Diary of a Hedgehog E-Book

Barton Biggs

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch
• Veröffentlichungsjahr: 2012

Seitenzahl: 345

Beschreibung

Barton Biggs was a Wall Street legend, trusted by investors around the globe. Now, in his last book, Biggs offers savvy insights into the innermost workings of the markets--today and for the years to come. Packed with keen insights, global experiences, and opinionated stances on investing, Diary of a Hedgehog: Biggs' Final Words on the Markets explores the ongoing downward economic spiral and where it's headed, to help readers keep their money safe and secure. Offering a unique look at the current state of the markets, why they continue to be depressed, and where we can go from here, Diary of a Hedgehog: Biggs' Final Words on the Markets is the ultimate guide to how investors--and the general public--should be handling their finances. * The last book from investment legend Barton Biggs * Offers investors and business readers of all levels of experience new insights into the current economic crisis * Presents news ideas for readers looking to make the most of their money in the face of ongoing market turbulence Insightful and creative, Diary of a Hedgehog: Biggs' Final Words on the Markets is the ultimate resource for anyone who wants to understand what's up with the market, where it's headed, and how to respond.

Leseprobe

Contents

Acknowledgments

Introduction

Mid-2010

FDR’s Fiscal Policy Redux

Staying Close to the Shore

Stay Long but Watch the Ticks

This Is No Time to Get Wobbly, George!

Make No Mistake: More QE Is Big Stuff

The Best and the Brightest Are Still Licking Their Wounds

Nobody Can See His Own Backswing

Fire and Ice

Miss at Least One Meeting a Day

Stick to Your Guns

Stage Two of a Cyclical Bull Market

The First Word in Analyst Is Anal

2011

Be Long Term but Watch the Ticks

Shake Well Before Using

Fancy Dinner and Candlelight

Stevie Cohen Tells a Good Story

The Canary in the Coal Mine?

Still Hanging in There

The Market Is a Discounting Mechanism

The Madness of Crowds

Earthquakes and Equities

The Riddle of Japan

Start Buying the Dips

Babbling Away

Swensen and Yale

The “Atlantic Crisis”

Turn Off Your Bloomberg and Tune Out the Babel

The New Face of China

Harvesting the “Grapes of Our Own Wrath”

No More Water, the Fire Next Time

The Valley of Death

Lest We Forget

“If You’re Going through Hell, Keep Going!”

Begin Thinking about Buying

Agnostic Optimist

My Bet Is that the Rally Is Still a Work in Process

The Truth Will Set You Free but Chardonnay Isn’t Bad Either

Investing in a World Lit Only by Fire

Private Equity

Another Tsunami

2012

A Tough Call

No Bull

The Elderly Kid Goes to a Tech Conference

Positive Change at the Margin Continues

Simpson Bowles Forever

Shake Well Before Using

This Business Is Getting More Complicated

Conclusion

Cover Background Image: © Ursula Alter/iStockphoto

Cover Illustration (hedgehog): © Igor Djorovic/iStockphoto

Cover design: Michael Freeland

Copyright © 2012 by Barton Biggs. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Biggs, Barton, 1932-2012

Diary of a hedgehog : Biggs’ final words on the markets / Barton Biggs.

p. cm.

ISBN 978-1-118-29999-9 (cloth) — 978-1-118-43176-4 (ebk) — 978-1-118-43178-8 (ebk) — 978-1-118-43160-3 (ebk) 1. Hedge funds. I. Title.

HG4530.B5153 2012

332.64’524 — dc23

2012033913

“He jests at scars who never felt a wound.”

—Shakespeare, Romeo and Juliet (Romeo at II, ii)

“If anyone really knew they wouldn’t tell you.”

—Anonymous

A Personal Message to Readers

Three days after the last entry in this diary, I spoke to my father on the phone and he told me he felt very ill. I was surprised, because he rarely admitted to feeling sick, but my concerns eased when he said he’d been to see his doctor, and had been given some medication for the flu. “This is really some flu, though,” he told me, “I feel terrible.”

