So What Could Really Turn the Economy Around?
I know Carl through a mutual friend — he’s in Washington State, and had been very successfully running several 100 million dollars, primarily in small cap companies. I’ve found his views to be informative and refreshing.
We last heard from Carl when he penned Its Dues Paying Time: American Myths Being Destroyed — And What May Happen Next.
Here’s his latest missive
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So What Could Really Turn the Economy Around?
by Carl Haefling
Could it be something as simple as a huge rally in the stock market? Think about it! The stock market is a reflection of what people are feeling at one point in time. One day their feeling good, another day their feeling bad. Stocks go up and stocks go down.
Since the end of 2008 the average investor has had the @@@@ scared out of them as they have confronted one negative headline after another. The real estate market collapsed, pension plans are in trouble, city and state governments are watching their tax revenues slip, slide away and our federal budget is out of control. Corporations have reduced expenses as much as possible and are socking away cash every moment of the day. They are afraid to hire–so instead they are buying businesses, and then firing even more people as they eliminate duplication of jobs. There is little confidence anywhere that tomorrow the financial system will survive, or that our jobs (your job if your working, I’m retired), will be there when you show up for work.
The federal reserve in their response to fear has lowered interest rates about as low as they can go. They have saved the day—they prevented 30% unemployment or worse instead of 10%. But what we see is the best of we may achieve, UNLESS confidence is established somewhere in our economy. The easiest place for that to happen is in the stock market.
Stocks are trading at 20 year valuation lows. You can buy blue chips yielding 5% with Treasury yields below 1%. I see stocks trading at 3 to 8 times earnings everywhere I turn. Companies are now run as tightly as possible. Employees work day and night because they fear loosing their jobs. Stock prices reflect zero confidence and many seem to be betting that the economy will not only have a second dip into a deeper recession (most people think we never escaped the first one), but it will officially called a depression. Economic fear is rampant.
There is most likely more cash sitting on the sidelines then any time in the modern history of financial choice making. If the market begins to rally and confidence builds, stocks will skyrocket—nothing else currently offers any competition. Government bonds are yielding little, CD’s yield little, and corporate bonds yield little.
The price of gold keeps climbing–a reaction to fear. Speculators are now bidding up grains and other food items—fear about supply. Fear is everywhere. Five years ago if I had attempted to discuss anything to do with the economy in a conversation people did not want to engage. Now it is the first topic of engagement. Over the last 2 years people have sat up and taken notice about how the economy works, what makes the stock market go up and down, and the relationship of the economy to politics.
The world of politics is predictably a reflection of fear. If people are fearful all politicians who are in power should be fearful. As long as the economy is suffering it will be the political party flavor of the year. Whoever is in power, will be at risk of loosing power. Two years ago the Republicans were blamed for everything that was wrong, rightfully so in my estimation, and this year the Democrats are being blamed. Since they have done a horrendous job of educating people about the problems now faced, they deserve to be blamed. If we are fearful of not being able to pay our bills you can be certain that political parties will point that out in their advertising campaigns. I now sit with my finger on the mute button when political commercials dash across my TV screen. The fear mongering must be near an all time record.
The stock market is a very emotional critter. If it starts to climb people will jump to the conclusion that things are getting better. If confidence builds the economy will get better. If stock prices go higher business people will be less interested in buying a business and more interested in building a business—and that means job creation.
I have been investing since I was 14 years old. I’m now 62. I have rarely seen stocks as cheap as they are. All that needs to happen is for the economy to improve at a 1 to 2% rate next year and stocks will become even cheaper relative to their buy out values, unless stock prices climb. Business men with excess cash are and will be buying every business in sight that is trading at a discount to future earnings. Why shouldn’t we? You could not come close to duplicating the business of many companies trading at current market capitalizations.
So if you want the economy to improve—invest in the stock market. If you want to get beyond the political wackiness now running rampant in American politics where your vote is determined by what you fear, not what is best for the country, hope for a higher stock market. I know it sounds greedy and even irrational. But having played this game for almost 40 years, I have learned that it is fear that drives stock prices higher—fear of not participating in a rally.
Its a simple formula. Higher stock prices, leads to confidence, confidence leads to investing in jobs.
