Tuesday, February 23, 2016

"Financial Markets and Politics"

Sydney M. Williams

Thought of the Day
“Financial Markets and Politics”
February 16, 2016

“The stock market is the story of cycles and of human behavior
that is responsible for over reactions in both directions.”
                                                                                                Seth Klarman
                                                                                                Founder, Baupost Group, LLC

Financial markets are humbling. After spending forty-eight years working in the industry, one would think I would have learned some, if not many, of the answers. Not so. In my late teens, I met the president of a regional brokerage firm based in Boston. He told me that he had been in the business for several years and claimed he knew less each year. That is familiar territory. Financial markets are akin to discoveries about space. Just as boundaries to the latter keep expanding, complexities to the former become more ubiquitous. Just when we think we know the answer, something else gets added to the mix.

One ingredient this year is the campaign for President and the possible nominees. A recent Barron’s article spoke to the “Bernie and Donald factors.” They included a chart which contrasted the spike in their respective polls, beginning late last year, with a collapse in the S&P 500. Coincidence? I don’t know. Isolationism is troublesome to markets. While neither man campaigns as an isolationist, they both advocate policies that lead that way. Mr. Trump talks of imposing tariffs on goods imported from China. Senator Sanders recently stated: “Unfettered free trade has been a disaster for working Americans.” While the odds that either man will win the Presidency may not be high, it is impossible to avoid the fact that the popularity of both reflect the thinking of millions of Americans. Voters should not ignore the positive contributions that free trade and globalization have brought to man’s well being. To the extent the policies of Mr. Trump and Senator Sanders have economic consequences, they will be reflected in financial markets.

Politics and financial markets are intertwined. Government’s role should be to set rules. Business should play the best it can within those rules, to the advantage of its owners, employees, customers and communities. Economies work best when free markets set prices and determine goods and services to be sold. There will always be risks. Creative destruction, an economic phenomena popularized by Joseph Schumpeter seventy years ago, destroys businesses that don’t adapt. While painful, change is necessary for progress. Cronyism is birthed when rules are established that serve to benefit an old (or favored) industry over a new entry. Consider the experiences today of Uber, Airbnb and crowdfunding.

Politicians are in the business of re-election. They do not necessarily operate in the long-term best interest of their constituents. Like us, their time horizons have shrunk – theirs to the next election. Businesses must have longer horizons. It may take a decade or more to recover the costs of a new manufacturing plant, oil well, mine or smelter. A fiduciarily responsible CEO must be confident of the future. He must believe government’s tax policies, rules and regulations won’t harm his business. He must be convinced that markets, foreign and domestic, will be open. Uncertainty breeds inaction. In a recent Wall Street Journal article, David Malpass noted out that total U.S. credit has grown by only 20% over the past five years, versus an average of at least 40% over previous recoveries. “To make matters worse,” he added, “80% of the increase went to government and corporate bonds, leaving only 20% for the rest of the economy.” Again, consequences are evident: According to a Gallop study, based on U.S. Census data, more small businesses in the U.S. are closing than opening, the first time that has happened since measurements began.

Over the past few years, the government agency that has had the biggest impact on financial markets is the Federal Reserve. This dates back to the financial crisis. The Federal Reserve can act more quickly than Congress. In 2008 they did, with an assist from Treasury and to the benefit of us all. In the subsequent seven years, however, their effect has been more questionable. Japan, over the past two decades, is proof that more than monetary policy is needed to perpetuate economic growth. Keeping Fed Fund rates at essentially zero in the U.S. has been good for financial assets (with the notable exception of savings accounts), but not for business investment, the economy, or even from preventing “too big to fail” banks from becoming even bigger. There are 25% fewer banks today than eight years ago, and the five largest banks control almost 50% of the $15 trillion in assets owned by banks. In 1990, the five biggest banks controlled 10% of banking assets. Negative rates should make people nervous. As the Bank Credit Analysis recently put it: “Negative interest rates do not generate growth; they destroy growth because they destroy capital.”

