Friday, July 30, 2010

"Quotas in Finance Reform? - An Insult to Those They Purport to Protect"

 Sydney M. Williams

Thought of the Day
“Quotas in Finance Reform? – An Insult to Those They Purport to Protect”
July 30, 2010

A problem with a 2300 page Bill is that almost anything may lurk within its pages, and probably does. On Wednesday, Politico, a political journalism organization based in Arlington, Virginia noted that, “A little-noticed section of the [Dodd-Frank] law grants the federal government broad new powers to compel financial firms to hire more women and minorities – an effort at promoting diversity that’s drawing fire from Republicans who say it could lead to de facto hiring quotas.”

Even in a Democracy old habits linger for a long time. Segregation in this country continued for a hundred years following the abolition of slavery. Not only was such activity illegal, it was immoral, inhumane and divided the nation. The Civil Rights Bill, signed into law by President Johnson almost fifty years ago, theoretically corrected those inequities, but, as I said, old habits die hard. It became necessary for schools, police departments, businesses and others to impose quotas and implement affirmative action plans – not because showing favoritism is a good thing, but because it was necessary to bring balance to an unfair system. In the same way, and coming at the subject from a different direction, profiling is equally distasteful, but if it is a process that, for the moment, saves lives it seems imprudent not to employ it, if only temporarily.

At the end of the day all people should be treated fairly and equally. Laws should not favor one group, nor should it penalize another. Hiring should be based on the needs and wishes of the employer. Advancement should be based on merit, not on the color of one’s skin, not on gender, not on religion and not on any other basis. There is no question that pockets of prejudice persist; there is also no question that some people will forever be biased. There is no way of totally eradicating such behavior. But fifty years after the signing of the civil rights legislation, and in the most diverse nation on earth, our government should no longer have to compel diversity.

Everything starts with education. Yet, yesterday the Wall Street Journal reported that less than half of New York City students scored proficient in English and math, suggesting a lot of work remains to be done before these students have the tools to compete. While we are all genetically unique, a sound educational foundation is the most important gift we can bequeath to our nation’s youth. It is also the best system for imposing equality. That should be our focus, not prosecuting some Wall Street (or Main Street) business because they hired three women when they should have hired four. It is our duty to provide the educational basics needed to compete in a global world. Some will succeed; others will fail, but it is the opportunity to succeed that we must provide our young people.

It is equality of opportunity that drives our nation, not equality of outcomes. We are a grown-up people. We have elected an African-American President, a man who won a primary against a woman. We should have moved beyond the need for affirmative action. While there will always be individuals who need help, to assume that whole segments of our society need special privileges is an insult to those people. It is not quotas that we need, but the best and the brightest, no matter their race, their gender or their religion, to compete against the best and the brightest from China, India and Brazil.

Thursday, July 29, 2010

"Trading Volume - What Can it Teach Us?"

Sydney M. Williams

Thought of the Day
“Trading Volume – What Can it Teach Us?”
July 29, 2010

The S&P 500 is 8.5% higher than it was on July 2, making for a pretty decent month after a devastating May and June. However, enthusiasm for the rally has been tempered by a lack of volume supporting the move. Eyeballing the charts for both NYSE and consolidated tape volume, it appears that the former is down about 20% and the latter 30% in July versus the two preceding months.

Volume though, as a determination of investor confidence, has become increasingly difficult to measure, a problem one can attribute to the proliferation of algorithmic traders, especially those utilizing high frequency trading platforms. While no one seems to know exactly, estimates have been that such traders represent up to 70% of all trading volume. Most of their trading is done via electronic exchanges (ECNs), so is included in the consolidated numbers. A friend who manages portfolios that exclusively use ETFs tells me that only 15% to 20% of his trades are executed on the NYSE. As an indication of the growing popularity of the consolidated tape, volume has risen from twice that of the NYSE in June 2007 to between four and five times at present.

Supporters of algorithmic traders claim they have replaced traditional market makers, as principal providers of liquidity, that they narrow spreads and reduce costs. Opponents, a group to which I belong, argue that liquidity disappears just when it is needed. In crowded trades, when something goes wrong, the exits get mobbed, as we saw on May 6 and the “flash crash”. It is hard to believe that someone who is trading for fractions of a penny and holding their positions for eleven seconds serves society, let alone other investors or corporate managements. Stock certificates, which represent ownership in a business, have been replaced by chips more appropriate in a casino. I find myself agreeing with the wag who said HFTs provide volume, not liquidity.

For the past twelve weeks the SEC has been “investigating” the causes of the “flash crash”, an incident that undoubtedly was caused (or aggravated) by high frequency traders. Volume that day, at 10.727 billion shares, was more than twice the average trading volume. Markets just don’t decline 1000 points, and then recover 600 points, for no fundamental reason. While the SEC seems to be studiously avoiding having to come to a conclusion, Congress passed, and the President signed, a financial reform bill that includes the establishment of a “consumer protection board” with a $600 million budget and unprecedented powers. Rather than creating new “Czars”, the people would have been better served if Congress simply ensured that existing regulatory agencies did their job. As the SEC fiddles, confidence in our markets ebbs.

According to research done by Jeff Rubin, director of research at Birinyi Associates, a proliferation of Index Funds and ETFs, another source of rising volume trends, have created a situation where correlation among individual equities has increased, reducing the dispersion of returns, making it tougher for traditional stock pickers. Arguably, those very inefficiencies should produce pricing opportunities for fundamental investors. But, at this point the magnitude of algorithmic high frequency trading programs simply overwhelm those done by fundamental investors. It is a case of the tail wagging the dog.

Public companies, in fact our capitalist society, rely on fundamentally-driven equity investors. Long term investors (which include passive investors, such as broad based Index Funds) lend an element of stability to the capital structure of companies. Additionally, active investors and knowledgeable analysts provide guidance to management and serve as watch dogs, with short sellers, among others, alerting the Street as to possible pitfalls or misdeeds. At this time, while quantitative traders of all stripes represent the bulk of trading activity, they manage only a small portion of equity assets. Nevertheless, it is surprising, as a friend and former specialist pointed out recently, that corporate managers seem to express little concern about the commoditization of our markets.

Index products, ETFs and various algorithmic trading platforms, especially high frequency traders, have juiced volume, thereby providing the specter of healthy capital markets, but they risk undermining those markets.

Fiscal policy can be employed to encourage long term investing and discourage very short term trading, but it requires a radical change in the tax code – for example eliminating capital gains taxes on investments held more than five years, while imposing stiff taxes on trades held for less than a day. The SEC needs to demonstrate that it is truly interested in protecting the interests of fundamental investors, those who provide the needed capital to businesses which employ most of our workers. Major Wall Street firms, which derive a substantial percentage of their profits from trading and are major donors to both political parties, are resisting these changes. The Dodd-Frank Bill appears to have done very little to reduce their playing fields. If these trends persist we all risk further alienating individual investors, the life blood of our capitalist system. Big volume days are no panacea; in fact they may be indicative of the problem.

Wednesday, July 28, 2010

"The Economy and the Market - Is There a Connection?"

Sydney M. Williams

Thought of the Day
“The Economy and the Market – Is There a Connection?”
July 28, 2010

In late 2001, Carol Loomis conducted an interview with Warren Buffett that gained some notoriety – it was based on a speech Mr. Buffett had given Allen & Co.’s annual Sun Valley corporate gathering. In it he compared moves in the DJIA to growth in GNP through two seventeen-year periods – 1964-1981 and 1981-1998. Mr. Buffett determined that in the first period, a dismal period for stocks, the economy did very well, with GNP gaining 373%. During the second period, with stocks gaining 949%, GNP was up only 177%.

Mr. Buffett attributes the difference to two economic variables and to one psychological factor. In the first period, interest rates moved higher, while in the second they moved lower. Also, in the second period, corporate earnings moved dramatically higher as costs were taken out of operations. In the first period they did not. The psychological factor was, as Warren Buffett says, “People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them.” The latter statement also explains why most investors are late to see both deteriorating and improving market conditions.

The relationship has been the subject of academic studies. Dimson, Marsh and Staunton’s Triumph of the Optimists: 101 Years of Global Investment Returns, concluded that there is no correlation, or perhaps a negative correlation, between stocks and GDP. Menzie Chinn, writing in Econbrowser, in late 2007, argued there is little relationship between the two, and included a statement of the obvious, “stock prices are an imperfect indicator of recessions and booms.” James Brumley, editor of “Small Cap Network” newsletter, recently wrote, “Generally speaking, the GDP figure was a pretty lousy tool, if you were using it to forecast stock market growth.”

Nevertheless, over long periods of time there seems to be a relationship. During the fifty years from 1950 to 2000, GDP grew from $293.7 billion to $9.951 trillion, an increase of 32.9 times. During the same period, the DJIA rose from 235.41 to 10786.85 or 44.8 times. (If one were to extend the time frame to 2010, the gain for both indices would be the same, as stocks retreated and GDP continued to grow.)

However, investing is never easy and lessons once learned may no longer apply. Over the past decade stocks and per capita GDP, adjusted for inflation, moved in unison. Stocks declined 15.5%, while per capita GDP, in constant dollars, declined 0.3% – assuming $9.8 trillion GDP in 2000 and $13.3 trillion in 2009, a population increase of 29 million to 310 million and using an inflation calculator. During the 1990s, in contrast, both GDP per capita and stocks moved higher.

It seems to me that the economy and the stock market, while not connected at birth, are certainly related. The stock market may be child to the economy and certainly benefits and/or suffers depending upon its direction. And stocks, also, do influence their older, less volatile relative. Over the past twenty years (two very different ten-year time periods), the S&P 500 compounded (price only) at 5.8%, in line with its long term returns. GDP has grown at 4.5% on an annualized basis – a faster rate than is generally expected for the next several years.

