Minyanville Round Table: Social, Political, Economic Polarization Threatening Recovery

By Kevin Depew  JUL 08, 2011 11:00 AM

Kevin Depew, Peter Atwater, Conor Sen, and Professor Pinch discuss the European crisis and what it means for the coming years.

 


On Thursday, July 7,  Peter Atwater, Conor Sen, Professor Pinch and I began an extended email back-and-forth exchange about the overall macro picture, the global economy, financial markets and what we expect going forward. Rather than sending the four of us off to write separate pieces based on these ideas -- the traditional way of generating content -- I thought, why not just publish the exchange as it originally happened? This is the Internet, after all, and we can do whatever we want.

Peter Atwater kicked it off Thursday morning:
I am gravely concerned about Europe.

From a safety and soundness perspective what the ECB is doing is horrendous. They are providing solvency at this point, not just liquidity. And the degree to which margin requirements have been stretched is very troubling. At the same time, the actions which Germany is now taking suggest that it is every man for himself. And I am afraid that from here on out the lifeguards will only provide assistance post-, not pre-default.

Conor Sen:

Over the past few weeks I have grown more and more pessimistic. I still think the economy is in much better shape than people think, and equity valuations until the past week have been compelling. But I no longer have any confidence that the people through their elected officials are going to let things continue as they are.

In the US I'm afraid that budget cuts will be far more severe than is warranted given the output gap and borrowing costs of the Treasury. In Southern Europe I don't know how much longer this level of austerity can continue. It's not clear how much longer Northern Europe will bail out the South. QE2 is over (though I don't think this matters much), the ECB is hiking (insane), and China continues to tap the brakes.

So we find ourselves in a spot where, left to their own devices, the economy and stock market should work higher over the next few years. But social mood continues to deteriorate despite the economic improvement -- the Minnesota state government has been shut down for a week now and it seems like nobody has any answers or is willing to compromise. I'm still looking to buy dislocations in the stock market, but I think we're nearing a point (could be a few weeks or a few months) where whether it's Greece, Portugal, Ireland, or the US Congress, some governing body is going to say no mas, and we'll get some level of a sovereign debt liquidity panic.

Politically the top 1% is going to get whacked. Hard. I don't see any way around that. The chart below illustrates, I believe, the economic and social polarization that must be reconciled.


Click to enlarge


Professor Pinch:

I completely understand. You have a real economy that is showing potential, but a macro construct that is just plain unhealthy. In Europe's case the situation is worse because the gang that can't shoot is playing with dynamite.

Peter, I agree. The ECB's course of action is reckless and idiotic. "Trash for cash" is not a strategy that will solve this mess. But, everyone there is afraid of letting go of the dream: both the euro & the EU. And they won't let go of it until there's no other choice. I have no feel for how long they'll try to hold on to it, but they will.

Kevin Depew:
This is interesting, and a great way to put it: "I completely understand. You have a real economy that is showing potential, but a macro construct that is just plain unhealthy." The uncertainty is terrible, but we will eventually repair the macro construct... or not. That, in my opinion, is the ultimate bull versus bear divide. Bulls believe we will inevitably repair the macro construct and emerge with something new, while bears believe we will not. 

I don't know if I need to add it, based on what I've written on Minyanville, but will: I'm in the bull camp and believe that we reconstruct this and rework it into something positive and unforeseen. The white swan. There will be much noise in the meantime, and the noise will be intense, but to me, if you can find quality companies that you can imagine might be around in 2025, at compelling valuations, and I think you can (See Minyanville commentary on large cap tech stocks such as Microsoft (MSFT), Cisco (CSCO), Intel (INTC), Google (GOOG) and Apple (AAPL)), then this is one of the greatest long-term buying opportunities of individual equities in a lifetime. Remember, too, the most important point, that the narrative always survives even as the mode of projection shifts. The current macro construct is like our TV set. It's how we view valuations, currencies, debt, relationships. Ditch the TV set, however, and we still have the media. We have revolutionized -- and are feeling the impact now of it -- immediate communications. By immediate I mean proximal and physical. Finance is a form of communication, but a secondary form, always subordinate to the physical, which is why it has always gravitated toward the immaterial, as if to disguise its origins, "filthy lucre." Its revolution comes next, is occurring now.