Now before you think I worship at the alter of the free market, I don’t. I have my own theories about human behavior that have helped me through this life. I do not believe that humanity will for the most part make the right choice when it comes to financial self interest. I strongly believe that an unregulated market is a precursor to economic disaster and allows the worse of what it means to be human to emerge. Stock market optimism is not the free market run wild. It is a statement of belief in the future of a regulated economic system that allows us all entry into the market place. The stock market is one of the few places that one can take paper route money and turn it into a significant amount of money. I know.
When things seem bad, it is very counter-intuitive to buy stocks. I’m a buyer.
Carl Haefling
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September 30th, 2010 at 9:20 am
Sorry. I just can’t get past all the grammatical errors. (their, loosing, your, etc.)
September 30th, 2010 at 10:22 am
“Its a simple formula. Higher stock prices, leads to confidence, confidence leads to investing in jobs.”
Oh really? We just had a 70% rally in stocks & there was no improvement in either confidence or jobs.
September 30th, 2010 at 10:31 am
It makes some intuitive sense. I also very much believe a large part of Bernanke’s plan is to restore confidence by whatever means necessary. He is a con man, after all.
But confidence is only half the story. Jobs are important, but jobs and confidence don’t eliminate global debt issues overnight. Confidence doesn’t eliminate negative home equity. Confidence doesn’t solve global economic imbalances in trade (see China and the US). These are large, structural issues that have been decades in the making (yes decades, so your 40 years really loses relevance along the way), and will likely take a similar amount of time to resolve. These are issues that can’t be ignored – especially given the prevailing bullishness around Emerging Markets (equity sales in developing nations this quarter exceeded the previous high of $72 billion in the last three months of 2007, greater than developed nations).
So as a corrolary to your point, while confidence is good for S/T market moves, you can not ignore OVER-confidence either. We are adjusting to back to back asset bubble bursts – housing, then commodities. While there is no shortage of bearish sentiment out there, bullish sentiment in risky stocks is now back to peak levels since the August-September rally began. And there is a prevailing assumption that QE provides us with a nice, handy, “risk-free” equity market. I believe confidence is important, but it appears to be as cyclical as anything else. And for all the bullish commentary and outlooks from companies on earnings calls, it doesn’t appear to me that they are lacking in this department. Perhaps they are playing the con game along with Berspanky.
September 30th, 2010 at 11:01 am
If stocks are so cheap and its time to buy then it must be time to buy a house also. Look, these cheap stocks are where there were 13 years ago. They have a negative return this decade, so I should buy again why? The “cheap” market is so stacked against us little guys.
September 30th, 2010 at 11:08 am
I think the last 40 years were an anomaly based on America’s position in the world. Currently the Achilles heal to your argument is the banking system, which has never been in jeopardy like it is now. The second weakness is that the debt to productivity ratio is skyrocketing. It takes so much production to safely support a certain level of debt. This relationship is destroyed and will result in a large decrease in the standard of living to rectify it.
September 30th, 2010 at 11:15 am
Cannibalistic Fat Cats
There is no hope. All the fat cats used to sucking 25% of the value out of everything bought and sold in this country have fallen upon hard times. Now they been trying to subsist for two years on a dramatically reduced economy and still get their 25% worth, which in this economy amounts to 50% of everything bought and sold. They have eaten their grandparents, their parents, their children and are now turning to their spouses with a hungry look. Normally they would be exiled from their families and communities, but in a global society, that doesn’t matter the problem just gets shifted.
So get used to it. We live in a world of dross, where everything of value goes to sustain the rich upon the top of society, while the rest toil day and night to support the topheavy load.
September 30th, 2010 at 11:31 am
Carl, please elaborate on the metrics you use to define equities as currently being “cheap.” If, by definition stocks are “cheap” then public sentiment is not a necessary condition for them to rise to their fair value, as professional money managers would arbitrage this spread away.
September 30th, 2010 at 11:33 am
Wow … that’s a perspective from another generation.
Carl, I’m 29. To me, your optimism is hilarious. My parents had a similar viewpoint based on their experiences. Work part time to pay for college, graduate, marry, buy a house, move up the corporate ladder, all on a single income. Let’s just say that NOT A SINGLE ONE OF MY FRIENDS HAVE BEEN ABLE TO DUPLICATE THIS SUCCESS.
This doesn’t directly relate to the stock market, but I don’t have a blind belief that what worked well for your generation is going to work for mine. You simply have lived in another economic reality.
