look heartless and irresponsible and then get the media to reinforce that message right through the election. As if anyone under the age of about 70 was watching the evening news. The Republicans just want to force the Democrats to have to keep talking about raising taxes, or propose another hike in the debt ceiling, preferably right before the election. Once both sides have decided they have hung something intolerable around the other side’s neck, some compromise will be reached. It will probably constitute and tiny and contingent baby step in the direction of fiscal probity, a long overdue journey that will only get underway in earnest in 2013, but it will be hailed as progress and the Market will move on.
This crisis reminds me of nothing more than a reality show about staging an intervention with some pampered young princess whose credit fueled lifestyle has reached a breaking point. She always seems oblivious to what I, from about age twelve, always thought that any reasonably well educated twelve year old knows, that more money going out than coming in will come to a bad end eventually. There is also that element facing up to how what were once considered luxuries have become necessities or even “rights”. I am optimistic that a plurality at least of voters understand that there will have to be an era of sacrifice, at least a little bit by nearly everyone and a lot by some (i.e., those currently living large on cash flows emanating from that plethora of government programs). They should be able to understand that entitlements conceived a couple of generations ago, when life expectancy was around 58 years and geriatric medicine was mainly palliative, can at some basic level be protected but have to be retooled to the 21st Century. The problem, as always, will be those special interests, whose “sacrifice” (i.e., giving back some of what they have contrived to take from the rest of us) will be acute and possibly life changing. So we will get drama. We will get fear mongering, which we can only hope does not trigger panic (Like the ill-considered “mark-to-market” rules that greased the skids on the way to the brink of catastrophe in 2008, rules that mandate rather than advise with respect to bond ratings are more than a little unsettling at this juncture.)
In the meantime, what’s not to like about this latest batch of earnings releases? Well, some of the action we saw early on, stocks getting crushed for very decent or even outstanding reports, got me thinking about What Time is It? My sense is that in terms of a Bull Market that started in March 2009 and will end at some point to be followed by a 20%+ decline, we are not yet late in the game, but we just might be getting to the late innings. That low water mark is going on 2 1/2 years already. The money at the margin seems to have gotten used to earnings “beats” as a matter of course, and inclined to dump if the “beat” falls short of another construct that seems to have crept back, the “whisper number”. If all this strikes you as faintly familiar, you are not alone. I could not help wondering, especially given the initial reception given some of my Old Tech stocks, if it wasn’t starting to feel like 1999 again. It’s not just the IPO Market back in force, cranking out multi-$B market caps for entities that will probably never turn a profit. No, what the response to the likes of INTC, CYMI and MKSI reminded me of is the way the investing world got starting in April 1998, when New Economy stocks floated as if gravity had been outlawed, and in so doing sucked all the oxygen out of the room for the Old (or, as I liked to put, Real) Economy stocks. This went on for almost two years before reality reasserted itself and valuations of these respective groups reversed course. For a few hours anyway, watching the Market at best yawn at the great results of worthy enterprises while going bananas over yet another dubious social media startup, it was tempting to worry that we were about to go through all that again.
This temptation would prove fleeting. Whatever seemingly orchestrated, trading desk induced “disappointment” at the results of the Old Tech stalwarts was quite short-lived and in some cases (MKSI in particular) no doubt painful for the perpetrators. Investors have not quite taken leave of their senses in the manner we endured through 1999. There is still a realization extant that if Facebook and Linkdin and the rest of their ilk, and even Apple and Google for that matter, are going to realize anything close to their purported potential, they will need Intel continuing to march on what it does so incomparably well. And for that to happen, the likes of ASML and CYMI, athwart that bottleneck in the path denoted by Moore’s Law, are going to have to continue to execute to plan as well. And as they move forward, the likes of MKSI follow right behind. Web 2.0 is most definitely happening, but none of us are truly capable of knowing who the biggest winners will be, and who is going to end up in that vast, teeming herd of also-rans. We can, however, recognize those companies who are key enablers of what the whole world seems to want more of, whose capabilities cannot be replicated and whose valuations are grossly out of synch with any but the most dismal of prospects. Once the data from these earnings releases had time to sink in, the Market at least hinted that it kind of gets this (at least until the Debt Ceiling Countdown got to about seven days), with even dinosaur MSFT shaking off its naysayers.
So what time is it? It’s nowhere near 1999, or even April 1998 for that matter, but it is closer to April 1998 (for Real Economy stocks) than it is to March 2009, i.e., a long ways already from early in the game. There are other factors that make this moment starkly different than what culminated in the Tech Bubble. For starters, the valuations achieved on the way to Y2K were a recognition of how massive and decentralized computing power was going to enable globalization over the next few decades. An Internet based economy has indeed developed, its just not the one the promoters were telling us about 14 or sp years ago. Massive wealth, and not just at the top, was about to be created. That prospect is not exactly gone today, but it is at the very least up against diminution at the margin. Then there is the matter of that national debt and the deficits that caused it. It seems like ancient history today, but in 1998 the Market was loving on federal budget surpluses, with the prospect of more to come (“a shortage of Treasuries, anyone?”). Today’s reality finds a federal deficit unlikely to shrink to even a low-single-digit percentage of GDP unless said GDP starts growing at 5%, and how likely is that?
Finally, in 1998 it had been a very long time since investors had endured a market downturn that wasn’t over and made up for in a matter of months. (Even the Crash of ’87 was over and forgotten, except perhaps for banks and real estate whizzes in the Northeast and the Oil Patch, by mid 1988.) Enough time has passed for the sting that was 2008-09 to fade, but the scars of what probably will be the Bear Market of a lifetime are still very much on our collective psyche. So we can expect the animal spirits to come out and play. And given how long it has now been since the Big Tide turned (that -18% correction last summer notwithstanding), the time has come, in my estimation, to be giving at least as much thought to taking profits and building up for the next rainy day as we give to taking advantage of the momentary buying opportunities that develop when it sure seems like somebody somewhere is trying to trigger a panic.