A day and a half later, his condition had deteriorated to the point that he had to be rushed to the emergency room. Tests showed that rather than a flu, his symptoms were the result of a virulent staph infection that had probably entered his bloodstream through a minor cut or scratch.

There were periods of optimism over the next several weeks as he fought the infection with typical defiance and stoicism. But the illness, as well as some of the so-called cures, took a heavy toll on several of his vital organs, and it eventually became clear (to him before the rest of us) that this was a battle he wasn’t going to win. He spent his last days at home, surrounded by close friends and his children, grandchildren, and extended family. On a pleasant Saturday evening, seven weeks to the day after our phone conversation, he died in his bedroom.

As the following pages make clear, my father believed that a great investor had to always be learning. He was a student of history and literature, and when discussing investing, it wasn’t unusual for him to cite Frost or Yeats, or to draw on the lessons of a great battle from a historical war. Concepts from philosophy and psychology were as important to him as charts and statistics. He frequently likened investing to combat, and talked about investment survival in terms usually reserved for life and death issues. No doubt, much of his success as an investor can be attributed to his ability to apply the broader themes of life to his work.

Over these last months, however, I have learned that this relationship worked both ways; not only did knowledge and understanding of the major themes of life help him to face investment challenges, but experience with the great themes of investing helped him to face life’s challenges. I’m struck by the parallels between how my father faced the difficulties of recent years as an investor, and how he faced the difficulties of his final weeks of life. In both, he was a realist, able to assess a situation with matter-of-fact reasoning and clarity. And while ever an optimist at his core, in investing and in life, when it was time to face an unpleasant reality, he did so with courage and conviction.

I confess that prior to this summer, I had wondered if my father was, in some sense, terrified by death. He went to great lengths to stay young for his years, keeping himself in excellent physical shape, and pursuing activities like mountain climbing, tennis, and even touch football long after most people his age had moved on to less rigorous pursuits. Professionally, he had no interest in retirement, and intellectually, he maintained a fresh point of view on modern culture and world events when many of his contemporaries had slipped into the narrow, stale thinking that is sometimes a symptom of age. So, while loving these things about my father, I also wondered how he would react when he had to face his own mortality.

He answered these questions for me as I spent time with him during his final days. As death became inevitable, he seemed serene, accepting, and perhaps even a bit eager to find out what was coming next. I sensed calmness, clarity, and a gentleness towards those around him. I detected no fear. After reading this book, I understand that it was his experience with facing questions of investment survival, those “life and death” investment questions he stared down every day, that helped him to face death with strength, courage, and dignity.

—Barton Biggs, Jr.

In Memoriam

Barton Biggs

November 26, 1932 – July 14, 2012

We at John Wiley & Sons are privileged to have published several books by Barton Biggs. Barton was an accomplished writer and a meticulous wordsmith. His first book, Hedgehogging, was a brilliant behind-the-scenes look at the players and the workings of Wall Street. For his next book, Wealth, War & Wisdom, Barton moved away from a discussion of the current markets to examine the intersection of financial crisis and the turning points of World War II.

We are especially pleased to publish Diary of a Hedgehog, which Barton completed shortly before his untimely passing. His observations on Wall Street were always illuminating, and this book is a collection of his investment commentary.

He reviewed the columns and provided introductory material before his death. The pages were then reviewed by his son, Barton Biggs.

Here are the books written by Barton Biggs.

Hedghogging

Wealth, War & Wisdom

A Hedgefund Tale of Reach & Grasp: or What’s Heaven For?

Diary of Hedgehog: Biggs’ Final Word on the Markets.

Acknowledgments

The publisher, John Wiley & Sons, and I wish to thank Bank Itaú BBA for its generosity in letting us use the material I wrote for them in this book.

Introduction

Macro investing as I try to practice it is simple but never easy. It’s not just about wrestling with the global environment and getting your asset allocation positioned. Good information, thoughtful analysis, quick but not impulsive reactions, and knowledge of the historic interaction among companies, sectors, countries, and asset classes under similar circumstances in the past are all important ingredients in getting the legendary “it,” that we all strive so desperately for, right. A worldview is essential, but you don’t have to be Henry Kissinger gazing out the window to the far horizons and thinking deep, world-shaking strategic thoughts.

