LETTERS FROM THE GLOBAL PROVINCE
GP 4 March 2009: Investment Outlook 2009: The Second Great Depression
Oil in Hell. The tale is told of Harry Svelte, a stockbroker who left this earth before his time, but not because of torrid drinking or blasphemous cholesterol or outrageous womanizing. Not Harry. He was a health nut who had bran for breakfast, yoghurt for lunch, and codfish for supper: his low body mass and ample hair were the envy of the thundering herd at his office. Alas, one day he tripped at the curb, distracted as he was by some ultra volatile market statistics that were flashing in a Merrill Lynch window as he crossed Broadway, only to be run over by an errant taxi cab whose driver was being verbally lashed by a chorine blonde East Side harridan, affectionately called Goldilocks by her 1000 best friends, who was late for liquid lunch with the balding real estate magnate who was keeping her in gemstones. Accidents like that happen in New York City.
Harry was honest enough as it goes and made it to the Pearly Gates for an interview with St. Peter. Rifling through Svelte’s paperwork, St. Pete exclaimed, “Ah, your papers are in order, and you can make it into heaven, even without a green card. But, But—” Peter shifted his eyes, “Look inside. We just don’t have any room. People are simply pouring in, and it is wall to wall.” Harry took off his sunglasses, and, peeking past Peter, he saw that heaven was just chockablock full of people.
He turned away and pondered. He was a clever enough broker. He went up to the gates again, stuck his head through, and shouted, “There’s oil in hell.” Lo and behold, masses and masses of people flooded out. The startled St. Pete then called to him, “Come on in. Now we have plenty of room.” But Harry hesitated and scratched his head.. St. Peter asked, “What’s the matter?” Harry replied, “Well, you see, there might be something in the rumor.” You see, Harry Svelte was a broker.
Devil’s Bargain. Even if there be oil in hell (these days, by the way, the big strikes are coming in from beneath the ocean), we’d advise you to make no pact with the Devil. The Devil, on the surface of things, seems like a jolly enough chap. But, underneath, he may turn out to be Alan Greenspan, Bernard Madoff, Paul Greenwood, Stephen Walsh, James Nicolson, Arthur Nadel, Mark Drier, Allen Stanford, Dick Grasso or one of the thousands of other venal characters who have brought the market low. The Devil has a 1,000 faces.
The conspiracy of dunces and scoundrels who brought our financial system down does not just include a Fed Chairman who threw cash every crisis and did not prick any of the bubbles that led to unruly, inflated markets, nor just hedge fund operators who stole funds, nor just private equity players who stripped companies of assets and leveraged them with debt at Uncle Sam’s expense, nor bankers who made loans that would never get repaid, but also included the brass at every investment banking firm in Wall Street, all of whom knowingly peddled subprime securities and structured debt at the very moment when their firms were going short the very things they were selling. One must understand the pervasiveness of the corruption in financial circles to figure out how to invest going forward.
The way one invests has been turned upside down. You’re foolish if you buy “growth,” or “value,” or certain industrial sectors, or international stocks, etc. The single, over-riding consideration investment-wise is to buy honesty, because it’s a rare commodity, and its value will hold up. If you’re to buy a company, or a government security, or gosh knows what else, you should be looking hard to see if it’s headed by an honest fellow who can look you in the eye and tell you the pluses and minuses. We’re in the hunt for what a Swarthmore psychologist calls ‘practical wisdom,’ which marries shrewdness with virtue.
When Did It All Begin? When did the United States and, consequently, the world financial system, become more rotten than Hamlet’s Denmark? We don’t know, and we are waiting for some academics to take a hard look at this question. We suspect that August 1987 is as good a date as any. That’s when President Ronald Reagan put Greenspan at the head of the Federal Reserve. Ray DeVoe, who writes the most literate and perhaps most incisive letter out of Wall Street, would be as good a fellow as any to ask about when it all began to become a pig in a poke. He’s written convincingly about the successive abuses out of government and Wall Street, including, importantly, the over-statement of our real economic growth rate, and the understatement of our persistent inflation rates.
