KnowRisk: Recognizing an Inflection Point (When You See One)
“Those that fail to learn from history, are doomed to repeat it” â€“ Winston Churchill
“History teaches us that man learns nothing from history” â€“ Georg Wilhelm Friedrich Hegel
â€œPredictions are hard to make, especially about the futureâ€ â€“ Yogi Berra
These are macroeconomic visions which we have been writing about in the KnowRisk Commentary and we concur with the contradictory quotes. Forget predicting the future, observing the present is hard enough and very few people do it.
David Iben, the Chief Investment Officer of Tradewinds Global Investors, a $30 billion global investment manager that we utilize for many of our clients, recently stated: â€œWhile bottom-up analysis and valuation remains absolutely prerequisite to sound investing, doing so while remaining oblivious to bubbles and other major macroeconomic dislocations in the economy equates to the proverbial â€˜rearranging of the deck chairs on the Titanic.â€
In 1929, it really didn’t matter what stocks you picked, what mattered was that you shouldn’t own stocks. During the â€˜guns and butter’ days of LBJ, not owning bonds for the next fifteen years was much more important than picking the â€˜right’ bonds to own. In the 1970s John Templeton avoided the US bear market because he found better bargains in Japan. He returned to US stocks in the 1980s since Japan had appreciated so much it was no longer a bargain. In 1980, with Paul Volcker reining in the money supply, getting out of gold, oil and other commodities should have been at the forefront of everyone’s mind. In 1999, recognizing that there was no growth rate high enough to make the math work for investors in tech stocks was all that needed to be done. Analyzing tech stock fundamentals was generally a waste of time until 2002 (except for short-sellers). During the 2005 through 2008 period, asking the question â€“ will mortgages on overpriced houses, extended to unqualified, over- extended borrowers likely be repaid? â€“ was all that analysts needed to do when assessing financial stocks.
Which brings us to 2011!
The most important analysis that a prospective investor can perform today is to ask the question: Will governments that have obligations that far exceed their ability to honor, eventually make good on them?
If you were considering making a loan to your neighbor for 10 years, you would want some data. High on the list might be: other obligations, integrity, employability, assets/collateral, and income. Low on the list (if there at all) might be: what do the government bureaucrats claim was the CPI or unemployment rate last quarter, what was the â€˜output gap,’ whether Bernanke is speaking this week, or what economists are suggesting next quarter’s growth rate will be. Why should loans to governments be treated differently?
That Japan, the U.S., and the U.K. won’t honor their commitments is a given in the opinion of David Iben who says: â€œWhen and how they renege is a more legitimate topic. We do not know the answer, we do believe that loaning money to them for 10 years at a sub-3% yield is madness! While it may or may not ultimately work out for buyers, the risk is far greater than the prospective return.â€ You might even say you are buying return free risk, instead of risk free return.
Our government’s management of our fiat currency has resulted in a loss of purchasing power exceeding 90 percent over the past half-century. In other words, the millionaire from 50 years ago is equivalent to a deca-millionaire now (and probably the hector-millionaire of the not too distant future). It is likely even more pronounced if one believes that purchasing power has declined even more than what the CPI fesses up to. It is highly likely that debasement over the next half century will be no less than it was during the past half-century. In addition to preservation of capital, investors must be mindful of preservation of wealth!
The mounting national debt is a potential danger to the long term health of the US economy. What once seemed unthinkable that one day the United States government would no longer be accorded the highest credit rating is now not only thinkable, but increasingly probable. â€œI am concerned about the unsustainability of our long-term situation,â€ said Peter G. Peterson, a co-founder of the Blackstone Group and a prominent deficit critic, said in a recent New York Times Article.
In a quarterly report on the nation’s credit risk, Moody’s Rating Agency said there was an increasing probability of revising its outlook on its Aaa rating for the United States to negative from stable within the next two years if no action were taken. That stops well short of actually reducing the rating. But even a small revision, if it comes, would probably rattle the financial markets and might even hamper America’s ability to borrow the money it needs to finance its deficit. Moody’s has been rating United States government debt since 1917, and has always rated it Aaa. Within the last 20 years and counting, (known as the â€œlost decadeâ€) Japan’s debt rating has gone from Aaa to A and is only back to Aa.
As an American, I’d like to see us return to sound value, more production and less consumption, a hard currency and a government that doesn’t have the authority to saddle our grandchildren with debt. If we must spend, why not invest in our future: energy independence, modern airports and roads, education, water conservation, mass transportation, and other infrastructure?
While many countries of the emerging markets are now embracing their own version of the â€œAmerican Dreamâ€, many Americans are asking, â€œHave we outsourced the ‘American Dream’?â€ Possibly. But with turmoil comes opportunity. As long term investors, we must find ways to leverage the lessons from the past to maximize our returns going forward. Rest assured that Equitas will continue to search the globe in 2011 and beyond for the most profitable investment themes and best managers to execute those themes so that our clients will continue to have the tools necessary to navigate the perils that invariably lie ahead and so that they may prosper into the future.