Dennis C. Butler, President
of all guest columns written by Dennis C. Butler, CFA
In the "real world," few people pay attention to the anniversaries of significant stock market milestones; most of us have better things with which to occupy our minds. With the exception of an event such as the Great Crash of 1929, which people tend to associate with a time of widespread economic hardship, such occasions have little real impact on most peoples' lives and are soon forgotten. Wall Street, however, loves to dwell on those times when markets have done something unusual, unexpected, or stressful for those who deal in securities, regardless of whether there is a lasting impact on the rest of us. True to form, with the approach of March 9 — the fifth anniversary of the bottom of the great market declines of 2008-2009 — the business media offered a raft of commentary on the occasion. Much of this financial reminiscing was of little interest, but there was one piece in The Wall Street Journal that provided a valuable perspective on past events, and permitted the reader to gain insights into how decisions were made βin the heat of battle,β with the benefit of knowing how events eventually played out.
What made this piece especially informative was its inclusion of quotations from market participants at the time of the crash (thus removing the temptation and ability to revise the history of one's market pronouncements, a common practice in the prognostication business). To refresh our readers' memories, 2008-2009 witnessed the greatest stock market decline since the 1930s. A major investment bank collapsed into bankruptcy, and the government was forced to make unprecedented interventions in the financial system to head off an unthinkable calamity. Panic was rife and uncertainty over the economy and even the continued existence of major enterprises prevailed. The investment professionals quoted in the piece were in the middle of it all. They operated in a variety of capacities — money managers, traders, analysts, strategists — and the range of their comments reflected their differing perspectives The level of fear and bewilderment at the time was summed up in a market strategist's statement from March 9, "I don't know if I've ever heard as many people being negative on the market as what's happening right now." It was also reflected in the paralysis felt by many operating in an intensely uncertain environment; traders were fearful of even owning stocks outside of market hours. "Nobody wants to get in the way as the freight train comes down the embankment," said one trader. Still another wrote, "Some people may say that is the bottom, but I think there is another leg to go on this." "There's a good chance the market could keep going lower," echoed a strategist at another firm.
As revealed in the quotes above, much of the commentary reflected the short-term mentality that dominates the securities business. However, a few individuals demonstrated a more nuanced view of the situation. One portfolio manager said on March 4, three trading days before the bottom, "At these valuations you have to be a buyer if you're investing for a long-term frame." Reflecting the pressures from fearful clients, he continued, "At the very least, if we can't get people to add to their positions, we try to avoid liquidating." Unfortunately, this view was rarely taken, as most of the participants and observers quoted in the article were obsessed with trying to forecast the bottom and an eventual turn-around.
Not to be outdone, we decided to look back at some of our own comments at the time of the crash (without "historical revisions" — and since we do not try to predict markets, we are at least spared that source of embarrassment). In October, 2008, after the Lehman Brothers bankruptcy, and as the declines were gaining momentum, we wrote: "¦much of what the financial industry is now suffering through can be thought of as the long anticipated re-pricing of risk." Continuing further, "With recent market declines, risk is becoming better balanced and, importantly, future returns are rising." In a client letter in January, 2009, reflecting back on the quarter just ended, we said, "The fourth quarter especially will go down as one of the most tumultuous periods in investment history." "It was also the busiest period in this firm's history, as we took advantage of a stock market in crisis to commit capital on better terms than any we have seen in years."
In April, 2009, after pointing to the large amount of cash sitting in money market funds, we wrote, "Any hint that the current financial distress is easing could prompt the owners of those dollars to shift a large portion of them into stocks, creating the potential for huge market rallies." ¦While the very idea of big stock gains may seem outlandish at present, recall that two years ago few could have imagined a market and economic collapse of the extent we are now experiencing.β Finally, in May 2009, we wrote, "Today, there is reason for optimism about long-term investing. On a rolling, 10-year basis, prices now are more depressed than at any time since 1974. Historically, a period of weak 10-year returns has been a good time to buy stocks." We hasten to add that we were not alone in holding these views, but it was certainly not the majority opinio
Clearly, the ability to focus on investment fundamentals, remain calm, and maintain a long-term viewand — , importantly, the determination to act upon it — holds distinct advantages as subsequent history has shown. It is unfortunate that so many people saw the events of 2008-2009 as a reason to "bailout." It is equally unfortunate that so many people got advice from investment professionals on Wall Street who seemed as traumatized as the average investor.
