Kass: The Best of Times, the Worst of Times
By Doug Kass, the street.com,
This blog post originally appeared on RealMoney Silver on Nov. 1 at 8:55 a.m. EDT
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way — in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only. “– Charles Dickens, A Tale of Two Cities
So began A Tale of Two Cities, one of only two historical works of fiction written by Charles Dickens. Dickens’ novel depicts the plight of the French peasants who were beaten down by the French aristocrats in years leading up to the revolution, the corresponding brutality demonstrated by the oppressed toward the upper class amid the early years of the revolution and the depiction of many unflattering social parallels with life in London during those years.
The idea of the “people” against the “elites” in which social and political system changes occur, embodied in Dickens’ work, is a recurring one over the course of history — and is omnipresent today.
In the broadest sense, as investors in November 2010, we face the best of times and the worst of times.
Above all, the “best/worst” literary metaphor is most apt in the tension between the best of times (the cyclical tailwinds of monetary/fiscal stimulation that have buoyed growth) and the worst of times (the secular headwinds of a number of nontraditional factors that have produced a shallow recovery and that threaten a self-sustaining recovery).
The Best of Times
Politics. Today’s populism — manifested by increased activism, distrust in our financial institutions and rejection of the incumbent status quo — began two years ago with the 2008 Democratic tsunami and has continued with the Republican Tea Party. The midterm elections tomorrow seem likely to produce gridlock, which has traditionally been market-friendly.
The social condition. The breathtaking growth in the Tea Party signals a growing conservatism in the U.S., an ideology typically associated with a desire for less government spending and for legislation favoring business.
The economy and policy.
- Global coordination: Through a committed all-in central banking community around the world, we avoided an economic Armageddon two years ago.
- Record low interest rates: With short-term interest rates anchored at zero, there are few alternatives for investors.
- Liquidity aplenty: A resolved Fed is promising that liquidity will remain abundant.
- An uptrending economy:: The overall rate of worldwide economic growth, while shallow, remains positive. Over here, the Chicago, Dallas and Richmond PMIs were better than expected last week. Over there, U.K. GDP rose by almost twice the rate of consensus expectations and, overnight, the rate of growth in the China’s October PMI quickened to the most rapid pace in six months.
- A likely nadir in the unemployment rate: Future jobs growth, based on improving initial claims data (lowest since July) and a continued improvement in corporate profits, appears likely to improve — especially within the context of a possible repudiation of the administration’s policies in the midterm elections this week (which could serve to reinvigorate business confidence).
- Inflation remains quiescent: Inflation rates remain subdued, owing importantly to minimal gains in the employment cost index. Low wage growth will help to sustain corporate profit margins.
- Housing has bottomed: New-home production continues well below demographic and household formation growth trends, and with mortgage rates at generational lows, affordability at the best gauge in several decades and the benefit of homeownership over renting at 10-year highs, there is an accumulated buildup in latent demand for housing.
- The conditions for a normal and self-sustaining economic recovery are at hand: Interest rates are low, durable expenditures (automobiles and housing) have been deferred, and the unemployment rate has likely bottomed. The consensus of forecasters for a moderate improvement in economic growth is a conservative one.
Equities.
- Valuations are not rich: The U.S. stock market’s valuations (at around 13x) remain below the historic mean (15.5x). When placed against the currently low level of inflation and interest rates, share prices are even cheaper.
- Return expectations and individual investor participation are low: While slowly building in the near term, multiyear individual inflows into domestic equity funds has been limited, providing the potential for greater equity buying power (and interest) in the years ahead.
The Worst of Times
Politics. It can be argued that the likelihood of gridlock in the aftermath of this week’s midterm elections is not a P/E-expanding event, as the significance of our fiscal challenges (local, state and federal) and the currently weak domestic economic growth trajectory need to be quickly addressed. Moreover, the politics and policy of populism will remain with us for the foreseeable future and, with it, is the continuum of higher marginal tax rates for the wealthy and the burden of costly and cumbersome regulation (after years of laissez faire attitudes regarding policy within our regulatory agencies).
The social condition. Our Dickenesque condition of social inequality remains in the forefront of the political tide and future. The contempt for the wealthy and large corporations could be manifested in continued initiatives aimed at increasing upper-income earners’ tax rates and in reducing corporate profitability (through increased taxes and the costs of heightened regulation).
Categories: Food for Thought, Investment Wisdom, North America, The Big Picture