The reason we came to rely on the Federal Reserve was because the President and Congress refused to provide fiscal relief through a reformed tax code and more effective (and less protective) regulation. The clue that something was wrong was when President Obama ignored the findings of the National Commission on Fiscal Responsibility and Reform in 2010, a bi-partisan commission headed by Alan Simpson and Erskine Bowles that he had established a year earlier. Congress never addressed reform. The consequence: The Fed became the only game in town. And now central banks are running out of options.

But back to financial markets. “Mr. Market,” as Martin Wolf recently wrote in the Financial Times, “is subject to huge mood swings.” Stock prices reflect more than just revenues and profitability. They respond to behavior and confidence. There are those like Robert Shiller whose cyclically-adjusted price-earnings ratio concludes that current market levels have only been exceeded by those that peaked in 1929 and 2000. I am not smart enough to debate Professor Shiller, but I believe it is worth noting that ten-year compounded annual returns for the Dow Jones Industrial Averages (DJIA) are quite different today than they were in 1929 and 2000. In 1929, those ten-year returns averaged 11.9 percent; in 2000, 16.0 percent. When the DJIA reached its interim high last June 23rd, the ten-year compounded annual return was 5.9 percent. Today that ten-year return is 4.1 percent It is okay to be bearish, but perspective is needed.

A financial market that has been in bull mode for thirty-five years is the one for U.S. Treasuries. The yield on the U.S. 10-Year Treasury has fallen from 15.8% in 1981 to 1.7% today. Can rates move lower? Of course. Will they? I don’t know, but caveat emptor would seem to apply.   

Assessing markets is difficult, not just because of the complexities of algorithms and mathematical formulas, but because markets also reflect human behavior – the nuances within each of us. As well, market participants confront myriad and conflicting government policies. Like baseball, there are statistics for everything in economics and markets. One can “prove” anything one wants. Person ‘A’ looks at a series of numbers and claim they mean X. Person ‘B’ draws the opposite conclusion. Norman Augustine, a businessman who served as Under Secretary of the Army from 1975 to 1977, once said: “if stock market experts were so expert, they would be buying stock, not selling advice.”

Age has few benefits, but one is perspective. It is based on one’s own experiences and from reading history, biographies and fiction – novels that deal with the human psyche. We know that tomorrow will not be “déjà vu all over again,” for history never repeats, though it rhymes, as Mark Twain allegedly said. We learn that not all questions have clear-cut answers, that events and individuals are unique, but we hope to have the wisdom to understand that human behavior is subject to emotions that are eternal. What history does say is that over the long term stocks have done well, and that investing is less risky than trading or market timing.

Tuesday, February 16, 2016

"Free Stuff"

Sydney M. Williams

Thought of the Day
“Free Stuff”
February 16, 2016

“Democracy and Socialism have nothing in common but one word, equality. But notice the difference:
 While democracy seeks equality in liberty, socialism seeks equality in restraint and servitude.
                                                                                    Alexis de Tocqueville (1805-1859)

“Free stuff” is an aphrodisiac; it is like honey to a bear – who can forget the image of Pooh stuck head-first into a tree, bees swarming about him. It was why Odysseus had his men lash him to the mast as they approached the island of the Sirens. It appeals to the emotions, not the intellect. Listening to Bernie Sanders speak after trouncing Hillary Clinton in New Hampshire last week, it was easy to be swept away with his promises of free stuff – healthcare and college – all with the illusion this would solve unfairness and inequality. No discussion of the cost or how it would be financed, other than to raise taxes on Wall Street moguls. No mention of the decline in cultural and moral habits, like marriage, religion and work habits, that accompanied the rise in entitlements. It is not just the words; it is the way they are said.