In many respects the market is the perspective to the economy’s reality. An analogy might be a dog chasing a car. As a child, my parents had such a dog. He was an Irish Terrier and his name was George. Why he was never killed remains a mystery. The car would move forward at a steady speed. George, seemingly mesmerized by the rotating tires, would dart toward them and back. A chart of both the economy and the market would show similar gyrations – with stock prices first above and then below the more sedate, gradually upward-sloping path of the economy.

The fact that there is no magic formula is what makes investing such a challenging profession. All we can do is to make guesses; mine would be that GDP growth, given the retrenchment of the consumer, will be significantly below trend line. On the other hand, remembering Warren Buffett’s admonition that we are victims of our immediate past, stocks, in my opinion, are more likely have a better decade in the one ahead than they did in the previous one.

In many respects the recession of 2000-2001 should have been deeper and longer. A combination of sharply reduced interest rates and a government policy encouraging profligacy in home ownership fueled the economy for another six years, resulting in the financial panic of 2007-2008 and the far worst recession we have just been through. It will take time to exit the economic hole we have dug. But stocks, over time, tend to be anticipatory. Humans tend to be emotional and reactionary; it is that divergence that should provide opportunity to the investor.

Tuesday, July 27, 2010

"Cap-and-Trade is Dead"

Sydney M. Williams

Thought of the Day
“Cap-and-Trade is Dead”
July 27, 2010

“The King is dead. Long live the King!” This proclamation (originally French) was traditionally used once a new king ascended the throne vacated by the death of his predecessor; the term suggested continuity. Cap-and-trade was officially buried on Friday when Senate majority leader Harry Reid said he did not have the votes to pass legislation; given that the November elections will certainly reduce the majority Mr. Reid has in the Senate, this was probably his last chance to muscle through this particular piece of legislation. In this case, at least for the next few years, the King is just plain dead.

The Left have been masters of using crises – what Ross Douthat has described as apocalyptic enthusiasms – to push through major government-run programs. Obama-Care and finance reform have passed, albeit on a partisan basis. Cap-and-trade was to be another such proposal.

In many respects it was the “e-mailgate” episode at East Anglia University late last year, which raised questions as to the validity of the science, the dismissal of doubter Freeman Dyson of Princeton as a “crank”, and the failure in Copenhagen to reach an acceptable, universal accord last December that sounded the death knell for cap-and-trade.

The reaction has been unsurprising – relief on the part of the conservatives and castigation by the Left for those who failed to heed the call of the environmentalists. Paul Krugman, the venomous mouthpiece of liberal causes, blames, in an op-ed in yesterday’s New York Times, “the usual suspects: greed and cowardice”, by which he means oil companies like Exxon Mobil and Senators like John McCain.

There is a general, but not universal, belief that the earth is warming. The debate surrounds man’s culpability and what, within reason, can be done about it. The United States remains the world’s principal consumer of energy, both on a per person basis and in aggregate. So it is unsurprising that we are the target. However, our energy efficiencies are improving. Even without cap-and-trade and with that FOOC (friend of the oil companies), George Bush, in the White House, energy consumption per person in the U.S. declined by 11% over the past decade, while GDP rose 45%.

Environmental awareness is a function of wealth. The first environmentalists, unsurprisingly, were members of the eastern establishment, President Theodore Roosevelt being the most famous example. Rich countries, like rich individuals, can afford what others cannot. Scrubbers for coal fired utility plants, waste treatment facilities, re-claimed land from open-pit mines, energy efficient appliances, once luxuries have become necessities. The primary need of the developing world, as Bjorn Lomborg has made clear in a series of op-ed pieces in the Wall Street Journal, is to generate wealth. As I wrote on this subject last December, the needs of poor nations: “Clean water, proper sewage and enough food are their priorities. The environment, of necessity, is at the bottom of the list.”

It would be wrong to dance on the grave of cap-and-trade. To the extent that man disfigures the earth, he should be held responsible, as the BP spill in the Gulf makes clear. Poorer nations have neither the luxury nor the leverage to demand equivalent restitution, as the natives in the Niger Delta know too well. Poor people in poor lands are consumed with the process of living. Their time horizons extend to the next meal or to the end of the day; they cannot afford to worry about the consequences ten years out. Ethically, the benefits to future generations must be weighed against the costs to current generations.

The best thing we can do for the environment is to help poor nations develop their resources and join the developed world. Environmental improvements are spun from wealth, not from government mandates. As nations become richer, they first consume more energy. As wealth increases, and if they are democracies, the balance begins to shift to conservation and the desire to live a healthier life.

Technology makes the transition to less dependency on fossil fuels more likely and easier –catalytic converters, nuclear plants and perhaps even solar panels. Initial investments require government assistance to defer some of the costs. Government has long partnered with business. NASA and the military are the best examples, but so were the rail, telegraph, telephone and auto industries. On the other hand, government programs, such as the ethanol lobby, designed to reduce gasoline consumption have proved exorbitant and have done little other than raise the price of corn for the rest of us.

It doesn’t take a stretch of the imagination to assume that man impacts his environment. The question is how much. Over millions of years the earth has warmed and cooled thousands of times; it has been doing so long before man evolved from his ancient ancestors. As a “thinking” beast, man has a responsibility to do as little damage as possible to his environment. But those of us who were fortunate to have been born in this place and at this time should not deny the benefits we enjoy to those who are just now emerging from centuries of poverty. Government actions which promote economic growth will do far more for environmental causes than government mandates. “Who cooked the Planet?” asks Mr. Krugman, in yesterday’s essay. A good question. The answer may tell us who created the universe.

Monday, July 26, 2010

"The Recession - How Does it Compare?"

Sydney M. Williams

Thought of the Day
“The Recession – How Does it Compare?”
July 26, 2010

While there is no debate that the recession we experienced has been a tough one and for those who have been unemployed for more than a year it can’t get much worse; nevertheless, the question arises – are things as bad as we are being told?

The irony of the situation is that both political parties appear to have an interest in promoting what is darkest: Republicans for the obvious reason that a dire economic outlook appeals to their playbook, and Democrats because they choose to argue they inherited the worst economic situation since the Great Depression – who wants to be seen wrestling a bobcat when a tiger is far more ferocious?

This unusual confluence of events has created a cloud over the landscape, causing a loss of confidence aided by a press grown increasingly opinionated; it hampers the recovery from the worst recession in a generation.

But is this period worse than the recessions of 1973-1975 or the double recessions in 1980-1982? In the post-World War II era, recessions occurred frequently and lasted, on average just under a year. From 1945 through 1991 there were nine recessions. According to data from the National Bureau of Economic Research, the average trough to trough period lasted 50 months with an average duration of 10.7 months. Something changed in the 1980s. The short recession of 1990-1991 occurred 92 months after the recession which ended in November 1982. We then experienced 120 months of growth before dipping into a recession which began in March of 2000. Eighty-one months would go by before the start of the recent recession, which began in December 2007.

During the 1970s, unemployment topped out at 8.7%, relatively benign compared to the present. On the other hand, year-over-year GDP dropped 6.8%, according to the San Jose State University Department of Economics, almost double the year-over-year decline of 3.8% in the current recession. Inflation during the 1973-1975 recession rose to 12.2%, placing the Misery Index substantially above where it now stands. During the 1981-1982 recession, unemployment peaked at 10.2%, similar to today, but then stayed above 10% for ten months.

A number of unique circumstances proceeded the current recession. For one, severe recessions appeared to have become obsolete. We were only in recession for 16 of the 300 month period between 1982 and 2007. Throughout the last thirty years, and especially during the past couple of decades, improvements in technology generated huge improvements in productivity, displacing millions of skilled and semi-skilled workers, requiring a new emphasis on education, which was not forthcoming as quickly as needed. Those improvements in productivity caused re-hiring to be slower than in previous recoveries. However, increased trade and a strong dollar during the last half of the 1980s and 1990s meant that consumers benefited from cheaper imports and masked some of the damage caused by drops in incomes for millions of workers. Ten years of economic growth – beginning in the last months of George Bush, Sr. and ending in the waning months of the Clinton administration – led consumers to become overconfident. Easier borrowing conditions, low interest rates and a desire to live as well as one’s neighbor caused consumers to become more vulnerable to an economic decline. The sparks that ignited the downturn were far-too-lose mortgage offerings and a focus by government in getting everybody into their own home. In retrospect, the collapse was inevitable.

When one steps back and takes a look, it is remarkable that the situation today is not far worse. Investors, which include half the population, lost $6 trillion between 2000 and 2002. Our country was attacked on September 11 2001 for the first time since Pearl Harbor. Consumer debt rose to unprecedented levels in the late 00s. We had a near-death experience in the fall of 2008, when the banking system came close to collapsing. Yet the recession seems to have lasted just four quarters.

There is little question in my mind that growth going forward will be slow. The consumer appears to be, sensibly, retrenching and since he represents two thirds of the economy, any absence on his part will have to be felt. The financial reform bill, while hopefully serving to avoid future catastrophes, will serve to limit and make more expensive credit, thereby limiting growth. The enormous entitlement programs passed by Congress will, at some point, have to be paid for. Both spending cuts and tax increases are inhibitors to growth. Technology continues to advance, improving productivity; yet Washington persists in discouraging competition in education by bowing to the will of teacher’s unions. Private competitors to Sallie Mae face tougher restrictions, at a time when education is needed more than ever, particularly the skills needed to advance in a more technological world. Ridiculous immigration laws discourage educated foreign students from becoming citizens, while doing too little to deter the illegal immigration of workers with little or no skills.

