I am devoting this memo to raising some controversial questions while offering no personal views. You think and decide.
First, I am posting a somewhat "edited" article by Mauldin about his views of the future investment scene and possible need to rethink one's portfolio strategy. (See 1 and 1a below.)
The Economy That Wasn’t Supposed to Happen - Neil Irwin, NY Times
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The second question pertains to the argument by radical progressives and many liberals that black citizens have made little progress in America. If that is so why are an increasing number, who have reached levels of governing and enjoying the power and benefits of public office, being arrested for fraud and corruption? The latest was the mayor of Baltimore etc.
You cannot be arrested for a crime if you did not hold the position.
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The third question pertains to repeated accusations by several of my liberal friends that Trump's attacks on the mass media signify he is a dictator and these attacks are an attempt to silence the Fourth Estate because he is corrupt and an unmitigated liar.
Are the two most powerful newspapers, WAPO and The New York Times, doing their ombudsman job or are they simply high powered biased hack organisations fearing Trump's draining of the swamp threatens their ability to control the direction of government through increasing efforts to smear and false reporting by employees who no longer understand their legitimate role and how editorial ethics plays a part?
Are Democrats Living on Another Planet? Tom Rogan, Washington Examiner
+++++++++++++++++++++++++++++++++++++++++++The final question has to do with Biden's latest comment that China is no basic threat to our nation. Is he correct or is this the same "Old Joe" who has seldom been right about anything?
When It Comes to China, Sleepy Joe Biden Is Still Snoozing Curtis Ellis, RCP
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++Obviously, I have my own thoughts, answers and biases but I am more interested in getting you to think about these subjects/questions and whether they are relevant and worth discussing if you can find someone interested in having a rational engagement.
In a few minutes, I am leaving to have breakfast with a dear friend, a fellow memo reader and one of my most liberal and severest "brain washed" critics. He says/thinks the same, if not more, about me.
Yesterday was his treat and one of the things I want to talk to him about are two bets we made about Obama and Hillary that are beginning to move in the direction I always thought they would and he has enjoyed almost two years of berating me about my views. I expect he will give no ground notwithstanding a mountain of evidence that has come to the fore supporting my thinking which formed the basis of my bets.
As always, it should be an interesting breakfast and the thing I most like about it, besides the food, is we always walk away friends, shaking our heads about how nuts the other one has to be to hold such views.
Have a Great Weekend.
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Dick
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1)
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We Have a Problem
My recent letters described what I think the future will look like. I hasten to add, it isn’t what I think the future should look like or what I want to see. Almost the entire developed world has painted itself into a corner.
It won’t necessarily be terrible. I don’t expect another Great Depression or economic upheaval, but we will have to adapt our portfolios and lifestyles to this new reality. The good news is the changes will happen relatively slowly. We have time to adapt.
In war movies, it’s common for the dashing leader to make bold promises like, “We will never retreat!” ahead of a glorious victory. The assumption is that retreat is bad. But real-life military strategists say retreat can be the right move. When the odds are against you, better to save your ammunition for another time. Better yet, adopt a new strategy that gives you a better chance.
My last few letters may look like retreat, but I’m just recognizing reality. There is no plausible path to stopping the world’s debt overload, much less paying it off, without a serious and painful purge. If you know of such a path, please share it with me, but I haven’t seen one. So I foresee a tough decade ahead.
Summing up:
- Entitlement spending, interest on the debt, defense spending, and so forth will continue to produce trillion-dollar-plus deficits.
- No constituency is arguing to reform the entitlement system by reducing benefits. By the middle of the next decade, deficits will be in the $1.5 trillion range even under the CBO’s optimistic assumptions. While the numbers look marginally different elsewhere, the developed countries are all going the same direction: toward higher deficits.
- Following the next recession (and there is always one coming), the US deficit will be well north of $2 trillion and the total debt will quickly rise to $30 trillion. It will almost certainly be in the $40 trillion range before 2030. Unless interest rates drop significantly, simply paying the interest will consume much of the tax revenue. (Fortunately, I expect interest rates to drop significantly. Think Japan.)