Moreover, there are no relationships or equations that always work. Quantitatively based solutions and asset allocation equations invariably fail as they are designed to capture what would have worked in the previous cycle, whereas the next one remains a riddle wrapped in an enigma. The successful macro investor must be some magical mixture of an acute analyst, an investment scholar, a listener, a historian, and a riverboat gambler, and be a voracious reader. Reading is crucial. Charlie Munger, a great investor and a very sagacious old guy, said it best:

I have said that in my whole life, I have known no wise person, over a broad subject matter who didn’t read all the time—none, zero. Now I know all kinds of shrewd people who by staying within a narrow area do very well without reading. But investment is a broad area. So if you think you’re going to be good at it and not read all the time you have a different idea than I do.

But the investment process is only half the battle. The other weighty component is struggling with yourself and immunizing yourself from the psychological effects of the swings of markets, career risk, the pressure of benchmarks, competition, and the loneliness of the long distance runner. We are all vulnerable in varying proportions to the debilitating and destructive consequences of these malignancies and there are no easy answers. Age and experience to a certain extent temper them but we are what we are. I’ve come to believe a personal investment diary is a step in the right direction in coping with these pressures, getting to know yourself, and improving your investment behavior.

Such a diary has to be written in the heat of the moment, in the fire and agony of the time, not retroactively or retrospectively. Its value comes from reading your thoughts and emotions later in the context of events and seeing where you were right and wrong. My writings for Itaú and my letters to investors are my investment diary of these crisis years that seem to drag on so interminably. As I scan through them, it’s appalling and frightening how often I was influenced, swept away by the ebb and flow of the battle (and it is a battle—the battle for investment survival), and made bad decisions.

Mid-2010

FDR’s Fiscal Policy Redux

After a very strong 2009, markets rallied briskly through most of April and a whiff of “maybe we are truly out of the woods” exhilaration swept through the still traumatized crowd, most of whom were still licking their wounds. We gained almost 6% in March, then abruptly a painful correction began at the beginning of May. Once again the chorus of “sell in May and go away” was heard.

We begin the diary in the first days of July 2010 with the S&P 500 down and the fund off 6.6% for the year to date. Not a happy time. As you will see, I was too cautious and as a result missed the first somewhat timid leg of the move higher that was developing. As usual, there were compelling arguments from both the bulls and the bears, but as markets fell, for uncertain souls like me the negative case became more compelling. Fortunately, long positions in U.S. energy stocks and in Asia kept me going. The gains of July were mostly retraced in August. The moral of the story is that you were probably better off to keep your powder dry until the fog of war lifted and then load up in late August, early September.

July 8, 2010

Equity markets and the high-frequency economic data around the world are weakening. Over the last couple of weeks, employment numbers, production indices, house price measures, and funding market stresses have been uniformly disappointing—and disconcerting. The S&P 500 sets the tone for the world, and in the last few days it has stumbled through the February and June correction bottoms reaching a new low for the year, and Treasury bond yields in both America and Germany are setting new lows. What’s more worrisome is that it is beginning to appear that the so-called Authorities are on the verge of making a serious policy error comparable to what occurred in the 1930s by prematurely tightening fiscal policy.

Keep Your Powder Dry

Data source: Bloomberg

Until the last week or so the received wisdom was that the global economy after its powerful recovery was entering a “soft patch” for several quarters during which growth would continue but at a slower pace. It was generally conceded that the stimulus programs were beginning to run off and that the recovery was healthy but not yet self-sustaining. In other words, that the patient was still a little fragile. The European sovereign debt crisis and funding issues in the banking system also were creating some uneasiness. Meanwhile, in the U.S., consumer confidence was falling faster than expected and measures of economic growth such as retail activity, the PMIs and ISMs were clearly showing that the pace of growth, the so-called second derivative, almost everywhere was slowing. More ominously the ECRI leading indicator (which, incidentally, has had an excellent forecasting record) has collapsed to a 45-week low in the most precipitous slide in fifty years. Investors were beginning to get nervous although the businessmen we talked with in the U.S., Asia, and Europe were telling us of strong order flows and activity.