But, as I look at our plight, I am far from dismayed. Our economy is tremendously resilient. The people of this country are amazingly adaptable. The consumer is doing what he or she needs to do – retrenching. Corporations have amassed almost a trillion dollars in cash, most of which could be invested productively. It is the third leg – government – that gives pause. More than anything else it is the restoration of confidence and a belief in the future that is needed. A Gallup poll released last week indicated that the percentage of Americans who say they have “a great deal” or “quite a lot” of confidence in Congress is now at 11%, its lowest level ever. Businessmen and women, who do most of the hiring, need a clear understanding of the rules and regulations that govern their industries. Not helping matters is a government which appears intent on enlarging its bureaucracy and increasing control; it is not one that will likely unleash the forces of creativity and innovation.

The recent recession was a doozie, the worst in a generation, but at about 15 months in duration (the NBER has yet to finalize the duration of the recession) it seems comparable to the 1970s, with unemployment not as bad as during 1981-1982 recession. (In contrast the Great Depression experienced two recessions, one of 43 months – 1929-1933 – and the second of 13 months – 1937-1938. Unemployment reached 25% and stayed above 15% until the start of World War II.) The recession could re-emerge in a more virulent form, but at this time the signs are not there. The ECRI numbers released last week suggest a flattening in the very recent down cycle. And, as Jim Grant writes in the current issue of his news letter, “shipping executives fretting over a container shortage doesn’t seem like the thing of which depressions are made.”

Friday, July 23, 2010

"The Law of Unintended Consequences Hits Dodd-Frank"

Sydney M. Williams

Thought of the Day
“The Law of Unintended Consequences Hits Dodd-Frank”
July 23, 2010

As President Obama was signing the financial reform bill, an unintended consequence of the bill was playing out on Wall Street. (At least I presume it was unintentional.) Included in the finance reform bill is a provision making it easier for investors to sue credit rating agencies for assigning unrealistically high ratings –a warning to the rating agencies and a sop to trial lawyers.

I am no fan of the rating agencies, as anyone who read the piece I wrote on May 3rd will recall (“Rating Agencies – Do We Need Them?”), and I have little respect for trial lawyers who have taken an honorable profession and have turned it into a vehicle to realize extraordinary personal gain. The fact that they are one of the Democrat’s largest political contributors endears them to that Party, a relationship which has become symbiotic.

The finance arm of Ford Motor Company was unable on Wednesday to sell a series of asset-backed securities because of the aforementioned provision. The always-alert Vince Farrell did mention the incident from his vacation haunt in Nantucket; however, the only report that I saw yesterday in the New York papers was in the Wall Street Journal, brought to my attention by Neil Crespi’s youngest son, Michael. They reported: “the law says that the rating firms can be held legally liable for the quality of their ratings” and that, “the trouble is that asset-backed bonds are required by law to include ratings in official documents.” “The result has been,” continued Anusha Shrivastava in her article, “a shutdown of the market for asset-backed securities, a $1.4 trillion market that only recently clawed its way back to health after being nearly shuttered by the financial crisis.”

While I have little sympathy with rating agencies and feel that they definitely should be held responsible for the ratings they assign, equating them as “experts”, in line with auditors and lawyers, overlooks the fact that their ratings are based on estimates as to future events – an inexact science, at best – as opposed to offering an opinion on existing facts, as do auditors and lawyers. The rating agencies, in collusion with the banks whose products they were rating, brought this problem on themselves in providing ratings that did not reflect the real value of the securitized products being sold. But the market for asset-backed securities, at $1.4 trillion, is large, and the securitization of these loans is integral to the auto finance and credit card industries and, therefore, to consumers.

The issue will get resolved, but it will likely result in the rating agencies demanding higher fees to offset the risks of lawsuits; the cost will be borne by consumers (as always) in higher auto loan and credit card interest rates. The problem points to the complexity of integrating government intrusion into market economies. Greed, an unhealthy coziness between Washington and Wall Street, and lack of enforcement of existing rules helped create the problem. As much as anything, this incident points out the fact that the reform bill, despite being 2300 pages long (or 35 times longer than Sarbanes-Oxley), will have consequences, both intended and otherwise.

Thursday, July 22, 2010

"Government Coming to the Aid of Journalism - A Bad Idea"

Sydney M. Williams

Thought of the Day
“Government Coming to the Aid of Journalism – A Bad Idea”
July 22, 2010

Lee Bollinger, the President of Columbia University (and recently named to head the New York Federal Reserve), wrote an op-ed in the July 14th issue of the Wall Street Journal, in which he argued the need for traditional media to have access to public funds. In addition to being president, as a First Amendment scholar, he teaches a course at Columbia, “Freedom of Speech and Press”. His op-ed, therefore, struck me as bizarre.

His argument is predicated on the concept, as he wrote: “The proliferation of communication outlets has fractured the base of advertising and readers. Newsrooms have shrunk dramatically and foreign [news] bureaus have been decimated.” His concern is that the internet is having as transformational an impact on communication as did the printing press in the middle of the 15th century. Being a skilled lawyer, he lays out the fear that many have about the public funding of a free press. He writes: “Can it be trusted when the state helps pay for it?”

His view is yes. For supporting evidence, he refers to the billions of dollars dispensed by federal research programs to public and private universities, and that academic freedom is every bit as important to those in education as a free press is to journalists. Mr. Bollinger discusses the irony that our traditional press has become increasingly dependent on international news services, many of which are state supported: the BBC, China’s CCTV, Xinhua news and Qatar’s Al Jazeera. He writes: “We should think about American journalism as a mixed system, where the mission is to get the balance right.” But he provides no clue as to how to get the balance right, or who would make such a determination. Does Mr. Bollinger really expect the reader to believe these foreign news agencies do not have biases? Do NPR and PBS conform to his opinions to such an extent that he cannot see the bias in their reporting? As for the state assuming some of the costs, Mr. Bollinger neglects to tell us how, once the nose of the camel is under the tent, we prevent the rest of the body from following.

He concludes his essay with a grand and idealistic statement with which no one could disagree: “The goal would be an American broadcasting system with full journalistic independence that can provide the news we need. Let’s demonstrate great journalism’s essential role in a free and dynamic society.” Grandiloquent words, but empty.

Even more than bizarre, I found Mr. Bollinger’s comments chilling. It is as though George Orwell’s “Big Brother” walked out of the pages of Nineteen Eighty-Four and onto the op-ed pages of the Wall Street Journal. He has spent most of his career within the cocoons of universities and comes across as a man unaware that millions of people may legitimately disagree with him and his ideas. His analogy with university funding is telling and unsurprising, as colleges are overwhelmingly dominated by liberals.

However to my mind, the principal problem is that his argument is based on a false premise. He suggests [though he is too circumspect to use such a term] that the news has become contaminated by the opinions of hundreds of thousands of bloggers and cable operators, many of whom, most likely, have opinions at odds with his own. Of course they have opinions and are not shy about voicing them. Such has always been the case. All news is biased, even that that pretends not to be. Readers and viewers must be skeptical and need to read a number of sources to acquire informed opinions. Skepticism should be nurtured in universities like Columbia, so that the views of professors are not accepted as dogma. Universities, as a group, offer far less diversity than is available on the internet. Does Mr. Bollinger truly believe that the New York Times or CBS are not prejudiced? Of course they are. The history of newspapers includes the history of muckraking. It is inherent to our democracy. The internet is a relatively new medium and people are learning their way around it. In many respects it is chaotic. But thanks to search sites such as Google and Microsoft’s Bing, research has become noticeably easier. The internet can be used to gain knowledge. It can reinforce one’s opinions, or can be used to question long-held beliefs. The pamphleteers who wrote in the early days of our democracy were a precursor to today’s blogs, multiplied millions of times.

Traditional news sources would be far better off adapting to new technologies, than looking for subsidies. If they are unable to adapt, should it be the responsibility of taxpayers to save them? Joseph Schumpeter’s doctrine of creative destruction may be outmoded in today’s environment, but it is the way capitalism has developed and worked with enormous success over the years. Rupert Murdoch, in a December interview in the Guardian, noted that the Wall Street Journal has a million paying subscribers to their on-line paper. He believes that internet users will pay for content. If people won’t pay for content from the New York Times, and I have no reason to believe that they will not, isn’t that a message? Today there are 134,000 apps (many of which are news related) available for the I-phone, with an average cost of $1.56. People are paying for content.

The brokerage industry went through a dynamic and trying time in 1975 when fixed commissions were eliminated as of May 1st of that year. Quite properly, no subsidies were made available to stock brokers. Some failed; a few thrived. As for journalism today, there is no dearth of news; in fact there is a surfeit. It may be opinionated, but as I mentioned before, all news is edited. The news may not conform to what Mr. Bollinger feels is appropriate, but the American public has never before had the opportunity to be so well informed. And that is due to the proliferation of cable shows and the ubiquity of the internet, all of which are surviving without any help from Uncle Sam.

Wednesday, July 21, 2010

"Looking for Bubbles"

Sydney M. Williams

Thought of the Day
“Looking for Bubbles”
July 21, 2010

On December 5, 1996, then Federal Reserve Chairman Alan Greenspan spoke at the American Enterprise Institute: “How do we know when irrational exuberance has unduly escalated asset values which then become the subject of unexpected and prolonged contractions as they have in Japan over the past decade.” He then spoke of the fact that the stock market crash in 1987 had generated few economic consequences. However, he concluded: “But we should not underestimate or become complacent about the complexity of the interaction between asset markets and the economy.”

