"This is No Time to be Too Bearish"

Sydney M. Williams

Thought of the Day

“This is No Time to be Too Bearish”

August 19, 2010

While there are many factors that give cause for concern, from deteriorating cultural trends to the uncertain path of the economy, one should not lose sight of the fact that markets march to their own drummer.

It is the cultural trends that provide the most reason for pause. Recessions are cyclical. They are a natural, if unfortunate, aspect of capitalism. Changes in cultural attitudes, in contrast, are more apt to be secular – longer lasting and more difficult to redress. The trends that are of concern include an increasing dependency on government, fomenting a growing sense of entitlement; college youths who seem reluctant to challenge their “liberal”, but discriminating, professors; a tendency on the part of both political parties to compartmentalize the electorate, in a divide to conquer mode, and an approach toward immigration that favors illegals over the educated and talented.

The economic problems facing the U.S. and the rest of the world have been discussed, ingested and regurgitated ad nauseum – unemployment, deficits, housing, implications of healthcare reform, unfunded liabilities for public pension funds and taxes. Additionally, as was recently mentioned to me, the trend in demographics works as an inhibitor to growth. Retiring baby boomers, the engine of growth over the past two or three decades, will emphasize savings as opposed to consumption, not a bad thing, but, nevertheless, a drag on the economy.

The news, as we all know, continues to be dismal, but is also well known and well publicized. It brings to mind the Cyrano Principle of Laszlo Birinyi, of Birinyi Associates and with whom I worked for ten years at Salomon Brothers in the 1980s. The principle states: “If the concerns of the market are as obvious as the nose on your face, the market and monetary policy makers will have an amazing ability to adapt and adjust.”

The environment in which we find ourselves is one that puts very high values on Treasuries, with the Ten-Year at 2.6% and on Investment Grade Corporates, with the FINRA-Bloomberg yield at 4.3%, and relatively low values on many large-cap stocks, with the yield on several exceeding that of their bonds. Ten years of poor equity performance have soured investors on the concept of long term investing. That is manifested in continued net outflows from domestic equity mutual funds and large inflows into bond funds. It was interesting, therefore, in response to a question, to look at the performance of stocks in the third year of a Presidential cycle. Going back to 1947, there was only one year in which the S&P 500 was not up and that was 1947 when the S&P 500 closed exactly flat. (The DJIA in that year, however, was higher.) However, the exercise demonstrated the value of patience and looking out over many years when investing. During those sixty-three years the S&P 500 has risen by 72 fold – 15.30 to 1094.16, a CAGR of 7.01%.

Those years covered a time of exceptional growth in the United States and I would suggest that future growth will likely be far more modest. Nevertheless, there are few asset classes that can match the returns of stocks over very long periods, and we must remember that today we have the advantage of ten years of flat to down performance to our rear. Timing, as the old adage goes, is everything and I acknowledge that I have no ability or advice in that regard, other than to invest gradually.

The past is never prelude to the future and the cultural forces we face are formidable indeed. Regardless, I suspect, like the late 1930s or the late 1970s, stocks are in the process of a long term adjustment. It seems likely stocks will remain in a trading range for the next few years, but I suspect along a rising grid, unlike the downward slope of the past decade.