On the other hand, at this stage of a recovery cycle after a full-fledged financial panic, doubt and worry about the vibrancy of the economy are normal. The bears come out of the woodwork. Alan Greenspan made this very point last week in an interview on television. ISI points out that in September 1992 Time magazine, at a similar cyclical moment, wrote:

The US economy remains almost comatose. The slump already ranks as the longest period of sustained weakness since the Depression. The economy is staggering under many structural burdens, as opposed to familiar “cyclical” problems. The structural faults represent once-in-a-lifetime dislocations that will take years to work out. Among them: the job drought, the debt hangover, the banking collapse, the real estate depression, the health-care cost explosion, and the runaway federal deficit.

This paragraph sounds like what the doomsayer economists whose last names begin with R on CNBC are saying today. The great economist Joseph Schumpeter liked to say: “Pessimistic visions about almost anything always strike the public as more erudite than optimistic ones.” It turned out that the economy was in a temporary soft spot in the fall of 1992 and stocks were about to soar. In fact, one of the greatest bull markets in history was about to begin.

However, the new development in the current equation is the tightening bias of the Authorities and the extreme rhetoric and power of the austerity brigade. Just this past weekend the chairman of the European Central Bank (ECB), a moderate man, added his voice to the chorus. Although most of the savants are maintaining that additional fiscal juice is needed to prevent the present global “soft patch” from becoming a “double dip,” the high priests of the temple who want us to be punished NOW for our sins with immediate pain and suffering are calling for no more stimulus.

As it has turned out, President Obama was the only leader at the G-20 meetings calling for more stimuli to sustain what he labeled as a “still developing recovery.” Ironically, the president’s own country is not listening. The Congress last week failed to extend unemployment insurance and is considering other measures to restrain spending. With the mid-term elections only months away and visions of Tea Parties dancing in their heads, partisan politics are affecting the willingness of many incumbent politicians to approve new spending programs. As it stands now, the U.S. will withdraw from both structural and cyclical forces about 4.5% of fiscal impetus from real GDP over the next five quarters as spending legislation and tax cuts expire.

At the same time, the other major economic powers are imposing fiscal austerity of one type or another to shrink budget deficits. To wit: the new U.K. government has presented a stringent emergency budget that adds to the tightening already in place another minus 4.3% of GDP; the new Japanese prime minister says he is going to restrain JGB issuance and raise taxes; and European fiscal policy is frantically moving towards the most aggressive tightening in more than four decades. The most extreme examples are Spain’s, where fiscal impetus is targeted at minus 5.4%, Portugal minus 6.9%, and Greece minus 6.8%, with Germany, France, and Italy in the minus 2% area. However, bear in mind that the recovery from the recession in Europe (with the possible exception of Germany) is barely perceptible. Emerging Asia where the economic resurgence is by far the most firmly based also is justifiably tightening, and a few Asian central banks are actually hiking interest rates. On the other hand, China, the third largest economy in the world and one of the principal growth engines, seems to be attempting to reduce real GDP growth from its current 10–11% to 7–9% over the next four quarters.

Thus the worrywarts like me are afraid that the U.S. and the world are going to repeat the error that Franklin D. Roosevelt (FDR) made in the late 1930s. FDR, assailed by conservatives for his boondoggles and public spending programs and believing that the Great Depression was over, in early 1937 imposed tax increases and drastic spending cuts that took about 5% out of GDP—or about the same amount as we are doing now. Then industrial production plummeted, the economy aborted into another recession, and the stock market, which had tripled from its 1932 low, plummeted 50% and gave back over half of its gains in 15 months. Back then the German economy was the strongest major in the world and Europe in general was increasing defense spending as World War II loomed, so its fiscal policy was expansionary—not concretionary as it is today. However, back then there were no billion-population dynamos with high growth rates and potential like Indonesia and the BRICs (Brazil, Russia, India, and China) are today.