Monday, July 18, 2011
Train Wreck Just Ahead?
This edition of Musings finds us freshly returned from what has probably become an annual pilgrimage to the mountains of Northern New Mexico and Southern Colorado. Being 9000+ feet above sea level, the water at one’s feet perhaps only hours removed from a snow bank, matching wits with salmonids that, while pea-brained, are quite exquisitely programmed for survival (at least if they are going to grow as large as the ones I tangled with) is a good thing. Sitting through an unrelenting succession of 1000 + days in what hopefully are the late innings of a bona fide contender for Drought of the Century, not so good. The 870 mile drive each way? A mixed bag, but definitely worth it. It makes for a couple of very long sits for what have become old bones, much of it through flat featureless country, but occasionally punctuated by very lovely scenery. This was also the year we learned that contrary to everything I had heard, speed limits will be enforced on the empty roads of West Texas. Specifically, 78 MPH will get you pulled over and warned on US 84 between I-20 and Snyder. (As the radar will see you up to a mile away on that flat, straight stretch, the officer will be rolling with lights flashing when you first see him.)
As much as I try to leave “the job” behind on trips like this (wireless Internet at the B&B not making that any easier), there was no getting away from the inner economist out on the sparsely peopled spaces traversed by US 84 between Lubbock, TX and Fort Sumner, NM. This is because on that stretch the highway follows the BNSF railroad. Inclined as I am to wonder about the actual state of the economy, the activity that is only symbolized by “indicators”, I could not help but notice the length and frequency of freight trains. Unless old-time games are being played with empty rail cars and containers (no doubt at least some of the eastbound containers were empty, but that is a trade balance issue), there is an awful lot of stuff moving from one side of the continent to the other this summer. Globalization and population density around port cities has made rail transport a decent business again after a generations-long decline (back to Henry Ford’s time, at least), unless of course the new owner of BNSF has lost his grip and succumbed to a childhood fantasy many of us had about playing with trains. In any case, highways were anything but devoid of trucks despite the massive numbers of containers that now go “most of the way” from port to destination by train. All this tells me that the global economy is not conking out.
Train traffic brings to mind that normally this far into the calendar quarter, we have seen a lot more earnings releases, including perennial early reporter CSX. Thus far we have seen Alcoa, Citigroup and Google, not much really in the way of a peek into how the economy is faring. This will change over the next few days, with IBM on Monday, CSX on Tuesday, and Intel on Wednesday, among many others that are going to make the next two weeks an unusually dense data dump indeed. I am especially looking forward to Intel, given the little throwdown that erupted a few weeks back when IDC cut its PC forecast. In a matter of just a few hours, and in a manner quite unlike anything I have seen them do in the years I have been watching, Intel came out with the statement that “Our Q2 results will speak for themselves.” This escalated a months-old tiff wherein Intel suggested that IDC does not quite have a handle on where PC demand is coming from in the still rapidly growing parts of the world. Considering how consistently and, quite often, grossly, the Street has underestimated the performance of Intel, one has to wonder who if anybody has a grip on just how well this company has responded that “crisis moment” a few years back (when AMD was supposedly on a rampage). We will see on Wednesday.
We should be surprised if this earnings release season does not depict an economy that is showing all the usual signs of recovery, however tepidly in the U.S., most of the EU and Japan, where effects of the earthquake dampen the already soggy prospects that go with such awful demographics. The global economy is recovering, and the earnings just ahead should spark a realization of this that manifests in another stair-step up in equity valuations. Unfortunately, there is this little distraction that is the budget impasse in Washington D.C., stinging the eyes of investors and otherwise making them uncomfortable, much like the smoke from that Las Conchas fire that threatened the Los Alamos National Labs. (Actually, while the smoke from that was pretty bad around Santa Fe, it was not evident up towards, Chama, NM, a stretch of highway as spectacular as I have seen in a very long time.) The politicians will probably (i.e., much more likely than not, if experience is any guide) manage some kind of compromise, probably one part chipping away at spending, ten parts kicking the can down the road. I cannot bring myself to bet otherwise, and uncertainty will abate, if only for a while. However, I cannot quite shake the uneasy feeling that this could end up being very ugly. It is not the substantive threat of technical default that should concern us. Owners of long term Treasuries should be delighted if perchance an interest payment were delayed by a matter of a few days or even weeks if the result was real progress towards assuring that principal will be returned on schedule and with dollars that have not been inflated into oblivion. What should concern us is the prospect of panic, that lethal admixture that bubbles up when craven demagoguery taps into seemingly programmed credulity. Like a bad accident no one saw coming.
How much of the bad stuff we see in history happened on purpose? Some of it, to be sure, like the fall of Constantinople, but probably not most of it. Did nineteen year old Gavrilo Princip have any idea he would spark WW1 when he shot that Archduke? Did Abraham Lincoln have any idea when the set out to preserve the Union that he would unleash a war that would rage for years and leave scars that would be generations in healing? And contrary to what some in the tinfoil hat set would have us believe, the Great Depression was an avoidable bad accident, too. 2011 finds us in a financial situation that while not yet precarious will become so if spending is not moderated and revenues are not increased (preferably by economic growth). An actual poll question I heard as I was taking a break from writing this (paraphrased): “Is the President incompetent or deliberately trying to make us more like Europe?” could easily and honestly be answered “Both”. The prospect of deliberate sabotage (making us more like Europe would be the same as sabotage, IMO) while not implausible given the atmosphere of the faculty lounges where his adult character hardened into shape, can be set aside and still leave us very nervous. This is because history has shown us that even truly competent leaders can cause the bad accidents that are history at its worst, and (at best) marginally competent leaders whose notions of their own competence have been inflated well beyond reality are especially dangerous in this respect.
