I know Carl through a mutual friend — he’s out in Washington State, and had been very successfully running several 100 million dollars, primarily in small cap companies. I’ve found his views to be informative and refreshing.
We last heard from Carl back in October, when he penned Its Dues Paying Time: American Myths Being Destroyed — And What May Happen Next.
Here’s his latest missive
Stimulus, A Little Stimulus, No Stimulus
by Carl Haefling
The question being battered around the internet, in conversations with friends and colleagues, and most obviously every political venue in the country is should we have a stimulus program; if so how large, how should it be spent,or given away? Maybe we should ask the 2m folks who lost jobs in 2008 and thus far in 2009 if we need a stimulus. Maybe we should ask the employees of businesses whose companies have disappeared, been downsized, or have seen the value of the stock held in retirement accounts decline by 50 to 100% in value.
There is a collective arrogance in Congress right now, and apparently a shared arrogance by those who do not believe their life style is going to be impacted by the economic downturn. There are still those who believe that tax cuts will improve the economy, and that the trickle down effect espoused by Republicans over the past 20 years will make all things whole. Denial and being oppositional are powerful forces. We have seen the culmination of deregulation, lower taxes, increased spending, and a free for all financial system with little regard to systemic risk lead us down a gangplank. We collectively fell off of the gangplank in September. The Republicans never knew they were walking down a gangplank, and never took the steps necessary to prevent what is currently happening when they were in control. They complained about big government and made it bigger. They complained about spending on social programs and education turned around and spent every dollar they cut and more in the military-industrial complex. They deregulated our financial systems, speeded up the decline of our environment, (natural and man made) and gave economic advantage to those whose first concern is a $50m bonus, stock options and building financial empires.
The Democrats also have an arrogance as they glow in the glory of having won control of the administration, legislature, and many state governments. Somehow they believe that by winning—they won. They have yet to win anything except an election. Now they have to prove they are worthy of winning. The real issue is that in our national elections, we really only have two choices, and it is possible that each are bad ones. The Democrats for a period of time when they were a minority in Congress screamed about spending. What they were really screaming about was spending in ways they approved. Now that they are in power, they are bickering about spending amongst themselves, and seem to have little understanding of developing programs that may provide relief to those trying to make home and car payments or considering the purchase of either. The Democrats may succeed in moving a stimulus/spending bill through the senate, but will they be able to arrive at compromises between the house and the senate?
In a poll I saw today, almost 50% of the workforce believes they are in jeopardy of losing their jobs. It makes me wonder how many who are entering the workforce for the first time have hope of finding a job? Let’s ask a simple question. If you believe you may lose your job, would you purchase a home or a car? If you were a bank and thought that your client who wanted a mortgage may loose their job in the next 12 months, would you loan them the money? Lets ask a few more questions. If you thought your retirement was insured with a tidy stock portfolio and CD’s yielding 5% at the beginning of 2008, and that at the end of the year discovered the stocks had dropped by 50 to 90% in value and CD’s were at best yielding 3%, would you think about buying anything other than food and paying your health insurance? Would you still plan on retirement? It is being estimated that the amount of wealth lost in the United States alone will be over $3 trillion dollars. That includes loss of value in homes, businesses, and equities.
I have been outlining in my various email letters for about 3 to 4 years how the clues that we were heading for a financial disaster and possible depression were emerging. Many of my ex clients (I retired two years ago) and readers thought I was at best overly cautious, and at worst chronically immersed in gloom and doom, with little ability to see the positive. I have explained to my clients, friends and those who follow my own trading in the market that every time I buy a stock, I see hope and at least an ounce of something positive happening that provides cause for the purchase. And I will become optimistic, most likely, when things become the bleakest. Currently the headlines suggest that the future is bleak, President Obama is fearful of a collapse of the economy, and people are loosing their jobs at the rate of 500,000 a month. Can it become worse? Yes, it can.
Over the past few years I have outlined how economic declines in many ways are reflections of the psychological health of the economy. The economy is behavioral. If you can understand how collective behavior is represented in the purchasing patterns of investors and traders, than you can also apply that to the economy and the behavior by those responsible for decision making in for profit and even non profit organizations. Ultimately there are, and I am simplifying this in the name of brevity, a few core behaviors that are always at play in the decision making of executives, investors and even consumers.
The first is self-preservation. When things get bad, the first issue to be addressed is protecting assets, paying off liabilities and saving as much as possible.
CEO’s start reducing expenditures, the next step is to reduce salaries, and third is to start laying off employees. Its really not anymore complicated than that.
Investors, for a variety of reasons, choose to liquefy when they become concerned about declining values. At first they maybe concerned with problems in a sector, prices become to high like they did in the internet/tech boom of the late nineties, so they sell. How many of us remember that when the internet/tech collapse happened the NASDAQ dropped by 90%? Fear drove investors into a mass panic of selling eventually taking many high flying technology and internet companies below the value of the cash on their balance sheets. What makes us believe the DJI may not drop 80 to 90% from its high?