Since March 2009, U.S. markets have gained about 170%, including a gain of 30% in 2013 alone. After a long string of strong years like this it is not surprising that the indexes would pause a little, as they did in the first part of 2014. While the popular market gauges have generally shown positive results so far this year (the S&P gained 1.8%; the Nasdaq index was up 0.5%; but the Dow Jones Industrials showed slight losses of -0.2%.), the gains were hard-won. Some attributed the hesitation to elevated or even extreme valuations; the Shiller index, which values stock markets based on long-term average earnings, has been flashing a warning signal. Possible changes in Federal Reserve policies caused some uncertainty and trepidation, which was reflected in the market volatility around the timing of central bank pronouncements. Geopolitics also played a role in dampening market enthusiasm, as events in Easter Europe promised significant changes in the balance of political power and prompted fears of a new Cold War. Nevertheless, an underlying current of enthusiasm coursed through Wall Street as evidenced by surging interest in initial public offerings of shares — especially of technology companies in the digital and biotech areas — and continued strength in the bond market. The frequent "outlooks" popular with Wall Street forecasters remain positive, although future gains are expected to be more modest than in recent years. As usual, prognosticators tend to look in the rear-view mirror at several years of good news, concluding (and hoping) that "momentum" will continue to carry the day.
Going forward, world developments could challenge investors accustomed to a period in which positive results have been relatively easy to come by. Events in Ukraine could prove costly for Russia, a country that has attracted considerable foreign direct investment, particularly from Germany. Capital flight has been a problem for Russia for quite some time; roughly $60 billion left the country in 2013, and a figure of similar magnitude is projected to find havens elsewhere during 2014's first quarter alone. The Russian stock market has taken a sizable hit this year already, and some investment projects involving foreign companies have been put on hold.
Russia is not alone in causing stress for external direct and portfolio (fund) investors. Countries from the Far East to Latin America are placing controls on foreign investment, mostly in areas having to do with natural resources. While the aim of policies designed to improve host countries' share of project income may be justified in some cases, such policies will inevitably reduce returns for investors, dampen interest, and make it more difficult for those countries to attract needed capital in the future. Additionally, the so-called emerging markets — often popular with Western mutual funds — can be acutely sensitive to policy changes at the big Western central banks.
China has become a key factor influencing market sentiment around the world. The country is facing daunting problems — environmental degradation, restive minorities, and corruption, to name a few. Economically, what had been the world's great "growth engine" suddenly looks vulnerable as opaque lending institutions obscuring too much debt, over-building in real estate, and slowing growth begin to catch up with policies that were designed to promote growth at seemingly any cost. China's links with resource-rich countries, and its impact on commodity prices — especially copper and iron ore — mean its economic fluctuations can wreak havoc for those heavily dependent on Chinese trade. Tellingly, even rumors of new Chinese economic stimulus packages affect stock markets almost everywhere. For years this impact has been positive, and it played a significant role in calming markets and helping the world economy avoid the worst during the recent financial crisis. As the country deals with its challenges, China's influence in the years ahead may not be as benign.
Investors also face challenges closer to home. Margin debt is at record levels; corporate debt has also stayed high despite record profitability. The return of speculative practices in debt and equity capital markets — not to mention full to extreme valuations — pose risks. However, five years ago we faced far more worrisome conditions. We are confident that the focus on fundamentals, and a long-term view, will once again prove adequate to meet the challenge.
_____________Dennis C. Butler, CFA, is president of Centre Street Cambridge Corporation, investment counsel. He has been a practitioner in the investment field for over 27 years and has been published in Barron's. He holds an MBA from Wharton and a BA in History from Brown University. His quarterly newsletter can be found at www.businessforum.com/cscc.html.
"Current low valuations reward the long-term view", an article by Dennis Butler, appears in the May 7, 2009 issue of the Financial Times (page 28). "Intelligent Individual Investor", an article by Dennis Butler, appears in the December 2, 2008 issue of NYSSA News, a magazine published by the New Yorks Society of Security Analsysts, Inc. "Benjamin Graham in Perspective", an article by Dennis Butler, appears in the Summer 2006 issue of Financial History, a magazine published by the Museum of American Finance in New York City. To correspond with him directly and /or to obtain a reprint of his featured articles, "Gold Coffin?" in Barron's (March 23, 1998, Volume LXXVIII, No. 12, page 62) or "What Speculation?" in Barron's (September 15, 1997, Volume LXXVII, No. 37, page 58), he may be contacted at:
Dennis C. Butler
Centre Street Cambridge Corporation
Post Office Box 390085
Cambridge, Massachusetts 02139
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© Copyright 2014 Dennis C. Butler, All Rights Reserved
Revised: April 8, 2014 TAF
© Copyright 2014 Dennis C. Butler, All Rights Reserved