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.

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.