Those who are duped with promises of “free stuff” ignore the simple fact that everything has a cost. Mr. Sanders’ admirers are asked to reject the critical concept underlying our history, which is the opportunity to succeed. No government can guarantee individual success, but ours does provide equality of opportunity and equality before the law, without regard to class, race or religion. Our government was created to protect us from the threat of kings and oppressors. It was based on the notion that our rights are God, not man, given. The Constitution provided us the freedom to think, speak, assemble and pray as we like. It enacted laws that protect us and our property from unlawful imprisonment and seizure. It promised that we would be judged by juries of our peers. America’s democracy recognizes inherent differences in individuals, as well as culture and heritages – that we are (and always have been and always will be) a nation of immigrants tossed in a cauldron, but maintaining our individual identities. American culture was based on pluralism, not multiculturalism. We are individuals, not cattle to be placed in pens convenient for politicians focused on group solutions to group problems. We are meant to be unified, not divided. The American meaning of liberty was never based on the promise of equality of outcomes – something that can never be delivered.

The cradle-to-grave care that Mr. Sanders feels is our due is enticing, especially to the naïve, those without aspiration and to those ignorant of our history. The fact that we cannot afford entitlements already promised, however, should give pause to those who believe that the riches of the one percent will be available for the the ninety-nine percent. The argument is made that Socialism has worked in some West European countries. But those countries are largely homogeneous, and the influx of refugees from the Middle East and North Africa is testing whether those systems will still function. The United States, in contrast, is an amalgamation of people from all over the world. It is our strength, but it is also one subject to abuse by politicians who choose to divide so as to conquer. They prefer compartmentalizing the electorate; it is easier to focus on specific promises to groups: the young or elderly, women, gays, Blacks or Hispanics than to discuss broad concepts like freedom, opportunity and individual responsibility that are pertinent to us all. We should, as well, not forget that Socialism has, at times, devolved into autocracies. Both Communism and Fascism were birthed under the promise of equality, fairness and socialistic solutions.

Populist politics, whether from the Right or Left, lead to authoritarianism. They involve finding someone to blame for society’s problems. Individuals or groups are singled out as responsible for whatever ills have befallen a nation and its people. Easily identifiable groups are vilified. For Fascists and Nazis, it was Jews and non-Aryans. For Communists, it was the aristocracy, free-holding serfs and Jews. For Donald Trump, it is foreigners; for Bernie Sanders (and others on the far Left), it is Wall Street and the “one percent.”

Extremism rises when dissatisfaction is high and expectations low. Mr. Obama takes credit for the fact that our economy is the fastest growing of the developed nations, that twelve million or so jobs have been added and that unemployment is below five percent. But he shuns the fact that developed nations have struggled in this economy and that about eight million jobs in the United States were lost between 2007 and 2009. He never mentions that this recovery has been the slowest in post-War history. He avoids mentioning the millions of people who have abandoned the workforce. The labor force participation, at 62.7%, is as low as it has been since the 1970s. The gap between unemployment for African-Americans and Whites, at the end of the third quarter 2015, was the highest in fifteen years. Wage gains have been nil. The most negatively affected sectors of the demographics are the poor and minorities, those very people Mr. Obama promised to help. While about three and a half million Americans reach retirement age each year, roughly four million turn eighteen.  An economy needs to absorb the natural growth in its population.

But this stagnation (and worse) for growing numbers of America’s middle class people pre-dates the Obama Administration. “The real family income of people in the bottom half of the income distribution,” according to Charles Murray writing in the weekend’s edition of the Wall Street Journal, “hasn’t increased since the late 1960s.” Ironically, but importantly, the slowdown in family incomes for the bottom half of Americans coincided with the increase in entitlements and the decline in family formations. Is there a correlation? I am not a social scientist, but the possibility cannot be dismissed. With Mr. Sanders, we would get are more of the same. History provides no support to suggest his solutions will work.

