The interview that I enjoyed--and thought was particularly revealing--was with J. Kyle Rosen in Barrons.
Barron's: Characterize this market, if you would.
Rosen: Broadly, what is striking is that the great coordinated stimulus of 2000 to 2003 has run its course, and market indexes around the world look as if they peaked around April and May.
Three very powerful forces occurred at the same time within a year after the bear market: The Fed took interest rates down to 1%, there were massive tax cuts, especially on dividends and capital gains; and there has been unprecedented government spending, between Iraq and everything else. Now the pendulum is swinging the other way, and we are starting to see contraction in the money supply, and certain things on the horizon could intensify that reduction in liquidity.
Such as?
First, the Fed has been at this for a while; they've been slowly reducing available liquidity for two years now. The Fed's moving rates from 1% to 5.25% is not insignificant. Now Asia, which has been a big force in the market, has also started to raise rates. We've had a big reversal in trend, and it might not be over yet. Whether the Fed rate hikes are coming to an end or not, Asia and Europe are raising rates, and the 10-year Treasury note is probably as mispriced as it could be at 4.75%, given the amount of worldwide strength we are seeing.
The expansion in Asia has been incredible, which has helped fuel record highs in net worth and full employment in the U.S. People will continue to spend whatever they make, and so the economy should continue to hum along. But, overall, there is less money available to invest. Also, it's just three months to elections in the U.S. The election does not bode well for the Republicans or the stock market.
J. Kyle Rosen
The market doesn't seem very focused on the election.
Exactly. That is one of the big changes in the market. Everyone's time horizon has become so short. Years ago, people cared about annual returns. Then it turned into quarterly performance. Then it became monthly. Now the focus is on weekly returns. They'll worry about the election in November, which is a big mistake if you look at the ramifications of this election.
If the Republicans lose, the tax issue is going to come into play because there is almost no doubt that if the Democrats take one or more houses of Congress, tax policy is going to become less friendly toward business and investors. Spending is going to go down, because if the Democrats have their say, they are going to do everything in their power to reduce spending on Iraq.
There is a lot riding on this election. What seems pretty obvious, if you look at history, is that even if you take arguably the two most popular presidents of the past century, FDR and Reagan, they both had very poor results in the midterm election in their second terms, 1938 and 1986. So if the parties of the two most popular presidents struggled in their second terms, it is hard to imagine that the most unpopular president since Jimmy Carter is going to be able to do too much better. So it is shaping up where it could be a rout for the Democrats.
Even if the Republicans somehow pull off a miracle, the mood of the country has changed so much, they are going to be forced to at least pull back on spending. The question is: Does liquidity dry up a little or a lot? This multiple contraction of the past couple of years could continue.
Some think the market is already cheap.
A lot of analysts are arguing the bull case and declaring 15 times earnings a cheap multiple. It is not cheap. It is historically average. In 1982, 1974 and 1942, we were at seven times earnings. Not that I'm saying we are going to go to seven times earnings, but 15 times is not cheap and there are a lot of reasons why not.
There are liquidity issues, but also cultural reasons. The bear market was so severe in 2001 and 2002 that it changed a 20-year pattern of investing. After not investing throughout the "Seventies, small investors poured into the market in the "Eighties and "Nineties, causing a mutual-fund explosion. They got burned so badly in "02 that an entire generation started to reassess stocks as an investment. That was one of the causes of the housing boom. In a lot of areas, housing could be near a cyclical top, but the mutual-fund boom lasted for 20 years, and we are only five or six years into the housing boom.
Housing and real estate are not just financial assets, but represent quality-of-life issues, too. A house or a second home can be upgraded or fixed up even if there is a retrenchment and you can enjoy it, unlike a stock certificate that isn't going up. After 9/11, people realized this is getting to be a scary world and maybe they couldn't plan 30 years ahead, but they could enjoy themselves today in a house. And investing in a house is a lot easier for the average person to understand than is investing in stocks.
If you are going to invest in stocks for the long term, the action continues to be in Asia. It is a risky place to invest, but the way I'm approaching it is to put money into Asia after every decline. It has been 16 years since Japan's bull market peaked, and it is almost 60% below where it peaked, and that market is just starting to gather momentum. Japan has raised rates to 1% and the cycle is young. I would focus on Asia. But, overall, it is going to be tough sledding, and the May-June decline in the stock market was probably a hint of what's to come. |
