"Washington - Stop Talking; Start Doing"

Sydney M. Williams

Thought of the Day

“Washington – Stop Talking; Start Doing”

August 9, 2011

The market’s reaction to the debt downgrade is unsurprising; though in a perverse way it seems to me that it was a positive event. That we have been spending far in excess of our means is well understood. That Congress seems incapable of bipartisanship is also well known. That the President talks restraint and fiscal prudence, yet he fails to practice what he preaches. Unsurprisingly, he blamed the downgrade on the earthquake in Japan, the “Arab Spring” in Libya and Tea Party members. Also expectedly, he bad-mouthed Standard & Poor’s and solicited friends like Warren Buffett (an owner of Standard & Poor’s largest competitor, Moody’s) to suggest that the decision is without merit and will have little effect. Equity investors came to the opposite conclusion yesterday, sending the S&P 500 down 6.7%. Their conclusion: a debt downgrade of the world’s fiat currency does not bode well for global interest rates or economies.

The problem, in a word, is confidence. However, it is possible – just possible – that the decision by S&P will spur a response from the Administration to tackle tax and entitlement reform now. President Obama said yesterday that he would further study the issue – that is not the response we want or need. Congress should act now. John Boehner should call the House back and pass a series of small reforms – raising the retirement age for Social Security and Medicare. They should increase the amount on which payroll taxes are assessed. They should begin the process of tax reform, eliminating most deductions, reducing marginal rates for individuals and businesses and broaden the base. To delay a decision until November 23rd, when the group of twelve legislators is expected to report their findings, is to wait too long. The downgrade should lend urgency to all those who are responsible for our government and institutions. Rarely has the country been in such need of a growth agenda.

Would the market respond positively to such actions? No one knows for sure, but to the extent it restores confidence it would certainly help. It is action not words that are needed. Recent market reactions to the President’s speeches have been negative. Every market is different. No two times are the same. So looking for historical precedence is often an exercise in futility. There are, for example, factors at work today that were not around in recent cycles. High Frequency Traders were not around during the 2000-2002 market collapse, though program trading added to the melt down in 1987. It is true that HFTs were responsible for last year’s Flash Crash and they aggravated the melt down in 2008-2009. Hedge funds play a far bigger role today than they did in years past. Markets are far more global today than even ten years ago, both in terms of investors and listings. The floor of the NYSE has become far less important to the execution of investor’s orders, as automation replaced brokers. Major Wall Street firms rely less on servicing customers and more on trading their proprietary books. Whether these factors will prove to be positive or negative remain to be seen. The point is these factors are relatively new; their long term effect has yet to be played out.

On the other hand, human behavior is the same as it always has been. Fear and greed have been common impulses since man exited his cave. In terms of understanding the human psyche, reading Shakespeare is more valuable than reading market pundits. As always, the madness of crowds persists. In attempts to be contrarian, people unknowingly often end up acting in concert. A decade of flat or negative returns has provided the professional investment world with more than its usual quota of cynics. Skepticism has always been critical to investment success, but over the long term to bet against the United States and its economy has not worked. The decade of the aughts was an exception, as has been the start of the century’s second decade. So times like the present lend credence to short sellers and give their pronouncements added influence.

It could be that we are witnessing the start of a long term decline of the United States. Anything is possible, and only the years ahead will tell. There will be no shortage of seers who will argue that we are on the cusp of collapse and that the U.S. has lost its will and ability to compete. I don’t pretend to know, but I suspect not. However, the nation is facing two possible roads – one leads towards greater government and West European socialism. The other heads in the opposite direction, towards smaller government and more self-reliance. Those differences outline the debate over debt and deficits. The President’s agenda would take the first road; the Republican Congress the second. There is uncertainty as to which direction we will go. At the same time, however, emerging nations are experiencing a broadening and deepening of democratic capitalism – ultimately a positive for global capital markets.

Twenty-nine years ago this coming Friday, the last extended Bear market came to an end after sixteen years of flat to down markets. (I recall speaking to the Salomon Brothers training class that summer and pointing out that the market was then lower then than it had been when I entered the business fifteen years earlier.) During those years we experienced several years of both up and down markets. In terms of conventional definitions, there were both bull and bear markets during those years, but overall trends were flat to down. The absolute high during those years was in January 1973, seven years after the DJIA first approached 1000 in January 1966. The absolute low occurred in December 1974, almost nine years into the correction. The next seven years witnessed a see-sawing market. 1975 and 1976 were positive. 1977 and 1978 were down. 1979 and 1980 were higher. 1981 was down and then the Great Bull Market took off in 1982.

Comparisons to the current period are striking. The market peaked in March 2000 with the internet-tech boom. After declining for two and a half years, the market bottomed in October 2002. It then made a slightly higher high in October 2007. A year and a half later the lows for the cycle occurred in March 2009, nine years after the peak of the current market. 2009 was an up year, as was 2010. At this point the S&P 500 is down 11% on the year. That will change, but the market does not go up every year, even in bull markets.

While I do not believe we are at a major turning point, as we were in 1982, neither do I believe that the next eleven years will be as difficult as the past eleven. It is more likely that we will follow the experience of the late 1970s – good years followed by dull or down ones. There will be times when markets get very oversold (as perhaps they are now) and overbought, but that will not alter the overall trend. The trend will remain until a “sea-change” event occurs.

A client and friend recently told me that whenever the President goes on the air, as he did yesterday, he is reminded of those words from “My Fair Lady’s” Eliza Doolittle: “Words, words, words! I’m so sick of words.” Eliza’s lament is that she wants to be shown. That is what the market and the people want. Yesterday’s stock market action has become typical. The market rolled its eyes as he spoke and sold down two hundred points. Enough of this talk and these meetings. People want action. If the President won’t, then John Boehner should. We can’t afford to wait for Thanksgiving and the recommendations from the twelve apostles. The time to start enacting legislation is now.