My bottom line as Earnings Season Q2 2011 gets underway in earnest is that stocks are probably about to pop due to both confirmation of just how profitable many companies have become and at least an easing of the uncertainty attendant when the Inmates Running the Asylum have the power to cause bad accidents. Train wrecks, literal and figurative, only very rarely happen because someone wanted them to. Fortunately, they don’t happen all that often, and certainly not as often as the near misses that we never even think about unless we happen to have been there and paying attention. This should be a good week to be on board.
As much as I try to leave “the job” behind on trips like this (wireless Internet at the B&B not making that any easier), there was no getting away from the inner economist out on the sparsely peopled spaces traversed by US 84 between Lubbock, TX and Fort Sumner, NM. This is because on that stretch the highway follows the BNSF railroad. Inclined as I am to wonder about the actual state of the economy, the activity that is only symbolized by “indicators”, I could not help but notice the length and frequency of freight trains. Unless old-time games are being played with empty rail cars and containers (no doubt at least some of the eastbound containers were empty, but that is a trade balance issue), there is an awful lot of stuff moving from one side of the continent to the other this summer. Globalization and population density around port cities has made rail transport a decent business again after a generations-long decline (back to Henry Ford’s time, at least), unless of course the new owner of BNSF has lost his grip and succumbed to a childhood fantasy many of us had about playing with trains. In any case, highways were anything but devoid of trucks despite the massive numbers of containers that now go “most of the way” from port to destination by train. All this tells me that the global economy is not conking out.
Train traffic brings to mind that normally this far into the calendar quarter, we have seen a lot more earnings releases, including perennial early reporter CSX. Thus far we have seen Alcoa, Citigroup and Google, not much really in the way of a peek into how the economy is faring. This will change over the next few days, with IBM on Monday, CSX on Tuesday, and Intel on Wednesday, among many others that are going to make the next two weeks an unusually dense data dump indeed. I am especially looking forward to Intel, given the little throwdown that erupted a few weeks back when IDC cut its PC forecast. In a matter of just a few hours, and in a manner quite unlike anything I have seen them do in the years I have been watching, Intel came out with the statement that “Our Q2 results will speak for themselves.” This escalated a months-old tiff wherein Intel suggested that IDC does not quite have a handle on where PC demand is coming from in the still rapidly growing parts of the world. Considering how consistently and, quite often, grossly, the Street has underestimated the performance of Intel, one has to wonder who if anybody has a grip on just how well this company has responded that “crisis moment” a few years back (when AMD was supposedly on a rampage). We will see on Wednesday.
We should be surprised if this earnings release season does not depict an economy that is showing all the usual signs of recovery, however tepidly in the U.S., most of the EU and Japan, where effects of the earthquake dampen the already soggy prospects that go with such awful demographics. The global economy is recovering, and the earnings just ahead should spark a realization of this that manifests in another stair-step up in equity valuations. Unfortunately, there is this little distraction that is the budget impasse in Washington D.C., stinging the eyes of investors and otherwise making them uncomfortable, much like the smoke from that Las Conchas fire that threatened the Los Alamos National Labs. (Actually, while the smoke from that was pretty bad around Santa Fe, it was not evident up towards, Chama, NM, a stretch of highway as spectacular as I have seen in a very long time.) The politicians will probably (i.e., much more likely than not, if experience is any guide) manage some kind of compromise, probably one part chipping away at spending, ten parts kicking the can down the road. I cannot bring myself to bet otherwise, and uncertainty will abate, if only for a while. However, I cannot quite shake the uneasy feeling that this could end up being very ugly. It is not the substantive threat of technical default that should concern us. Owners of long term Treasuries should be delighted if perchance an interest payment were delayed by a matter of a few days or even weeks if the result was real progress towards assuring that principal will be returned on schedule and with dollars that have not been inflated into oblivion. What should concern us is the prospect of panic, that lethal admixture that bubbles up when craven demagoguery taps into seemingly programmed credulity. Like a bad accident no one saw coming.
How much of the bad stuff we see in history happened on purpose? Some of it, to be sure, like the fall of Constantinople, but probably not most of it. Did nineteen year old Gavrilo Princip have any idea he would spark WW1 when he shot that Archduke? Did Abraham Lincoln have any idea when the set out to preserve the Union that he would unleash a war that would rage for years and leave scars that would be generations in healing? And contrary to what some in the tinfoil hat set would have us believe, the Great Depression was an avoidable bad accident, too. 2011 finds us in a financial situation that while not yet precarious will become so if spending is not moderated and revenues are not increased (preferably by economic growth). An actual poll question I heard as I was taking a break from writing this (paraphrased): “Is the President incompetent or deliberately trying to make us more like Europe?” could easily and honestly be answered “Both”. The prospect of deliberate sabotage (making us more like Europe would be the same as sabotage, IMO) while not implausible given the atmosphere of the faculty lounges where his adult character hardened into shape, can be set aside and still leave us very nervous. This is because history has shown us that even truly competent leaders can cause the bad accidents that are history at its worst, and (at best) marginally competent leaders whose notions of their own competence have been inflated well beyond reality are especially dangerous in this respect.