We are inclined to say the financial system broke free of any governance with the Clinton Administration’s accession to power in 1992, and the deadly sins of omission and commission were compounded during the Bush tenure. Oddly enough, the Sarbane-Oxley Act, which some thought to be a reform of the market’s bad practices, came along in 2002 as one president went off into the sunset, and the other was looking far ahead to the day when he could land on the deck of the USS Abraham Lincoln. As we have said time and time again, it reformed nothing, and was an expensive, deceptive failure, an empty gesture that made the nation feel it had achieved transparency and honest markets. Instead, it was just another sinkhole in our financial quicksand: its main effect was to fill the coffers of accountants and lawyers, the very people who had failed to police public corporations before the act came along. We generous Americans like to reward people who don’t do their jobs: bear witness to all the failed CEOs who have been sent packing with outrageous goodbye sums of money.
The financial system of the United States and of the globe is out of control. We think it fair to say that the mess, for sure, dates back 16 years. And it’s also fair to say that it will take about that long—another 16—to get out of the hole. Chances are that 16 years will be the length of the Second Great Depression. That means that successful, honest market strategists can no longer think tactically and tell us how to play the next market cycle: they should have a 20-year strategy that banks on unstable financial markets. It’s a good time to read the history books in order to understand that things that have been happening for a long time will be happening for a lot longer. And this means that most businessmen, for the first time in their lives, will have to consider becoming strategists, rather than opportunists.
This week the mail brought in a recent investor presentation from the Carlyle Group, a huge private equity firm in Washington that has ties with the Federal Government that make all the lobbyists on K Street look smalltime. Headquartered on Pennsylvania Avenue, it’s a swinger virtually everywhere in the world that counts. Eric Leser in Le Monde once detailed just a few of the well-connected that swam in its sea including “John Major, former British Prime Minister; Fidel Ramos, former Philippines President; Park Tae Joon, former South Korean Prime Minister; Saudi Prince Al-Walid; Colin Powell, the present Secretary of State; James Baker III, former Secretary of State; Caspar Weinberger, former Defense Secretary; Richard Darman, former White House Budget Director; the billionaire George Soros, and even some bin Laden family members. You can add Alice Albright, daughter of Madeleine Albright, former Secretary of State; Arthur Lewitt, former SEC head; William Kennard, former head of the FCC, to this list. Finally, add in the Europeans: Karl Otto Poehl, former Bundesbank president; the now-deceased Henri Martre, who was president of Aerospatiale; and Etienne Davignon, former president of the Belgian Generale Holding Company.”
What the January 2009 presentation says, made simple, is that the country is coming unglued because of ‘deleveraging’—debt repayment or defaults. Bad times will continue for a while, says Carlyle. But then, when balance sheets get cleaned up (by the Federal Government at taxpayer expense, though Carlyle does not care to emphasize this implication), there will be some wonderful investment opportunities. Of course, it is the private equity groups like Carlyle that got us so heavily leveraged in the first place: the hope of the public spirited amongst us is that Uncle Sam will not finance their next follies. It is important, however, to know that the financial gunslingers, like Carlyle, hope to prowl the plains again, and it will take some dexterity to stay out of their sights. Watch out for your wallets and your livelihoods. At the end of the day, probably the other Carlyle has done a lot more for us and American civilization.
Never Make Predictions. Movie Mogul Sam Goldwyn akaSchmuel Gelbfisz (and manyothers besides) was reputed to have opined: “Never make predictions, especially about the future.” It’s not just that Wall Street is venal: the whole predictive decision-making process in that swamp is tarnished from beginning to end and needs serious revamping. In “Formula for Disaster,” Wired, March 2009, pp.74-77, we learn that the financialmodels of David X. Li, which the Street bought hook, line, and sinker, were terribly flawed, and did not expose the risks lurking just around the corner. The collapse of John Meriwether’s Long Term Capital Management in 1998 also stemmed from terrible gaps in risk analysis, with events coming to pass that ostensibly had one chance in a million of happening. Sooner or latter, the once in a million always happens. Those who have been around the track a few times know that risk evaluation is simply terrible: the schemes and even the staffs of home lenders commonly accept people for mortgages who should not get them, and as commonly reject people who are very creditworthy. By and large all the fancy financial models offered up by the Street and other institutions just don’t tally risk accurately in the most extreme circumstances, the very kind of conditions we are experiencing now. Chaos-and-complexities mathematics that is investigated at the Santa Fe Institute comes closer to what we need in our new world where once-in-a-lifetime events happen every day.
