U.S. stock markets continue a bull run

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In my response to David Stockman’s op-ed piece in the New York Times, I stated that our problems are, in fact, solvable, and that we are—however slowly and painfully—in the process of solving them.

Not everyone is convinced, to put it mildly, and to state it is not to demonstrate it. Looking through today’s papers, though, I found a couple examples of exactly what I was talking about.

For the past couple of years, we’ve seen a strong first quarter followed by a much weaker second quarter. Initial signs suggest that the pattern may continue this year as well. Should we expect that—and, if so, what would it mean?

First, the good news: the first quarter was very strong. Economists are estimating that growth could have been as strong as 3 percent, which is well above expectations. Private employment continued to grow, with signs of an increasing growth rate over the past year, while government employment recovered somewhat after a tough fourth quarter, as shown in the chart below.

Several people have forwarded me “State-Wrecked: The Corruption of Capitalism in America”—a recent New York Times op-ed by David Stockman, former budget director for President Reagan—and asked for my thoughts. Having read through the piece, it’s actually not that easy to respond, as Mr. Stockman seems to be all over the place. In fact, I’m not sure exactly what he’s saying other than that we’re all doomed.

Trying to pick out the different parts of his argument, I come up with following. First, abandoning the gold standard was a huge mistake and has led to fiscal and moral debasement. Second, the Fed has been the agent of said debasement, printing money to enable the federal government’s wanton spending. Third, Wall Street has captured both the Fed and Washington, D.C., and is using them to enrich itself. Fourth, the 2008 financial crisis would have burned itself out and we would have been fine had the government not intervened. Fifth, our fiscal situation is not only worse than admitted but beyond hope. We cannot solve our present problems and face a future of poverty. In short, under the present system, we’re doomed, and we largely deserve it for past sins. Thus endeth the lesson.

At the end of the quarter, we all look at our statements and evaluate how we’re doing. Depending on the results, we either congratulate ourselves or start to ask what went wrong—and what we can do about it. The implicit assumption here is that we are in control of our investments.

To a great extent that’s true, of course, but the markets are beyond anyone’s control. Trying to manage that uncertainty has been the great quest of modern finance. The management of uncertainty is also characteristic of another financial endeavor: gambling.

With all of the focus on Cyprus over the past couple of days, the refrain has gone something like this: what really matters isn’t Cyprus itself but the bigger picture and what that might mean for Europe. No one has really gotten into what happens and how, so I thought I’d give that a shot.

Cyprus is an even smaller piece of Europe than Greece was. The banking system, which was seven times the size of the economy, is also small in the larger scheme of things. The amount of money required to bail out the system was a rounding error; there was no financial reason not to simply write a check.

Looking at the effects of Cyprus echoing around the financial markets, one thing that’s become apparent is that it really isn’t all about the U.S. any more. Even as the U.S. economy continues to recover, the international press doesn’t care that much. We are a much smaller piece of a much bigger pie. Still the largest piece, still important, but not what we were.

Some of the perennial questions I get from clients arise from our diminished place in the scheme of things. What happens, for example, if the dollar collapses? Given the central role the U.S. occupies in the world financial system, the standing answer has been that it won’t happen any time soon. World trade is denominated in dollars, the world’s low-risk reserve currency. Under current conditions, there is no alternative.

First of all, credit where due: today’s title came from David Rosenberg of Gluskin Sheff, a terrific economist whom I read daily. I laughed the first time I saw it, but per yesterday’s post, I’ve come to believe that it has real applicability to most client portfolios.

The larger point here, though, is that the new new normal we now live in has forced us to reexamine many assumptions. To the extent that portfolios are based on how things were, and not how things are, we may be in the wrong place. The title above is a great way to express that.

One of the perennial questions in the investment world over the past couple of years has been “When are interest rates going to take off?” Very soon now has been the consensus—but it hasn’t happened yet. I’ve been as guilty as anyone, although I’ve tended to say something like, “Well, about 12–18 months from now.” I’ve been saying that for the last three or four years.

Mind you, it is likely that at some point everyone will be right, and interest rates will head up. I started calling the real estate market overpriced in 2005, for example, and I was wrong for several years—until I was right. I wasn’t the only one, of course, but you can be wrong for a while before you’re eventually right. Being early, especially too early, is wrong, though.