"Long Term Problems - Short Term Answers, So Far"

Sydney M. Williams

Thought of the Day

“Long Term Problems – Short Term Answers, So Far”

June 17, 2010

Eleven years ago John Bogle, founder and former chairman of the Vanguard Group, had an op-ed in the New York Times in which he referred to the casino nature of the market. Putting aside the obviously self-serving aspect of his piece – defending index funds – he pointed out the significant increase in trading activity. Mr. Bogle pointed out that in 1960 the annual turnover on the NYSE was 12%. By 1999 it had risen to 95%. He wrote: “These trends show no sign of abating.” They have continued to accelerate, so that today turnover is approaching 200%.

Yesterday, I received a bulletin from my friend Laszlo Birinyi entitled, “Market Frustrations,” indicating that since the market’s peak on April 23rd, the correlation of stocks in the S&P 500 to the Index has risen 62%, from 0.48 to 0.78, indicating that there have been very few places to hide as the market collapsed. Mr. Birinyi provided a second chart indicating the rolling 200-day correlation of stocks to the Index over the past ten years. That chart indicates a rising correlation over a ten year period, confirming, in my opinion, the growing importance of quantitative programs, be they Index Funds, trading relationships that are correlated or uncorrelated, ETF’s, high frequency trading platforms, dark pools, or whatever.

This trend toward treating stocks as little more than casino chips has been abetted by a financial press, especially TV programs like CNBC and Bloomberg with their emphasis on the short term. Jim Cramer, who I am sure is a very smart man, cannot seem to make a point without screaming. Alas, he is not alone.

It might all be amusing were it not so serious. Baby boomers born in 1946 will reach 65 next year. And the numbers of retirees will accelerate over the next twenty years. Social Security is already on life support with more money going out than coming in. Since its early days, it has never been a savings system; it is a transfer system – from workers to retirees. Medicare is in equally bad shape. The combined unfunded liability is approaching $50 trillion. The recently passed health bill will only add to the burden. In the meantime, on a price basis, the S&P 500 is 23% below where it was ten years ago. Interest rates are abnormally low, penalizing savers while aiding borrowers. Since the average mutual fund underperforms the Indexes, investors must sympathize with Mike Tyson: “Everybody has a plan until you get punched in the face.”

Wall Street is still characterized and cartooned as populated by greedy, fat, white men, while the reality is that over half the population own stock, either directly, or indirectly through mutual funds, IRAs or 401Ks. There are very few remaining defined benefit programs, suggesting that virtually all workers will have to rely on their own savings. Nevertheless, neither government nor Wall Street seems to have fully acknowledged this changed landscape. Wall Street worries about the next quarter. And government will increase taxes next year on investment income and capital gains.

We live during a time when people demand instant gratification. Long term has become, for most people, next week, not thirty years in the future. And today the Country faces a number of very visible problems from the War against Terrorism (if we dare call it such), to a recession from which we are slowly exiting, to the oil spill in the Gulf. The problem of adequate capital that allows people to retire is not so visible, but is just as serious, perhaps more so. The tax code is a powerful tool government has available to encourage or discourage behavior. It has long been used for just such purposes, from encouraging home ownership to discouraging smoking. There are actions government could take now to nudge people toward saving more and consuming less. Higher taxes could be used to discourage short term trading and reduced taxes would encourage long term investing. Unfortunately, government reacts and does not anticipate. The patient must be in the ICU before Washington pays attention. Let’s hope this time will be different.