"Markets"

Sydney M. Williams

swtotd.blogspot.com

Thought of the Day

“Markets”

November 27, 2017

“I will tell you how to become rich. Close the doors.

Be fearful when others are greedy. Be greedy when others are fearful.”

                                                                                                            Warren Buffett (1930-)

The Law of gravity has not been repealed. What has risen will, at some point, decline. But, when? Hundreds of people are paid millions of dollars to predict the unpredictable. Yet, the best advice about the direction of the market over the short term I have ever read was given by J.P. Morgan. The story may be apocryphal, but it was re-told by Benjamin Graham in The Intelligent Investor (1949); it still resonates. Asked by his lift boy, in 1901, what will the stock market do? He replied, “it will fluctuate.”

The past year has seen establishment-types in Washington, mainstream media and coastal elites trying to undo last year’s election. Has the market’s positive performance deepened their denial and made more passionate their hysteria? Would they have been so relentless had stocks done as Paul Krugman (economist and New York Times columnist) predicted when news of Trump’s election was clear? Krugman wrote as stock futures plunged early before trading began on Wednesday, the 9^th of November. As to when they would recover, he opined: “a first-pass answer is never.” The DJIA rose 257 points that day.

The performance of U.S. equity markets since the election of Donald Trump has been remarkable. He came after a President who entered office following the worst financial crisis since the 1930s. Stocks were at five-year lows. Mr. Obama’s two terms saw the market (DJIA) rise 151%; he left office with an approval rating in the mid 50% range. In contrast, Mr. Trump was elected with stocks near all-time highs, and he has the lowest approval numbers in memory. However, those ratings run counter to optimism seen in polls like the IDB/TIPP Poll: Economic Optimism Index – a mixture of consumers, workers and investors. Over the first sixteen years of this century, the Index averaged 49.3, or slightly negative. Today, it stands at 53.6. During the last year of Mr. Obama’s Presidency, the number was under 48.

Benjamin Graham, considered the father of value investing, explained his concept of investing this way: “In the short term, it is like a voting machine – tallying up which firms are popular and unpopular. But in the long run, it is like a weighing machine – assessing the substance of a company.” Is a year a long enough period to measure Mr. Trump? Is the market reflecting his popularity, or is it weighing what he has accomplished, in restoring cost-benefit analysis and undoing restrictive regulations in federal agencies like the EPA, FDA, FCC, Transportation and the Department of Education? Is it measuring Betsy Devos’s focus on making public school more competitive through vouchers and Charter schools? Is it weighing Mr. Trump’s appointment of originalists as judges, ones more predictable, as they are aligned with the Constitution and less governed by politics or relativism? Does it see an end to authoritarianism at the CFPB?

I don’t pretend to know why markets have done what they have. And I know they will correct, but when and by how much? So, what should investors do? There are no simple answers. The needs of each is individual. The future is like peering through a windshield in driving rain. Clarity is confined to the past.

But, in my experience, market timing is only accurate in retrospect. What I do know is that over the long term – two, three or four decades – stocks have risen. They should continue to do so. If one had bought stocks on September 3, 1929, the day that year the DJIA peaked, one’s compounded annual return, through today, would still have been 4.8%, even though stocks did not exceed those 1929 prices until 1954.[1] If you had reinvested dividends your total compounded annual return would have exceeded 6%. On my birthdate, January 31, 1941, the DJIA was roughly one third of what it had been twelve years earlier. If my grandparents had given me a $1000 as a birth gift, and if I had been smart enough to leave it invested, it would be now worth $187,000, or a 7.01% CAGR. Over the 48 years I spent on Wall Street annual returns compounded at 6.3%, despite stocks being lower fifteen years after I got into the business.

Mr. Obama became President at a fortuitous time. During his eight years in office, the DJIA compounded at an annual rate of 12.1%. But, had you bought stocks on the dawn of the new millennium, on January 3, 2000, your compounded return would have been only 3.9%. That modest performance reflects the bear market that began in March 2000 and ended in March 2003; and the one that began in October 2007 and ended in May 2009. If one goes back 100 years, stocks, as measured by the DJIA, have compounded at 5.9% – a reasonable assumption for future prospects, considering what the last century saw: a world-wide depression, two world wars and numerous smaller ones, a cold war that lasted forty-five years, the deaths in office of three presidents (one by assassination), a bout of inflation that sent Treasuries to 20% yields, the first attack on American soil since the war of 1812, and a credit crisis that nearly sent financial markets into a tail spin.  But it was also a period that highlighted American creative genius, that saw the Country land a man on the moon, and which witnessed revolutions in farming, manufacturing, transportation, merchandising, electronics, computing and communications.