Consumers follow a similar pattern. They cut back on non-essential purchases like an expensive coffee drink, return to buying groceries that are not labeled organic, they try to save more, and eventually if things really get bad they choose not to buy any big ticket item. But even in good times self preservation is a dominant behavior. Our notion of self may shift from taking care of our survival needs, to taking care of our discretionary needs. Our decision making takes on a different set of driving forces, but self-preservation whether it is feeding ourselves or keeping our identity is our concern.
The second behavior impacting decision making is fear. It can be fear of many different things, including fear of failure, fear of loss of savings, fear of loosing one’s job, fear of loosing one’s identity, fear of loosing control, fear of not having done enough, and or fear of not doing anything. The list is extensive. I believe fear is always a primary driver in the decision making process. I use fear as an indicator in the purchase and sale of securities. I have created a system of investing that uses fear as one of the driving forces. I do not deny my fear, but I try to stay aware of how it is influencing my vision of the future. Fear is in control right now throughout all segments of the economy.
Arguably I believe that narcissism plays a significant role in decision making. Any psychologist will tell you that there is healthy and unhealthy narcissism. Our identity as a professional, our need to be recognized (I often wonder how much that is why I even bother to write these letters), and our desire to be identified as being a member of a group (religious, national, political, social, etc.) are extensions of our desire to be a part of something larger than ourselves and to be seen. When our decision making becomes more about being seen and recognized than being thoughtful about the impact of our behavior on others, we take risk that may ultimately impact others. Systems theory teaches us that our behavior impacts the larger system. In a system where the narcissistic drive for extreme wealth means taking systemic risk, the narcissism of a few can destroy a system that many are dependent upon.
There are of course other behaviors that impact our decision making and thus those we are connected to. When the economy is good, it has an ability to assimilate and balance out bad decision making. When the economy is bad, bad decision making compounds the problems.
The driving force right now is a combination of fear, self-preservation and the desire to keep our identities. Anyone who is paying attention to what is unfolding should feel threatened. Every segment of society is being impacted by the unraveling of the economy. Churches, schools, governments, business small and large, individual life styles, families—you name it, every part of our social fabric is being forced to question its ability to survive and maintain a life style that is familiar, secure and has some modicum of hope for a better future. I could provide various economic statistics about how the economic decline compares to ones in the past, or similarities with happened in the 1920’s and 30’s, but I don’t believe that is necessary. We all know it is bad and it is getting worse.
In the business world, old famous companies have seen the value of their business hacked into miniscule prices compared to the past. Any market historian knows that it is relatively common for corporations to have their years in the sun, then fall into decline, and often disappear except for their place in history. Normally this happens in sectors, with an industry leader that looses its competitive edge. In some cases the need for the product or service of that company vanishes. We all know the stories of products that once dominated the landscape that no longer are needed, and the only value they may hold is in the eyes of a collector of memorabilia. Now, many well known companies have seen the values of their businesses decimated, in ways that seemed impossible a few years ago. Names like Washington Mutual, Indymac, Countrywide, and others under attack in the financial sector have been forced out of business or are only in business because the Federal Reserve is still recognized as the most powerful economic organization in the world. Outside of the financial sector, names like Alcoa, Kodak, International Paper, and so many others are trading at 10% of their market values of the recent past. Those who thought that there is safety in working for the leading company in an industry 20 years ago have had a very scary awakening to the rise and fall of business empires. Take the time and think about the collective psychological impact that this has had on shareholders, employees, executives and all of their families. Think about the loss of faith and hope in an economic system that is under attack by all of its participants. The truth has been that the only safe job in our free market economy has been a job in the U.S. government, the safest being in the military. If you dislike change, fear economic dislocation, and like structure—join up!
It will take years of rebuilding and reregulating the system to create the feelings of trust and faith that our system protects us against systemic collapse. In the meantime each of us must recognize the limitations that the failure of our past leaders have thrust upon us.
One of the characteristics of the capitalistic system is that it is a non-value based decision making system, whose only values are those imposed by its participants. Capitalism is about creativity and the attempt by the system to find the most efficient method of managing resources. It is also about survival of the fittest. An important part of capitalism is creative destruction. The entire system is now in the destructive phase. I believe that a valueless, unregulated capitalistic system does not recognize the need of the system to exist for the benefit of the greater good. It is only interested in the survival of the fittest not the survival of those in the system. Capitalism is about being the becoming more and more efficient. In a purely capitalistic system to have efficiency we must eliminate caring in the system. If we care for the system, then ultimately we have to make decisions that allow the system to exist that may not be to the advantage of the individual.
