WSJ: Lessons from a Dow Decade

 

A year ago yesterday, the world almost ended. The stock market was in free fall, with the Dow Jones Industrial Average bottoming out at 6547, down from its Oct. 9, 2007 peak of 14164. Financials were in a death spiral and there was even talk of nationalization. Citigroup hit $1.05, GE traded at $7.41 and golden Goldman Sachs was given away at $73.95. A bear market extraordinaire.

Contrast this with 10 years ago today, when the dot-com-laden NASDAQ peaked at 5048. Then we had the opposite mentality—companies like Pets.com were going to fundamentally reshape the economy in the new millennium through a nirvana of spectacular growth and well being. Or something like that. A bull run extraordinaire.

No one would blame you for thinking the market is a textbook delusional-paranoid-schizophrenic, not knowing the difference between the real and unreal. And you'd be right. But you'd miss a valuable lesson. Misallocation of capital is everywhere and anywhere a fallout of bad government policy. The South Sea Company, a government sponsored entity with a monopoly on trade, caused the South Sea Bubble in 1720.

The late '90s Internet love fest was crazy enough, driven by former FCC Chairman Reed Hundt's misguided telecom reform that had the effect of keeping data rates artificially high. This created a gold rush to install fiber and build applications that didn't make economic sense (though electronic commerce, online banking, as well as wireless and broadband deployment would eventually prove productive over the next decade). Bad policy meant capital got overallocated and too quickly, as momentum mutual funds (momos) and day traders furiously drove up stock prices of every company with dot-com in its name for no fundamental reasons. Wall Street trading was broken.

Then, adding insult to injury, Alan Greenspan and the Federal Reserve flooded the system with money, fearing that banks would face a run brought on by the Y2K problem. The problem and the run never happened. The money ended up in the market. Mopping up that money burst the bubble. The market bottomed out on Oct. 9, 2002, when the Nasdaq hit 1114.

And the world after 9/11? Unfortunately, the accounting scandals at Enron, WorldCom and elsewhere brought us the costly Sarbanes-Oxley law, adding a complex regulatory burden so that many companies fear going public. We also got a decoupling of research from investment banking because of an alleged conflict of interest, and a Federal Reserve whose nightmare fears of deflation ushered in a long era of cheap credit.

Instead of finishing what the dot-com era started to deliver—a productive, wealth-producing economy—capital was seduced into the financial lair of private equity and real-estate mortgages. Trillions were pumped into unneeded housing stock. Fannie and Freddie fanned the flames, and then fizzled and failed. And leveraged buyouts reigned. Even in 2007, one Blackstone private equity fund raised almost as much money as all of the venture capital industry.

And now? The bear market of a year ago may have ended because of the Geithner Plan, Treasury stress tests and TARP money injected onto bank balance sheets. You can go with that narrative if you'd like. Or maybe it was a change in the mark-to-market rules so banks no longer had to write down their toxic subprime loans. But the reality is that on March 18, 2009, Ben Bernanke and the Federal Reserve began their $1.2 trillion quantitative easing, buying Treasurys and mortgages and pumping dollars into a deleveraging economy. Hair of the dog. More cheap credit that again ended up in the market, helping banks refinance.

Today, we are still left with almost no initial public offerings. While private equity fund-raising was down 68% in 2009 to $96 billion, venture capital barely raised $13 billion.

Capital gains taxes are set to return to 20% on Jan. 1, 2011. And worse, investing is as uncertain as ever. No one wants to fund health care, medical devices or even much biotech if they can't figure out how they are going to be paid via reimbursements from ObamaCare. Energy investing is also a mess. And while "green" investing is booming, with few exceptions that is about efficiency rather than productivity. There's a big difference: You can make the Post Office more efficient while email makes us more productive and wealthier.

Big regulated oligopolists control our communications infrastructure. Startups are nowhere to be found. Few are willing to take the risk of true venture investing.

It's been 10 long years since the economy has created real wealth, as opposed to easy-credit induced real-estate or paper wealth. Amidst all the current confusion over health care and tax rates and energy and banking reforms, maybe it's time that the market transitions back to investments that drive productivity and increase living standards rather than just paper profits.

