"The Complacency Trap"

Sydney M. Williams

Thought of the Day

“The Complacency Trap”

July 18, 2011

Complacency has always been the scourge of investors, as well as being the gruel off of which politicians feed. On May 15, 2000, I quoted George Soros who had said, “The music has stopped, but people are still dancing.” In December 2006, I wrote, “Complacency has settled over the financial markets like a soft coating of December snow.”

Today, consumers are distinctly more cautious, as retail sales and debt repayment indicate. The concept of a house as an ATM seems as antiquated as an Edsel. Other than a few social networking stocks, a number of common stocks are reasonably priced and a few well-known, large-cap ones appear attractive. But the Treasury market, acts as though all is copacetic. I am far from an expert on Treasuries, but with the Ten-year yielding 2.9% complacency seems abundant. Headline consumer prices have sapped a large part of the total returns on Treasuries, as that index has risen 3.6% over the past twelve months. Foreign investors have seen the value of their dollar holdings punished, as the Dollar Index has declined about 5% year-to-date. Washington is like an arena with two punch-drunk boxers, endlessly repeating their respective mantras, as August 2 looms. Yet Treasuries continue to rally!

While low rates have given a boost to speculators, whether in commodities or in social network stocks, they also serve to disguise (in keeping interest costs artificially low) what will become the enormous costs of Washington’s current borrowing binge when rates finally normalize, which they will. The recent rally in Treasuries may have leant reassurance to the Fed and the Administration as to the soundness of the Dollar, but its depreciation in real terms is more meaningful. Treasuries have not been rising because of a love affair with the U.S. and its debt position. They have been doing so because the world is awash in liquidity and the Administration has done very little to restore confidence on the part of small and midsize businesses. Money must flow some place, and Treasuries serve as a holding place until confidence is restored and small and midsize businesses decide to invest and expand.

Reflecting concerns regarding the Administration, business investment is at historically low levels. Concerns are myriad. Will a tax holiday be granted to corporate cash now stashed overseas? When and by how much will the Administration push to raise taxes? What will be the real course of healthcare under Obamacare? What specific areas of the budget will the President reduce or eliminate to bring down the deficits? Why has the President been so reluctant to push the trade bills? Will he persist on backing unions, which represent 7.6% of private sector jobs, or will he work to help the 92.4% of Americans working in the private sector who are non-unionized? Keep in mind to a large extent he owes his Presidency to union bosses, men and women who have hindered the free flow of capital and labor, the most publicized recent example being the NLRB fight with Boeing.

The situation in Europe makes the U.S. seem relatively stable, but provides a preview of what could be in store for us should we persist on this path toward a welfare state – Socialism for those who do not like euphemisms. Europe’s problems are unique in that the Union lacks a cohesive political body, and diverse cultural differences are difficult to bridge. It is their economic shortcomings that should concern us. Greece, Spain, Portugal, Italy and likely France have been living beyond their means for two generations. Definitionally, as states consume an ever increasing share of GDP, the people become more dependent on that state and, even more worrying, political power becomes more centralized. However, in its initial stages a welfare state is an aphrodisiac, attracting its citizens as more and more services are offered with very little asked in return.

Detoxification, should that be the route we choose to follow, will be painful; the more dependent on government we become, the more difficult the extrication. And polls suggest that Americans exhibit a Janus-like attitude when it comes to deficits and entitlements. According to a recent Pew Poll, 47% of Americans express deep concerns about raising the debt ceiling, versus 42% who feel that not raising the debt ceiling poses the larger risk. But when asked if deficits are more important than maintaining entitlements such as Social Security and Medicare, 60% opt for keeping the entitlements. A welfare state is one that depends upon rising taxes, as it consumes an increasing percentage of GDP. Taken to an extreme, it eventually saps diligence and initiative. Ultimately it becomes self-defeating, as standards of living erode. Politicians and social scientists have long tried to find the right balance between free capital markets and a nanny state. Europe has swung far to the left.

Despite the “Reagan Revolution” that reversed the trend for a while, in the U.S. we have gradually, but inexorably, since FDR’s “New Deal” and Lyndon Johnson’s “Great Society,” moved toward a welfare-focused society. Mr. Obama, with Obamacare and his efforts to bypass cap-and-trade, would have us accelerate the trend. His proposals would have government mandate which light bulbs we use and would push wind (except in Nantucket Sound – home to too many Democrats) and sun over oil and gas, regardless of costs. Complacency regarding this trend is not a condition for those on the fringes, but the vast majority of Americans seem immune to the consequences of the direction we appear to be traveling.

The declining dollar is another example of complacency taking root and speaks directly to concerns over Treasuries. Since my birth seventy years ago, the dollar has lost about 96% of its value. Since my oldest child was born forty-five years ago, the dollar has declined about 83%; and, since my eldest grandchild was born in 2000, the dollar has lost 30% of its value. The trend is unmistakable. Inflation is an insidious tax perpetrated by governments interested in cheapening the debt they have issued. As Jim Grant, in an interview in last weekend’s Wall Street Journal, put it: “I can’t explain the world’s infatuation with government securities and negligible yields. These bonds and notes and bills are denominated in currencies that central bankers are doing their best to depreciate.”

Opportunities to invest exist; but, in my opinion, in attractively yielding, relatively low multiple mundane common stocks, where yields match Treasuries. As Mr. Grant says in his interview, many of these stocks are “hiding in plain sight.” Unlike commodities and the type of esoteric security Wall Street is famous for creating, these common stocks are not reliant on artificially low interest rates. Most of these companies generate cash and, with the prices of their stocks at relatively low levels, they can use that cash to invest in their business, shrink their capitalizations, or increase their dividends. Once confidence is restored, these companies will be more likely to invest in their own businesses and increase employee count, something our country badly needs.

Tom Friedman, in Sunday’s New York Times, entitled his column “The Clash of Generation.” Mr. Friedman is right that the boomer generation who grew up in the 1950s and 1960s and who received much from their parents in terms of “bounty and freedom” have left their kids with “debts and constraints.” But I disagree that what we are experiencing is a clash of generations. The problem, in my opinion, is more fundamental. It represents political/philosophical differences between those who would be more dependent on government and those who would be more self-reliant. The answer will affect deficits, taxes and the dollar. Complacency in that regard is a trap that should be considered carefully and viewed warily.