Right now we are involved in an international right sizing of the economic system. Economic decision making beginning with the Carter administration and the deregulation of the S&L industry has been a series of events designed to increase competition, and to allow creative destruction to eliminate the weak. Creative destruction unchecked will ultimately destroy just almost everything and then attempt to replace it with greater efficiency. It is little different than March Madness when we are left with one college team that is the victor.
I believe that as the number of unemployed accelerates the backlash against capitalism will be severe. We are already witnessing a backlash as those who work for the larger banks in the nation have ascended to one of the most hated professions in the nation. If creative destruction would have been allowed to unfold uninterrupted the shares of Countrywide, Merrill Lynch, Bear Stearns, National City Bank, Fannie Mae, Freddie Mac, AIG, Citigroup and others would have ended up totally worthless, instead of the pennies that they either trade for or were assimlated for into another company. If that would have happened I believe it is fair to assume that every other major bank in the nation would be close too if not out of business, and the financial sector of the United States would essentially no longer exist. This would have also meet the destruction of uninsured deposits of all businesses that kept money in what had been perceived as the largest and safest banks in the world. The unemployment levels in the U.S. would be astronomical, our properties that we believed to have value 6 months ago, would have little value and the quality of life as we know it would have been decimated.
Let’s look it at another way. If big government were not so big, and people did not believe in the full faith and credit of our big government, then it would have not been able to orchestrate the rescue of so many our leading financial institutions at one time. Without our government, its size and ability to influence markets, we would now be in the deepest, most sudden and darkest depression in the history of the U.S.
Back to the question of a stimulus plan. Do we need one? My answer is yes. Is there a difference between stimulating and spending? The answer to that is murky. Spending does support the economy, and it can create jobs. The real question is who is creating the jobs, government and other non-profits or the business community? Right now the business community is not creating jobs. The only sectors creating jobs are education, health services and government. We need a combination of spending projects that support existing jobs, and stimulus that offers tax credits to those buying autos, homes and businesses investing in equipment. Will lowering taxes increase spending? No, in a declining economy it leads to increased saving because peoples decision making is now centered upon conserving money, not spending it. If consumers and lenders are not willing to consume or lend for consuming, who is left to spend money? The government. What a stimulus plan can do along with spending is create the incentives to buy with temporary tax credits. This stimulus/spending program seems to be lacking that critical component for both business and consumers.
Ultimately, those who have lost their jobs may ask, why didn’t you do more in 2008? Why did we allow the possibility of systemic risk to even exist? There has been a focus on the fraud investigator who informed the SEC about Madoff many years ago. There were clear signals that Madoff had created a Ponzi scheme that the SEC ignored. One of the contributing factors to Madoff’s ability to succeed as long as he did with his deception was the unraveling of our regulatory systems. There have been clear signals for years that the system of deregulation that has been evolving was creating one gigantic system wide Ponzi scheme, and now we know how. In many ways our banking system of intertwined systems of wealth creation have managed to do the exact opposite of their intent—destroy wealth.
Will a stimulus plan succeed? Not in the way we need it to. I believe it is to late. The damage is done and it will take years to reestablish confidence and belief in our economic system. Job losses will accelerate, my belief is that ultimately the DOW has to drop far further, below 5000. The stimulus will prevent some jobs from being lost, it will help us believe that our government is attempting to fight the decline, and it may give us added breathing room to begin the long and tedious process of rebuilding our financial system and economic viability. It will not lead to economic growth, or enough job creation to balance out the losses that have taken place and will continue to expand.
Yes there will be those who are clever, energetic, and will have the ability to be successful even in a declining economy. There were many success stories that emerged out of the 1930’s. There will be tiny companies that become large ones, and their stocks will bestow wealth among the lucky few who own them, once again creating a sense of hope and vision among the masses. And yes the stock market will offer trading opportunities as it goes up and down.
But many things have changed since the 1930’s. This time it may not be the U.S. that leads the way with economic recovery. There are far more people in China, India, Brazil and other countries that have been tasting the Kool-aid of Capitalism. They have a far greater pool of intellectual capital that has just been unleashed over the past 20 years. The United States may have built their own stepping stones along a path of declining influence and wealth with its great experiment in a deregulated free market economy. The problems before the U.S. are in some ways unique to the world. We have burned off and mined most of our natural resources over the past 100 years as we have attempted to satisfy our material needs. We have allowed our educational system to become secondary to the value of wealth creation. We have allowed our infrastructure to decline, and are seeing the abandonment and decay of many of our towns and cities. And we have been a nation of borrowers, unwilling to pay the taxes necessary for providing the services and protection that we demand from our government. We have borrowed when we should have saved, and now that we should be borrowing to spend, we have nothing in reserve other than “the good faith and credit of the United States Government”. It remains to be seen how long anyone will believe in our ability to pay our bills.
On George Stephanopoulos, George asked Larry Summers essentially, are we in a depression? Summers ducked the answer. What is your answer?