- A growing body of academic literature and real-world experience suggests there is a point beyond which debt becomes a drag on growth. That means that the recovery after the next recession will be even slower than the last one. If, as I expect, the Federal Reserve and other central banks react with massive quantitative easing, it is entirely possible that the whole developed world will begin to look like Japan: slow nominal GDP growth, low interest rates that penalize savers, low inflation or even deflation, etc.
- In such an environment, normal equity index funds won’t produce the returns many have grown to expect.
- Public pension funds will get hammered in the bear market and many will have difficulty meeting their obligations. Governments will be forced to either cut benefits, raise taxes, or both. That is not going to make for a happy citizenry. It will play out in different manners all across the world, but the resulting frustration will be the same. And to put it very bluntly, “frustration” is inadequate to describe the result of underfunded pensions. Retirees made plans for their futures based upon receiving those pensions. And taxpayers likewise make plans.
- All of this will have significant investment implications, which we will visit below and in great detail in the coming weeks and months. But Japanification, to use a word, is going to make income and wealth inequality worse, not better.
This all being the case, the priority now isn’t whether to “retreat,” in the sense of changing your investment strategies, but how and to where, so you can pick up the fight later. Developing a strategy requires us to understand exactly what is happening and why. So I’m looking at the situation from different angles.
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We Have a Problem
You have likely heard of “income inequality”—that wealthy people are making a larger share of our collective income. In one sense, it’s nothing new. Of course, the people with the highest incomes have more of the total. Math guarantees it.
But it is true that the top’s share has grown in recent decades, as has the share of assets owned by the wealthiest. Ray Dalio of Bridgewater Associates has been writing about this for a few years now. Here’s a chart and quote from his latest article.
As shown below, the income gap is about as high as ever and the wealth gap is the highest since the late 1930s. Today, the wealth of the top 1% of the population is more than that of the bottom 90% of the population combined, which is the same sort of wealth gap that existed during the 1935-40 period (a period that brought in an era of great internal and external conflicts for most countries). Those in the top 40% now have on average more than 10 times as much wealth as those in the bottom 60%. That is up from six times in 1980.
Dalio thinks it is significant that inequality, at least by these measures, is now in the same area it was in the Great Depression. It plunged in the postwar years and began rising again in the 1980s.
I suspect, if we had data going back a few centuries, we would see that those 30 or so years between 1950 and 1980 were actually the statistical aberration. Mass prosperity hasn’t been the historic norm. It certainly wasn’t that in the 1800s and the Gilded Age. Nor was it so in Europe.
Some people see this inequality as somehow unfair. I think it is more complex than that. It depends on how those with wealth became so. There’s a big difference between (a) despots who use political authority to enrich themselves and their friends, (b) monopolists who thrive by taking choice away from consumers instead of adding to it, and (c) entrepreneurs who grow wealthy by selling useful products to willing consumers.
(Incidentally, Dalio does a good job describing the problem, but I think he lays the blame at the wrong doorstep. His proposed solutions leave a lot to be desired. I will discuss this at length in a forthcoming letter.)
The problems begin when people perceive the wealthy are getting rich at the expense of others. And, it’s hard to escape that conclusion when the data say the top tier is keeping a bigger share of the pie, even if the pie is growing. Especially when your piece of the pie is not growing nearly as fast as those of the top. The relative distance becomes even more stark.
Let’s review some charts from my friend Bruce Mehlman’s latest fascinating slide deck. (He has much more that you can and definitely should view here.)
If you take GDP as a proxy for national income, it’s been growing far faster than median family income, even adjusted for inflation. The wider that gap gets, the more people feel like they are being left behind.
Here’s another one comparing stock market growth with family net worth. This isn’t really surprising since we know the top quintile owns most of the stocks. The lower 80% see little direct benefit. But the magnitude of the disparity is still remarkable.