September 30th, 2010 at 11:47 am
@Pure-Water: Bingo.
September 30th, 2010 at 12:06 pm
[...] What could turn the economy around? Hint, the stock market. (Big Picture) [...]
September 30th, 2010 at 12:09 pm
The title should really read “So What Could Really Turn the Economy Around-with the least amount of pain to the top 10% of Americans”
As of 2007, the top 10% of Americans own 88% of all investment assets (including 92% of all stocks).
Barry, check out G. William Dumhoff’s paper titled, Wealth, Income & Power. He’s a Sociology Professor here in Surf City USA (Santa Cruz). He’s “lefty” but the numbers can’t lie much…
http://sociology.ucsc.edu/whorulesamerica/power/wealth.html
September 30th, 2010 at 2:40 pm
br, carl – excellent!
September 30th, 2010 at 3:10 pm
Sure thing. If you believe that profit margins are sustainable at seriously above-historical-norm levels then we have a cheap market. Personally I tend to agree with Hussman that estimates are too high and margins will correct. But it wouldn’t be the first time I’ve been wrong. But a high stock market isn’t going to bring jobs back here. Our wages are too high relative to our competitors in the developing world.
That doesn’t matter to you if you bought assets back in the 80s and watched them inflate thanks to our interest rate policies. It sucks @ss if you are young and setting out. You are expected to compete with Chinese, Mexican or Indian labor, and pay unheard-of multiples of your diminishing wage for assets like housing, bonds and stocks which are propped up by zero interest rates. So you are expected to buy assets at the top, earn nothing on your savings, and compete with close to zero wages. Oh, and fund the retirement promises that the previous generation made to themselves without funding them.
Thanks anyway, but I’ll stick to buying things that are priced for distress, not nirvana.
September 30th, 2010 at 8:06 pm
pure-water writes:
“Oh really? We just had a 70% rally in stocks & there was no improvement in either confidence or jobs.
Actually, consumer confidence more than doubled — from 25 in Feb 2009 to 53 in August — and the job market went from shedding 700k jobs a month to adding tens of thousands.
September 30th, 2010 at 8:54 pm
Thanks Carl, but why didn’t you write this back in March-09? BR notes you’ve been “successful running several 100 million dollars..”. Now say at a meager 1% fees per annum, that would come out to one cool million /yr/100 million…sweet indeed! Where does the 30% unemployment prevented figure come from? it is your estimate? if so, can you back it up?
September 30th, 2010 at 9:48 pm
There are so many hidden assumptions buried in this piece, one practically needs a mop and bucket.
Re, 20 year valuation lows, where is the evidence for that? John Hussman not long ago made a compelling case based on historical valuations that equities could be as much as 40% overvalued. David Rosenberg is similarly rigorous when it comes to providing data and metrics to back up his assertions.
Re, stocks at 3 to 8 times earnings everywhere? Like who? Like what? The S&P multiple is still a matter of significant dispute given the tendency of the street to focus on forward operating earnings, which are inherently sketchy.
Re, ‘cash on the sidelines,’ that idea has been repeatedly debunked as a fallacy — a sort of pleasant illusion — by Hussman and others. Not to mention Kingworld News reporting that, as of less than three months ago, mutual fund cash levels were at RECORD LOWS.
Also, re, cash on the sidelines, Zero Hedge has pointed out a remarkable 20 weeks (and counting?) in small investor outflows from the market…
Perhaps the biggest fallacy in this piece, though, is the blatant embrace of magical thinking. We are where we are now because of bad choices and structural issues 25 years in the making. We are at the tail end of a quarter century leverage and debt supercycle, having eaten our seed corn or otherwise blown it on “stuff.” We are also facing the painful realities embedded in the aftermath of a major financial crisis, the consequences of which have been documented by Rogoff and Reinhart via studying eight centuries worth of financial crisis data.
In other words, the headwinds facing the U.S. economy are very serious and very real. Unfortunately there has been no real effort to fix those, only massive doses of ‘extend and pretend.’ Nassim Taleb and others have in fact made credible arguments that the government’s stimulus policies are actually making the crisis worse. We are certainly seeing the Fed’s roles as a destroyer of savings in their wilingness to push everyone out on the speculative curve with zero interest rate policy.