After a financial panic, severe recession, and a secular bear market such as we have experienced followed by an economic recovery and major stock market rally that retraces about half of the ground lost, it makes a lot of difference what then happens to the economy. At about the stage of the revival that we are in, it is normal for business activity and the stock market to become choppy as investors and businessmen are still licking their wounds. If after its big revival the economy transitions into nothing more serious than a soft patch of slower growth (say 2% to 3% real GDP for two to three quarters), investors worry but stocks usually pull back only 10% to 15% before surging again. However, if the economy suffers a “double dip” (two to four quarters of real GDP growth of only around 1.5% with no improvement in employment), then stocks can plunge 25% to 30% as everyone becomes really frightened that the stall will turn into another recession. If, heaven forbid, another recession actually occurs, then the declines can be far more severe as happened in the late 1930s. The bears are speaking of a testing of the lows of the spring of 2009.

Complicating the assessment is whether the environment is inherently inflationary or deflationary. For the time being, deflation seems to be more of a threat than inflation. As Japan has demonstrated, deflation is a very insidious plague because low or declining nominal GDP emasculates consumer spending (don’t buy now because it will cost less later) and corporate profits. If the U.S. and the world slip back into a long stall or another recession, some episodes of deflation are probable. However, Jim Cramer’s rants on CNBC about “deflation now” in my opinion are far too dramatic.

So what do I think is going to happen? Frankly, I’m not sure because, as noted, I am very concerned that governments and politicians are making a serious policy error by tightening fiscal policy. A massive dose of austerity makes about as much sense as the 18th- and 19th-century practice of bloodletting from deathly ill patients. Eventually we must reduce the size of government deficits and overall debt, but we need a self-sustaining expansion of the U.S. and global economy to be firmly ensconced before we start raising taxes and drastically reducing government expenditures. By moving prematurely, the Authorities are playing with fire and the outcome could be disastrous. Since I am an optimist (most of the time), I think we will come to our senses on policy. The global economy is frail but regaining its health, although the mature developed countries could be in for a “new normal” of slower, trend-line growth. However the emerging markets are a new and very positive force for world growth and for multinational companies. The BRICs are gradually transitioning from being export-dependent, commodity producers to domestic, consumer demand–driven growth. That’s good. The only consistently profitable extractive industry is dentistry.

Quarterly GDP growth forecasts

Source: Traxis Partners LP

The table on page 8 summarizes our most likely outlook. As you can see, it envisions a mild double dip.

For the time being, I am reducing my exposure to equities very substantially. I think a long-only equity account should have its maximum permissible cash position. What would make me change my mind? Several months of rising employment numbers, a firming of house prices in the U.S., real progress on stress testing of European banks and the unlocking of the banking system, or another significant injection of fiscal or monetary (quantitative easing by the Fed) stimulus in the U.S. Obviously a further decline in stock prices and signs of panic selling would also be helpful. At this point my sense is that the aggressive money is beginning to understand the negatives I have outlined above but is not yet positioned for it.

Unfortunately bonds are not an attractive alternative at this point unless you believe a recession with whiffs of deflation is likely. Bonds are already priced for a double dip. Treasuries and bonds are overbought and most other fixed-income markets such as high yield and emerging market debt are extended. High-grade corporate bonds are the least unattractive category.

As for stocks, large capitalization, high-quality American equities with global franchises and good dividend yields are a fine place to be for the long run. In particular, big capitalization technology, capital equipment, oil service, pharmaceuticals, consumer cyclicals, and probably the REITs are attractive. Most major names in these categories are demonstrably cheap on earnings, free cash flow, true book value, and yield. Our studies indicate that only twice in the last hundred years have they been as cheap relative to the rest of the market. There is no urgency to buy them now, but unless you are running a hedge fund I would not disturb long-term positions. If the economy stumbles they will get cheaper.

As the forecast table suggests, emerging markets are still the place to be, but bear in mind that the great global multinationals are major participants in the developing economies. Warren Buffett has said he prefers to get his emerging market exposure through companies like Coca-Cola, McDonalds, etc. I prefer mine through more direct participation.