My bottom line as Earnings Season Q2 2011 gets underway in earnest is that stocks are probably about to pop due to both confirmation of just how profitable many companies have become and at least an easing of the uncertainty attendant when the Inmates Running the Asylum have the power to cause bad accidents. Train wrecks, literal and figurative, only very rarely happen because someone wanted them to. Fortunately, they don’t happen all that often, and certainly not as often as the near misses that we never even think about unless we happen to have been there and paying attention. This should be a good week to be on board.
Saturday, July 2, 2011
Signs of Recovery
That five day burst of enthusiasm that was the week just passed was nothing if not a collective “Aha!”, a realization that for the global economy, May was a mere speed bump rather than the start of an increasingly rough and rocky road. The road got smoother in June, and looks to get even more so in July and beyond. This week saw a tipping point, a burgeoning accumulation of outlooks by corporations that confirmed that the “double-dip” scenario is not meant to be. It was really not much of a surprise. The combination of what looked for all the world to be accelerating energy costs, along with business decision-makers rightly waiting out the full implications of Japanese supply chain disruption, did indeed produce something of a “soft patch”. As June progressed, however, it became apparent that it was just a patch, and that it is behind us. The Greek tantrum was really just a sideshow, a handy diversion jacked up by the owners of the channels who compete for our attention. Global economic recovery continues unabated, and this was the week that the Market figured it out.
Musings managed to tune the first few days of it out by taking a trip down to the coast. While the winds have moderated some, months of unrelenting southerly winds seem to have pushed the water up to a level well above ideal for flats fishing. This did not stop us from connecting with a few unsuspecting redfish and otherwise enjoying the natural splendor. I have tried to make this trip more than once or twice a year for the past several, and in doing so have gotten quite familiar with a thin slice of the thoroughly rural country between Austin and Aransas Pass. Observant old cuss that I seem to be, whatever changes occur between trips seem to stand right out. On this trip, I noticed two starkly different sorts of change that could be described as economic stimulus at work. Passing through the orbit of San Marcos/Seguin, I was struck by the plethora of road signage that has sprouted up since the last trip. A whole lot more marginally paved side roads have big signs or even lights. Coupled with various construction projects along the way, this is yet another partial answer to “So where did the $700B+ in stimulus spending go?” It is pretty obvious that it filters down through counties and other local, politically connected authorities. It rubs off on those politically connected enough to get the contracts to put up the signs and otherwise perform all that activity that passes for work along the by-ways. (Leasing those big plastic barriers, for who knows how many $$/day each, must be a great way to dip one’s snout into the public works trough, a political “in” well worth playing dirty to obtain.) Of course, some of the money goes to the politically connected sign manufacturers. Last but not least, the politically connected (in a low-rent sort of way) folks who belong to the political influential union whose members are allowed to put up the signs (when they are not leaning on shovels or taking a break) get a slice of the pie. So there is some perceptible economic activity, but once the signs are up it is not long before it has pretty much fizzled out.
A much different sort of stimulus is evident as one traverses Karnes County, towns like Karnes City, Kenedy and Panna Maria. This is where the highway passes over the Eagle Ford shale play. Three years ago, these little towns struck one as somewhere between sleepy and slowly dying. They are now positively alive with economic activity. Aside from having to pass a six vehicle drilling rig convoy going just under the speed limit, it was a delight to see. There are all kinds of new businesses, or spiffed-up, expanded businesses that a couple of years ago looked to be on death’s door. Pipelines are being laid, which should supplant the endless procession of tanker trucks now shuttling back and forth to the Corpus Christi refinery complex. There seems to be a complementary uptick in activity down on the coast, though more on the shipping and refining end of things. And lunchtime in Karnes County saw nearly full parking lots at every eatery we passed. Looking at the map and seeing just how tiny a speck this intersection of shale play and highway is in the grand scheme of recent discoveries around the country, it is hard not to feel a bit more optimistic about economic recovery.
Well, maybe a little hard. The technological breakthrough that is shale development (both gas and oil) is but one of many good things that the Texas economy has going for it. Of all the states that could use a boost, Texas is pretty close to the bottom of the list. Contrast this with New York, a state that needs all the help it can get. Sitting atop a reputedly even larger gas play, the used-to-be Empire State has opted to remain in the thrall of whatever influences seek to keep that gas off the market. (Anyone worrying about chemicals a couple of miles below the surface somehow getting into the water table, or an increased likelihood of earthquakes, isn’t thinking too clearly.) Texas and Pennsylvania get it, New York doesn’t have a clue. What is striking about this contrast at this particular point in time is what we can hope will be a salient if not preeminent issue in the upcoming election. To the extent that the governor of Texas gets into the race, we will be hearing about and hopefully talking about it. It is in my estimation just about the only prospect around which hope of undoing the current fiscal mess might be grounded.
We should be greatly encouraged if this election prompts a sustained revisitation of the Tenth Amendment to the Constitution. If we are to escape from the mire of debt and open ended liabilities that might otherwise swallow us up and diminish us, it will be from a concerted effort to reassert that “the powers not delegated to the U.S. by the Constitution, nor prohibited by it to the States, are reserved for (and must be returned to) the States respectively, or to the people.” This is not to be seen as an ideological imperative, though it has elements of that, nor as deference to the wisdom of the Founders (that some of them were slave holders is a non-issue, a condition to which they were born. That they struggled with this issue and failed to resolve it is a shortcoming, not an indictment. That they laid the groundwork for something that has succeeded a well as it has for as long as it has is a miracle.) It is a management issue. What we seem to have learned in the past few decades of our 235 year grand experiment is that while States are for the most part manageable entities, capable of turning themselves around when bad policy and other circumstances turn against them, the federal government as it has recently evolved is not. It seems to able to conduct that inherently wasteful activity that is war, in a boundlessly deep-pocketed sort of way, of course, and to undertake special project like Apollo or the Interstate Highway system, but everything it does seems to cost way too much and deliver far less than promised or hoped for. We cannot afford this anymore. It’s time to restructure, and that means devolving power to entities that at least have a shot at being manageable.