In fact, the math models, which ultimately are mechanical in nature, just aren’t a match for the forces swirling around in Mother Nature. And the fanciest prediction and risk stuff coming out of the financial community is a disaster waiting to happen. In time, we are likely to look at risk and many of the other imponderables of our society with something more organic that is akin to ‘swarm intelligence,’ the interactive smarts demonstrated by bees that are part of a hive in which the group can find right answers, though any one bee would be at a loss. “Swarm intelligence,” which we have covered in many places on the Global Province, has the potential for addressing risk, terrorism, our healthcare mess, and several other phenomena that are currently overwhelming us. The Wisdom of Crowds, by a New Yorker writer, addresses some of its dimensions. The problem is for us to tap into ‘swarm intelligence,” as opposed to groupthink or herd behavior which so characterizes our financial leaders. Currently we have only made imperfect attempts to imitate swarm intelligence in our human and robot systems.
Where to Park Some Money? About eighteen months ago we began to poll our clients to make sure they either had plenty of cash or were going to sell enough securities to be dripping in it. Many of the smarter big boys were heavily in cash already, sometimes in direct defiance of their investors who wanted to see all the cash ‘put to work.’ The prudent money managers did not let all the loose change burn a hole in their pockets.
But we were not asking them to get invested. Urging them to stay on the sidelines, we wanted to know where they had their cash. Many of the big institutions more or less had their cash parked at Goldman: we said to them, “What makes you thinks Goldman Sachs is safe?” It wasn’t, although Warren Buffett has since given it some expensive capital to keep its feet dry. Kindly note that the Treasury and the New York Stock Exchange have been littered with Goldman types for the last few years: look where that has gotten us.
Parking one’s assets is the big question now. One should not be staying up nights wondering if you’re making money. As Ray DeVoe and others have said, “A whole lot of people have gone broke reaching for yield.” The challenge is to hold on to what one’s got, and that’s not necessarily easy. Many are relying on Federal Deposit Insurance to save them if their bank goes down the drain, but if enough banks go down, one could wind up waiting a fair piece before the payoff arrives.
In “The Great Solvent North,” Theresa Tedesco of Canada’s National Post proudly claims that Canada has a better (regulated) banking system than the United States, and, as a consequence, it has not experienced U.S. style meltdown. We’d debate her at length about how good the system is: we think the Canadian banks have been a long-term drag on the economy and Canadian culture. Nonetheless, its banks are not feeling as much pain at the moment, and it is one of the small economies of the world where for now some of one’s assets can be safer. The investor today must look for benign ports like this, but, further, one must spread the money around, because today’s safe port may be hit by a tornado tomorrow.
Think Small. Inside the United States, but even around the globe, the question is to think small. Pick small countries: we have commented on several small interesting countries on the Global Province. But pick small companies as well. Large companies, not just banks, but GE, or Warren Buffet’s Berkshire Hathaway, are so large that they are part and parcel of the GNP. If the fortunes of the whole country are in trouble, then big GNP companies will tank sooner or later. It is just a matter of time.
For now big companies with subprime or junk merchandise (we are talking about hard goods that you can touch, not financial products) are doing pretty well. Wal-Mart is finally turning in a good performance, buoyed by a bad economy in which consumers have downgraded their tastes and their expectations. McDonald’s is doing well as people on the run gobble down fatburgers. Other bargain chains such as Family Dollar are shining amidst the gloom. Of course, these companies will hit the wall sooner or later, but they’re drawing in consumers during the early part of this severe downturn.
Moreover, there’s another compelling reason not to be investing in large companies with huge stock floats. The institutions—mutual funds and banks and pension funds—invest in them. As the big investors suffer, they will peel off more stocks at fire sale prices. And there are simply not enough buyers out there. One wants to be investing in all the places the big boys won’t go. Safety is now defined as something that CREF, or California’s state pension fund, or the big failing banks won’t touch.