Chinese equities have had a big and, in my view, an unjustified correction. After a recent visit kicking the dusty tires, I am quite confident China is artfully managing its exchange rate, the economy, and asset prices for sustained progress. My affection also extends to many other Asian emerging markets and the BRICs, particularly India. The longer term, trend-line growth for Europe and Japan may only be 1.5%, for the U.S. 2.5%, but 5% for the developing world. That’s a big difference!

Staying Close to the Shore

The sad truth is you may be right where the market is going, but you can’t possibly predict where it will go after that. I was uncertain in July 2010 so I was staying close to shore and treading water. Don’t forget you can be 200% wrong when you switch; sometimes twiddling your thumbs is the least malignant activity.

July 19, 2010

In the last two weeks the global economic outlook has deteriorated, and equity markets after an initial rally in early July faltered at the end of last week. I remain uninspired. It is too soon to tell whether the world economy is transitioning into a “soft patch” or a more serious “double dip.” For the time being, what happens in the global economy in the next three to six months will rule financial markets. I will need more high-frequency data before changing my basic position, which is now to be around 40–50% net long equities in a hedge fund account and to be holding 15–20% cash in a long-only, benchmark-judged equity account. Being long Treasuries, bonds, and high-grade corporates is the same as being short equities. High-yield, distressed, and emerging market debt are directly correlated with equities, as are the industrial commodities. I have no strong convictions on currencies. Remember what Keynes said when he was questioned about his uncertainty. “When the facts change, I change my mind. What would you do, sir?”

The most recent high-frequency data indicates that global growth, which essentially rolled over in late May and early June, is now declining. In most cases this is the second derivative change—in other words a decline in the rate of change. Global manufacturing, which surged 12% from its low, is now expanding 7–8% on its way to perhaps 5%. This can be construed as a “soft patch”—a normal correction at this stage of the recovery cycle as production aligns with final demand. If the recovery is truly self-sustaining, this pause should be followed after a few quarters by stronger gains as employment increases and credit flows. History suggests that if this benign outcome is the case, with the S&P 500 having fallen 18% and other markets around the world down by roughly similar magnitudes, the decline is probably about over.

What bothers me is that the financial panic and global recession we experienced were substantially more extreme than any post–World War II cycle. Everyone either has read or is reading Reinhart and Rogoff’s book This Time Is Different (Princeton University Press, 2009), which argues forcefully that what’s different ain’t good. At this point, both the banking system and confidence are still suffering from a severe hangover that paralyzes capital spending, hiring, and the animal spirits of the commercial beast. It also casts a pall over the stock market. Since so many subliminally believe that the stock market is the best forecaster of the economy, a negative feedback cycle comes into play.

European banks’ balance sheets and capital accounts are not healed, and at the end of last week there were renewed signs of stress in the interbank lending markets. Consumer confidence in America is very fragile. In fact, the University of Michigan survey that was released last Friday showed one of the steepest declines on record. Something like half to two-thirds of the swings in U.S. retail spending are driven by the top 10% of income families. As I have mentioned previously, house prices and stocks in the vast majority are what affect these people’s net worth. It appears that in June the decline in the stock market had quite an effect. Unfortunately house prices don’t look that healthy either, but we will know more this week.

Meanwhile the very latest data indicate sharp declines in industrial production around the world. It appears the pace of China’s IP not only slowed in June but actually declined. This is a big deal! China is the growth engine of the world currently accounting for almost half of world GDP growth. If it conks out, global growth is going to come in much lower than now expected. At a small lunch last week, two very rich, very well-connected Chinese industrialists painted a sobering picture of the near-term outlook for the Chinese economy. They maintain that the government does not presently have the monetary tools to stimulate the economy because real estate is the lever of the transmission mechanism, and land and property prices are falling. The world needs a vibrant China, and it is possible GDP growth, which was 10.8% in the first quarter and around 7.2% in the second, could fall to 4–5% in the second half of the year. The Chinese stock market has underperformed so far this year and is grossly oversold. I have a big position, and I am concerned.