One reason income may be unequal is that talent is increasingly unequal, too. Or at least, the willingness of businesses to buy talent. Here’s a chart showing the most valuable companies have been getting that way with a smaller headcount.
Mehlman cites technology as the explanation for this, and I agree that’s a significant part of it. But so are other things, like the increasing number of sectors where a small number of companies, whose existence is enabled by financial engineering and monetary policy, dominate their respective markets.
My good friend Ben Hunt of Epsilon Theory notes that the S&P 500 companies have the highest earnings relative to sales in history.
Quoting Ben:
This is a 30-year chart of total S&P 500 earnings divided by total S&P 500 sales. It’s how many pennies of earnings S&P 500 companies get from a dollar of sales… earnings margin, essentially, at a high level of aggregation. So at the lows of 1991, $1 in sales generated a bit more than $0.03 in earnings for the S&P 500. Today in 2019, we are at an all-time high of a bit more than $0.11 in earnings from $1 in sales.
It’s a marvelously steady progression up and to the right, temporarily marred by a recession here and there, but really quite awe-inspiring in its consistency. Yay, capitalism!
Ben goes on to say many people think that is because of technology. He argues it is the financialization of our economy and the Fed’s loose policies. I agree 100%. If you think they haven’t changed the rules since the 1980s and 1990s, you aren’t paying attention, boys and girls!
Work-saving technology isn’t bad. In the past, it freed our bodies from dangerous, exhausting toil, and now it’s freeing our minds from mental drudgery. We can adjust. The problem is that it is hitting us so fast. Farming went from manual labor to automation over several generations. Now we’re traveling an equal distance in only a few years, resulting in millions of unemployed humans.
As unhappy as all this is making people now, imagine how it will be when recession hits. And then couple that with an ever-increasing explosion of new technologies that reduce demand for many types of labor (like automated driving).
No Solutions
Some degree of unhappiness and discontent is part of the human condition. It’s what drives us to improve our lives. We accept challenges as long as we think we have a fair chance at overcoming them.
Many Americans no longer believe they have that chance. That’s partly because they have higher expectations—possibly too high. But right or wrong, the perception is there. It affects behavior and, more to the point, it affects what people expect from the government. When they perceive less ability to reach the next level on their own, they look to Washington for help.
I noted last week that almost no one really wants to cut government spending. Even the so-called fiscal conservatives mostly nibble around the edges, reducing budget growth here and there. Bill Clinton was wrong when he said “the era of big government is over” in 1996. It’s bigger than ever and growing faster than ever. Whether you like it or not, that is a fact.
Government revenue is not growing faster than ever, which means rising debt even in today’s relative prosperity.
Again, whether you like this or not is irrelevant. It’s happening. I see no way out. Raising taxes on the wealthy won’t get us even close to a balanced budget, even at confiscatory levels. Raising taxes on the middle class won’t happen in a recession. The only tax system with a shot at actually paying for current spending (even without adding the new programs some Democrats want) is a “VAT” or value-added tax, and it is anathema in both parties.
No matter how I look at this, I keep coming back to gigantic deficits that the Federal Reserve will have to monetize in some fashion—probably something like the previous QE rounds but on a vastly larger scale. And thus my belief it will launch an era of Japan-like deflation and economic doldrums.
If you think this is impossible or I’m being too pessimistic, please, please tell me why I’m wrong. Show me where we can get the necessary tax revenue without severely impacting the economy. Show me how we can cut benefits without getting massive pushback from politicians. And please, show me how we get off the path we are on. And tell me what scenario you think is more plausible. I don’t see one. I really don’t.
Friends Don’t Let Friends Buy and Hold
You probably read my letters because they help inform your investing strategy. If so, then let me say this loud and clear: your strategy probably needs to change. The methods that worked well recently won’t cut it in the new era I think we will enter soon.
At the risk of repeating myself for the 20th time, bear markets like last December that are not accompanied by recessions have V-shaped recoveries. Bear markets that happen in the context of a recession have long recoveries. The next one, because of the massive debt that will be increasing at an astounding rate, is likely to see an even slower recovery.