The next day the S&P 500 closed down 4.78 points at 739.60, but a year later the same index was 33% higher and it finally peaked more than three years later on March 24, 2000 at 1527.46. Stocks peaked and in the subsequent decline six trillion dollars were lost, but again, like the late 1980s, the economic impact was modest. In part, that was due to the fact that, generally, stocks were not highly leveraged. Even the attack on 9/11, in the midst of a bear market, did not catapult the economy into a recession longer than two quarters.

It is curious, in retrospect, that the collapse of Long Term Capital in 1998 did not leave a more lasting imprint on bankers regarding the risks of leverage. Perhaps the answer lies in its quick containment, so that only a few were affected. The banks that helped in the rescue learned no lesson; they persisted in the pursuit of levered profits; so now, ten years later, many have disappeared into Never-Never Land.

It was our complacency, brought about by the lack of economic impact following the sharp stock market correction in 1987, the Asian crises of 1997 and the collapse of Long Term Capital, that set the stage for the housing bubble of 2002-2006. The mythical story of the boy who cried wolf proved prescient. When banks, already heavily leveraged, were left holding the bag after highly mortgaged house prices collapsed, the economy was hit by a series of round-houses. Politicians, who were importantly responsible for the devastation, ducked for cover and quickly blamed institutions for fomenting the bubble. We are now living through a bubble and the consequences of its collapse, so a bubble is no longer something we read about in dusty histories. It is, then, unsurprising that commentators on Wall Street and in the Press see bubbles everywhere.

Bubbles are not new to our lexicon. The South Sea Bubble, 290 years ago, is known by that name. A bubble can be defined as the price of an asset that is trading, typically in high volumes, at a considerable variance to its intrinsic or historic value. Bubbles are usually associated with leverage, but they are rare.

It is Treasuries, today, that most commonly are being dinged with the label, “bubble”. But not every over-priced asset becomes a bubble. In fact most do not. Regardless, bonds and especially Treasuries, as the ultimate “safe” vehicle, have done very well. Their rise has not gone unnoticed. Over the past ten years, as the S&P 500 Index slumped 24%, the yield on the Ten-Year declined from just over 6% to just under 3%, indicating that Treasuries were the place to be. At the end of June, 2007, just prior to the housing bubbles’ appearance, the yield on the Ten-Year was just over 5%. Even today, following an incredible 83% return to stocks from bottom to top, the fifty-two week total return to stocks is a mere 12.5%. That can be compared to a 24.4% for high yield bonds, the most equity-like debt instruments. Jeremy Grantham, in his July 2010 quarterly letter, writes: “fixed income is desperately unappealing.”

Wall Street commentators love labels; they dramatize our condition; thus the “new normal” of PIMCO and Jeremy Grantham’s “seven years”. “Bubbles”, as a label, have become ubiquitous. Over-priced assets are common and, fortunately, very few become bubbles. Over-priced assets always correct and when they do those that are long, suffer; those who are short make money. Bubbles, in contrast, are rare. They are often debt induced. Their collapse has enormous consequences. Extended, over-priced assets when they fall are no fun and the resulting bear markets cost investors trillions of dollars and can cause a few to lose everything. When bubbles implode, as happened in Holland in 1637, in London in 1720, in New York in 1929 and most recently across vast swaths of the United States in 2008, chaos ensues.

In comparison to bonds, stocks seem reasonably priced; though I worry about the effects of a contracting consumer on economic growth and the impact of a government swollen with bureaucrats and debt. But, I note that many historic skeptics have become more positive on certain equities: people like Jim Grant of Grant’s Newsletter, Bill Gross of PIMCO and even, though reluctantly, Jeremy Grantham of GMO.

Nobody can predict how high prices will go when they soar, or how low they will go when they fall. To one who is expecting deflation and notes that the yield on the Two-Year has fallen from 1.01% at the end of March to 0.57% today, going further out the yield curve may make sense. But the further out the curve you go, the more risk you assume. Treasuries seem extended to me, but I don’t believe they fit the definition of a bubble.

Tuesday, July 20, 2010

"The Financial Wreck We Missed"

Sydney M. Williams

Thought of the Day
“The Financial Wreck We Missed”
July 20, 2010

A good friend recently mentioned that the most important event of his investment career (which at 43 years is the same as mine) is what did not happen following the collapse of Lehman Brothers in 2008 – Armageddon never arrived. I concurred. It is almost impossible to recreate the feelings experienced during those few days when the world’s financial system teetered. Had the financial system collapsed, trade and commerce would have ceased. I have mentioned this before, but it is worth repeating. No matter our opinions today, we owe a debt of gratitude to Treasury Secretary Henry Paulson, Fed Chairman Ben Bernanke and Timothy Geithner, then President of the New York Federal Reserve, for holding the system together. It is easy from our perch today to “Monday morning quarterback” and to criticize them for doing too much or too little at the time. What they did worked. It may not have been pretty, mistakes were surely made, but we did not topple over the edge.

Our very lives depend upon trade and commerce: without them we would starve. None of us are self sufficient. Trade and commerce, in turn, depend upon banks and the flow of credit; and credit is based upon confidence, a fragile and vulnerable condition. The failure of Armageddon to arrive gave birth to the restoration of confidence; the wheels of banking and commerce continued to turn, gradually and reluctantly perhaps, but turn they did. GDP, which had declined by 5.4% in 2008’s fourth quarter and 6.4% in 2009’s first quarter, was down only 0.7% in last year’s second quarter, and was actually positive in the third and fourth quarters.

That confidence is best manifested in the TED spread. It is the difference between Three-month LIBOR and Three-month Treasuries and reflects the “risk premium” of lending to a bank as opposed to the Federal government. For the six years ending December 2006 that spread averaged 39 basis points. By the end of 2007, the spread had widened to 156 basis points, a clear warning of storms ahead. It reached its zenith during the week of October 10, 2008 at 460 basis points. Yet, a little more than two months later, by the end of December, the spread had narrowed to 131 basis points – lower than it had been a year earlier! While a recent rise in the TED spread from 14 basis points at the end of 2009 to a little over 40 in early June worried some observers, the spread remained well within the range for the years 2000-2006 when year-end spreads varied from 67 basis points in December 2000 to 20 basis points in December 2002.

Despite the avoidance of Armageddon, the fear of that near collapse remains with us and is manifested in confusion and cynicism among investors. But the future is never clear and human psychology can be deceiving. A market trending in one direction or the other can provide a false sense of confidence. In December 2006, on the eve of the financial collapse (it arrived in the summer of 2007), the mood was very different. In a Market Note dated December 21, 2006, I wrote: “Complacency has settled over the financial markets…This happy-go-lucky attitude is reflected in the opinions of Wall Street strategists…the consumer [is] borrowing to ensure he lives as well as the next man, while ignoring rumblings from the housing sector…risk is an adaptable beast and can attack when least expected.”

The focus of investors and most people is directed toward the problems we have…and they are real. Debt at the federal and state level is far too high. The consumer, sensibly, is retrenching, but thereby slowing economic growth. The unprecedented expansion of government appears to be at the expense of the private sector, at least in terms of employment. But none of this has gone unnoticed in the market place. Stocks are lower than they were a dozen years ago, and the S&P 500, at 1071, is slightly below the midpoint between the lows of 666 and the highs of 1576. During the past decade, while stocks languished, earnings for the S&P 500 have risen 37% (and 180% from the trough in second quarter 2002). GDP has risen during the past decade by 45%, while energy consumption – according to a table in today’s Wall Street Journal – has declined. Despite no “cap-and-trade” bill, energy consumption per person in the U.S. declined 11% during the decade.

Stocks partied hard during the 1980s and 1990s, and real estate in the 00s; what we are experiencing is the hangover, a perfectly natural consequence. This self-adjusting mechanism has to work itself through the system and, as it does, stocks become more reasonably priced. It is my opinion, for what it is worth – not much I am sure – that we will remain in a trading range for a period of time, as we make amends for the excesses of past years. But, as time goes on, and as despair may deepen, the fundamental attractiveness of stocks will increase. The future is never clear, but investors should take care not to be governed by the emotions of the moment; the fatal crash that did not happen in the fall of 2008 has made regulators and investors more vigilant and, consequently, decreased the likelihood of a repeat.

Monday, July 19, 2010

"Financial Reform - A Lawyer's Dream"

Sydney M. Williams

Thought of the Day
“Financial Reform – A Lawyer’s Dream”
July 19, 2010

Whether the $862 billion stimulus bill added a couple of million jobs, as the White House would have you believe, or whether it hastened the decline of a roughly equal number of private sector jobs, as Republicans would tell you, one thing is certain – the President’s two landmark pieces of legislation (Health Care and Finance Reform) are certainly LEGAL (literally, Employment Guarantee Acts for Lawyers.)

“With passage [of finance reform] we will have a clear sense of the rules of the road.” So spoke a “senior” Treasury official, according to Friday’s Financial Times. However, after reading reports of the bill in the New York Times, the Wall Street Journal, and Investor’s Business Daily, it is my sense that there are no clear rules. The bill creates a council of regulators, led by the Treasury Secretary. It is regulators who will decide, for instance, which derivatives must trade through clearinghouses. Senator Chris Dodd of Connecticut, the principal architect of the Senate’s legislation, said, according to the New York Times, that the bill’s success “ultimately would depend on regulators’ performance.” Binyamin Appelbaum and David Herszenhorn, in the New York Times, write, “The legislation will be carried out mostly by the same federal workers who were on duty as the financial system collapsed.” And one should not forget the loose practices of Fannie Mae and Freddie Mac; both institutions were instrumental in the financial collapse and are not included in the reform bill. Notably, both GSEs were particularly close to Senator Chris Dodd and Representative Barney Frank, leaders respectively of the Senate and House committees responsible for the Act’s passage.