Almost every state was dealt a tough blow by the economic tsunami that was 2008. A good number of them seem to have responded quite effectively. States with strong executives and serious minded legislators seem to be able to find ways to cut costs and balance their budgets. If New Jersey of all places (where I lived for nine years), can right its boat, what state can’t? Probably three or four of them. Upwards of 45 states are what could be deemed “manageable entities”, i.e., capable of planning for growth and executing on it, and responding effectively when adversity upends those plans. These states are either undergoing a turnaround or, like, North Dakota, didn’t really wobble in the first place. The exceptions would be California, Illinois, New York and (possibly) Nevada, which almost doesn’t count as a state. All of these are largely rural in terms of space but dominated by megapoli, which in turn have deeply rooted traditions of corruption. These states might not be able to fix themselves. The rest of us should not be stuck with having to enable their obdurate dysfunctionality.
The beauty of federalism as demarked by the Tenth Amendment is that it pushes power toward the manageable entities and away from those entities that are too large, complex and as is inevitable with the passage of time corrupt to be manageable. It is entirely consistent with the venerable Catholic principal of subsidiarity, which recognizes that functions which subordinate or local organizations perform more effectively belong more properly to them than to a dominant central organization. This has been entirely at odds with the Progressive notions of government that have erupted like so many cold sores from time to time over the past 100+ years. An electoral campaign that is in large part a conversation about the inherent profligacy of unfettered federalism and the need to shift power back to more manageable entities should be taken as a sign of encouragement. Similarly, the recognition that the status quo on entitlement spending is broken and unsustainable. The “they’re feeding granny to wolves” demagoguery isn’t getting the traction it might have in the past. This is only because it is demonstrably not true. It is because a preponderance of the grannies understand, if only intuitively, the mess that will befall their beloved grandchildren if the open-ended obligations that were conceived a couple of generations ago are not reined in.
As I ponder the future, it is relatively easy to see a few more quarters at least of “good enough” economic growth (good enough to sustain earnings growth for well-situated global companies, not necessarily good enough to bring down unemployment to normal levels). Given the revenue prospects and open-ended obligations that the federal government finds itself up against, it is way to easy to default to pessimism further down the road. However, if we see movement toward becoming more a union of states, most of which will conduct themselves like FL, IN, NJ, VA and WI have in recent months (their growth no doubt spurred by in-migration from the recalcitrant few states that can’t get it together, i.e., that right to “vote with one’s feet” that overblown federalism forecloses) and less like a vast, mostly rural space dominated by the singularly corrupt megapolis which straddles the Potomac, there just might be a basis for longer term optimism.
Musings managed to tune the first few days of it out by taking a trip down to the coast. While the winds have moderated some, months of unrelenting southerly winds seem to have pushed the water up to a level well above ideal for flats fishing. This did not stop us from connecting with a few unsuspecting redfish and otherwise enjoying the natural splendor. I have tried to make this trip more than once or twice a year for the past several, and in doing so have gotten quite familiar with a thin slice of the thoroughly rural country between Austin and Aransas Pass. Observant old cuss that I seem to be, whatever changes occur between trips seem to stand right out. On this trip, I noticed two starkly different sorts of change that could be described as economic stimulus at work. Passing through the orbit of San Marcos/Seguin, I was struck by the plethora of road signage that has sprouted up since the last trip. A whole lot more marginally paved side roads have big signs or even lights. Coupled with various construction projects along the way, this is yet another partial answer to “So where did the $700B+ in stimulus spending go?” It is pretty obvious that it filters down through counties and other local, politically connected authorities. It rubs off on those politically connected enough to get the contracts to put up the signs and otherwise perform all that activity that passes for work along the by-ways. (Leasing those big plastic barriers, for who knows how many $$/day each, must be a great way to dip one’s snout into the public works trough, a political “in” well worth playing dirty to obtain.) Of course, some of the money goes to the politically connected sign manufacturers. Last but not least, the politically connected (in a low-rent sort of way) folks who belong to the political influential union whose members are allowed to put up the signs (when they are not leaning on shovels or taking a break) get a slice of the pie. So there is some perceptible economic activity, but once the signs are up it is not long before it has pretty much fizzled out.
A much different sort of stimulus is evident as one traverses Karnes County, towns like Karnes City, Kenedy and Panna Maria. This is where the highway passes over the Eagle Ford shale play. Three years ago, these little towns struck one as somewhere between sleepy and slowly dying. They are now positively alive with economic activity. Aside from having to pass a six vehicle drilling rig convoy going just under the speed limit, it was a delight to see. There are all kinds of new businesses, or spiffed-up, expanded businesses that a couple of years ago looked to be on death’s door. Pipelines are being laid, which should supplant the endless procession of tanker trucks now shuttling back and forth to the Corpus Christi refinery complex. There seems to be a complementary uptick in activity down on the coast, though more on the shipping and refining end of things. And lunchtime in Karnes County saw nearly full parking lots at every eatery we passed. Looking at the map and seeing just how tiny a speck this intersection of shale play and highway is in the grand scheme of recent discoveries around the country, it is hard not to feel a bit more optimistic about economic recovery.