There have been structural changes in markets. Among them has been the shrinking of the number of publically traded stocks, and the concomitant increase in value of those that survived. According to the Carlyle Group, there are 3671 companies listed on U.S. stock exchanges today. Twenty years ago, there were about 7300, yet the value of publically traded stocks today – about $27 trillion – is double the value of all publically traded stocks in 1997. What happened? Private equity allows start-ups to wait longer to go public. Mergers and bankruptcies caused the disappearance of many micro and small-cap stocks. Also, passive strategies have limited the number of shares available for trading. Since the millennium, about $1.7 trillion has been invested in index funds, ETFs and other similar strategies, while funds actively managed have seen about $1.4 trillion in outflows. Equity derivatives have affected valuations, altering the nature of risk. And, over the past eight years, the Fed purchased over $4 trillion in government and agency debt. That has ended. The yield on 30-day Treasury Bills has risen from 0.26% on September 30, 2016 to 1.29% now. Over the same time, the spread between Investment Grade Corporates and the 10-Year Treasury has narrowed from 191 basis points to 137 basis points, implying a willingness to assume more risk.

In response to Mr. Buffett’s quote in the rubric at the top of this essay, I suspect people are neither greedy nor fearful. They are somewhere in between. But, keep in mind, investing is for tortoises, not hares. Avoid being cute or believing every seer. Think long term and maintain perspective.

The only addition I would add to the wisdom of J.P. Morgan quoted at the start of this essay is that over the long-term stocks rise; though returns can be negative for a decade or more. The caveat: our democracy, entrepreneurship and capitalism survive. Warren Buffett recently predicted the DJIA will hit 1,000,000 in the next hundred years. One’s first reaction is that the Wizard of Omaha is losing it; but 1,000,000 on the DJIA from the current level implies compounded annual returns of 3.7%, easily doable, as long as our democracy stays strong. My guess is that my great grandchildren will see that happen.

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[1] All the data for the Dow Jones used in this Thought of the Day comes from The Book of the Dow, published by Birinyi Associates in 2012. Any errors in calculation are mine. Data since 2011 is from my own records.

"A Political Philosophy"

Sydney M. Williams

Thought of the Day

“A Political Philosophy[1]”

October 23, 2017

“The ideas of economists and political philosophers, both when

 they are right and when they are wrong, are more powerful than

 generally understood. Indeed, the world is ruled by little else.”

                                                                 John Maynard Keynes (1883-1946)

                                                                 The General Theory of Employment, Interest and Money, 1936

In universities, we were exposed – at times through the lens of prejudicial teachers, but ones with less bias than today – to the writings of political philosophers, from Socrates to Locke to Marx. We glimpsed the ancient Greeks and Romans. We read history and surveyed the Bible.  We grazed on the works of economists, like Adam Smith, Jeremy Bentham, John Maynard Keynes and Friedrich Hayek. While most of us did not study these philosophers and economists in detail, they were, at least, unmasked for our inspection. We were taught to think – to reason for ourselves – to determine what principles would help guide us past the Scyllas and the Charybdis’ we were bound to encounter. Today, too much focus in our universities is on issue-specific, special studies that pass as education.

It is the ability to think independently that is critical for democracy. Today, that is at risk. STEM programs help with jobs, but a vibrant democracy depends on a broadly educated electorate. For most older American, the concepts of personal liberty and economic freedom, along with a legacy of democracy and respect for institutions, are deeply ingrained. These beliefs have kept us free and democratic. Yet, youth today seems less critical, less challenging of their teachers. They believe what they hear and read in the mainstream media and on social media. The threat to democracy comes not from coarse, loud-mouthed people like Mr. Trump, but from subtle, cavalier politicians who surreptitiously insinuate themselves into our minds under the guise of doing good. To me, the biggest risk to our country is from within – elitists on both coasts, in the media, academia and in Washington, who use the threat of populism as justification for plutocracy.