Critics on the right and the left, according to the Wall Street Journal, say that one of the bill’s key flaws is that it relies on the judgment of officials rather than hard rules.

As a comment on the bill’s complexity, a front page article in Friday’s Journal noted: “J.P. Morgan, one of the biggest U.S. banks by assets, has assigned more than 100 teams to examine the legislation.”

Lawyers at Davis, Polk & Wardell declared that the bill will “unleash the biggest wave of new federal financial rule-making in three generations.” In their summary to clients (itself requiring 150 pages) they estimate that it will require no fewer than 243 new formal rule-makings by eleven different agencies, unleashing, as the Wall Street Journal put it on Friday’s front page, “a lobbying blitz from banks – that will determine the precise contours of this new landscape…Decisions will be made by officials from new agencies, obscure agencies and, in some cases, agencies like the Federal Reserve that faced criticism in the run-up to the crisis.”

What is needed are a few commonsensical rules, clearly written and easily understood, that addressed some of the root causes. Growing disparities in incomes, as we’ve written about before, created tensions between “haves” and “have-nots”. Those tensions were temporarily masked as many consumers, in a bid to “keep up with the Jones’”, borrowed at unsustainable levels. They were encouraged to do so by the Federal Reserve, which kept short term rates low in the early years of the last decade, a decision which abetted asset inflation, particularly houses. Government policy, with passage of the Community Reinvestment Act of 1977 and regulatory changes in 1995, effectively endorsed the notion of living beyond one’s means. Passage of the Financial Modernization Act of 1999 repealed part of the Glass-Steagall Act that had prohibited a bank from offering a full range of investment, commercial and insurance services. The Bureau of Labor Statistics, which computes the CPI, does not include home prices, only rents; so run-away home price increases, as a determinant of inflation, were ignored, helping the Fed justify the continuation of low interest rates. Despite convincing information brought to their attention, the SEC failed to nab Bernie Madoff from defrauding thousands of people of millions of dollars. The elimination of Glass-Steagall permitted banks to use depositor’s money to make bets which served to enrich a small number of employees at the expense of depositors, lower level employees, the community and shareholders. Technology permitted the leveraging of bets to a size where the notional value of the financial industry’s derivative bets dwarfed, by a factor of ten, the economies of the world.

The bill does have its good points. In time, rules are expected to be set prohibiting deposit taking institutions from proprietary trading and limiting their investment in private equity and hedge funds. Most derivatives, but not all, will be forced to trade through clearing houses, thereby reducing the risk of counterparty bankruptcies. Consumers should be better protected, as “abusive” practices will be more closely regulated. It should be understood, however, that the costs will include higher fees and more restricted credit. “Too big to fail” banks have now become “systemically significant” and will face stricter capital, leverage and liquidity standards, but will remain too big.

The bill reminds one of the old cliché: “A camel is a horse designed by a committee.” At 2300 pages, it is a bill that few understand and is immeasurably complex. In adding new bureaucracies, it dramatically increases the size of government. It gives more power to agencies that failed earlier and creates new ones; a host of derivative products may or may not be subject to clearinghouse rules; politicians, many of whom fomented the problem in the first place will largely remain in Washington, revered and untouched. It is a bill which will take years to implement; it is one which will provide employment for lawyers for years to come.

Friday, July 16, 2010

"Technology - For Good and For Evil"

Sydney M. Williams

Thought of the Day
“Technology – For Good and For Evil”
July 16, 2010

It is probably my age, but I find it offensive when a necessary market is used for purposes that were never intended – especially when the results provide no societal economic benefits other than padding the pockets of a few. I refer, of course, to the stock market and the deployment of quantitative technologies in algorithmic-driven high frequency trading platforms, which generate trading volumes equal to an estimated 70% of a total day’s volume.

The necessity for governments and corporations to raise capital and the subsequent need for investors to be able to sell and to buy provided the impetus that created stock exchanges in the first place. Exchanges date back several centuries, with the earliest operating out of coffee houses and were often only open for an hour or two a day. The Venetians (think Shakespeare and The Merchant of Venice) were among the first, trading debt securities of other governments in the early 1300s. In the first part of the 16th century an exchange was established in Antwerp. London was not far behind. The Buttonwood Agreement, establishing the forerunner of the NYSE, was signed on May 17, 1792. Those exchanges played a critical role in the growth of commerce, the furtherance of global trade and helped raise living standards for millions of people around the world.

That some of those exchanges now serve as little more than casinos, permitting a few thousand people to place bets is antithetical to the original intent of those exchanges. And worse, as we learned on October 19, 1987 and then again on May 6 of this year, quantitative-driven programs increased risks for legitimate investors. The holding periods for many high frequency traders is often measured in seconds. Their claim that they provide liquidity rests on dubious evidence at best. They have, though, enriched a small number of people to an extant virtually beyond measure.

There is no (and there never should be) stopping technological development and, despite my misgivings, there seems little likelihood that any obstruction in the form of regulation (other than circuit breakers) or taxation will be placed in the way of high frequency traders.

It was, therefore, a pleasure to read in Wednesday's Wall Street Journal of a small firm, Rebellion Research, which is using algorithmic equations to design artificial intelligence programs to make investment decisions. At this point, firms utilizing A.I. are small enough to have little market impact, but there are significant differences between those using quantitative approaches to enhance fundamental returns and what HFTs attempt. First, as Spencer Greenberg of Rebellion explains: "What makes Star (as they call their program) intelligent is its ability to adjust its strategy based on shifting dynamics in the market and broader economy." The firm considers more than 30 factors that can affect a stock's performance, from price earnings ratios to interest rates. And, second, the average holding period for Rebellion is four months versus a few seconds for HFTs.

Firms like Rebellion use algorithmic equations to create artificial intelligent platforms in order to make quantitative, but fundamental, bets, while HFTs use similar mathematical models to be able to trade more rapidly, eking out a few pennies per trade, at times arbitraging price discrepancies; for example, ETFs from their underlying stocks, or they may engage in simple old fashion front running. Whether Mr. Greenberg’s firm succeeds or does not – and early reports look promising – he is using technology in a creative and non-destructive way.

Technology, while usually a blessing, can also be a curse. Michael Cembalist, Chief Investment Officer for J.P. Morgan Private Bank and who writes a column, “Eye on the Market”, recently wrote about high frequency trading programs and the temptation to define all forms of innovation as progress: “You do not have to be a Luddite to raise questions about undesired consequences of innovation, particularly when financial services are involved.”

Wednesday, July 14, 2010

"Long Term Investing - A Perspective Helps"

                                                                                                                                                                      Sydney M. Williams

Thought of the Day
“Long Term Investing – A Perspective Helps”
                                                                                                                                                                      July 14, 2010

Abraham Lincoln once said “you can fool all the people some of the time and some of the people all the time, but you cannot fool all the people all the time.” The stock market seems determined to prove him wrong. Stealth-like and to little fanfare, the S&P 500 advanced 5.4% last week and is up another 1.6% in the first two days of this week.

One of the more depressing truths that one learns after many years toiling in the markets is that most investors are doomed to mediocrity, or worse. Like Sisyphus who was condemned to constantly roll a rock up a hill, individual investors, as a group, appear compelled to buy when they should be selling and sell when they should be buying. Rallies, like major sell-offs, eventually prove too tempting. The market bottomed in early March 2009, after an horrendous slide (down 57%) from its peak eighteen months earlier. But it wasn’t until April 2010 that domestic equity mutual funds received positive cash flows – once the market was up 80%. These behavioral attitudes are well known among professional investors and serve as the best argument against people taking control of their own retirement funds.

In the immediate post-war years major U.S. companies, competing for returning servicemen and women, offered defined benefit retirement plans. Like Social Security, an abundance of workers and a deficit of retirees guaranteed solvency for these plans in their first couple of decades. However, as time passed and as workers demands increased, most plans adopted the aggressive use of higher discount rates, thereby permitting the injection of fewer corporate dollars into the funds’ tills – an early form of corporate sleight-of-hand. The flat market of the 1970s convinced corporate employers that market risk should be borne by employees, so the adaption of defined contribution plans gradually began to replace the old defined benefit ones.

A friend has a son who has been working a city job for a dozen years. His retirement plan allows him to contribute $200 per month to funds of his choosing. Having a “big shot” father on Wall Street, the son sought advice of him. Now, after twelve years of contributions, he finds the value of his assets is less than his total contributions – an uncomfortable and disagreeable situation for a 34-year old man with three children. Now this young man is fortunate. His father is wealthy, but for thousands of others in similar straights the outlook is less promising.

All long term studies have validated the value of stocks as a key component in long term financial planning. The problem, of course, is the phrase “long term”. Following the markets peak in 1929, it took 25 years for the market to recover to its previous high. In the 1970s, it took 16 years. The NIKEI is selling at 25% of where it sold in 1989 and our NASDAQ today sells 57% below where it stood ten years ago. The S&P 500 today is 6% below where it was on July 13, 1998 – twelve years ago. As markets decline, skepticism should give way to optimism for long term investors, but, unfortunately, the opposite tends to be true.

History, with all its faults, remains our best guide to the future. Total long term returns to stocks is about 6%, 50% above “safe” returns embedded in the U.S. Thirty-Year Treasury. Cash is a different animal. A zero return should not prevent investors from holding it, for cash should be looked upon as an option on opportunity, but those who are investing with a fifteen to thirty year horizon should consider equities and be unafraid of the volatility embedded in stocks.