Well, maybe a little hard. The technological breakthrough that is shale development (both gas and oil) is but one of many good things that the Texas economy has going for it. Of all the states that could use a boost, Texas is pretty close to the bottom of the list. Contrast this with New York, a state that needs all the help it can get. Sitting atop a reputedly even larger gas play, the used-to-be Empire State has opted to remain in the thrall of whatever influences seek to keep that gas off the market. (Anyone worrying about chemicals a couple of miles below the surface somehow getting into the water table, or an increased likelihood of earthquakes, isn’t thinking too clearly.) Texas and Pennsylvania get it, New York doesn’t have a clue. What is striking about this contrast at this particular point in time is what we can hope will be a salient if not preeminent issue in the upcoming election. To the extent that the governor of Texas gets into the race, we will be hearing about and hopefully talking about it. It is in my estimation just about the only prospect around which hope of undoing the current fiscal mess might be grounded.
We should be greatly encouraged if this election prompts a sustained revisitation of the Tenth Amendment to the Constitution. If we are to escape from the mire of debt and open ended liabilities that might otherwise swallow us up and diminish us, it will be from a concerted effort to reassert that “the powers not delegated to the U.S. by the Constitution, nor prohibited by it to the States, are reserved for (and must be returned to) the States respectively, or to the people.” This is not to be seen as an ideological imperative, though it has elements of that, nor as deference to the wisdom of the Founders (that some of them were slave holders is a non-issue, a condition to which they were born. That they struggled with this issue and failed to resolve it is a shortcoming, not an indictment. That they laid the groundwork for something that has succeeded a well as it has for as long as it has is a miracle.) It is a management issue. What we seem to have learned in the past few decades of our 235 year grand experiment is that while States are for the most part manageable entities, capable of turning themselves around when bad policy and other circumstances turn against them, the federal government as it has recently evolved is not. It seems to able to conduct that inherently wasteful activity that is war, in a boundlessly deep-pocketed sort of way, of course, and to undertake special project like Apollo or the Interstate Highway system, but everything it does seems to cost way too much and deliver far less than promised or hoped for. We cannot afford this anymore. It’s time to restructure, and that means devolving power to entities that at least have a shot at being manageable.
Almost every state was dealt a tough blow by the economic tsunami that was 2008. A good number of them seem to have responded quite effectively. States with strong executives and serious minded legislators seem to be able to find ways to cut costs and balance their budgets. If New Jersey of all places (where I lived for nine years), can right its boat, what state can’t? Probably three or four of them. Upwards of 45 states are what could be deemed “manageable entities”, i.e., capable of planning for growth and executing on it, and responding effectively when adversity upends those plans. These states are either undergoing a turnaround or, like, North Dakota, didn’t really wobble in the first place. The exceptions would be California, Illinois, New York and (possibly) Nevada, which almost doesn’t count as a state. All of these are largely rural in terms of space but dominated by megapoli, which in turn have deeply rooted traditions of corruption. These states might not be able to fix themselves. The rest of us should not be stuck with having to enable their obdurate dysfunctionality.
The beauty of federalism as demarked by the Tenth Amendment is that it pushes power toward the manageable entities and away from those entities that are too large, complex and as is inevitable with the passage of time corrupt to be manageable. It is entirely consistent with the venerable Catholic principal of subsidiarity, which recognizes that functions which subordinate or local organizations perform more effectively belong more properly to them than to a dominant central organization. This has been entirely at odds with the Progressive notions of government that have erupted like so many cold sores from time to time over the past 100+ years. An electoral campaign that is in large part a conversation about the inherent profligacy of unfettered federalism and the need to shift power back to more manageable entities should be taken as a sign of encouragement. Similarly, the recognition that the status quo on entitlement spending is broken and unsustainable. The “they’re feeding granny to wolves” demagoguery isn’t getting the traction it might have in the past. This is only because it is demonstrably not true. It is because a preponderance of the grannies understand, if only intuitively, the mess that will befall their beloved grandchildren if the open-ended obligations that were conceived a couple of generations ago are not reined in.
As I ponder the future, it is relatively easy to see a few more quarters at least of “good enough” economic growth (good enough to sustain earnings growth for well-situated global companies, not necessarily good enough to bring down unemployment to normal levels). Given the revenue prospects and open-ended obligations that the federal government finds itself up against, it is way to easy to default to pessimism further down the road. However, if we see movement toward becoming more a union of states, most of which will conduct themselves like FL, IN, NJ, VA and WI have in recent months (their growth no doubt spurred by in-migration from the recalcitrant few states that can’t get it together, i.e., that right to “vote with one’s feet” that overblown federalism forecloses) and less like a vast, mostly rural space dominated by the singularly corrupt megapolis which straddles the Potomac, there just might be a basis for longer term optimism.
Wednesday, June 15, 2011
Doldrum Time
“Sell in May and go away.” This homely adage seems to be on its way to yet another validation in 2011. It has had an undue share my attention as well, given the surplus mental bandwidth that besets those of us in a downshifted career mode. Careful readers will have noted my inclination to anticipate this seasonal tendency and raise a little cash back on April 4. That idea that certain times of year might might be more or less kind to investors than others is not something that I have found particularly compelling, with the possible exception of that abatement of year-end tax loss selling the old timers called the Santa Claus rally. That it seemed more about the pundits’ need to not ever get caught without something to yammer about, however, did not mean that there might not be at least a little something tactically useful to it. How many times have we gotten a few months into the year with a YTD return running well ahead of our long-term objective, and it dawned on us that it would probably be a good idea to “call it a year”? That is, go to cash, book that return, and take it easy for the rest of the year while we wait until perhaps year end tax selling season to re-invest. Of course we never did. But more often than I would like to remember, there were times when on a “heartburn adjusted” rate of return basis, “Sell in May...” (or thereabouts) would have been not only health enhancing but career enhancing as well.
