“We act as though we are able to predict historical events, or, even worse,
as if we are able to change the course of history. We produce thirty-year
projections of social security deficits and oil prices without realizing that we
cannot even predict these for next summer—our cumulative prediction
errors for political and economic events are so monstrous that every time I
look at the empirical record I have to pinch myself to verify that I am not
dreaming. What is surprising is not the magnitude of our forecast errors,
but our absence of awareness of it.”

The Black Swan
By Nassim Nicholas Taleb

Readings

“On October 1, according to Thomson Financial, the Wall Street consensus was that S&P 500 earnings would rise a whopping 47% from the fourth quarter of 2007. Now, analysts think earnings actually fell 15% from a year ago…But analysts are still gung-ho about the future. Analysts expect S&P 500 earnings to be roughly flat this year, according to Thomson, but post a 33% year-over-year rebound in the fourth quarter”…Wall Street Journal, January 12th.

“Credulity Suffers Bigger Losses Than Markets in 2008: After a year of a near-collapse of the credit markets, the demise of storied investment banks and unprecedented government efforts to rescues the financial system, 2008 might actually be remembered for the demise of credulity… Unique in this boom-and-bust cycle is the lack of skepticism that permitted the most elaborate structures the world has ever seen to be foisted on a credulous investment public, in this case almost exclusively supposed sophisticated institutions around the globe. What distinguished both the sellers and buyers of these complex instruments is that, in most cases, they all shared the same advanced degrees from top universities, where they all were indoctrinated with the same theories. At the core is the faith that risk could be eliminated by employing the right structure; or if not eliminated entirely, then at least transferred. Financial engineering based on statistics and using advanced mathematics and massive computing power could produce what medieval alchemists could not: Turn lead into gold. It takes a high intelligence and a higher level of learning to understand how a triple-A credit could be constructed out of a bunch of dicey loans made to people who could not afford to pay for over-priced houses”…Barron’s Online, December 24th. 

“France is to step up efforts to instill moral values in the global market economy by urging policymakers to consider fresh ways of combating financial short-termism…‘There is no system of wealth creation without a system of values and this values system has been badly shaken,’ said Eric Bosson, the French minister for policy planning. ‘People are prepared to accept others getting high pay and enjoying different lifestyles, but only if they have a feeling that the system is fair and that the law is the same for everybody’”…Financial Times, January 3rd. (Note: You know losses will be huge when global markets need moral lessons from the French government!)

“The dilemma facing investors in government bonds: Two-year treasury bonds yield less than 1%. The 30-year bond yielding less than 3%...All this is occurring when Western governments are conducting an immense economic experiment, with vast fiscal stimuli accompanied by monetary expansion. In the medium term, a sharp rise in inflation is a distinct possibility…This leaves investors with a dilemma. In the short term, they may like government bonds for the security they offer. Treasury bonds outperformed the S&P 500 index by an incredible 53 percentage points last year. But if yields are heading back to 4-5% (or even higher) by 2011 or 2012, at what point do they sell? The rational investor would want to get out of the asset class before the herd decides to do so. The logical extension of that argument (assuming most investors are rational) is to sell now. But what if Japan provides the template? Many people thought Japanese bonds were over-priced when yields fell to 1-2% in the late 1990’s. They have stayed around that level for the past decade despite a vast amount of issuance…The crucial difference is that Japan has been running current-account surpluses, not deficits. The Japanese owe the money to themselves whereas Americans are in debt to foreigners…It is a precarious balance. It may well hold through 2009 and even 2010. But at some point, government bonds will surely suffer a horrendous bear market”…The Economist, January 10th.

“Rents for office space dropped 1.2% in the fourth quarter nationwide when such landlord concessions as free rent were taken into account, according to Reis Inc., a New York real-estate research firm. It was the largest one quarter decline since 2003, and came after rents rose 10.6 % in 2007…Markets hit hardest by the crisis in finance and the housing markets saw the biggest declines. Rents in California’s Orange County fell the most, by 3.6% in the fourth quarter. In New York City, rents were off 2.1%”…The Wall Street Journal, January 6th. 