What can be done to help the young and those without financial experience gain some sense of perspective about investing? I am unsure, but certainly a focus on educating our youth on the basic requisites for investing and instilling a sense of personal responsibility would be useful first steps.

Tuesday, July 13, 2010

There is a Way forward - Rely More Heavily on the Individual

Sydney M. Williams
Thought of the Day
“There is a Way Forward – Rely More Heavily on the Individual”

July 13, 2010

The deteriorating financial situation in southern Europe has ramifications far beyond the ultimate survivability of Greece and the Euro. It is a proxy, if you will, on the relative merits of “continental” socialism versus the “Anglo-Saxon” model. Stratfor Global Intelligence, in their “Third Quarter Forecast 2010”, discussed the issue: “For much of the financial crisis the Europeans held up the continental model as superior to the ‘Anglo-Saxon’ model. Slower growth with stronger social safety nets seemed superior to the more aggressive, less protective, American and British model. The continental Europeans are now facing both cuts in social services and slow growth.”

The horrors of two world wars converted a continent which had been almost continuously at war into a placid Eden where the emphasis was on paternalistic government, equitable distribution, a foregoing of empires and cultural growth. War, which had destroyed two generations of young men, would be confined to the dust bin. Their only threat, the Soviet Union on their eastern edge, was checkmated by the United States and the NATO Alliance.

The British historian, Niall Ferguson, teaches a course at Harvard entitled “Western Ascendancy, Mainsprings of the Global Power”. His course is an attempt to understand why, five or six hundred years ago, London and much of the West became the dominant entities. He has pointed out that, could one travel back in time to 1400 or 1500, one would be far more impressed with the clean, wide streets of Beijing with its dazzling palaces, the Mughal Empire in India, the achievements of the Ottoman Empire, or the advanced civilizations of the Aztecs and Incas than with the smelly and dirty streets in the small village of London. Professor Ferguson provides answers to his rhetorical question: among them, the existence of competition in both the political and economic arenas; a rule of law, determined by property owners through a representative assembly, and a strong work ethic – prerequisites all for a capitalist society.

Professor Ferguson’s course and his comments are relevant today, as there are many who believe we are undergoing a sea-change with the East rising, Phoenix like, from the ashes of the West. It is far too premature, in my opinion to write the West’s obituary, but it is equally impossible to disagree with his assessment when he writes: “And that means it’s unlikely that the West will continue to occupy that position of extraordinary predominance that it had, say, 100 years ago when maybe 20% of the people of the world lived in western empires, western societies, but they accounted for more than 50% of all global income. I think that’s pretty much coming to an end now.”

That the East is rising seems indubitable. China is exhibit “A”. The question is, does the West have to decline? America, under Job-like trials, is at a cross roads. An over-inflated stock market deflated in 2000-2002. In the midst of that bear market, the United States was attacked by Islamic terrorists. In 2007, we faced a financial crisis of our own making and, in the fall of 2008, that crisis came close to destroying the entire capitalist system. The ties that bind our society have become stretched, as the gap between rich and poor show no sign of diminishing. Our youth has suffered, as public education, instead of being a leveler, manifests the difference between the haves and the have-nots. Is it any wonder that people are confused and upset?

But, fortuitously and as is the nature of Democracies, rarely have the political choices been so stark. One way out of the morass is to rely more heavily on the wisdom and benevolence of government. The other way is to rely on the creativity and wisdom of individuals. The first, perhaps, provides more immediately comfort; it is the preference of the President. The second has been roundly blamed, with some reason, for the mess in which we find ourselves. However, a reading of Representative Paul Ryan’s 87 page “A Roadmap for America’s Future” (scored by the CBO) presents a clear vision for extracting ourselves from the current morass, a path that relies more heavily on the individual than the state. The fact that Congressman Ryan’s proposal has received so little attention reflects the biased nature of “mainstream” media.

Continental Europe’s decline could prove to be the West’s saviour. A society that promises what it cannot afford will fail, or will assume the markings of totalitarianism, in which case failure will only be delayed. Niall Ferguson’s analysis of the causes of the rise of the West 500 years ago should be required reading for those who would lead us to the Promised Land. It is difficult to imagine a continuing competitive West that not only embraces, but celebrates, the individual.

Monday, July 12, 2010

"Rally, What Rally?"

Sydney M. Williams

Thought of the Day
“Rally, What Rally?”
July 12, 2010

From the depths of gloom, the market, surprising most pundits, sent a message of optimism which carried stocks to their best weekly performance since the week ending July 17, 2009, with the Dow Jones covering more than half the loss incurred in the second quarter. Yet the Press, on Saturday, was surprisingly circumspect. Investor’s Business Daily was the exception, carrying a story on the lower half of the front page: “Street Adds to Win Streak, But Volume Remains Low.” However, the New York Times, the Wall Street Journal, the Financial Times and Barron’s apparently decided that the rally was not worth a front page location.

Alan Abelson, writing in Barron’s, is perennially bearish, so it was no surprise that he wrote that stocks remain in a “bear market that has some years to run.” Paul Lim, in Sunday’s New York Times, quoted Sam Stovall (of Standard & Poor’s): “The chances of the correction morphing into a new bear market are definitely rising.” Mr. Lim added that, “the underlying economic optimism that spurred the stunning rally seems to be subsiding.” Echoing that same theme, Alan Beattie and Robin Harding headlined their piece in the weekend edition of the Financial Times: “Optimism on Hold.” The writers blamed “uncertainty” in the economy.

Declining volume does not, typically, lend support for a change in price trend. With the exception of May 6 (the 6th heaviest volume day ever), volume has been gradually declining since the hectic days of September-October 2008. Despite the fact that last week was holiday-shortened, an average daily volume decline of 13% from the previous week is significant. However, with such a large percentage of volume now coming from program trading, high-frequency-trading and various algorithmic platforms – up to 70% of total volume, according to some estimates –- it is difficult to assess the meaning of changes in volume. As proprietary trading desks undergo more scrutiny, and may become subject to regulation once the finance bill is enacted, the value of volume analysis will become increasingly complex. Nevertheless, the fact the market rose on declining volume cannot be construed as a positive.

Sentiment remains cautious, as a front page article in today’s Wall Street Journal makes clear: “Small Investors Flee Stocks, Changing Market Dynamics”. That attitude is mirrored in Barron’s, with Bulls in the Consensus Index at 37% versus 43% two weeks ago. Market Vane, was virtually unchanged with Bulls at 39% against 40% two weeks ago. Regardless, the rally was broad, with the NYSE Index rising 5.8% and all major indices up more than 5%.

It all suggests we are far from a “Goldilocks” environment, one in which stocks get priced to perfection. The financial crisis and the ensuing recession are still fresh in the minds of people, minds which were already numbed by the market decline of ten years ago. Whereas skepticism, when it comes to investments, is healthy, fear and cynicism are not. And extended bear markets – and the market today is lower than it was a dozen years ago – breed fear and cynicism, conditions increasingly common among individual (and professional) investors. However, as Jim Grant writes in the current issue of Grant’s Interest Rate Observer, “Armageddon is usually a no-show.”

For a long time I have believed we are in an environment similar to the 1970s, a period when the market traded within a relatively narrow range for sixteen years. I believe we have been in the current period for the past twelve years. No one knows how long it will last, but we are most likely in the last few innings. What is important for investors is to keep one’s emotions at bay and to seek values when and where they exist.


On an unrelated matter, I cannot let the opportunity pass without recommending the reading of Naomi Schaefer Riley’s wonderful interview in Saturday’s Wall Street Journal with Wendy Kopp, the founder of Teach for America. What Ms. Kopp has achieved over the past two decades is truly remarkable.

There is no better way to preserve and enhance the pre-eminence of our Country and culture than by improving elementary and secondary education. The domination of teacher’s unions has created an environment in our public schools that has riveted them to the past, fostered mediocrity, with seniority taking precedence over meritocracy.

Graduating from Princeton in 1989, Wendy Kopp found it easier to get a job at Morgan Stanley than one in the public school system in New York, as she lacked a traditional teacher certificate. Teach for America, as a concept, emerged from her senior thesis and, in lieu of working at Morgan Stanley, she began the program. This fall Teach for America will send 4500 of the best college graduates to 100 of the lowest performing schools in urban and rural America. Those 4500 teachers were chosen from 46,000 applications, which included 12% of all Ivy League seniors.

Funding for the program – this year the operating budget is $180 million – is mostly private, with $21 million in Federal appropriations. In contrast, the Peace Corps, created by Congress in 1961, received $340 million in 2009 and $400 million in 2010. This year they sent 7,671 volunteers to 77 countries.

The mission of the Peace Corps is to bring American ideals and technology to undeveloped parts of the world and for the volunteers to bring back to America a greater understanding of that world. It has proven successful for almost fifty years. But the comparison to the Peace Corps makes the success of Teach for America even more extraordinary. One woman’s idea has morphed into an organization that today deploys more than half as many people as does the Peace Corps for only a fraction of the cost to the Federal government. Teach for America is a program that serves perhaps the most critical need of our Country – improving the education of our youth. It is good to know that one individual with vision, optimism and determination can continue to play such a meaningful role in America.

Thursday, July 8, 2010

"Tax Increases are Coming"

Sydney M. Williams
Thought of the Day
“Tax Increases are Coming”

July 8, 2010

Following the Group of 20 meeting in Toronto – a meeting which highlighted the differences between the U.S. and many of its allies in terms of deficits – President Obama was asked what he had planned for deficit reduction. His 4 minute, 19 second response included a host of initiatives he has already implemented (dubious), a promotional comment on the health care bill (?), the usual slap at Republicans and a promise that the Commission of Fiscal Responsibility and Reform will issue their report in November (after the mid-term elections). He added that he hopes that those who have been calling for deficit reduction will not back away from the commission’s recommendations. He said he would be “calling their bluff.”