There certainly seems to be something of a calendar-based influence at work. While apparently “Sell in May...” has been around for a long time in the U.K., it was first noted in the U.S. in The Stock Trader’s Almanac in 1986. It was noted at that time that since 1950, stocks (as measured by an index) held from May 1 to October 31 actually produced, on average, a slight negative return, while stocks held for the other six months were up some eighteen-fold. More recently, we see that in the last ten years, there have only been two when “selling in May” did not turn out to be a good idea. (That 2003 and 2009 were exceptions is no surprise at all, in that in both cases the preceding March were major Market bottoms. And even in those years of massive decompression, there was a two month pullback commencing in mid June 2003, and in 2009 it backtracked from June 1 until the morning after Intel kicked off Q2 earnings season.) Of course, there are also studies pointing to the opposite conclusion, that being out of the Market at any particular time based on past averages, is a fool’s errand. Our memories, however badly the passage of time has abraded their reliability, inform us of plenty of times between June and October when it would have hurt like hell to be out of the Market. Last year, for example, “Selling in May” looked really smart for four whole months, but on September 1 the Market went on a tear that by November 1 had blown through the April highs and then some.
So what are we to make of this saying? In my estimation, there is clearly something to it. At very least, it seems to be a self-fulfilling prophecy, a reflection of the actions of speculators based not on any fundamental factors but on the prospect of what other speculators might do, that can be counted on to more often than not negatively affect stock prices in the May/June timeframe. But just as we know, if we are honest in our assessment of the human condition, that stereotypes do not emerge wholly out of thin air, (and that habitually defaulting to stereotyping and other mental shortcuts will impoverish us in more ways than we know) there is at least a shred of substance to this notion. Given the degree to which fundamental data embodied in earnings announcements gets concentrated around a few relatively thin slices of the calendar, how surprised should we be that when the data thins out, an informational dead zone will tend to occur? I suspect that, except in years like 2003 and 2009, when a very low tide of sentiment was just starting to rush back in, an informational dead patch starts to take hold in May and linger into July. Once prior YE and Q1 earnings are largely out of the way, but the Q2 reports are well out in time and it is still too early for that shift in focus from current year to next year’s estimate, a bit of a vacuum sets in. The reasons for the speculative buyer-at-the-margin to step up and play thin out, and so the siren song of the fear mongers becomes harder to disregard. The flow of fundamental data recedes, quite naturally enough, and the data-hungry among us become more susceptible to its junk food equivalent.
This year, we find ourselves feted with a buffet of “double-dip”, slowdown, and of the fiscal travails of inconsequential nation states that have been decaying into oblivion for longer than anyone can remember. Are we supposed to be surprised that the uncertainty posed by a literally quite rattled Japanese economy caused a few thousand (at least) industrial decision makers to risk erring on the side of caution? (There was no way of knowing how bad the potential parts shortages would be until they were over, and now they are pretty much over.) Over the past six-plus weeks, a tradable pull-back seems to have been orchestrated and, one supposes, harvested by its perpetrators. I strongly suspect that while it did turn out to be a good idea to be “less invested” going into May, the “six losing weeks” have heard so much about of late is not on its way to a record tying eight weeks (something that has only happened three times). The Bear case is looking threadbare, strong enough to hold its own during this doldrum season, but a spent force when compared with prospective earnings that will start to come into focus in a couple more weeks.
“Doldrums” is probably the most apt way to think about this time of year. This term derives from an area of the Atlantic, a low latitude zone with a marked tendency to turn calm. Somehow, for perfectly natural reasons, this region (now know as the Inter-tropical Convergence Zone) does not enjoy the generally fair and predictable breezes that define so much of the Atlantic. Instead, it tends to prolonged bouts of lassitude punctuated by severe squalls. This was a very serious matter for sailors, and, when sail power was what held together the then preeminent transatlantic economy, for lots of others, too. To be becalmed was a dispiriting thing, at the least, so sailors came to refer this patch of torpor within an otherwise more amenable natural order as the doldrums. This did not make the doldrums a place to be avoided at all costs, but it certainly meant taking its perverse tendencies into consideration. The same can be said for this doldrum time of year.
“Sell in May” is a useful aphorism, a statement that expresses a belief that is quite often but not invariably true. This is as opposed to an axiom, which is more like a law which it is presumed that nature, or some other agent, will enforce. Such adages are like the Proverbs in the Bible, a collection of timelessly wise sayings that one would profit by heeding, as opposed to the conditional divine promises that the uninformed reader might take them to be. If the months leading up to May are characterized by the sort of high and rising spirits that enlarge equity valuations, there will probably be a doldrum-like stretch of time that facilitates a reversion toward a more normal mood and valuation. Of course, if May 1 finds us just a matter of weeks from what felt like a financial near death experience, we probably find ourselves sailing through that seasonal dead patch as if it were barely there, but that is usually not going to be the case. 2010 utterly fit the mold until the announcement of QE2 sent the Bears scurrying. In 2011, the Market did not exactly reach May in a state of headlong euphoria, having undergone a healthy correction in the Feb/March timeframe. Nonetheless, the doldrum season arrived as if right on cue. It has been more notable for its duration (that “...down weeks in a row” refrain we kept hearing) than any sort of ferocity. And all through this interlude wherein Fear seems to have sent Greed on a sabbatical, the IPO market has reminded us that Greed (and its co-dependent handmaiden Credulity) is indeed alive and well. Expect it to reappear as the summer progresses and the earning releases of July make it plain that global economic growth continues unabated.
