Review and Outlook
My Clients, Friends & Observers:
February 7th, 2003
A gentleman who is not a client recently asked me to forecast
the stock market. There is little to gain in venturing forecasts to
strangers, so instead I asked him, “What would you do if I told
you?” He was hoping, he said, “to get his
money back” after losing a fortune over the last four years.
I told him that I manage portfolios, not the stock market, that I
couldn’t predict the direction of the next 10% move but I would
predict the direction of the next 100% move and that would be up.
Not the answer he was looking for, he responded that “it’s
all a crap shoot.” I thought
to myself that anyone who perceives investing as a crap game should
be reminded that the soaring marble and gilt edifices of the casinos
are monuments to the giddy losers who paid for them. The odds are
always against the player. Not so in the securities markets.
Yes, there are unfortunate similarities between Wall Street
and the casino these last few years. The securities markets are, always
have been, and always will be a confidence game to a certain degree.
But it is “confidence” in the best sense of the word,
confidence in progress and real economic growth. If one insists on
calling it a game (which it’s not), then it would have to be
the greatest game on earth. The significant difference between markets
and cards is that you can be paid in the markets for every hand you
are dealt, weak or strong. You can fold a hand and sit out ‘til
the next but the pot is progressive. You only forfeit your rights
to it when you leave the game.
When I look at portfolios that are paying current yields
well above inflation rates, money market rates and short-term deposit
rates, I can live with reasonable drawdowns
in portfolio value, particularly when the portfolios are outperforming
the indexes on the up and downside. These are growth portfolios suitable
to their owner’s needs, not fixed income portfolios whose owners
require perpetual safety of principal. If one doesn’t require
liquidation of principal, then one should patiently ignore drawdowns in valuation, particularly when cash flows from
coupons and dividends are sufficient.
Bear markets exhaust themselves finally when the distribution
(selling) process is completed. It is completed when new sell orders
are lacking, when buyers are compelled to outnumber sellers. Buyers
and sellers are constantly looking ahead to future cash flows. What
is their present value? We are constantly looking ahead for reasons
to sell or reasons to buy, or reasons to avoid either.
The January close was lower than December, an indicator
of a lower year ahead with 80% probability. That would give us four
successive down years in a row, something which has only occurred
once in the last century, a negligible probability on its face. But
there are studies that show that the probabilities of extraordinary
(improbable) events increase with the length of time they do not occur.
This much is clear: there is nothing on the horizon from
sea-level that suggests faster growth ahead. Corporate managers are
cutting, not hiring. They are holding on to capital, not investing
it. Consumers aren’t spending the way they used to, and the
demographics of an aging population will continue this. Savings rates
are up – in spite of historically low interest rates. The cost
of oil at $34 a barrel sucks like a leach on our economic physiology
yet there is little or no will to drill in ANWR or the Santa
Barbara channel, or to develop alternative
fuels. Bizarre and stupid behavior. The peace
dividend of the ‘90’s is exhausted. The prospect of war
is a substantial damper. We’ve returned to a wartime economy
and the economic benefits of building weaponry are very shallow. After
a weapon is built it generates no other economic activity. It is sunken
capital until it is used and replaced. This is not to diminish the
importance of military strength. Morally projected, it’s the
foundation for global free trade, currency stability, and world peace.
The federal government has been accommodative fiscally
although far too aggressive with pork-spending and blatantly recalcitrant
with regard to tax cuts. Fed monetary policy has been stimulative, M1 up 2.57% and M3 up 6.54% year over year ended
12/31/03. I do not foresee any rate
increases or cuts this year.
A Party Line To Recessions?
This email received at our site at year-end: “Could
you tell me if there has ever been a Republican administration that
hasn’t had a recession under its tenure?” And the response:
The broadest acceptance of the definition of recession
remains two successive quarters of negative GDP as released by the
Bureau of Economic Analysis, division of the U.S. Dep’t of Commerce.
Let us instead use business cycle contractions. This allows us to
go all the way back to the first Republican president (Lincoln), obviates
the lack of quarterly GNP/GDP data prior to 1947, and does not alter
the results for Democratic presidents.
If we frame the question as, “Has there ever been
a Republican president that hasn’t had an economic contraction
under his tenure?” the answer is yes, one. That was James Garfield,
who served from March to September 1881. We might add Lincoln’s
first term with an asterisk. He took office in March, 1861 during
a business contraction which reversed within three months to an expansion
which lasted the remainder of that term. If we change the question
from “president” to “administration” (as requested)
we could add William McKinley’s second term, March to September,
1901. During the same period Democrats have had two presidents who
completely escaped contractions: Johnson and Clinton. We can safely
add Kennedy with an asterisk. He entered office in a contraction which
ended a month later.
The business cycle data were taken from www.nber.org.
There is no pattern here and little to conclude. Neither
party is better at managing the economy. Both have gotten better over
the years. The expansionary “guns and butter” giddiness
of the Johnson years and the oil price shocks of the Nixon years led
to the devastating, inflationary hangover of the Carter era. Without
prejudice, the Clinton
years inherited a huge peace dividend, shrinking defense budgets,
a bull market in bonds, and oil at $10 a barrel, just three years
ago. We will simply not see these conditions again soon and our technological
and capital infrastructure is vastly overbuilt. It’s going to
take time to use up that excess capacity.
At year-end I predict Dow @ 9,706; S&P 500 @ 1,020;
and NASDAQ @ 1,554; Five year U.S. Treasury @ 3.88%; Ten year U.S.
Treasury @ 5.12%; Fed funds unchanged.