1992 was a frustrating year for us as our Deutschemark bond position went to all time highs in October, only to sell off substantially in the euphoria over Bill Clinton’s victory. This has to be endured in long bull markets sometimes, but it is plenty annoying to live through in the here and now. We think two magazine covers within the past month capture the current mood exactly. Time declared Mr. Clinton “Man of the Year”, although as he himself bemusedly acknowledged, he hasn’t done anything yet. And Der Stern, a sort of oversized Time with pictures, has a cover of a movie star handsome Mr. Clinton superimposed over the American flag with the caption, “Hope for America, hope for the world”. Though he certainly gets around, we were unaware Mr. Clinton had made any election promises to the Germans at all. Meanwhile the financial markets seem determined to positively banish skepticism for the duration of the new government’s term.
The current lust for financial assets has quite a past. For a few brief months in 1982 American bonds sold at yields over 15%. From that time to this, the bulk of the American public has been engaged in ever more frantic spasms of remorse for a missed chance at effortless investment success. This moment lasted but a few months, and to have been even half a year early in seizing it, as we were, was unbelievably painful. Nevertheless, the notion has persisted that there is a class of assets out there, somewhere, that has as its intrinsic peculiarity the ability to yield fifteen and twenty percent after inflation no matter what the season, no matter what the state of business.
Oil partnerships, junk bonds, real estate schemes and worse have all been tried and exhausted. Yet the belief persists that the characteristic of an asset in itself makes it attractive and profitable, and not its price versus its value. After a decade long bull market, financial assets are today thought to be so charmed.
For the last 18 months, this absurdity has taken the form of a mutual fund craze that dwarfs all previous enthusiasms. The recently released November stock mutual fund sales were not only greater for the month than the years 1988, ’89, and ’90 combined, but taking stock and bond fund sales together, they equaled approximately $4000 per American house-hold if continued at an annual rate. That is about 4 times greater than the national savings rate, which, of course, includes mortgage and credit card paydowns, insurance cash buildups and a host of savings vehicles other than bank accounts. Obviously, the public is disgorging all else in order to purchase stocks and bonds at all time highs.
We are, we hope, exaggerating a little, as November’s inflows were the highest so far, and we think it unlikely such a thing will last for an entire year. On the other hand, we certainly never thought six months ago the public’s enthusiasm could mount to here. Indeed, were you keeping a wall chart of stock mutual fund buying, you would be adding pages to the top of it and looking to shift ceiling tiles around to accommodate coming months. Clearly the people doing the buying are making no level headed judgment about the profitability of the underlying businesses versus the current multiples of the shares. They are simply certain that 3% from a money fund is too little and their neighbor’s share portfolio has been going higher.
This enthusiasm comes in the face of a profits collapse amongst the worst in the history of the stock averages, and that is the motive force for these historically low rates in the first place. Whatever the public is about, it isn’t value investing or a strenuous attempt at preserving capital in an inflation prone world. It is perhaps toward the threat of inflation that the market’s gaze is most firmly fixed in the wrong direction, dreamily contemplating the past successes of the Volker years while ignoring the very real harbingers of inflation to come. The new government is proposing to expand government borrowing, shorten the term of the debt, pressure the Federal Reserve to peg those short rates even lower, and raise energy prices sharply. All this before we find out just how much universal health care will cost the nation’s businesses.
Against a backdrop of competitive devaluations in Europe, a resurgence of inflation would catch the financial world sorely unaware. For one thing, most of the world’s gold producers are heavily short their own future output, and with demand from the Far East greatly outstripping mine supply, a swing in investment sentiment would likely prove explosive to the gold price. Not only would this be sure to unnerve the wildly optimistic bond market, but it would prove that there is in fact investment alternatives to chasing momentum mad mutual funds.
This would be just the tonic for our German bond position, as it would confirm the German authorities’ fears completely. American newspapers cannot get over the fact that the Bundesbank and the German public alike think 3.5% inflation rates are too high and that something ought to be done about it. That the German public likes high interest rates more than we do is hardly surprising considering consumer debt is 15% of income there vs. over 70% here, while their savings rate is almost four times ours. Sometime this year it will dawn on the world that we need a good burst of inflation to give our new government room to maneuver. The Germans do not. When that realization comes the dollar is in for a considerable fresh downdraft.
The stock market is likely to run out of steam even before that. Wall Street is working double shifts printing stock certificates in ventures worthy of the South Sea bubble, from blind pools to ostrich farms. Meanwhile the public may quietly be running out of money. Rates on certificates of deposit are actually slightly higher this week than they were six months ago, the first time that has been true in over two years. And Wall Street has a well earned reputation for poisoning the goose laying the golden eggs with toxic stock offerings right at the top.
Wishing you and yours the best, we are,
Sincerely,
Edwin A. Levy
Michael J. Harkins
____________________________________________________________________________________________________
LEVY, HARKINS & CO., INC.
In 1992 our average account appreciated 1 ½% from all sources, inclusive of all fees.
The statistics below are also from 1992:
GNP Price Deflator +2.9%
Consumer Price Index +2.9%
Average Treasury Bill Rate +3.1%
Standard and Poors 500 Appreciation +4.45%
Dow Jones Industrial Appreciation +4.17%
New York Composite +4.68%