"Where Have All, the Investors Gone?"

Sydney M. Williams

Thought of the Day

“Where Have All the Investors Gone?”

June 20, 2011

We live during a time when economic growth will be mediocre at best for several years. That is due to the basic tenet that in a deleveraging world growth is compromised. Credits and debits, as Albert Wojnilower recently wrote, are opposite sides of the same coin. One depends upon the other. As debt shrinks, or at best expands only modestly, so will credit; economic growth relies on expanding credit. The fact that the U.S. has an expanding population serves as our savior in times like these.

It is possible that a focus on exports to the developing world will offset moderating domestic consumer demand, but, in an economy in which the consumer comprises about almost 70% of the economy, that puts a lot of pressure on exports. At best, they could prevent the country from slipping into another recession. Our domestic economy will have the additional drag of a likely default (in some form) by Greece on their sovereign debt. As to whether a defaulting Greece portends a second coming of a bankrupted Lehman, nobody knows. My guess is that it would not. Greece seems to me to be the most drawn out, slowest motion default in history.

Over time, the stock market mirrors the economy, but does not always march in lock step. While reported economic numbers are a matter of hard data, the stock market rises and falls on perceptions on the future, and is greatly influenced by human behavior – we feel good about things, or we don’t. For the past several weeks the market has reflected multiple concerns: Europe is a mess; a two year advance in the S&P 500 of 88% was deemed to have been too aggressive, or unwarranted; a polarized political situation has raised concerns about the debt ceiling; earnings reports, in some instances, have been less than robust; inflation, as measured by both core and headline numbers, has increased to the highest levels in a decade; a growing sense of malaise has permeated America’s middle class; riots in the Middle East and North Africa and what appears to be an intensifying hot war in Libya risk shortages of crude oil, and a slowdown in China’s economy have provoked a number of demonstrations and risk contaminating global expansion.

One of my favorite collectors of market data and market gurus is Laszlo Birinyi who operates the eponymous firm, Birinyi Associates. I have known Laszlo for over thirty years. One of his sayings is that when problems are as prominent as the nose on one’s face (what he calls the Cyrano Principle) they tend to be priced into the market. Most of the concerns mentioned above – if not all of them – are well known and are not original. Of course things could get worse. Congress may decide that an increase in the debt ceiling is not warranted. A Greek default could lead to others, ala a Bear Stearns to Lehman to Merrill. Inflation could ramp up sharply and the economy stall, leading to a 1970s style stagflation, (or what Doug Kass of Seabreeze Partners has called “screwflation.”) The malaise among the middle class could intensify and spread. Corporate earnings could be squeezed between rising raw material prices and declining final demand. Oil supplies in the Middle East could be shut down by rising tensions. And who knows what demons may lurk in China?

But behind those dark and somber clouds lie a few rays of sunshine. Consumers have been reducing debt and increasing savings, though both numbers lag where they were fifteen years ago. Commodity prices have recently declined. Banks, either voluntarily or under duress, are increasing capital ratios. Reality is being faced. Politicians of both stripes (Andrew Cuomo in New York and Chris Christie in New Jersey, for example) are recognizing the necessity of dealing with unfunded pension and healthcare liabilities. Even AARP, according to a Friday article in the Wall Street Journal, has dropped its long standing opposition to cutting Social Security benefits. The market’s reaction to LinkedIn’s IPO has been cited by some as a return of the 1990s, but also suggests that speculative money is looking for a home. Both the Wall Street Journal (“Death of the Duopoly”) and the New York Times (“Standstill Nation”) did weekend stories on Washington’s stalemate just as President Obama and Speaker of the House John Boehner were sharing a golf cart as they played the game on Saturday. And many large and well known stocks sell at less than ten times earnings. In fact, Bloomberg has a story this morning suggesting that stocks, on anticipated earnings, are selling at the cheapest levels in twenty-six years.

Three weeks ago (June 1) I wrote a piece, “Are Large Stocks Attractive?” I concluded they were and was promptly proved wrong, or, at a minimum, proved too early. They are cheaper today.

Measuring investor psychology is an art, not a science. I certainly do not profess to any expertise in the field. But I do know that following the herd is not the way to go. In my opinion, we are nowhere near the point where we could expect a multiyear bull market similar to the 1980s and 1990s. Those were truly “black swan” years. But so were the events that led to the collapse of Lehman in 2008; barring unpredictable consequences of a defaulting Greece that’s not where we are either.

As David McCullough said in an interview with Brian Bolduc in Saturday’s Journal, “There is no such thing as a foreseeable future.” However, knowledge of history permits a perspective that can help remove emotion from market decisions, and provides the assuredness to purchase good companies at reasonable prices, even recognizing that prices, short term, may become even more reasonable.

The long term is nothing more than the stringing together of short periods of time. There is nothing new or unique in believing that we live in momentous times. The last hundred years witnessed extraordinary events – World War I; a global “Great Depression;” World War II; the Cold War and its end; placing a man on the moon, and 9/11. Yet through it all, the Dow Jones Industrial Averages compounded at 5.3%. Dividends provided an additional two to three hundred basis points. Total returns for stocks far outdistanced inflation which, during the past 110 years compounded at about 3%.

Following the market collapse in 1929, it took twenty-five years for the market to recover to where it had been on the eve of the greatest stock market crash the world has ever seen. Yet compounded price returns for the DJIA have risen 4.3% since that date in late August 1929, again besting inflation which eroded the dollar annually by about 3.1%. Dividends added about 200 basis points to bring compounded total returns to about 6.5%.

Where have all the investors gone? Unlike the flowers in Pete Seeger’s song which went to cover the graves of dead soldiers, the disappearance of investors will likely prove more ephemeral. At least, I hope so.