The answer to our problems is somewhere along the lines of 1) facing up to some seriously hard choices, and 2) getting the clowns in Washington to actually implement intelligent and thoughtful policies, getting government out of the way where it is a hindrance and actually directing help to the parts of the real economy that need it.
What is NOT the solution, what is in fact a MILLION MILES from the solution, is more of the same blatant Wall Street mollycoddling that we’ve had since time immemorial, back-stopped by the Fed’s game plan of simply juicing risk assets in the frankly naive hope that a paper asset boom will somehow help out the real economy.
Articles like this depress me because they demonstrate that the quality of our collective thought is still not serious. As Ed Seykota quipped, rather than using intuition we are still “into wishing.” The problem is that a focus on magical thinking — a sort of clicking of the ruby red slippers and whispering “there’s no place like home” — only allows for more rot and structural decay in the areas of the economy that are facing severe problems, while the powers that be focus on the financial version of bread and circuses.
Kumbayah, if only we would all join hands and buy stocks. Perhaps then we could enjoy the fruits of Dow 20,000 as the price of gold triples, the cost of living quintuples (via food and energy prices untracked in the CPI), and the real economy goes from inflationary recession to borderline hyperinflationary depression. Yah, that sounds like such a wonderful fantasyland to embrace. Sign me up, tomorrow I’m going 200% long on margin.
October 1st, 2010 at 8:00 am
Captain Jack, your reply is PERFECT ! I’m in your camp.
October 1st, 2010 at 9:42 am
I really think both the author and these replies have merit. Let me explain.
The young folks disagreeing are correct from the perspective that they are going to have tough careers with far worse ROI on their efforts.
The author is correct that the long term for America (as well as the current top 1%) is positive.
How could both of these things be? Because it is going to take 20 or 30 years for China and India to inflate their way into equilibrium with American salaries and prices. This would not have to be the case if deflation of prices and salaries were allowed to take place in America, but the intelligentsia, the rich, and the Fed think that is the wrong direction. So, the US can go sideways for 20 or 30 years instead of meeting India/China halfway (i.e. allowing modest deflation in US). The unfortunate side effect of this is that many of the blogger’s careers/lives will be worse.
Bloggers, my best advice: you can still make it happen through careful attention to financial defense. You may not believe me but many of you can probably reduce your expenses by 30% and that is money you can still invest in companies that will profit in India and China. You can still buy low; I bought RE so low–at the peak of the bubble–that I have not lost any core value and have gained some.
October 1st, 2010 at 10:55 am
I think we should Lay Off all people over the age of 60 that don’t know the difference between their and they’re and give THEIR jobs to competent unemployed recent college grads.
Douche
October 1st, 2010 at 1:47 pm
Your question: “So What Could Really Turn the Economy Around?”
The answer: Eliminate FICA (See: http://rodgermmitchell.wordpress.com/2009/09/08/ten-reasons-to-eliminate-fica/ )
Rodger Malcolm Mitchell
October 2nd, 2010 at 1:19 am
Captain Jack, great response, I wish I could be half as eloquent. But, I submit not all is bad, not until I see the flood of illegals (40% of whom enter legally and then overstay their visas) reversed. Here’s my dilemma: if Wall Street is a rigged game (as Buffett says and we all have experienced over and over again), how can one trust the bourses of India or China?
October 2nd, 2010 at 9:26 pm
To clarify, I didn’t mean to imply that all is bad. Fortunately the core of America’s greatness is pretty hard to extinguish, though we seem damn determined to try sometimes. Nor did I mean to imply that stocks can’t go up. They certainly can… and under the right circumstances they can still go up a lot, at least in nominal terms.
From a hard-nosed trading perspective, the game is the game. “Trusting” India or China thus matters less than gaming the price action when it comes to making a buck. But from a moral perspective — or, if you wish, a fixing-the-problem perspective — certain viewpoints are distressing.
It’s like the old communist-era factories — the way we measure determines our results. If the only measuring stick applied to the health of America is the level of the Dow Jones Industrial Average, then fine — the powers that be can engineer a happy-happy joy-joy result, in nominal terms, even as real values continue to deteriorate.
Nothing like a free-for-all financial orgy where the value of America’s true assets are declining even as fiat prices are going up. This is a world in which the quick and the nimble and the sufficiently skilled (or connected) can do fine, while most everyone else gets screwed. I can hold my own in that world, as can many other traders, but prefer not to endorse it even implicitly as something we should move towards.