Another important engine of world growth is emerging Asia, which over the past year has been expanding at a 10% pace. Now all of a sudden two of the biggest economies, Korea and Taiwan, are drastically slowing towards what I hope will be a 5% pace. Don’t be misled by the very strong numbers posted by Singapore. It’s a tiny economy. Japan is still a basket case and is now having to endure another emasculated prime minister and a hung parliament. Disinflation is almost everywhere, with the exception of India. Last week the U.S. reported the lowest inflation in 50 years. Remember Gibson’s Paradox.

When inflation falls below 2%, it is no longer good for equities; it is bad and price-to-earnings ratios fall. What all this says to me is that the odds have increased to 50-50 not for a two-quarter pause, where world real GDP falls to 2–3% in a “soft patch,” but a longer “double dip,” where GDP growth slows to 1.5% and there are whiffs of deflation. Equity markets could have another 10% on the downside if the latter is the case. The high-frequency data on PMIs, ISMs, employment, and house prices will tell the tale. If we actually fell into another recession with mild deflation, prices could decline considerably further. This is what happened in 1938 after FDR tightened prematurely in 1937.

What keeps me awake at nights is the worry that the governments and central banks of the world, instead of alleviating the risks of a double dip or a recession within a recession, are compounding them by making a “policy error.” Of course I believe we eventually will have to deleverage, write off the bad debt, recapitalize the banks, et cetera, but the sensible way to do it is to spread the pain over five to ten years rather than concentrate it in two years or three years of a Great Depression and a massive dose of Hegelian Creative Destruction. The global economy is too fragile, the political system too distended, the disparities between rich and poor too extreme. Revolutions and Barbarians at the Gates. Look what happened in the 1930s and then the 1940s. The Tea Party movement may just be a precursor.

The mistake the Authorities are making is that they are tightening fiscal policy and withdrawing stimulus at a time when the recovery is not self-sustaining and in fact is weakening. They should be pumping steroids into the system, not withdrawing them. The analogy is with a patient who has suffered a life-threatening infection. His doctors gave him powerful antibiotics and steroids. He began to recover and move around, and now he is eating again. His doctors, confident he is ready to stop the drug regime before it has run its course, are lecturing that drugs are bad for you. Of course you don’t want to get hooked on them, but on the other hand, you want to be fully recovered before you go cold turkey. Now the poor guy is flushed, is running a low fever again, and is in a weaker position to fight the infection.

On the other hand, to repeat, I can seldom remember such overwhelming bearishness by the great wise men, professors, and stock market soothsayers. My experience has been that it is almost always right to bet against them when the consensus is the largest and the loudest. The surveys show that the hedge fund, aggressive investor world, although nervous, does not seem to be positioned for a major decline. As I said at the beginning, I would stay close to shore.

Stay Long but Watch the Ticks

Investing, whether aggressively or long term, is about averaging into a stance, whether bullish or bearish. Getting the timing exactly right when loading up or cutting back is a rare pleasure. As you will read, I am somewhat timidly moving towards a more fully invested stance. At this time I was gradually developing the confidence to build a major position in U.S. technology and was benefitting from being short Brazil and U.K. real estate.

July 26, 2010

I have increased my net long in equities from 50% to 75%, a posture I consider moderately but not wildly bullish. What has made me change my mind? I’m not making any money but it seems as though the clouds are lifting.

What has altered is that the economic data over the last ten days have been better than the experts’ expectations. The global economy is showing surprising resilience, and Europe, supposedly the sick man of the world, is actually accelerating. One swallow doesn’t make a spring, and the situation is still precarious, with whiffs of deflation, but the case for a soft patch rather than a double dip has strengthened. That’s what equity and credit markets are focused on, and to the extent it continues, stocks will move higher, government and high grade corporate bonds will sell off, and high-yield and emerging-market debt spreads will contract.

