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High Anxiety on Wall Street
This past week saw high anxiety on Wall Street. And
I'm not talking about the 1977 comedy film by Mel Brooks either. We saw
the worst week for US stocks since the Great Depression which ended on
Friday with the most volatile trading session ever in history.
This week, I believe, was part of the payback for a
decade of excess. During this decade, Wall Street exploited the
opportunity to create a false prosperity based on a debt-driven consumer
binge. At the same time, Wall Street enriched themselves by trillions of
dollars. Now the hangover headache for all Americans will be very
unpleasant.
Instead of statues of a bull and bear on Wall
Street, there should be a statue of a Trojan horse. It was not some
outside force that has brought America to the brink of financial
disaster. It was the incredibly greedy “Masters of the Universe” on Wall
Street that has put America on the brink of the largest financial
calamity since the Great Depression..
There is good reason to doubt that the US
government will succeed in re-inflating the bubble. In an effort to save
their own skins and prevent consumers from a return to living within
their means, politicians are again making a bogus promise that
everything will be fine, but only if we go even more deeply into debt.
After all, who could ever imagine Americans living within their means
ever again and actually saving money? We need more debt!
Hedge Funds aka Investment Companies
Specifically this week, much of the carnage on
global stock markets this past week can be laid at the feet of hedge
funds. Many of the 'genius' hedge fund managers, who controlled $2
trillion in assets, were incredibly over-leveraged. This past week, many
hedge funds were forced to de-leverage and liquidate pretty much
everything they owned, at any price, in an effort to survive.
I am struck by the parallels between hedge funds
and the investment companies that flourished on Wall Street in the late
1920s. By 1929, it seemed as if a new investment company was being
launched nearly every day amidst frenzied demand from investors.
Investment companies promised their investors
investment expertise from professional money managers. Investment
companies used borrowed capital in an attempt to increase investment
returns. Investment companies imposed restrictions on the ability of
investors to withdraw their money.
Investment companies were also shrouded in secrecy.
No one knew what their holdings were or what their investment strategy
was or what the renumeration was for their managers. Investment company
managers were highly compensated via incentive contracts. For instance,
managers of the famous Goldman Sachs Trading Corporation received 20 per
cent of any profits above an 8% threshold.
Does the description of investment companies sound
familiar? It should. Can you say modern-day hedge funds? What happened
to investors in these investment companies? Most of these investors were
wiped out in the Great Depression. Investment companies died and gave
way to the birth of mutual funds and much greater regulation of
financial markets by the government.
More Parallels
There are parallels from the crash in 1929 to the
recent crash we have had in the stock market. In 1929, the financial
system had also been grossly over-leveraged and the de-leveraging which
followed had the effect of draining credit from the real economy.
Famed economist John Maynard Keynes observed in
1931 that the whole panic in the markets resulted from the slump in the
value of assets held by the banks. Sounds eerily familiar. Sadly, the
disagreements between policy makers globally on how to solve the problem
is also eerily familiar.
Stock Market History
It turns out that the stock market in this decade
is more similar to 1930s than people realize. I saw an interesting chart
this week The chart compared the performance of the S&P 500 index
(rebased) for the periods from December 1929 to October 1938, and from
Dec 1999 to October 2008.
The chart patterns are somewhat different. The drop
from 1929 to 1932 is much steeper than the drop from 1999 to 2002.
Perhaps the 1999 to 2002 drop was lessened by all of the bubbles that
Alan Greenspan was blowing. However, the ending point is the same, down
approximately 40%.
So a better historical parallel may be to say that
we are not in a new 1929 - hooray! However, we may be in a new 1938. If
so, that is not so good news either. In the decade that followed 1938,
the S&P 500 gained a whopping 5%.
Not All Is Lost
What is an investor to do? Hope is not a viable
investing strategy. Neither is giving up. What investors need to do is
to go back to the basics. Think long-term. Forget the Jim Cramer method
of short-term, momentum trading.
Look for companies that have great balance sheets.
Look for companies that have very little debt, particularly short-term
debt that needs to be rolled over soon. Better yet, look for companies
with no debt, a boatload of cash, and that are paying a healthy
dividend. With the massive drop in stock prices, there are now many high
quality companies with a good dividend yield.
I would also prefer companies that have real
businesses and real assets. Avoid companies that just shuffle paper
assets, such as financial companies. Also avoid companies based on
'gadgets' such as many tech companies. I would concentrate on companies
that own real assets such as gold, oil, other metals and minerals,
farmland, etc.
Do not forget the one major difference between now
and the 1930s – the rise economically of the emerging markets. Keep in
mind that there is a huge difference currently between the performance
of the emerging stock markets and the actual emerging market economies.
Next year, China will still grow at 9%, India at 6%, Brazil and Russia
at 4%, etc.
These megatrends – growth in Asia, energy,
infrastructure – have not disappeared. These trends still have trillions
of dollars of wealth behind them. Does anyone seriously think that the
emerging nations, with their trillions of dollars in wealth, will ignore
the needs of their own people and throw the money down a Wall Street
rabbit hole, ala Alice in Wonderland.
Regards,
Tony Daltorio
Analyst,
Oxbury Research
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