Federal debt now stands at just under $13.2 trillion and is growing at the rate of a million dollars every 30 seconds – $2.88 billion every day. Something has to give. Liberals, like Paul Krugman, call for continued federal spending and an increase in taxes. Fiscal conservatives, like Niall Ferguson, suggest an approach that relies on the private sector and a reduction in taxes.

Barring some unforeseen legislation, on January 1, 2011 the United States will experience the largest tax increase in its history, as the Bush tax cuts roll off the books. Raising taxes, like draconian cuts to public spending, increasing interest rates, or restricting trade are no-no’s during a period of anemic economic growth. Mr. Obama needs cover for the tax increases that are coming and the Commission will be there for him.

According to IRS data, the top 1% of all wage earners in 2002 (before the 2003 Bush tax cuts) paid 33.71% of all personal income taxes. In 2007 (the last year for which I could find data), the top 1% paid 40.42% of all taxes. The top 5% of all earners (those who earned more than $160,041 in adjusted gross income) paid 60.63% of all taxes in 2007 versus 53.80% in 2002. In 2002 the bottom 50% of all wage earners paid 3.50% of all taxes. By 2007 that percent had declined to 2.89%.

The rich are paying a larger percentage of total taxes, suggesting that the “tax breaks for millionaires and billionaires” has not been detrimental to the Treasury. There is, however, a separate issue which the Administration has chosen to confuse with lower tax rates and that is the widening disparity in the earnings between the “rich” and the average worker. For example, using average gross income (AGI), the share of income earned by the top 1% has grown from 16.9% in 2002 to a 23.5% share in 2007. Average gross income is, of course, a pre-tax number and this trend has been in place for thirty years, through tax cuts and tax increases. For example, in 1982, the top 1% of earners generated 12.8% of all income in 1982. Understanding the cause of this expanding polarization is important. It reflects changes in technology and an education gap that has disadvantaged many of the poor. Bringing competition to the educational system, as charter schools and voucher systems do, is an important first step, something the powerful teacher’s unions have been fighting. This gap also reflects the dramatic increase in CEO pay versus the average worker over the past few decades. According to the Economic Policy Institute, the average CEO in 1965 earned 24 times more than a typical worker. By 2007 that number had risen to 275 times. The bulk of that expansion occurred since 1990 and, I would argue, was largely a function of a decision of the Clinton Administration in 1993 to limit the deductibility of executive salary compensation to a million dollars – a decision that had the unintended consequence of grossly expanding the use of options, which in turn led to a focus on short term results and fraudulent practices such as backdating.

Addressing this disparity is not a simple matter. While few would argue that rising inequality is a good thing, it is also important not to destroy the potential for wealth for those on the ladder. Candidate Obama’s vow to “spread the wealth” has not been well received. Mobility, up and down the income scale, is a deeply embedded American belief. Keep in mind that in a 2005 study of the Forbes 400, it was found that a vast majority – 294 – built their wealth through hard work and building businesses in insurance, oil, technology, consumer products, entertainment and real estate, while 40 inherited their wealth. Americans, more than others, have shown a willingness to accept a higher level of inequality in income, as they aspire to success.

Raising taxes on very high income ($10 million or more) may make good headlines, but won’t raise much revenue. Since the holding period for some high frequency traders is measured in milliseconds, and from what I can tell they serve no real economic purpose other than feathering their own nests, I could well support a draconian increase in the capital gains tax for such short term holding periods. But off-setting such an increase should be cuts (or elimination of) in capital gains for securities held for five years. Long term investing needs to be encouraged for the long term health of the country. The automatic increase from 15% to 20% next year will prove counter-productive, as will the virtually doubling of taxes on dividend income. (The increase on dividends may be limited to 20%, according to Treasury Secretary Timothy Geithner in an interview last night on CNBC.) It is consumption, not investing, that should be discouraged.

The National Bureau of Economic Research (NBER) is the official scorekeeper for recessions. According to their work, the current recession began in December 2007 and is now in its 32nd month, twice as long as the previous postwar recession record. (Keep in mind, though, when the NBER declares the recession over it will be long after the fact.) Nevertheless, while the recession began under President Bush, it now belongs to President Obama and it has become his to repair. The 1930s showed the folly of raising taxes, tightening money, attempting centralization and discouraging trade. Had the War never happened and had Roosevelt been a two-term President, his Presidency would be considered a failure. Hoover made serious mistakes in terms of raising taxes, attempting to balance the budget and signing Smoot-Hawley. FDR’s policies did not work either. It was the War that brought recovery to our economy.

Economic growth is the one elixir that will painlessly remove us from the abyss of debt Armageddon; so the question is how best to do it? From my perspective, the best answer is for government to provide an environment that encourages the private sector to invest and to hire, and that requires regulations that are simple, straight forward and easily complied with, and a tax policy that recognizes that many small businesses are sole proprietorships, so subject to individual tax rates. The pending tax increases scheduled for January 1st will prove counter-productive.

Wednesday, July 7, 2010

"Restore Confidence, Jobs will Follow"

Sydney M. Williams

Thought of the Day
“Restore Confidence, Jobs will Follow”
July 7, 2010

Other than the President, who after seeing Friday’s job report, responded: “Make no mistake – we’re headed in the right direction”, the general consensus was far more subdued. The Financial Times: “US jobs data point to flagging recovery”; The New York Times: “U.S. Reports Job Growth Lagged in Private Sector”; The Wall Street Journal: “U.S. Jobs Picture Darkens”, and Investors Business Daily: “Private Payrolls Lag, Leaving Total Jobs Off 125,000 In June”. In fairness to Mr. Obama, he did add that growth in job creation was too slow. But Paul Krugman, in a New York Times op-ed piece on July 4, wrote, “American workers are facing the worst job market since the Great Depression.” The unemployment numbers were higher and for longer during the 1980-1982 period than today; nevertheless, today’s environment is very tough.

A perusal of the release from the Bureau of Labor Statistics, out on Friday speaks to the Administration’s focus on government jobs, not those in the private sector. For example, the number of people employed in private industry has dropped by about 1.25 million over the past year (107.995 million to 106.740 million), while the numbers of those working for government have increased by just over 200,000 (22.567 million to 22.770 million). Unemployment among government workers is at a non-recessionary 4.4%.

All employment numbers must be viewed in the context that each year about 1.5 million new entrants are added to the workforce, which means we must add 125,000 jobs every month just to stay even. The civilian labor force – those working or actively seeking a job – shrank by 652,000 during the month, thereby explaining the unemployment rate decline from 9.7% in May to 9.5% in June. Despite relatively upbeat comments from the Obama White House the employment situation remains bleak. According to Monday’s New York Times, the fraction of the working-age population employed stands at 58.6%, its lowest level since the double recession of 1980-1982.

The story of a friend’s sister lends a human element to the job situation, which, thus far, has shown very little improvement, despite the nearly $800 billion of stimulus money allocated a year ago for that purpose. Her story goes beyond the almost forty pages of numbers from the Bureau of Labor Statistics. That report notes that there are 14.6 million people unemployed, 8.6 million “involuntary” part-time workers and 2.6 million who are “marginally attached” to the work force (a number which includes 1.2 million “discouraged” workers.) The civilian workforce, according to the BLS, is comprised of 154 million people, so that 16.8% of the population is either unemployed, working part-time, or discouraged.

But even for many who are employed the environment has been rough. My friend’s sister is an example. As a 50-year old, she had a good job working on Wall Street as an administrator making $140,000. Soon after the financial crisis struck she found herself out of a job. After a few months she was offered another, virtually identical, position for about half of what she was making before – $80,000. She swallowed her pride and took the position. Less than six months later that firm was merged and again she was out looking for work. A few months later, with her ego further deflated, she was offered a similar opportunity, but at $50,000. She had no choice but to accept the job. The damage to her confidence and self-esteem, however, has been severe. And she is one of the lucky ones. As a statistic, she shows up on the positive side of the ledger – she has a job, but is earning about a third of what she had been three years ago; it is not possible to mathematically quantify the impact on her psyche and her behavior. Her case, unfortunately, is all too common in today’s environment

With almost 17% of the workforce out of work, working part-time or just dissatisfied (essentially the U6 numbers), the focus must be on growth. Austerity has become the buzz-word and certainly government deficits (federal and state) are unsustainable. (The President has suggested that deficit reduction is on the calendar for next year, but I fear his words are only a euphemism for raising taxes, not spending cuts.) It is the debate between Paul Krugman and Niall Ferguson that needs to be joined. Professor Krugman yesterday suggested “throwing the kitchen sink” at the problem, a sink, he might not have noticed, we no longer possess. Professor Ferguson suggests a solution similar to that employed in the early 1980s (a combination of tax cuts, rate increases and spending reductions), a solution which tipped the economy into a steep but short recession, but which set the economy up for twenty years of growth. It is the restoration of confidence that is imperative. Should stimulus come from government or the private sector? The returns from last year’s government-led stimulus look pretty meager. It may be the moment to see what the private sector can do.

According to the U. S. Census Bureau there are 1.5 million businesses with 10 or more employees. These, along with the 4 million even smaller businesses, have been the engines of growth in our economy and employ 80% of American workers. These firms cannot function without confidence in the future, and that confidence requires visibility, which is critical for those making investment and hiring decisions. When government intrudes, as it has in health care, looks to be doing in finance reform (incredibly, not waiting for the report from the President’s own National Commission on Fiscal Responsibility and Reform) and cap-and-trade with unknown consequences, it sends a message to American business – pause, watch and wait.

