|The Eye of the Financial Storm|
By Todd Harrison JUN 16, 2010 7:30 AM
It's never wise to mess with Mother Nature.
“Outside in the cold distance, a wildcat did growl. Two riders were approaching and the wind began to howl.” --Bob Dylan
It’s easy to finger the bears as a cabal of pessimistic pundits who root against the world.
Following the single worst decade in financial market history, they’ve earned the benefit of their own market doubt.
As negative headlines abound and social mood sours, some might view the mounting malaise as a contrary indicator. One could also argue that the prolonged period of substandard performance is on the margin constructive; that a regression to the historical mean would suggest double-digit returns for the foreseeable future.
I would agree, if not for the inherent fragility of the global market construct and the sheer size of the imbalances. (See: Five Things You Need to Know About the Markets)
We often discuss our current crossroads; government drugs that mask the symptoms after years of societal largesse versus medicine that cures the disease in the form of asset class deflation and debt destruction or restructuring. We repeat this analogy for good reason: it’s true. (See: Defining a Path to Economic Recovery)
I may be off base -- I’ve learned to stay humble or the market will do it for me -- but a single word continues to resonate in my mind’s eye as we edge our way through this historic fray. That word is “cumulative.”
As offered in 2005 at the Minyanville retreat in Ojai, “The problem that comes from engaging in high-risk behavior for which the consequences are absent, even if only temporarily, is that such high-risk behavior begins to appear normal and the entire scale of risk gets adjusted and pushed out.” (See: Ojai Keynote)
Therein lies the fatal flaw of our current conundrum. We’ve been pushing risk further out on the time continuum for such a long time that it’s become an accepted -- dare I say normalized -- pattern that interconnects the world through a tangled web of derivatives.
While the recent price action has been docile, I believe we’re in the eye of the storm, a relative calm between the first phase of the financial crisis and the cumulative comeuppance that'll flush -- and perhaps reset -- the system.
You know it won’t come easy; this decade will require steadfast stamina and proactive patience. While the first half will be focused on preservation and perseverance, the back nine will be ripe with rewards.
Where You Stand is a Function of Where you Sit
Some may perceive the above-mentioned vibe as overtly negative but I’ll offer a different take. I shared the following thoughts in September 2008 and they’re equally apt today as the second side of this storm builds on the horizon. (See: The Great Expression)
There are many ways to view this seismic shift: anger (as expressed by Main Street), sadness (as savings are destroyed), fear (as reality bites), and confusion (as folks try to understand how this could ever happen).
And there’s anticipation, as we cast an eye forward and look for the phoenix that will eventually arise from the scorched earth.
The unfortunate capital market destruction is an inevitable comeuppance, the cumulative result of risk gone awry.
It’s been percolating under the seemingly calm surface for several years, magnified by financial engineering and consumed by an immediate gratification society.
The socioeconomic consequences will be pervasive as we enter the other side of the business cycle, an unenviable retrenchment that politicians and policymakers have tried so hard to avoid. It’s certainly scary as new beginnings typically are. Therein lies the opportunity.
The media portrays the Great Depression as one where everyone in America stood on street corners or waited in a bread line. A closer look shows that similar to our current situation, economic hardship for the middle class began well before 1929.
We’ve got a few lean years ahead but that’s nothing to fear. In fact, it’s a healthy and positive progression. To get through this, we need to go through this and as painful as the process is, it takes us one step closer to an eventual recovery.
I view the Great Depression as the framework for optimism. Most of society worked, great discoveries were made and formidable franchises were established.
Disney (DIS) built a global franchise through that period.
Hewlett-Packard (HPQ) was born on the back-end.
Texas Instruments (TXN), Tyson Foods (TSN), and Continental Airlines (CAL) were birthed.
Indeed, if the greatest opportunities are bred from the most formidable obstacles, we’re about to enter a most auspicious era.
The 90’s were about wealth, accumulation and consumption and we’ve now entered a period that is entirely more austere, if not more sensible. Debt reduction and the rejection of materialism will continue to manifest as we come to terms with doing more with less.
Flashy rides and big-ticket items that were once badges of honor now serve as hollow reminders of misplaced priorities.
Humility, once viewed as weakness, will be embraced.
Doing for others -- rather than asking what others can do for you -- will become more commonplace as people learn to appreciate what they have rather than constantly keeping up with the Dow Joneses.
This mess is a bitter pill to swallow, particularly for the mainstream American who doesn’t know a derivative from a dividend. We can point fingers and wallow in the “why” or take a deep breath and begin the process of recovery.
Something good comes from all things bad and the greatest wisdom is bred as a function of pain. It’s unfortunate that the structural foundation of the global capital market system had to shake before people -- and policymakers -- paid attention but it is what it is and we’ll do what we must.
Surround yourself with people you trust. Practice risk management over reward chasing. Preserve capital, reduce debt and become financially aware of your surroundings. It won’t be an easy road but it won’t be impossible either.
For as my grandfather Ruby used to tell me, “This too, shall pass.”
Fast-Forward to Today
George Soros spoke at a conference in Vienna last week and offered, “The collapse of the financial system as we know it is real and the crisis is far from over. Indeed, we have just entered Act II of the drama.”
I don’t profess to know how long the calm lasts before the thunder arrives; while we were early in identifying the sovereign sequel to the first phase of the financial crisis, future gusts may come from any given direction. (See: Ten Reasons Why This is Not a Bull Market)
The uptick in the tone and tenor of the doom and gloom crowd isn’t lost on this self-proclaimed contrarian. As the market tends to pave a path of maximum frustration, we must allow for a scenario where a reflex rally -- triggered by currency devaluation or game-changing regulatory reform -- masks the hazardous horizon for the foreseeable future.
I will simply say this: free market capitalism hasn’t been allowed to dictate the process of price discovery for a long time as policymakers have attempted to engineer the business cycle.
As we’ve learned before and as we’ll again see, it’s never wise to mess with Mother Nature.