Needless to say, there are small stocks, in sector after sector, that are relatively unscathed, their prices holding up pretty well. Generally institutional investors mimicked the S&P last year, falling somewhere between 30-38%, their performance even worse during the last quarter of 2008. By way of contrast, the portfolios we manage in-house were down 15-17% last year. One fund out in the nether regions which we follow closely proudly said it was only down 5% in 2008: there aren’t many of those. When the professionals start bragging that they did not do as badly as the S&P, then it’s time to invest in some other way. It’s time to jettison the experts.
Jim Rogers. We referred to Jim Rogers, Investment Biker, in our last investment report in 2007. He played a large part in the fabulous early successes of the Hungarian American investor George Soros. Now and again, he goes down some torturous routes: we remember that he began his round-the-world auto adventure in Iceland, and nearly got wiped out there. It was almost a very short global tour.
That said, we think he makes a point or two. He hangs out in the Far East and thinks the world is moving in that direction—particularly towards China. One must figure out some durable ways to invest in Asia in spite of the risks posed by porous financial regulation there. And he’s been enthusiastic about commodities: lately he’s been talking up oil and some agricultural crops. At any rate, he’s broadly telling us to go where others aren’t, and that’s the central theme of this investment perspective.
DIY. Do-It-Yourself investing is quite the fashion in some quarters. Smart citizens realize they won’t lose any more money than the so-called professionals. Oftentimes, they will do better. Here is what one reader has to say:
So what am I doing? Three basic things. First of all, we are keeping any available cash in fully insured places. Secondly, our portfolio is very diverse (a friend told me recently that his “nest egg” was tied into a single bank stock. I have heard that tale too many times.) Third, while I don't pretend to be more than passably competent as an investor, I have never believed in discretionary accounts. Accordingly, Elizabeth and I make whatever investment decisions there are. Only my 201(k) is in mutual funds.
Many professional investors, as we have noted, are immoral, sometimes dumb, often forced by the nature of what they do to invest in things that are doomed to fall to earth. There’s a seasoned journalist in Washington who has followed big investors for years, but has never found a publication which will run the real article about them he thinks he should really write. That is, he believes the only people who make money in Wall Street are the brokers and investment bankers, never the customers. Now, when almost everything is headed downhill, it’s pretty likely that the only one that can save a mom-and-pop investor is mom and pop. Like Ralph Waldo Emerson, it’s time to start believing in Self Reliance.
Jeffrey St. John. Years ago one of our colleagues was interviewed for an hour on the radio by Jeffrey St. John. St. John was a quick study, offbeat and irreverent. Two things always stick in our associate’s head about the conversation. St. John said, “Well, all Wall Street amounts to is Ivy League Socialism, right? Just a bunch of guys who went to well-known colleges who are overpaid for not doing much.” St. John also asked our sidekick, “When you get down to it, the stock market and all that investing stuff is just a roulette game, don’t you think?” The answer was yes. It’s good to remember that Wall Street, and the banks, and the pension funds, and the mutual funds, and the hedge funds—they’re just all a bunch of imperfect ways for losing your money. If they have not made off with it already.
P.S. In “When Will It End,” The New York Times just interviewed a bunch of experts who predicted that our economic calamity will last anywhere from a few months to a few years, six at the outside. So much for experts: this imperfect storm will be around a long while.
P.P.S. If only Samuel Goldwyn were around. He would turn our present ordeal into a movie saga for sure. He would have found another Margaret Mitchell to write a real bodice ripper entitled “Bubble, Bubble, Toil, and Trouble.” Those who can tell a good yarn have a pretty good shot at making a buck during a blow-out depression. You will not be surprised to learn that “Americans Flock to the Movies, Seeking a Silver-Screen Lining,” New York Times, March 1, 2009, pp.1 & 16. Ticket sales are up 17.5%. With the downturn, Americans need to escape; the movies have become an outlet they can afford. Sumner Redstone must be smiling, because his empire is troubled and sinking under its debts: maybe his movie chain will save him.
P.P.P.S. If you want to stay abreast of the financial shenanigans swirling around us, read
Floyd Norris who writes for the Times. He’s a straight shooter and is one of those rare business writers who knows in depth what he is talking about.
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