Saturday, January 2, 2010

Martin Capital Management - Fireside Chat No. 7: Among the Last Skeptics Standing

Rather, the question that should be on everyone’s mind is whether the reflation in the prices of stocks and lower-quality bonds is a false-positive error, one born of excessive credulity. If the markets in risky assets are correct in forecasting a sustainable economic recovery enabled by a smoothly functioning financial system, that prospect has already been priced into the markets with the Shiller PE pushing a “bubble territory” 20 times earnings.
If, on the other hand, the current financial and economic episode is not a run-of-the-mill, post-World War II business contraction but rather the aftershock of a massive credit bubble that went into overdrive post-2000 , a Shiller PE of 10 is not out of the question. Having read daily summaries for the last seven months of the feature stories in the Wall Street Journal for the corresponding day in 1930, two conclusions jump off the pages: First, for every pound of wheat there were 10 pounds of chaff and, second, the focus was so much on the short term and so deeply influenced by the herd instinct that virtually no one saw (nor did the market discount) the onrushing Depression tsunami until it overwhelmed them. The ongoing exercise is almost surreal—like reading a murder mystery having already seen the end. You turn page after page, incredulous, as the characters miss clue after clue. It reads so much like today.
The future hinges on forces not easily seen among all the news clutter. Like the 1930s, the “experimenters” in Washington are unquestionably bright but so inexperienced as to often be inept. Their mental models have proved time and again to be too small for the huge task at hand. The factors that make headlines—growth vs. stagnation, inflation vs. deflation, the cost/benefit trade-offs of multiple monetary and fiscal stimulus packages, fiscal budget and trade deficits, dollar devaluation—fall substantially into the realm of the unknowable. Those factors that get little public attention (Will the growing segment of the population that feels disenfranchised be made to once again feel empowered? Will business shake off the burden of leftist government intervention and higher taxes and become spontaneously optimistic?) are the ones that will determine whether employment and the economy generally rise or whether they stagnate. Will the “great moderation” be followed by the “great malaise”? I wish it weren’t so, but I wouldn’t bet against it.
Related books:
Related link: News from 1930