J. Pierpont Morgan had a stature in the financial world somewhat akin to that held by Warren Buffet today, only grander. When the U.S. Treasury was so distrusted that it could not float bonds, Morgan led a syndicate in 1893 to finance the Treasury’s needs. When a panic gripped the New York Stock exchange in 1907, what we would call today a “systemic breakdown”, Morgan organized powerful banks to purchase shares of key, financially healthy stocks. This renewed investor confidence and the crisis ended. Out of these events, Congress created the Federal Reserve banking system, so that the nation would never again rely on the good will of a single man or small group of financiers to avoid financial disaster.
After a century, confidence in the US Federal Reserve appears to be at an all time low, despite its being instrumental in avoiding a wide scale collapse of major financial institutions and a near-certain depression during the systemic crisis that came to a head three years ago. The abuse heaped on the Fed for “running the printing presses” is not necessarily justified, in my opinion. Much of what the Fed has done over the years has been to offset bad economic policies and programs created by from Congress and the President of the day. The Fed has attempted to compensate for distortions introduced into our economy by government sponsored programs like guaranteed mortgages, agricultural subsidies, social welfare programs, wars paid for by borrowing and rules that drive up the cost of labor. Federal Reserve Chairmen like Alan Greenspan and Ben Bernancke have pleaded with Congress to move toward a truly balanced budget in public testimony on scores of occasions. Now, it seems apparent that the Fed’s power to manage things is simply being overwhelmed by generations of profligate spending by Congress. Until recently, the rest of the world has had enough confidence in the financial might of the United States to extend credit with few questions asked. Now questions are being asked, and last week Congress provided no reassurance that meaningful reform of our profligate ways is at hand. In Europe, monetary decisions are made with a less coherent approach than our own. Regulators are suspected of abetting banks accounting to permit them to appear more solvent than they are in reality. Shaken confidence in the European economic union is now compounded by shaken confidence in the United States. Financial authorities and politicians both hope to see economic growth, especially unemployment rise, as this begins a virtuous cycle of improved tax revenues, and reduced welfare spending. So far this pattern is anemic, and now all levels of the financial world have become concerned.
What’s the investment decision to make in this environment? Undoubtedly, certain sectors of the equity market are particularly vulnerable to an economic slowdown: banks, cyclical companies (chemicals, steel, autos) and the defense and aerospace industry. But it seems illogical for some investors to be abandoning the shares of viable, financially sound businesses in the utility, food service and technology sectors for the illusory safety of cash. I’ve spent a lot of time reassessing our client holdings, held in discretionary managed balanced account. My conclusion is that what they own is of good quality and I see no intrinsic reason to join the headline panicked buffalo as they hurl themselves over a cliff. In fact, I’ve done a little buying or portfolio reorientation to companies that are showing themselves to be relatively resilient in the current environment.
For nearly all clients in balanced portfolios, our significant holding of bonds and preferred stocks issued by what appear to be sound borrowers is serving to brake the extent of notional losses on equity holdings. Further,most of our equity holdings throw off significant free cash flow of which much is shared in the form of dividends and stock re-purchases. Since we are being well compensated to sit tight, that is what I intend to do.
The US stock market has now declined approximately 15% from its April high, back to its November 2010 levels. From a technical perspective (the charts),it looks pretty unhealthy. Yet, the same thing could have been said last year, when the market fell through bullish trend lines while correcting by 16%. It then proceeded to rally by some 25%. In the short term, the markets are a voting mechanism, and I believe they are saying to the politicians: “grow up and get serious about this deficit”. Benjamin Graham, father of value investing is quoted as saying that In the long run the market is a weighing mechanism, meaning that regardless of how nervous traders “vote” during any given short term period,
the heavyweight businesses will recover and go on to provide a rising stream of income in the form of dividends and capital gains. With time, the price of these more substantial businesses will and must inevitably recover as the many calm rational long term investors (like ourselves)will spot an ever rising stream of dividend income, and spark buying of such healthy enterprises.
I cannot express my feelings any better than to quote the words of an article in Friday’s Financial Times:
“Some perspective is in order. If one was comfortable making a long-term bet on stocks back in December, much less at the April peak, then there is little reason to feel differently today unless fundamentals have changed. The likelihood that billions will be pulled out of stock funds just illustrates that the stock market is the only one in the world where customers run away during a sale.”
Financial Times, August 4 2011