In fact, history suggests a different path. Democratic, free market capitalism has been the strongest force for good the world has ever known. Arthur Brooks, president of the American Enterprise Institute, recently wrote that free market capitalism has moved more people out of poverty – 700 million, according to his estimate over almost 200 years – than any other system. One has to look no further than Cuba, or as far away as China, to understand the truth of his message. In his book, The Great Surge, Steven Radelet, professor at Georgetown University, noted that the number of developing countries, over the past twenty-five years, that have seen annual economic growth exceed two percent has risen from 21 to 71. That has led to a doubling of per capita income for millions of people. What triggered the surge? Mr. Radelet writes that it was the collapse of the Soviet Union and the discrediting of Marxist-Leninism

Democracy is not perfect and neither is the United States. Nevertheless, with its laws, institutions and respect for human endeavor, our system has allowed us to become wealthy, as a nation and individually. It is a system where people are free to make choices, to succeed or to fail. The combination of free market capitalism and democracy have allowed us to be the most generous nation on earth, with beneficiaries being libraries, hospitals, universities, museums, symphonies, etc., institutions that have enhanced life for everyone. That is not to minimize the importance of safety nets; for we all know that there are are those who for reasons of age, infirmities, prejudice and misfortune cannot fend adequately for themselves.

Taxes and regulation, while necessary for government to function and to keep people safe and competition fair, act as governors on economic growth. The conundrum for government is to find the right balance. When no rules are applied anarchy and economic free-for-alls result. When they are applied too rigorously economic growth is impacted. Mr. Sanders’ socialist policies, which avoid mention of positive character traits like work, marriage or faith, risk slowing further an already anemic economic recovery.

“Stuff” is not free. If its price is not determined in dollars, its cost will be measured in freedoms lost.

Monday, February 8, 2016

"The Bloomberg Factor"

Sydney M. Williams

Thought of the Day
“The Bloomberg Factor”
February 8, 2016

Will he, or won’t he? That is, will Michael Bloomberg decide on an independent run for the Presidency, will Democrats tap him, or will he stay home? A decision must be made reasonably soon, if he wants to get on the ballot in all fifty states. A couple of weeks ago the New York Times published a front page article, “Bloomberg, Sensing an Opening, Revisits a Potential White House Run.” They noted he had tasked his advisors with determining the merits of an independent candidacy.

Mr. Bloomberg, a three-term Mayor of the City of New York, is said to be motivated by the possibility (remote as it may seem) of voters having a Hobson’s choice in November: Bernie Sanders or Donald Trump. Mrs. Clinton assured him there was no reason for him to harness up. She would be the Democrat nominee. Republicans remained silent. They know that an independent run by Mr. Bloomberg would do more harm to the Democrat contender than the Republican. Mr. Bloomberg ran for Mayor as a Republican and is now an Independent. But he had been a life-long Democrat. It is where his sympathies lie.

History is replete with third parties, from the Anti-Masonics and Free-Soilers during the first half of the 19th Century to the American Independent and Reform Parties in the second half of the 20th Century. In 1860, Abraham Lincoln was the first man to run for President as a Republican, effectively making him a third party candidate. He won against three others, garnering 39.6% of the popular vote. But apart from Lincoln, over the past 150 years no third party candidate has ever won 30% of the popular vote. Theodore Roosevelt, as the Bull Moose candidate in 1912, came closest, garnering 27.4 percent. Eighty years later, Ross Perot received 19% when he ran on the Reform Party in 1992, but he received no Electoral College votes. Third party candidates Robert LaFollette got 16% in 1924 and George Wallace, 10% in 1968.

Third party candidates have been, however, spoilers. In 1912, Roosevelt’s entry cost William Howard Taft re-election. In 1924, Calvin Coolidge won, in part, because LaFollette’s candidacy took votes from John Davis. In 1968, George Wallace siphoned off southern Democrats, and Hubert Humphrey lost to Nixon. And, almost certainly, Ross Perot’s run in 1992 cost George H.W. Bush re-election. Mayor Bloomberg may face one other historical impediment: No modern mayor of New York City has gone on to higher office.

Nevertheless, the Presidency of the United States - the most powerful position on earth - is a big prize.  The prospect for historical immortality is seductive. Mr. Bloomberg has a good-sized ego and is worth north of $30 billion. And, perhaps most important, his political philosophy (apart from a preference for “nannyism) tends to be centrist. His ties to Wall Street would provide fodder to negative populist rhetoric, but he is a self-made man, a “doer” with vision. He may think this is his time. At the age of 73 (he will be 74 next week), this would be his only shot. (Ronald Reagan, at 69, was the oldest man ever elected President, and he was five years younger than Michael Bloomberg would be.