Friends don’t let friends buy and hold. At a minimum, you need some type of you from the worst of a massive bear market.hedging program on your equity portfolios. Using a simple 200-day moving average to signal the time for going to cash, while not the best, will help protect
The recent flurry of IPO filings by “unicorn” companies like WeWork ought to be ringing alarm bells. The venture capital investors who financed these businesses thus far are ready to exit. They’re doing so because they think the risk-reward equation is as favorable as it will ever be. Possibly they’re wrong, but I don’t think so.
We have reached the “distribution” stage, when insiders and professional investors become net sellers while the small investors who missed most of the bull market finally jump in. History says it won’t end well for the latter group.
As the economy weakens into recession and public markets retreat, I think we’ll see two strategic trends.
First, active management will return to prominence as investors realize prices can move in both directions. The RIAs, mutual funds managers, and hedge funds that have managed to hold on through the lean years (and many didn’t) will draw assets once again. That doesn’t mean they will succeed, performance-wise, but they’ll get a chance to try.
Second, and possibly more important, the best opportunities will leave the public markets entirely. We already see this unfolding as the number of listed companies declines, mainly at the expense of small caps. There is just no reason for most successful companies to accept the hassles and expense of an exchange listing. They can raise all the capital they need from that small number of investors in whom most of the wealth is now concentrated.
This will, unfortunately, aggravate the inequality frustrations. Our regulatory structure keeps most private investments off limits to the average investor, or even above-average net worth investors. So even if you manage to accumulate some capital, you may not have the much better options for investing it than those with a few million dollars and more. The government has rigged the markets against small investors in the name of protecting them.
That doesn’t mean investment success will be impossible. You’ll have opportunities, but you may have to hunt for them and act quickly when you find them. That’s what active managers do, and not just in stocks and bonds. I foresee many opportunities in real estate as well. There are going to be amazing opportunities in new technologies. Like smart generals, sometimes we have to retreat from the unwinnable battle and develop a different plan. That’s what I am doing.
1a) Republicans in a Nation Needing Repair
But beyond that fact is something bigger. America needs help right now and Americans know it. It has been enduring for many years a continuing cultural catastrophe—illegitimacy, the decline of faith, low family formation, child abuse and neglect, drugs, inadequate public education, etc. All this exists alongside an entertainment culture on which the poor and neglected are dependent, and which is devoted to violence, sex and nihilism. As a people we are constantly, bitterly pitted against each other, and force-fed the idea of America as an illegitimate, ugly, racist and misogynist nation. Even honest love of country isn’t allowed to hold us together anymore.
1a) Republicans in a Nation Needing Repair
Less taxes and spending won’t resolve America’s deep crisis. We need a farsighted conservatism.
By Peggy Noonan
I want to say something big, quickly and broadly.
This week I talked with an intelligent politician who is trying to figure out the future of the Republican Party. He said that in presidential cycles down the road, it will be a relief to get back to the old conservatism of smaller government, tax cuts and reduced spending. I told him what I say to my friends: That old conservatism was deeply pertinent to its era and philosophically right, but it is not fully in line with the crises of our time or its reigning facts. As Lincoln said, the dogmas of the past are inadequate to the present: “As the cause is new, so we must think anew, and act anew.”
Here is how I see it:
The federal government will not become smaller or less expensive in our lifetimes. There is no political will for it among elected officials in Washington, many of whom privately admit this. Nor is there sufficient will for it within the Republican or Democratic party, or among the majority of their voters. Even if there were such a will, both parties in Washington have trouble working together on such big things.
I want to say something big, quickly and broadly.
Here is how I see it:
The federal government will not become smaller or less expensive in our lifetimes. There is no political will for it among elected officials in Washington, many of whom privately admit this. Nor is there sufficient will for it within the Republican or Democratic party, or among the majority of their voters. Even if there were such a will, both parties in Washington have trouble working together on such big things.