“Where have all your savings gone? If savers treated financial assets as they do other goods, they would sell them when they are expensive and buy them when they are cheap. Actually, they do the opposite. They piled into the market in 1999-2000, at the peak, and are piling out of it now. They should, of course, have got out in 2000, when the global price-earnings ration was 35; shares look relatively much more attractive now, since the ratio is down to ten…Inadequate savings badly managed are a problem for individuals and the economy. Cautious savers are putting their money in banks; banks are reluctant to lend; companies therefore find it hard both the borrow money and to raise equity capital. This timidity hurts companies and, in the long term, savers. Implausible as it may sound, right now equities and corporate bonds are a better long-term bet than cash”…The Economist, December 6th.

“Well, we did it again. Only eight years after the last big financial boom ended in disaster, we’re now in the migraine hangover of an even bigger one. Every time this happens, we think it will be the last time. But it never will be…In the words of the great investor Jeremy Grantham: ‘We will learn an enormous amount in the very short time, quite a bit in the medium term, and absolutely nothing in the long term.’”
Former Merrill Lynch Internet Analyst Henry Blodget
The Atlantic, December 2008

Reflections

I spent the holidays with my extended family in north Dallas. After the past few years in Florida, it seemed like boom-time. As a Wall Street Journal article noted on January 6th:  “In the 1980s and 1990s, more than 800 banks and thrifts in Texas went bust, doomed by the oil and real-estate bust and foolish lending. But with the U.S banking industry now suffering through its worst mess since then, Texas banks have been surprisingly resilient.” It seemed more homes were being built than have been built in years in Sarasota. And not small homes either. Yet the local press reported that homes in the three major Texas cities rose in value between 2 and 3% in 2008. Restaurants and malls seemed quite busy, even considering the season.

Yet when I worshipped with my sister in her prominent mega-church, I was startled when the young assistant pastor began by informing the audience this “is the worst economy since the Great Depression.” The young pastor should be forgiven as I’ve read several economists who should know better who’ve used the same unfortunate language. Yet while I’ve grown quite accustomed to hearing questionable economics in religious circles, this pronouncement caused genuine cognitive dissonance for me. For it came in an exquisite sanctuary complete with cafeteria, stores and television cameras beaming his economic message around Dallas. The campus was huge and included a school. Sis said they have another campus and may build more.

Ironically, the young pastor then asked members to give generously as the church was under budget for the year, which undoubtedly caused him to “see reality not as it is but as we are.” Apparently, he had also never read all those studies on philanthropy that suggest people’s perceptions of the economic future may influence their giving at least as much as current economic realities. As a percentage of income, giving was relatively high during the Great Depression. It stagnated during the early nineties when even best-selling religious books forecast another depression. I expect it did again when they predicted Y2K would end Western civilization. Yet even ministers, who are supposed to count blessings and be focused on the eternal, never seem to learn anything for the long-term, particularly about economics. So while there are very real and disturbing similarities to 1929 today, it might enrich us to look at the economy as a car. We’ve been speeding along at 75 but have recently slowed to a less than maximum 65. We may go slower yet. But by comparison, we were doing 20 when I was born in 1950, about 15 when my mother was born in 1929 and about 5 at the depths of the Great Depression. Yes, the recent slowdown of 10 mph may equal that of the Great Depression but the cars, and our comfort, have little in common. Here are the facts: 