I'm not saying the market should transition or it ought to—you don't tell the market what to do. As we know from one and 10 years ago, the market works in weird ways and makes these transitions in the fog of something else, in this case it's the Fed's life support that is misallocating capital. When that ends, look for new eras to begin.

 

 

Comments

[ilene]

Hi Andy, what do you see as happen when the life support ends, what do you think the transition will look like? - Ilene

[Rich Vail]

Instalanche...interesting points. Thanks.

[John Furrier]

You timed the market perfectly when you got out when you did .. your legend grows selling at the top of the mkt..smart boy .. me I was on 34 then..

[Lorelei Kilbourne]

Andy and Readers,

“Blame the bankers!”
“Blame the mortgage brokers!”
“Blame the speculators!”
“Blame anyone and everyone. Just don’t blame us,” shout the politicians.

Say, remember actual gold-coins? Real silver-coins? Yellowbacks? Silver certificates? Sure you do. Printed on every dollar-bill were the words “Payable to the bearer on demand one dollar in silver.”

Now, printed on dollars are the words “Federal Reserve Note”. What do those words mean? They’re a tautology. If you hold a Federal Reserve Note, the government bases its value on another Federal Reserve Note of the same denomination. Do the words then mean nothing? Not at all. What they mean is that each Federal Reserve Note is based upon the governmental power to tax. But wait? What if productive taxpayers (now less than 50% of the American population) refuse to pay the politically-imposed taxes on which the Federal Reserve Note is based? Well, as Mao Tse-tung used to say as he was slaughtering tens of millions of Chinese, “Ultimately, all power comes out of the barrel of a gun.” Ask the IRS.

So, how do the productive people of America stop “capital misallocation” as “a fallout of bad government policy”? By electing Republicans? No, they tried that. By supporting a third party, such as the Constitution Party? Possibly, depending upon its platform. By imposing martial law? A last resort but maybe an inevitable one.

How about this option? By embracing an entirely new approach - an approach based upon Science, American Tradition, and the Constitution? Believe it or not, there is a way to employ scientific methodology to clean up the mess we Americans have created for ourselves; it includes the issuing of a sound U.S. currency not based upon gold. “How?” you ask.

Let me refer you to a just-released novel that presents a detailed blueprint on applying Science to the four cornerstones of society - government, law, education, and medicine. Its longest chapter deals with economics and begins with an economic crash in China. It’s entitled Inescapable Consequences. Its website is ... www.inescapableconsequences.com.
Andy is right. Productive Americans must create a context and employ contingencies that promote real productivity not phony profits. I predict that, without employing science as we have in other areas with great success, we’ll fail. The consequences of our current actions are inescapable - and frightening.

[Robert Dobb]

It does not matter if a nation holds gold or not. There are all sorts of ways to become wealthy. And gold is just one way to measure wealth.

"If you see ten troubles coming down the road, you can be sure that nine will run into the ditch before they reach you".

[John]

Andy, you missed badly on this piece

We did not just come through a period of capital misallocation. That can happen only when money is scarce and it wasn't. Everything was financed that could be financed. It was not misallocation but a lack of discrimination that exploded.

Faced with falling and stagnate income American's borrowed and borrowed and borrowed. The criminal class--the bankers on Wall Street---used such a natural human tendency to create trillions in junk securities that were sold to the world.

The political class went along because it lacked the fortitude to attack our two fundamental problem---income distribution coupled with a lack of control over the price of oil, resulting in billions of tribute being paid each month for oil imports.

Nothing has changed. Oil is going back up. The story of 2008, that oil reached $145 a barrel on the 4th of July has been long forgotten.

[Stock market lesson]

There are many good points in your post.. According to me it will be very helpful for everyone..

[Stock Market Lesson]

“ If your broker [or investment advisor] is not familiar with the concept of standard deviation of returns, get a new one.”

[Belstaff Jacket]

So cute! I already like you on FB and also get your posts on Google Reader. :)

[JuanitaCastillo28]

This is understandable that cash makes us independent. But what to do when someone does not have cash? The only one way is to try to get the mortgage loans or student loan.