America to my mind is what Pope Francis said the church was: a field hospital after battle. We are a beautiful and great nation but a needy, torn-up one in need of repair.
All that takes place within a larger historical context. You can’t see all the world’s weapons and all its madness and not know that eventually we will face a terrible day or days when everything will depend on our ability to hold together and hold on. Maybe it will involve nuclear weapons, maybe an extended, rolling attack on the grid, maybe bioterrorism. But it will be bad; there will be deep stress and violence. The great question in those days, under that acute pressure, will be: Will we hold together? Will we suffer through and emerge, together, on the other side? Which is another way of saying: Will we continue as a nation, a people?
My belief is that whatever helps us hold together now, whatever brings us together and binds us close, is good, and must be encouraged with whatever it takes.
If these are your predicates—America in cultural catastrophe, and hard history ahead—you spend your energies on a battle not to make government significantly smaller, but to make it significantly more helpful.
That would mean a shift. Republicans should stand for a federal government whose aim and focus are directed toward conservative ends, a government focused on concerns that have to do with conserving. They should do this not furtively or through strategic inaction but as a matter of declared political intent, in a way that is driven by moral seriousness, not polls and patter about populism.
What would a large government harnessed toward conservative ends look like?
Judging by what its presidential candidates are saying on the campaign trail, the Democratic Party intends to aim its energies in a progressive direction—global climate change, free college, reparations for slavery. A conservative path would address the immediate crises Americans on the ground see all around them.
On domestic issues this would include the following:
• Whatever might help families form and grow.
• Teaching the lost boys of the working and middle classes, black and white, how to live. The infrastructure bills floating out there are good because we need better bridges, tunnels and roads, and the pride that would come from making them better. But also because they could provide a stage for a national mentorship program in which men teach boys how to do something constructive. Heck, they should go out and recruit in the poorest neighborhoods, drag teenage boys out of the house and integrate them into a world of dynamism and competence.
• Resolving the mental-health crisis. We need a vast overhaul of services so families can get the help they need. We deinstitutionalized sick people and closed the hospitals in the 1960s through ’80s. Liberals pushed it for reasons of ideology and conservatives accepted it for reasons of savings. It marked a great denying of reality: We need hospitals for the mentally ill.
• Helping immigrants become Americans. However the illegal-immigration crisis is resolved, or not, there are tens of millions already here. Who helps make them Americans? We used to have settlement houses for the great waves of immigrants who came in the early 20th century. Why not now? They need instruction on the meaning and history of America. Here it should be noted that we have some of the best immigrants in the world, who work hard and have no hostility to American religious culture. In fact, they’re part of that culture. Help Americanize them in other ways.
• Help revitalize small towns. Whatever will help, do it. We lose a lot when we lose those old shared ways and values. We can’t all live in cities and suburbs; we need diversity.
• Protect religious freedom. The threats are real and will grow. Americans may not always be breaking down the doors to go to church, but they respect religious life and don’t want to see it under siege.
Really, the point of conservatism is to conserve.
Here we degenerate into mere practical political advice for the GOP.
Americans would respect the Republican Party if it gave the impression its leaders are actually noticing America and have a farsighted sense of its real plights. If the government is going to be large, people might be inclined to see sober-minded Republicans as the best stewards of it. It is still only the GOP that can perform the fundamental mission of protecting the system that yielded all our wealth and allowed us to be generous with the world and with ourselves—free-market capitalism. Only the GOP can do this, because Republicans genuinely love economic freedom. You fight hard for what you love. Progressives do not love it. They just accept it.
Republicans will be expected to foster and encourage the economic growth that can at least make a mild dent in our deficits. When you are understood not to be hostile to all spending you have greater leeway to see it coolly, and go after waste and fraud in spending. Republicans naturally enjoy that.
When you think like this—we are in a crisis, it will get worse, we must accentuate what holds us together and helps us muddle through—it helps you prioritize. These are my priorities as a conservative.
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