Investor sentiment about equities is still depressed, pessimism about the economic recovery and President Obama is elevated, valuations are reasonable, and there is a huge amount of cash—public, institutional, and hedge fund—on the sidelines earning nothing. In essence, for the next few months owning equities may be the least bad alternative in an uncertain world. As a benchmark, the S&P 500 could have a rally up towards the top of its trading range for the year; in other words, a move of 10–15% is conceivable. That’s worth playing for. After that, we have to wait and see the shape of the global economy. Nothing is inevitable.

Last Friday European consumer confidence, retail sales, and industrial production numbers, instead of deteriorating as was forecasted, actually strengthened and in some cases were downright strong. Admittedly much of the gain was concentrated in the German economy, which constitutes over 40% of Euroland. The stress test results for the European banks released late Friday were positive, even if the rigor of the exam was not as intense in its treatment of sovereign debt holdings as some would have liked. In addition, real GDP in the U.K. rose 4.5% in the second quarter.

In the U.S., the high-frequency numbers are looking better. My two keys—employment and existing single-family home prices—are gradually improving. ISI’s weekly company surveys of retail, capital goods, truckers, and construction all rose for the first time in almost a month. Admittedly they are still below their April highs. Companies continue to report superb second-quarter earnings, and, in general, second-half guidance is for more of the same. Corporate balance sheets are financial fortresses.

In non-Japan Asia and China, growth is coming off the boil and is settling back towards the trend of 5–6% for the former and 7–8% for the latter, but after all, there is nothing shabby about that. Eastern Europe continues to recover, but Japan is faltering again. Similar to the U.S., global GDP is soft-patching.

Finally, stock markets around the world have improved. To some it is heresy, but the truth of the matter is that for America, stock market action has been an excellent forecaster of the path of the economy and is included in the best leading indexes. This is not surprising when you recall that markets are a discounting mechanism, and they are a highly visible barometer of confidence for both businessmen and consumers. When we met with corporate executives over the last few weeks, they were telling us: “Our business is good and orders for the second half look strong. Before we came to New York, we were feeling confident but now after listening to the bearish economists, Wall Street, and CNBC, we are doubtful.” Also, in the U.S. equities represent almost half of the spending class’s net worth.

None of this is to say that we are out of the deep woods. The global economy is fragile. I’m still worried that the governments and central banks are making a serious policy error by tightening prematurely. The risk of deflation remains high, and government deficits, debt, and spending are out of control. There are bubbles out there that are yet to be popped. The U.S. economy has experienced the strongest recovery in nearly 30 years, but the recession was deeper than any since the early 1930s. Thus job creation and the breadth of the recovery are still depressed, and it remains to be seen how the people in the developed economies will react to sticky, high unemployment and benefit deductions.

However, there is no use in our beating our breasts indefinitely. There could be an opportunity here. I still think non-Japan Asia is the growth cockpit of the world. The Chinese H share market (an index of the major Chinese companies that is heavily weighted towards the banks) and Hong Kong may be turning as China takes its foot off the brake. Korea and Taiwan have discounted a slowdown in economic growth from almost 10% to 5%, and markets such as Indonesia and Thailand (particularly the banks) look attractive. Emerging markets should be a major destination for long-term money, particularly Brazil, Russia, Poland, and Turkey.

In the U.S., as I have previously discussed, big-capitalization, high-quality stocks are unusual long-term investment values. This group ranges from the great consumer franchise names to capital goods and technology companies such as Caterpillar, United Technologies, and Cisco. I suggest reading Jeremy Grantham’s latest letter on the Web (Jeremy Grantham Summer Essay). Grantham is an original and great thinker, and his long epistle is worth digesting and thinking about. He writes that there is a possibility of a run back towards the highs of 2000 and 2007, which could then be followed by the apocalypse. I have also added to my holdings of certain large-cap U.S. technology stocks (a new equipment cycle is beginning), pharmaceuticals, REITs, and oil service.

This Is No Time to Get Wobbly, George!

As the old saying goes, the trouble with the stock market is not that it is controlled by mathematical factors, or that it is controlled by non-mathematical factors, but that it is controlled by both. This is what I was writing in mid-August.

August 16, 2010