The Year Ahead: Annual Market...
Tectonic Plates, Colliding
More than a few people today are no doubt feeling like Dante in those memorable opening lines of “The Divine Comedy”: lost, looking for the way back home, and fearful of what lies in store. The good news, of course, is that after descending to the depths of hell Dante then ultimately ascends to a glorious vision of heaven and winds up back in his native Florence much the better for the whole experience. We can all hope for a similar outcome après le deluge.
What began in the summer of 2007 as a disruption in the credit markets brought about by the effect of falling real estate prices on collateralized debt instruments turned into a full-blown pandemic in 2008 that not only triggered a worldwide crash in asset prices but in fact shook the very foundations upon which the global financial marketplace as we know it was built. For the perquisites and propensities of this global financial marketplace – we use the shorthand “Wall Street” although in reality the geography of this market long ago ceased to have any one single terrestrial epicenter – have for the better part of the last 30 years dictated the contours of our lives in far-reaching ways.
Wall Street hours for Wal-Mart wages – Americans now work longer, earn less and get fewer vacation days, fewer benefits and no job stability – but all the while we borrow more, consume more and thereby feed the insatiable Beast of the Quarterly Earnings Announcement, and the totality of this arrangement was supposed to be good, patriotic even. The American citizen somehow morphed into the American consumer, the reliable Borrower of Last Resort. The world economy depended on our incandescent desire for more stuff and Wall Street lined its coffers helping us find ingenious ways to spend more money we don’t actually have.
And then there was no Wall Street. The preening, chest-thumping Masters of the Universe turned off the lights and either closed up shop or settled into the déclassé status of regulated bank holding companies. The cops on the beat – the SEC whose charge was to protect Mr. & Mrs. Plain Old Investor from becoming chum in the feeding frenzy of the Sharks N Da Street – stood around slack-jawed and dazed as yet another shameless tale of malfeasance – a $50 billion fraud whose perpetrator, Bernard Madoff, once sat among the Valhallan gods of Self-Regulatory Organizations as chairman of the Nasdaq Stock Market – served as the sad coda for a miserable year.
Gotterdämmerung – the twilight of the gods – reigned in all places. The policymakers whose apparent genius was breathlessly celebrated by earnest middlebrow journalism over the years – think of Alan Greenspan and his sidekicks on the Committee to Save the World chronicled by Time Magazine in the late 1990s, steeped in their Chicago School mantras of efficient markets and Rational Man – turned out to be shocked, shocked, that when you figuratively give gluttonous drunkards the keys to the liquor store they will, to be perfectly blunt, get extremely drunk and bloated, and then die. Or, at the very least, cease being Masters of the Universe and become Quasi-Civil Servants instead, clinging obsessively for one last time to the toys of their bygone days – the corporate jets with Hermès silk pillowcases, the $35,000 antique commodes as office furniture, and of course the bonuses rewarding them for value they destroyed rather than created. Fitting is the title to a forthcoming book by Newsweek financial correspondent Daniel Gross called Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation (Simon & Schuster, February 2009).
For three months in the fall of 2008 the tremulous arias of this vivid opera frightened and fascinated us, with the Dow Jones Industrial Average falling by 800 points one day and then rising by the same amount the next, with auto loans disappearing from the reach of all except the most perfect credit ratings, with economists’ dour references to the decade of the 1970s giving way to bleaker still comparisons with the 1930s. The final two months of the US presidential campaign played out against the sharp clarity of our economic deluge, and Americans went to the polls to take a chance on the candidate, Barack Obama, who over the course of a long, brutal campaign had seemingly come into possession of the trade rights to the words “hope” and “change”, words in which most of us desperately wanted to believe.
Now, six weeks into 2009, the opera continues. The Dow Jones Industrial Average and the S&P 500 both closed more than 8% down for the year to date at January month-end. That’s supposedly an ill portent for the year, at least according to that particular strain of market kibitzer which touts the “January effect”, a dubious but mildly entertaining prognostication that places undue weight on performance during the first calendar month of the year. More likely than not, though, the fate of popular nostrums like the January effect will be to gather dust in the attic as memories of a different time – the once bright, fluffy and cheerful festoonery of a 25 year bull run, the longest and the most profitable since the outset of the 20th century.
But whatever the stock market does for the rest of 2009 – and very plausibly that could be a rally, another crash or a jerky sideways corridor – will not change the enduring effects of the tectonic collision that in 2008 sank the World Made by Wall Street. The economy of the past three decades, a creature of debt-fueled US consumption bankrolled by Asian and petrodollar savings, will not reassert itself any time soon. Something else is going to generate whatever growth we are capable of achieving in the coming future, and figuring out what that “something” is will be the key to successful long-term investing. The regulatory and policymaking institutions, and the legal and academic theories that support them, will be different. We believe there will be significant socio-cultural changes as well, including the rather existential question of what it is exactly that nation-states and their individual citizens expect and demand of one another.
So 2009 really is a new beginning. To commemorate this we have chosen as our decorative panel at the top of the first page of this report several images that we think are appropriate. At the center of these five images is a familiar representation – the Gaussian (normal) distribution that underlies so much of our probability-based theories about risk and return in investment markets.
2008 showed us the practical limits of these risk management approaches and we discussed this in a commentary to our clients last year called “The Limits of Analysis”.
To the left of the Gaussian distribution graph is the image of a black swan. This refers to a term popularized by the mathematician Nassim Taleb, author of “The Black Swan: The Impact of the Highly Improbable”. The essence of Taleb’s Weltanschauung is that conventional risk measurements (like Gaussian distributions) are useless in that the only risks that really matter are the ones we cannot anticipate and thus cannot measure – the eponymous “black swans”.
On the other side of the bell curve image there is a depiction of the Chinese phrase “wei ji”, commonly translated as “crisis” but actually consisting of the two characters for “danger” and “opportunity”. We would elaborate on this except that it seems blazingly self-explanatory given our present circumstances. Yes – to quote a tried and true Old Russian proverb, those who don’t risk anything will never drink Champagne.
But for those who prefer their images to be a bit more tangible and down-to-earth, well, there’s a tempest at sea girding the left side of the panel and a calming sunrise as its twin bookend on the right. The confusion and violent passions of the storm, these things pass and yield to the clarity and serenity of the morning light. It has always been thus, and always will be. In the meantime settle in and buckle up – we’re in for the ride of a lifetime.