There are, in my opinion, flawed candidates in both Parties, beyond Senator Sanders and Mr. Trump.  Mrs. Clinton comes to mind, with her deliberate decision to store her State Department e-mails on a private server, her lies regarding Benghazi and myriad scandals reaching back into the 1980s. Ted Cruz is not deemed collegiate by his Congressional colleagues. It says something about his character that not one of his Senatorial brethren have endorsed him. Being able to get along is a lesson Americans should have learned from the incumbent. Democrats have a limited menu off of which to choose. But Republicans have viable alternatives: Governors Jeb Bush, John Kasich and Chris Christie are experienced and competent. While faults can be found in all of them, I would be happy with any. My favorite, however, is Senator Marco Rubio. His youth is countered by sensible judgment and good character. He is energetic, smart, and liked and admired by is colleagues - and he is the Republican candidate most feared by Democrats.

Democrats, on the other hand, could be in a tough spot. Most do not want a 74-year old Socialist and there is risk – perhaps low – that Mrs. Clinton could be indicted. While Democrats work hard to portray inclusiveness, in fact they have a shallow bench. The age of their candidates (now that O’Malley is out of the race), including potential ones, suggest a Party more comfortable with the past than the future. The Obamas and the Clintons are not close, but if Mrs. Clinton becomes the standard bearer, the President will stick with her. But if her legal problems worsen, Mr. Obama may look elsewhere. Joe Biden and Elizabeth Warren are obvious possibilities, but both have imperfections. Mr. Biden is older, without the freshness of Bernie Sanders. Mr. Obama could turn to his kindred spirit, Elizabeth Warren, but he may want a more attractive alternative. Ms. Warren has lied about her past in order to advance her career. If you recall, she claimed to be of Cherokee heritage. (See the piece I wrote on November 9, 2012, “Pocahontas Goes to Washington.”[1]) She is also on the extreme fringe of the Left. As well, she is not young. She will be 67 in June - old enough (but not wise enough) to be Marco Rubio’s mother.

Mr. Obama is determined that his legacy not be at risk, which could happen should Republicans gain the White House and keep the Senate and the House. The inevitability of Hillary’s coronation now seems not so inevitable. President Obama has kept his options open. He has not said whom he would support. This is where Michael Bloomberg could step in. Keep in mind, Mr. Bloomberg had been a life-long Democrat before running for Mayor in 2001 as a Republican. That year the Democrat field was crowded with aspirants wanting to succeed Rudy Giuliano. Michael Bloomberg, always a pragmatist, correctly thought it would be easier to win the nomination against former Congressman Herman Badillo, then a 62-year-old former Congressman, than to compete for the Democrat nomination against a field of a half dozen. In 2005, after winning re-election, he switched his registration to Independent.

Perhaps it is only wishful thinking, but my guess is that Republicans, in the end, will nominate a candidate with broad appeal - an individual who exudes optimism, and whose policies will give business the confidence to invest in the future and give people the confidence that, with the right education and incentives, they can create their own destinies – a person who recognizes that government is necessary, but should always be subordinate to the rights of individuals. There is no one on the Democrat slate who can do that. Mr. Sanders beliefs imply a state that supersedes the individual. Mrs. Clinton has abandoned the more centrist views of her ethically challenged husband for the more radical views espoused by Mr. Obama and Mr. Sanders. If Democrats hope to keep the White House, they will have to find someone with broader appeal. Michael Bloomberg might be that person.

Perhaps it is already too late, but if I were a member of the Democratic National Committee, I would be nervous regarding my prospects, especially if Mr. Rubio is nominated. I would look upon Mr. Bloomberg as a possible savior. As a competitor he would be formidable, but not necessarily unbeatable by the right Republican. His “nannyism”, for example, is troubling. But he would be an attractive candidate, with generally centrist views. It is curious that the possibility has received so little attention.

[1] The essay can be retrieved  by going to www.swtotd.blogspot.com and typing in its title under search.