"The Market and the Debate"

Sydney M. Williams

Thought of the Day

“The Market and the Debate”

September 23, 2011

On a day the stock market declined 3.5%, Republican candidates held their third debate in Orlando. The market opened down sharply on Thursday, traded lower until 3:30PM and then rallied to a level approximately where it had been at 10:00AM. That suggested to market guru Laszlo Birinyi of Birinyi Associates that the initial decline was a reaction to the deteriorating situation in Europe. That may be the case, and certainly the problems of Greece do bring unpleasant reminders of the dark days of three years ago in New York.

But the market is obviously focused on problems at home as well – unemployment remains above 9%, after more than two years of “recovery;” Congress cannot pass a budget, so a threat of a government shutdown looms once again; banks that are “too big to fail” remain. Goldman Sachs, according to this morning’s Wall Street Journal is expected to post its first quarterly loss since the financial meltdown of three years ago, and numerous other problems are making headlines, converting optimism to fear.

The debate in Orlando was like a comic relief in a Shakespeare tragedy. That is not to say it was not a serious event, for it was. One of the nine people standing on the stage in Orlando could possibly become our 45th President, so listening to their words and how they handled each question is important. But it was entertaining to watch the back and forth ripostes. The debate centered on myriad economic problems plaguing our country, with its persistent unemployment. “Hope and change,” they all agreed, have been replaced with fear and despair. The lines between the two parties have been drawn and they are more highlighted than in the past. The differences are not ones of personality; they are ones that reflect very different views of the country, the economy and how it should be repaired.

The debate highlighted those depths, not only of the political differences, but the philosophical ones as well. Mr. Obama believes in the concept of statism, in which the federal government plays a crucial role in the allocation of capital. The nine contenders feel that free markets are the path to economic resurgence. Capital transfers, increased government intrusion and federal stimulus mark the current administration. Reforming the tax code, reducing regulation and becoming energy independent are the hallmarks of those who would replace Mr. Obama. Every election is deemed the most critical in a generation. Certainly this one fits that mold.

According to most viewers, Mr. Romney won the debate last night. He was animated and standing next to Governor Perry he seemed generally to get the best of him in a number of heated exchanges. However, the biggest applause went to Herman Cain when he was prompted to talk of his bout with cancer five years ago. And the best line of the evening, in my opinion, came from Governor Gary Johnson in response to a question as to the value of the Stimulus Plan: “My next door neighbor’s two dogs have created more shovel-ready jobs than our current President.”

However, as much as we might like to look out a year, it is the here and now with which we must contend. This weekend the Group of 20 will be meeting in Washington, so the weekend papers will be filled with falling confidence around the world, manifested in collapsing global equity markets, as well as the ongoing saga of the European sovereign debt crisis. While it seems to me that there is little question that Greece will have to default – and that probability appears baked into the CDS pricing on their debt – the manner in which it happens remains unknown. One can only hope, with this ultimate eventuality having been discussed for eighteen months, that banks have taken advantage of the last several months to mark down their sovereign.

In my opinion, the biggest question remains the one as to which camp will prevail – Keynesians or those who believe in free markets and smaller government. I suspect, over time, the latter. The governor of Indiana suggested recently that the country was “crab-walking” toward free markets. One can see that trend in population flows toward the west and south. Governor Daniels cited his election in 2004, Governor Chris Christie’s in 2009, and the 2010 Congressional and gubernatorial elections, which switched ten states from the Democratic to Republican states, in places like Wisconsin, Michigan, Iowa, Ohio and Pennsylvania, and gave Republicans control of the House.

But don’t expect the rancor in Washington to die down quickly. Certainly, the two parties must be able to agree on items such as budget resolutions, but the answers to our problems will not come from compromise; the answers will come when one philosophy prevails over the other.

In the meantime, sounding like an echo from yesterday, stocks by most measure are inexpensive. Trailing twelve month price earnings multiples are about twelve times. The yield on the S&P 500 dividend paying stocks is approaching three percent, while the yield on the Ten-year is only 60% of that number, at 1.7%. Oil is $79.16 versus $140.00 in the summer of 2008. The fall in commodity prices may reflect the concern of diminishing demand as global economies weaken, but they also reflect changes in the behavior of speculators, and lower prices improve affordability for consumers. While the sovereign debt crisis has the potential to create another global credit crisis, in general the world is more forewarned than it was in the halcyon days leading up to the autumn of 2008. Banks are less leveraged. Consumer savings are running around five percent today, as opposed to no savings back then. To paraphrase the ignoble President Nixon, when he spoke of us all be coming Keynesians when he removed the country from the gold standard, we have all become cynics now.

It has been my opinion for some time that we are in a trading range, and we will continue to be in one until resolution becomes clearer as to which path we are likely to travel – the one emphasizing free markets or the one focused on statism. While I believe (and I hope) it is the former, the bell has not yet tolled. In the meantime, stocks, in my opinion, are distinctly closer to the lower end of the trading band.