According to the U.S. Department of Commerce, annual per-capita income was about $700, unadjusted for inflation, and $273 for farm people, who constituted the majority of Americans, in 1929. My mother can remember a year during the thirties when her farm family of seven had cash income of $100. When I was born in 1950, per capita income was around $1,500 per American, which is about $11,000 in today’s dollars. By 2008, it was nearly $40,000. The unemployment rate is currently 7.2%. In 1933, it was 23.6%. In 1950, it was 6.5% and was headed to 10.8% in 1982. Most economists thought 5% was the “natural unemployment rate” as less would cause undue inflation. The Dow Jones Industrial Average peaked in 2007 around 14,000. It fell by less than 40% last year. The Dow peaked near 400 in 1929 and fell by roughly 90% to about 40 in 1933. By 1950, it had only risen to a bit over 200. GDP was likely down a bit during 2008; it fell by 40% from 1929 to 1933. In 1929, federal spending, which tends to be less cyclical than personal spending, was 3% of national income. It is roughly 20% today, with spending by the states adding around another 10%. My guess is we are headed for a more stable but less dynamic economy, similar to pre-Thatcher Great Britain or even the current Denmark where government spending exceeds 40% of GDP. 

So it’s good we also enjoy a relatively stable political environment as President-elect Obama begins New Deal Two as America’s wealth and income is again highly concentrated among the elite. Don’t under-estimate that. It is a nearly unbelievable piece of American history that during 1933, a group of prominent industrialists reportedly planned to over-throw Roosevelt and establish a fascist empire. They were reportedly led by the Du Pont and J.P. Morgan empires and joined by other well-known American corporations, supposedly including Senator Prescott Bush, granddaddy of W. They were to install General Smedley Butler, called the “racketeer for capitalism,” as a dictator but loyal to democracy, he reported the plot to Congress. Yes, that sounds like Internet conspiracy theory; but I’ve confirmed it with a political historian I trust and it was reported by the BBC and the New York Times. Still, if you’re like me--and as a political science graduate I am surprised by little--you’ll need to Google Butler’s name to explore the plot for yourself. That will also cause you to be most glad you’re living now rather than the 30’s. 

Still, we have real economic problems, which is why we’d better keep hope alive and transcend politics for a while. Our recently departed friend Sir John Templeton told us in 1999 that American stocks would go nowhere during this decade. He was more than correct of course, as he had been for decades. However, I’ve recently discovered that Sir John grew even more bearish than I had thought. I stopped bothering Sir John about markets around 2003 or 2004. Apparently, some continued to ask his opinion; for a friend has just shared a formal three-page letter John wrote in June 2005. It is entitled “Financial Chaos.” Here are the most important excerpts:

“I am now thinking that the dangers are more numerous and far larger than ever before in my lifetime. Quite likely, as we near the end of the first six months of 2005, the peak of prosperity is behind us…Debts are over ten-fold greater now than in 1970. This can lead to manifold increases in bankruptcy auctions…Clearly, major corrections are likely in the next few years…Voters are likely to insist on rescue-type subsidies…Not yet have I found any better method to prosper during the future financial chaos, which is likely to last many years, than to keep your net worth in shares in those corporations which have proven to have the widest possible profit margins and the most rapidly increasing profits.” “God only knows” if John’s prediction of Dow one million during this century will also prove reliable. But I’m sure glad to have known him this decade. 

Readings & Reflections is an email publication of The Financial Seminary, a non-profit whose sole interest is to encourage the reintegration of spirit and ethics into political economy and personal finances. While R&R is written by an investment professional who gladly submits this newsletter to officials trained in the intricacies of securities regulations, nothing in it should be construed as counsel to consider any particular investment opportunity. R&R is also posted on www.financialseminary.org, along with other articles and speeches by Gary Moore, the Seminary’s founder, and other contributors .Gary Moore offers securities through NPC of America (NPCOA), Member FINRA/SIPC. Gary Moore & Company, The Financial Seminary and NPCOA are separate and unrelated companies. The political, religious and ethical opinions contained are not endorsed by NPCOA. Opinions are not intended to provide specific investment advice and should not be construed as recommendations for any individual. To determine which investments and investment strategies may be appropriate for you, consult your financial, tax or legal professional. Please remember that investment decisions should be based on an individual’s objectives, goals, time horizon, and tolerance for risk. Furthermore, any listing of a vendor or product does not constitute an endorsement or warranty of the vendor or product by NPCOA. NPCOA is not to be held responsible for, and not be held liable for, the adequacy of the information contained herein. International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods. Past performance cannot guarantee future results.