2012: The Year Ahead

In 1989 a political scientist named Francis Fukuyama wrote an article titled “The End of History?” in the international affairs journal The National Interest. Due no doubt to the timing and the provocative title, the article became a must-read among the foreign affairs chattering classes and led to a 1992 book with the expanded title (and absence of a question mark) “The End of History and the Last Man”. Exactly two hundred years had bookended the onset of the French Revolution and the crumbling of the Berlin Wall. After numerous experiments and wrong turns, argued Fukuyama, the “last man standing” was the political system of small-l liberal, representative democracy. The days of the divine right of kings had come and gone, and the more recent Frankensteins of communism and fascism had likewise been consigned to the dustbin of history. All that would happen in the future, went this line of reasoning, would be ever more perfect forms of representative democracy – more suffrage, more freedom from arbitrary persecution, less discrimination against minorities and marginalized citizens. Truly, a more perfect union.

While Fukuyama was not an economist, there was a clear economic context to his “last man standing”. The representative democracy would be the Elysian fields of opportunity where anyone could dream a dream of a more prosperous life and see it come true within his or her lifetime. The so-called “invisible hand”, born in the fervid intellectual climate of the eighteenth century Enlightenment, would forevermore reign in the practical world of enlightened, free trade and commerce.

When we stand back and allow ourselves to take in a sweep of history that goes back more than two hundred years it is easy to identify some colossal markers of progress. In much of the world today there is indeed less discrimination. There is more participation in the mechanics of civil society, and more economic opportunity for more people than was the case even fifty years ago, let alone two centuries ago. At the same time, though, history is not over – it continues. In 2011 the continuation of history was a constant context for an exceedingly volatile year in investment markets. History continued in Tunisia, in Tahrir Square and Zuccotti Park, in Athens and Moscow, while the S&P 500 lurched up or down by more than 2% on sixty trading days (as compared to not accomplishing this feat on even one trading day just six years ago, in 2005).

That’s what makes looking at historical progress so difficult. Draw a line between two points, say, one in 1789 and one in 2012 with no reference points in between, and you will most certainly have an upward-sloping line that reflects how much freer and more prosperous so many more people are today. That gives the illusion that progress somehow marches forward in a smooth, straight line. But reality looks bumpier than a straight line connecting two points. It looks…well, more like a stock market index:

[chart]

The Dow Jones Industrial Average launched in 1896. Eleven years later it plunged during the Panic of 1907 back to levels close to its outset level. For much of the remainder of the first two decades of the twentieth century the markets lurched along, buffeted by war, the dying gasps of European monarchies and the Molotov cocktails of revolution. Then – inexplicably – they soared to vast new heights during the Roaring Twenties. The Great Depression brought an end to those good times and another protracted period of volatility ensued. It took until the mid-1950s for price levels to regain the losses suffered during the 1930s, but in essence the seeds of a long-term bull market took root in the late 1940s, when visionary American leadership (remember what that looked like?) helped Europe and Japan back onto their feet after total devastation and facilitated a golden age of international growth and trade.

Francis Fukuyama’s error was in seeing this happy chapter of history – from the end of the Second World War to the demise of communism in Eastern Europe – as the final word. But humankind – civilization – just doesn’t work that way. There are questions anew about freedom and economic security, governance and what it really means to be a nation. In the revolutions of Europe during the tumultuous year of 1848 the two questions at the forefront of political debate were simply these: the national question (what does it mean to be a nation?), and the social question (how do we relate among each other, take care of each other, ensure fairness and access to one’s individual dreams without tearing apart the fabric of the society?). Those questions are still being hotly debated and challenged today. History continues.

So do markets. 2011 was a very strange year for investment markets, as we will see in this report. But look up again at that long-term chart of the Dow. Sometimes the market soars, sometimes it plunges. Most of the time it muddles along, and in the long run the direction trends up. When it behaves strangely people say that everything has changed, that old methods no longer work. People have said that since Dutch tulips cost more than a house in 17th century Amsterdam, and they have always been wrong.

That, we believe, is one thing that has not changed. Markets, too, continue. It’s time to go back to basics.