Mr. Raclin: At that time, the Enterprise Portfolio was up 1.7% for the year, The Dow was down 13%, the S&P had declined 11% and the NASDAQ was about even.
Markets have recovered sharply; we are having a good year with The Enterprise Portfolio up 43% year to date.
I think there are two issues to discuss. First, what have we learned from the fiasco and secondly, what are the likely repercussions, financially and politically?
We all have a good understanding of how we got into this mess. To review, a lot of people, who should have known better, as a result of arrogance and greed, ended up acting in the most bizarre fashion while claiming to be properly managing both their businesses and, their personal affairs. Whether it was Fannie Mae, AIG, Lehman Brothers, Bear Stearns and/or numerous other firms that barely survived, what really caught everybody by surprise, including myself, were that so many presumably well-respected people could be so irresponsible. It was the breadth, the numbers of institutions that acted so badly and the absolute size of their mistakes that truly staggered the system.
No shortage of villains; wannabe homeowners with no real expectation of paying their debts, banks who irresponsibly lent monies because they could send the risks to Wall Street, rating agencies that blessed almost anything breathing with a AAA moniker and professional investors, brokerage firms, ordinary individuals who thought they could outwit the markets. No shortage of villains.
Even as we understand how we got into this mess, the real question should be; what are the financial and political/regulatory repercussions? I think they will be severe. Despite the market's recent revival, there has been a sea change in the center of financial power, from Wall Street to Washington, a transference unseen since the aftermath of the Great Depression. Political considerations will impose significant constraints.
It was clear to me, at the beginning of the year, that the government would do whatever was necessary to save the financial system from imploding. It was a near thing, almost a complete meltdown when short-term credit markets froze up and very large, very creditworthy organizations were incapable of financing their businesses. This one had a real potential to bring down the system.
Many of the things that the government did were necessary, if politically unpalatable, to save the credit system. Without credit, nothing else in the economy can work. It was my experience during the Crash of 1987 when the then Federal Reserve Chairman Alan Greenspan declared that the Constitution was not a "suicide pact", that they were prepared and in fact, did take extraordinary measures, often without a legal justification, in order to save the capital markets. I expected no less this time and, I took full advantage. If one wants to know how the markets can have rallied so strongly in the face of such seeming disaster, one has to go no further than to remember Winston Churchill's famous quote; "Nothing is quite as exhilarating, as having been shot at and, missed".
Going forward, I don't think inflation is going to be a problem, at least for awhile, for several reasons. First, there is a tremendous amount of excess manufacturing capacity and ample labor availability. Secondly, the ongoing flood of relatively high quality, low priced imports should hold down prices. We are seeing an incredible amount of de-leveraging, paying the Piper, which is fairly deflationary.
The government is, as it should, leaning against these winds. Too bad they were not on the other side of the previous excesses as opposed to adding fuel to the fires. Massive stimulus programs are good for asset pricing; they stabilize housing with very low mortgage re-financings and a lot of the funds go into the stock and bond markets, keeping interest rates low and raising valuations. That is exactly what it was meant to do; stabilize the economy and support the capital markets. Rising stock prices exude confidence, a commodity that was in dire need of support.
In March, I anticipated an approximate 50% rebound from the market's bottom. When you get these sharp breaks, looking back to what the markets usually do once the crisis has passed, the charts almost always look like a square root sign; down sharply, back halfway and then sideways for a period of time. I think we've entered the sideways period with the S&P trading somewhere around 1005, up from a low of 666. From here it should be a low volume, a grudging, jagged recovery that will likely frustrate many participants.
I sense two great risks. The biggest risk is the dollar, the risk that comes from an irresponsible political class spending without a thought beyond the next election. While there is an incentive on the part of large owners of dollars not to let valuations go down too far because it will damage their existing holdings and to prevent Americans from gaining too much of a competitive advantage in export markets, it's a clearly a major longer-term consideration. I anticipate the Chinese, the Brazilians and other major countries outside of Europe will continue to attempt to come up with an alternative to both the Euro and the Dollar, perhaps a basket, for another reserve currency. The damage, should an alternative appear, could be significant. As the reserve currency, we pay all of our debts in dollars. Should we have to pay debts back in alternative currencies, it could cause a severe upheaval to our debt structure.
The second major risk I sense is the unraveling of our Middle Eastern policies, from the possibility of a fight between Israel and Iran, to the likely unpleasant end of our simply unsustainable situation in Afghanistan with resulting pressures on Pakistan. Americans are weary of war and as the various "allies" pull back, I sense that we too will increasingly abandon the battlefield. Our policies will not allow for the level of violence necessary to defeat these myriad foes. Lawyers have replaced Lieutenants. Obama and his minions do not have the stomach for prolonged conflict. Increasingly, neither do the rest of us.
In the short term, the economy will look like it is recovering but that will be due largely to inventory restocking and gimmicks like cash for clunkers. Ultimately, the economy is driven by the consumer which requires having both an access to credit, credit cards, mortgages, auto loans, and a willingness to incur additional debt. I sense that people are going to be very reluctant to take on additional debt. In fact, they are doing just the reverse; paying it down. The banks have been severely burned and are now concerned about prospects for difficulties in the commercial real estate market. They are likely to be very reluctant to lend to all but the most credit worthy buyers.
After an initial upsurge due to inventory restocking and other activities, the economy is likely to stabilize at a relatively low growth rate. Unemployment will remain quite high with a real political risk that politicians will put tremendous pressure, into the mid-term elections, on the Federal Reserve not to withdraw the stimulus too rapidly.
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