I just quantified my 401k stock portfolio for the first time since the spring of 2007. (My rule: Open statements when markets rising and toss them when falling.)
Bottom line: Damage done, but not tragedy.
The question: Is this April 1930, or July 1932? After falling around a third in the 1929 crash, stocks recovered almost half the loss over the next six months; then they fell again, hitting values in July 1933 barely 10 percent the 1929 high.
Why shouldn’t now be more like April 1930? Look at the landscape:
Looting, power-mad politicians are in control and are strangling the economy’s “animal spirits,” which suggests deflation. The value of our currency is being wrecked, which suggests inflation. Judy Shelton (below) says we already have the latter, with the funny-money going into stocks, bonds, gold, even real estate (none of those should be rising given unemployment, low capacity utilization, savaged balance sheets and more).
It looks to me like big wheeler-dealers are borrowing nearly-free money and putting it into stocks and other financials – the “carry trade.” Are there big earnings ahead for the companies they’re buying, notwithstanding the policy poison the pols are mainstreaming into the economy’s lifeblood? I don’t see it.
Instead, this looks like a trap – when rates start to climb the smart boys will exit and the market will crash. Unlike 1987, when the market popped right back, today there’s no virtuous policy mix and no big productivity gains percolating.
So what pops the bubble? All the funny money creation tastes great and seems less filling at the moment. And I do believe in Tinkerbelle, I do believe in Tinkerbelle – not. See Douglas Holtz-Eakin (below).
Current Asset Allocation Choices (and the downside of each):
- Gold: Already has been a big run-up despite deflationary real economy.
- Real estate: It’s steady to rising (with exceptions) despite deflationary real economy.
- Bonds: They’re strong (rates low), despite unprecedented government debt and funny money creation.
- Stocks: We’ve had a big run-up from the low, despite public policy poison and dubious future earnings prospects.
- Cash (in dollars): It’s being eroded by dollar decline.
Jeez, what’s left – Swiss Francs? (The Swiss have gone wobbly on some things too, but still . . .)
Maybe a few eggs in energy stocks – the havoc the pols are wreaking there may enrich select real energy providers who can still function (oil services, perhaps).
from The Fed’s Woody Allen Policy: Efforts to stoke a recovery may be creating new asset bubbles in equities and elsewhere, By Judy Shelton, WSJ, 11/11/09:
In the Woody Allen film “Annie Hall,” the main character tries to explain irrational relationships by recounting an old joke. “This guy goes to a psychiatrist and says, ‘My brother’s crazy, he thinks he’s a chicken.’ The doctor says, ‘Well, why don’t you turn him in?’ And the guy says, ‘I would, but I need the eggs.'”
It takes similar reasoning to reconcile the elation felt across America every time the stock market rises—partially replenishing personal investment portfolios and 401(k) retirement plans—with the uneasy feeling that we are being set up for yet another big financial disappointment. We dare to hope that the economy is growing solidly once more, that the Federal Reserve has superior knowledge about providing liquidity, and that the U.S. Treasury knows what it’s doing by guaranteeing money market-fund assets.
But what if the Fed’s efforts to stoke a recovery are merely creating asset bubbles in equities and elsewhere? What if government guarantees—explicit and implicit—are encouraging high-risk investment behavior rather than restoring conditions for normal market returns? What if excess dollars produced here are being channeled by speculators into foreign stock and bond markets as part of a currency play?
. . . But wait a minute. If unemployment is high, doesn’t that indicate a surplus of labor relative to the demand for labor? Wouldn’t that cause the price of labor to come down? If you throw in the fact that industrial capacity utilization, at 70%, is lower now than during any prior recession since the Fed began tracking it in 1967, and that the housing vacancy rate is nearly 11%, you begin to wonder why the price level should nevertheless continue to rise, even by a little bit, every month.
. . . But the Fed seems to think that prices should only go in one direction—up—no matter the circumstances. It’s this bias toward inflation that is revealed by the FOMC’s reference to “stable inflation expectations”—which is less a paean to price stability than an inadvertent oxymoron.
The Fed’s asymmetrical thinking extends as well to its treatment of financial assets—such as equity and debt instruments—en route to a bubble. As prices surge and markets soar, the Fed is reluctant to raise interest rates lest it be accused of hindering growth. But when the bubble bursts and asset prices begin to tumble, the Fed quickly steps in with dramatic interest rate reductions to “restore investor confidence” in hopes of avoiding a meltdown.
The answer would seem to lie in whether the Fed’s money machine is fueling an illusory recovery that is only manifested in financial markets as opposed to the general economy.
. . . Sure, we could be facing the latest Fed-induced bubble—but so what? We need the eggs.
from The Coming Deficit Disaster, by Douglas Holtz-Eakin, WSJ, 11/20/09:
“At what point, some financial analysts ask, do rating agencies downgrade the United States? When do lenders price additional risk to federal borrowing, leading to a damaging spike in interest rates? How quickly will international investors flee the dollar for a new reserve currency? And how will the resulting higher interest rates, diminished dollar, higher inflation, and economic distress manifest itself? Given the president’s recent reception in China—friendly but fruitless—these answers may come sooner than any of us would like.”
Ben Stein, 1/20/2009:
. . . we have been fooled so much in the past 15 months about what real earnings are, what real book value is, that we cannot trust the data given to us. Yes, by current price-earnings measures, stocks look fairly reasonable. But we don’t really know what true earnings are. That is the vicious truth. So if we are in the quicksand of not being able to rely on the data our companies give out, then anything can happen. Yes, we may be at a bottom or near it. Or we may not be anywhere near a bottom.
Ben Stein, 1/6/2009
. . . Still, I have learned a bit of a lesson. I was wrong to have as little as I did in cash and Treasuries. I was wrong to be as sanguine as I was about my stocks and real estate in terms of their volatility. It was, in fact, possible for almost everything to collapse at once — and it did. “The market trades to cause maximum pain” is a fine adage for investors then, now, and in the future.
Toward the end of his life, Ben Graham, Warren Buffett’s brilliant teacher on value investing, told his friends that he had decided the stock market was simply too dangerous for him; he would keep all of his money in Treasuries. He was much smarter than I am; I am still foolish enough to think I should have a good chunk in stocks, especially at the current marked-down prices. Mr. Graham, by the way, died in the mid 1970s — a terrible time to own either bonds or stocks.
But, although I will keep money in stocks, I will keep more than I did in insured cash and Treasuries. I will follow the advice of author and speaker Raymond J. Lucia to keep many years worth of spending needs in cash or near cash. I will, in a word, hedge myself more in US government bonds and cash than I previously did. I shake when I think of this because I feel sure inflation will eventually come back in a big way. But I am hedged on that — I hope — by my real estate, which I did not — cannot — sell.