The Administration has been determined to use the financial crisis has an excuse to centralize power, in banking, auto production, insurance, health care and energy. In doing so, they have increased regulation, passed a health care bill that will indubitably cover more people, but at the cost of raising prices and reducing benefits. The executive branch now has a pay czar whose responsibilities include monitoring and influencing the compensation of millions of Americans from industries as diverse as banking, autos, insurance and energy. The Administration has divided Americans by blaspheming Wall Street, failing to recognize the inextricable bonds between Main Street and Wall Street. They do not differentiate between the wheat farmer who uses the futures market for legitimate hedging purposes from the speculator whose motive is a quick buck.

What the Administration has not done is to encourage long term investment, or discourage consumption. Most importantly they have done nothing to restore consumer or business confidence, the single most important ingredient for the recovery process.

Tuesday, July 6, 2010

"The Second Quarter: Risks Bows to Safety"

Sydney M. Williams

Thought of the Day
“The Second Quarter: Risk Bows to Safety”
July 6, 2010

The trouble with stock market adages is that you can’t count on them. Investing, like life, is not easy – if it were, the game would be no fun. However, a number of records were set during the second quarter which lend credence to the old saying, “sell in May and go away.” I wish I had. The second quarter was the worst quarterly performance since the fourth quarter of 2008; it was the worst second quarter since 2002, and May, according to the Financial Times, was the worst May since 1962.

It was a quarter that could be best characterized as a flight to safety. The DJIA were down 10% versus a 13.1% decline for the broader New York Stock Exchange Index. The German DAX was down 3.3%, while the London FTSE and the CAC 40 in Paris were down 13.4% and 13.3% respectively. Of the major overseas markets, the Shanghai Index put in the worst performance, down 22.9%. U.S. Treasuries rose, with the yield on the Ten-Year declining 23% to 2.95%, while the yield on the Bloomberg-FINRA High Yield Index rose from 8.68% to 8.93%. Gold, silver and natural gas were all higher; nevertheless the CBOT Index was down 8.1%, led by copper, oil and grains. The Dollar Index was up 6.1% for the quarter. As investors fled risk, volatility picked up, with the VIX almost doubling, up 96.4% to 34.54. The number of days in which the market traded up or down more than 1.5% doubled from the first quarter – 12 days versus 6 days.

The stock market’s decline reflected slowing economic growth and the fear of a “double-dip” recession. The Economic Cycle Research Institute (ECRI) reported the growth rate of its leading indicators fell to a thirteen month low. First quarter GDP, at 2.7%, was less than half that of the fourth quarter. Unemployment remains high and the jobs numbers on Friday did not add to confidence. Keep in mind, though, that the slow return of jobs, which was indicative of the previous two recessions, is illustrative of improving technologies, growing productivity, expanding global trade and older workers staying on the job longer. On the positive side, but ignored by the market, the consensus estimate for second quarter earnings, according to Barron’s, is estimated to be up 27%. Additionally, recent ISM data (representing the manufacturing sector of the economy – 12% of GDP), while slowing, is still expanding.

The question investors must address: Has risk become cheap enough? Any answer is only a guess, but with the S&P 500 trading at about 12X consensus estimates and the yield on that same index just under 2% – about 2.6% if one includes only the 371 dividend paying stocks – and with the Ten-Year Treasury under 3%, stocks seem pretty reasonable. The earnings yield on the S&P 500, at nearly 8%, compares very favorably to the 3% yield on the U.S. Ten-Year. However, stocks can look attractive for a long time. Even so, an article in the weekend edition of Barron’s pointed out that 13 of the top 25 companies in the S&P 500 now sell at 10X or lower estimated 2011 earnings. The forward multiple on the Index is at its lowest level since the late 1980s, a time of significantly higher interest rates.

At the same time, Treasuries look expensive. Three percent for ten years only looks reasonable if one is betting on deflation. The richness of Treasuries can be seen in the spread of Investment Grade Corporates over the Ten-Year, which widened during the quarter from 105 basis points to 181 basis points. (Of course, the biggest beneficiary of low Treasury interest rates is the U.S. Government. Should rates tick up 100 basis points that would add $130 billion to the governments operating budget, based on current debt of $13.1 trillion.)

History, like statistics, can be used to prove any premise, but with that as a caveat it may worth looking back at 2002, the last time we had a second quarter as bad as this one – then down 13.7% versus the 11.9% decline in the last quarter. Most of you recall that the market peaked in March 2000 and by the end of June 2002 it had declined 35.2%. (In comparison, today the S&P 500 is 34.6% below its peak in October 2007.) Ten years ago, the Index fell further in the first three weeks of July before a powerful four-week 23% rally into August. The market then fell sharply before bottoming in early October 2002. The biggest differences between then and now are the ten year numbers: In 2002, even with the market down substantially from where it had been two years earlier, the market was still up 142.5% from where it had been ten years earlier. Today the market is up 4% from where it was at the end of June 2002.

In 1959, Art Linkletter wrote a book, Kids Say the Darndest Things; one could certainly say the stock market is capable of the “darndest” moves.

Thursday, July 1, 2010

"In Investing, Extrapolation of Recent Experience Leads to Agnosticism - At Best"

Sydney M. Williams

Thought of the Day
“In Investing, Extrapolation of Recent Experiences Leads to Agnosticism – at Best”
July 1, 2010

A good friend who is managing his own wealth recently relayed the concerns of his son. The young man, in his early thirties, works as a policeman in another city; his entire experience with the market over the past dozen years has been unsatisfactory – in fact worse than that; he concludes that those of us in the business (and his father has been on Wall Street for over forty years) are either morons or crooks. My friend’s brother, an architect, agrees with his nephew and contrasted the 1950s NYSE advertisement about buying a piece of America to the eleven second average holding period for Tradeworx, a high frequency trading fund in Red Bank, New Jersey.

The Press is filled with stories of strikes in Greece, a slowdown in China, synthetic CDOs – problems that seem alien to the average investor. This has created, as my friend Craig Drill wrote yesterday, “an amorphous sense of fear and a loss of faith in the equity culture with which we all grew up.”

While these concerns do reflect a changing culture, they are also a function of a market that is lower today than it was a dozen years ago. At the end of February 1998 the S&P closed 1049.34. As this is written, the S&P 500 stands at 1030.69, an unpleasant experience for a young person just beginning his investment career and equally disheartening for one nearing the end of his career.

What makes the experience even worse and affects behavior has been the volatility of markets, the corruption and scandals and the enormous sums of money a few people have made while the indices went nowhere. In the past dozen years, the S&P 500 has twice been above 1500 (March 2000 and October 2007) and twice below 800 (October 2002 and March 2009). The scandals, in the first part of the last decade, at Enron and WorldCom, etc. made investors skittish, and the failure, in 2008, of household names like Lehman, Countrywide Credit, AIG, Fannie Mae and Freddie Mac added to investors nervousness. High frequency traders, operating in recesses of the market unavailable to the average investor, were largely responsible for the “flash crash” of May 6 of this year. And, despite a market that produced no gains over the past dozen years and scandals which racked the market, a small number of hedge fund managers pocketed a billion dollars for a year’s work.

Is it any wonder that this young cop feels that he is playing against a stacked deck? We all extrapolate our most recent experiences. It is human nature. The investment experience, over the past twelve years, has been disappointing. Millions of young people feel as does my friend’s son – that Wall Street is a fixed game, that investing is, at best, a no-win concept.

While it may not be comforting to a young person suffering from today’s market, we have been stuck in these ruts before. It took just over twenty-five years for the Dow Jones to reach a new high following the Great Depression – August 30, 1929 until November 23, 1954. On February 6, 1966 the Dow Jones closed at 995.14; it would take until December 17, 1982 before it consistently traded above that level. Those periods – twenty five and sixteen years respectively – are long, but keep in mind we have been in the current rut for a dozen years.

There is a sense that events are controlling Washington, that no one in charge fully appreciates this loss of faith by the millions of smaller investors in our capital markets and the importance of those markets to their future well-being. However, government can act. The tax code can be used to encourage long term investing. Profits on day trades, for example, could be taxed at 90%, while investments held more than five years might incur no tax. Regulatory bodies can ensure that high standards for listing on the various exchanges are maintained and that brokers comply with all regulations. A healthy investment environment is critical to the well-being of our nation. It is not Main Street against Wall Street. Theirs is a symbiotic relationship. Wall Street cannot function without Main Street anymore than Main Street can operate in isolation from Wall Street. We need a renewed sense that man, once again, controls events.

It is easy for me, an aged Wall Street warrior, to quote King Solomon, “this too shall pass.” And it will. But that does not help one whose investment experience, as of today, has been so discouraging.

The consequences of doing nothing are daunting. The tax code needs to be used to encourage savings and long term investments, discourage consumption and encourage exports. The economy, even as growth resumes, will be hindered by a deleveraging consumer. We have a government that has stretched its borrowing beyond reasonableness. We have consumers who have not saved for a retirement age that is fast approaching. We have interest rates that pay very little for the prudence of saving. We have a social security system well on the road toward insolvency, public pension funds that are dramatically underfunded and there is too little money in millions of 401K plans. We have a government that seems oblivious to this problem of inadequate private financial resources that threaten the future welfare of our people – a government that seems intent on gaining political advantage by condemning private enterprise and bad mouthing Wall Street; in exchange they offeri the welcoming arms of a [bankrupt] state.

We all extrapolate our experiences. Those experiences govern our behavior, but they also bring wisdom – wisdom from which we can learn. Nobody can foresee the future, yet history suggests, despite the last dozen years and no matter how bleak the future appears, that long term investors will be rewarded.