Politics is an empirical process. Ours has changed over the past two hundred plus years, adapting to differing conditions and mores. The President is more isolated and more powerful. Congress has not expanded in line with the population growth, and has ceded responsibility to the Executive. Today, the judiciary (at least, those who are not activists) and local government most closely resemble what the Founders envisioned. Politicians, regardless of Party, exude an arrogance that sets them above those they represent. Many are hypocrites, spouting promises, with no intention of upholding them; passing laws, while exempting themselves; beholden to lobbyists and special interests, rather than the people; pledging prudence, but practicing profligacy. They use identity politics, which are counter-productive to assimilation and unity, leading, as they do, toward pluralism – a salad bowl instead of a melting pot.

Beware dogmatism born of ignorance. Like all self-respecting pundits, I see things I like and things I don’t. I have beliefs, and I have doubts. I do not believe climate skeptics are deniers, or that extremists come only from the Right, or that Francis Fukuyama was correct in proclaiming that the fall of the Soviet Union represented the end of history. I do not want to be lectured to by a supercilious Al Gore on climate – a man who made millions, while frightening gullible innocents. I do not want to be instructed on morality by cocky, ethically-challenged late-night hosts, like Jimmy Kimmel and Stephen Colbert. I do not want to be preached to by Barack Obama or Hillary Clinton on civility in politics, when they look upon conservatives as gun-toting, Bible-thumping “deplorables.” I do not want to listen to anti-Trump rants from sanctimonious Ivy League professors, hiding behind ivory towers. I don’t like duplicity or hypocrisy. I don’t like those who invoke identity politics, and I don’t respect those who use public fame to generate private wealth. I do not believe that any country, government, system or political party is perfect, but I do believe ours comes closest. I do like a sense of humor, civility and respect. I also believe that citizens have the responsibility to be conversant on matters of public policy, or, at least within reason, and that they should always exercise their right to vote. While unions have served a useful purpose, in recent times public sector ones have become more interested in preserving jobs and benefits, regardless of the costs to taxpayers. As well, in impeding progress by delaying or denying innovation, they have become advocates for the status quo.

We learn through discussion and debate, not propaganda-filled lectures. Life is a constant learning process. Since the advent of the industrial revolution, science has altered the lens through which we view the world. Religious faith had to be reconciled with Darwin’s findings. What had been certain gave way to doubt. But doubt led to creativity, and to improvements in living standards. Before the Industrial Revolution, our forefathers could predict what life would be like for their descendants. Afterwards, they could not. Today, we cannot foretell how our grandchildren’s lives will differ from ours, but we know they will.

The importance of reading political and economic philosophers, like Hume, Kant, Rousseau, Paine and Ricardo, is not to discover the answer one has long sought, but to provide a base of knowledge, to challenge one’s beliefs, to ensure one can argue cogently. We do not have to be disciples of a particular school of thought, but we should understand why we think as we do. We should be able to debate and defend our positions. Most importantly, we should be prepared for whatever lies ahead, and to ensure the survival of that that which is (and what we hope always will be) most important – freedom.

Authoritarianism emerges from ignorance and propaganda. Ignorance is born when students are encouraged to seek safe places, where they will not be exposed to arguments they find uncomfortable. Consequently, they are uninformed of alternative views. Most professors preach from the same political handbook. In the 2017, (William F.) Buckley Free Speech Survey, 93% of respondents agreed that there is educational value in listening to and understanding views and opinions that are contrary to their own. Yet 30% of the students believe that physical violence can be justified to prevent someone from using “hate” speech or making racially charged comments. A recent op-ed in The New York Times by Professor Clay Routledge of North Dakota State University noted that parental behavior has become “increasingly guarded and safety focused.” He worried that such attitudes, taken to extremes, delay personal independence. He found that “today’s teenagers and young adults are less likely than those in past generations to engage in a range of activities that involve personal independence, such as working for pay, driving, dating and spending time without adult supervision.” In a recent speech, former President George Bush noted: “There are some signs that the intensity of support for democracy itself has waned, especially among the young.” That would be a death knell for freedom.

We learn through reading, experience, mistakes, pain and fear. We do not want to unnecessarily expose children to risk, but if we want future generations to value freedom, as Mr. Routledge concludes, “we need to restore our faith in them.” Learning to handle disappointment and failure is part of growing up.

My advice to the next generation: Read as much and as widely as possible, but don’t rely on social media. Let commonsense be your guide. Remember, no one – parent, teacher, professor, economist, philosopher, pundit or politician – has all the answers. And be humble; we are all fallible.

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[1] On March 14, 2016, I wrote a piece titled, “I Believe…” On May 29 of this year, I wrote “Things I Think About.” This can be read as an extension of those two pieces.