There certainly seems to be something of a calendar-based influence at work. While apparently “Sell in May...” has been around for a long time in the U.K., it was first noted in the U.S. in The Stock Trader’s Almanac in 1986. It was noted at that time that since 1950, stocks (as measured by an index) held from May 1 to October 31 actually produced, on average, a slight negative return, while stocks held for the other six months were up some eighteen-fold. More recently, we see that in the last ten years, there have only been two when “selling in May” did not turn out to be a good idea. (That 2003 and 2009 were exceptions is no surprise at all, in that in both cases the preceding March were major Market bottoms. And even in those years of massive decompression, there was a two month pullback commencing in mid June 2003, and in 2009 it backtracked from June 1 until the morning after Intel kicked off Q2 earnings season.) Of course, there are also studies pointing to the opposite conclusion, that being out of the Market at any particular time based on past averages, is a fool’s errand. Our memories, however badly the passage of time has abraded their reliability, inform us of plenty of times between June and October when it would have hurt like hell to be out of the Market. Last year, for example, “Selling in May” looked really smart for four whole months, but on September 1 the Market went on a tear that by November 1 had blown through the April highs and then some.
So what are we to make of this saying? In my estimation, there is clearly something to it. At very least, it seems to be a self-fulfilling prophecy, a reflection of the actions of speculators based not on any fundamental factors but on the prospect of what other speculators might do, that can be counted on to more often than not negatively affect stock prices in the May/June timeframe. But just as we know, if we are honest in our assessment of the human condition, that stereotypes do not emerge wholly out of thin air, (and that habitually defaulting to stereotyping and other mental shortcuts will impoverish us in more ways than we know) there is at least a shred of substance to this notion. Given the degree to which fundamental data embodied in earnings announcements gets concentrated around a few relatively thin slices of the calendar, how surprised should we be that when the data thins out, an informational dead zone will tend to occur? I suspect that, except in years like 2003 and 2009, when a very low tide of sentiment was just starting to rush back in, an informational dead patch starts to take hold in May and linger into July. Once prior YE and Q1 earnings are largely out of the way, but the Q2 reports are well out in time and it is still too early for that shift in focus from current year to next year’s estimate, a bit of a vacuum sets in. The reasons for the speculative buyer-at-the-margin to step up and play thin out, and so the siren song of the fear mongers becomes harder to disregard. The flow of fundamental data recedes, quite naturally enough, and the data-hungry among us become more susceptible to its junk food equivalent.
This year, we find ourselves feted with a buffet of “double-dip”, slowdown, and of the fiscal travails of inconsequential nation states that have been decaying into oblivion for longer than anyone can remember. Are we supposed to be surprised that the uncertainty posed by a literally quite rattled Japanese economy caused a few thousand (at least) industrial decision makers to risk erring on the side of caution? (There was no way of knowing how bad the potential parts shortages would be until they were over, and now they are pretty much over.) Over the past six-plus weeks, a tradable pull-back seems to have been orchestrated and, one supposes, harvested by its perpetrators. I strongly suspect that while it did turn out to be a good idea to be “less invested” going into May, the “six losing weeks” have heard so much about of late is not on its way to a record tying eight weeks (something that has only happened three times). The Bear case is looking threadbare, strong enough to hold its own during this doldrum season, but a spent force when compared with prospective earnings that will start to come into focus in a couple more weeks.
“Doldrums” is probably the most apt way to think about this time of year. This term derives from an area of the Atlantic, a low latitude zone with a marked tendency to turn calm. Somehow, for perfectly natural reasons, this region (now know as the Inter-tropical Convergence Zone) does not enjoy the generally fair and predictable breezes that define so much of the Atlantic. Instead, it tends to prolonged bouts of lassitude punctuated by severe squalls. This was a very serious matter for sailors, and, when sail power was what held together the then preeminent transatlantic economy, for lots of others, too. To be becalmed was a dispiriting thing, at the least, so sailors came to refer this patch of torpor within an otherwise more amenable natural order as the doldrums. This did not make the doldrums a place to be avoided at all costs, but it certainly meant taking its perverse tendencies into consideration. The same can be said for this doldrum time of year.
“Sell in May” is a useful aphorism, a statement that expresses a belief that is quite often but not invariably true. This is as opposed to an axiom, which is more like a law which it is presumed that nature, or some other agent, will enforce. Such adages are like the Proverbs in the Bible, a collection of timelessly wise sayings that one would profit by heeding, as opposed to the conditional divine promises that the uninformed reader might take them to be. If the months leading up to May are characterized by the sort of high and rising spirits that enlarge equity valuations, there will probably be a doldrum-like stretch of time that facilitates a reversion toward a more normal mood and valuation. Of course, if May 1 finds us just a matter of weeks from what felt like a financial near death experience, we probably find ourselves sailing through that seasonal dead patch as if it were barely there, but that is usually not going to be the case. 2010 utterly fit the mold until the announcement of QE2 sent the Bears scurrying. In 2011, the Market did not exactly reach May in a state of headlong euphoria, having undergone a healthy correction in the Feb/March timeframe. Nonetheless, the doldrum season arrived as if right on cue. It has been more notable for its duration (that “...down weeks in a row” refrain we kept hearing) than any sort of ferocity. And all through this interlude wherein Fear seems to have sent Greed on a sabbatical, the IPO market has reminded us that Greed (and its co-dependent handmaiden Credulity) is indeed alive and well. Expect it to reappear as the summer progresses and the earning releases of July make it plain that global economic growth continues unabated.
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