Conor Sen:
I'm in the bull camp as well, I just think we have to get some combination of a fairly massive debt jubilee/reconciliation, whack the top 1%, help out the bottom 50%, and/or break up Too Big to Fail and some of our archaic political/corporate/media/academic institutions along the way. Do I think the major US markets, let alone individual names, double over the next 10 years? Yes. But that path is going to be incredibly bumpy, and I suspect there will be major crises along the way (just as there have been over the past decade, and throughout history, of course).

Professor Pinch:
Two things:

1) Bullishness wins way more than it loses. There will be a constructive outcome from all of this, the question is how much pain is endured in the process.

2) I'm starting to wonder how significant these crises are. None of us has the context to know what it was like to live through The Banking Crisis of 1907 or the Wiemar Republic or The Great Depression. So I'm starting to wonder if it's merely a function of the instant accessibility to so much media all the time. That maybe these aren't big deals or at least not as big as we hyperbolize and pontificate them to be.

Kevin outlined it: Either these issues get resolved or not. We wring our hands and speculate and opine 24/7 these days. And why? To pass the time. We already know the possibilities. There's five chess pieces left on the board and several sequences of moves are known. There's not much left to say or add.

I know collectively we've spilled a lot of virtual ink on this. But sadly, it seems we're going to spill even more virtual ink on this kind of crap before it's over.

Meanwhile, I'm just going to enjoy the beach.

Peter Atwater:
One of the toughest conversations I had to have with my clients last year was the one where I told them that the core fundamental of banking -- credit -- no longer mattered because all of our assumptions about borrower repayment patterns were going to be trumped by social and political unrest. Rather than being the dog, the banks would become the tail.

What we are witnessing in Europe right now is the political equivalent of cash-hoarding, only today we call it burden-sharing. The problem with burden-sharing is that it acts like a vortex -- the closer you get, the more it pulls you in. And with Northern European voters demanding more and more of it, more and more of the South will be sucked into the vortex. And unfortunately, when she demanded it last October, Angela Merkel did not understand that burden-sharing eliminates time, not adds it. And to me that is what Moody's finally awoke to this week with Portugal.

Societally our worlds are shrinking.  We want everything more local because more local feels safer. It's as if we no longer trust the interconnectivity that technology and the financial services industry spawned. We are "logically" becoming more protectionist.

What is so interesting to me -- and I think this picks up on Kevin's theme -- is that as I look back in history, the big bear markets/political crises always follow major advances in communication:

I don't know if this is because we present value too much from valuation perspective, we get overwhelmed by interconnectedness (both systemically and psychologically) or what -- maybe a combo.  But the pattern is clear.

Finally, to Kevin's point about stocks, I agree that there are and will be many opportunities. The problem that I see is that those who determine price -- the top 1% economically -- are beginning to come under siege -- socially and politically. And whereas in March 2009 politicians were willing and able to do whatever they could to help this group, today the opposite is true. (As Stephanie Pomboy pointed out in her piece this week, from an economic dispersion perspective we now resemble Jamaica!)

As I try to narrow it down, it feels to me like price stability is entirely a function of the top 1% confidence in whether they can ride this out. If they can, they stay in. If they can't, they leave. That said, the hedge fund closures by successful managers makes me think that the smartest guys have already figured out that they can't ride this out and it is better to exit sooner rather than later.

The net to me is that we have a white swan in terms of business opportunity with a black swan in price.

If the banks are the leading indicator that I think they are, from here on out, price will be determined in the Halls of Congress and in the streets of Athens (if not Detroit).

Kevin Depew has positions in CSCO; Conor Sen has positions in CSCO, MSFT;

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