For the international members of this community let me point out that the New England Patriots are generally viewed as the single best team in professional football. Most observers also believe that their coach is the single best coach in professional football. Prior to the game, I was discussing the match-up with a close associate who lives a few miles from Foxborough Stadium (where the game was played); I was assured that the locals were convinced that the New England Patriots would once again win. The New York Jets home base is in New Jersey, and their practice field is supported by the hospital group whose investment committee I chair. Thus, I am a supporter of the Jets. My reaction to my Massachusetts associate before the game was that I would be happy if the score would be closer than the 45-3 shellacking that the Patriots delivered to the Jets in their previous game in December.
The reason I link last night’s game to the investment game is that there were a number of lessons to be learned. I found it curious that when these two competitive teams met last night the gross total of points achieved was very similar to their last meet. In the December game there were 48 total points scored. In last night's game there were 49. The big difference was the distribution. In the second game the team with the fewer victories to that point scored 28 points, while the perceived better team scored only 21. One of the statistical lessons from this comparison is that the distribution of numbers within a numbers’ set is extremely important, even if the numbers’ set appears to be identical to a past experience. The second lesson from this game is learned from how the New York Jets changed their game. The Jets introduced four new defensive schemes which confused and/or delayed the superior quarterback of the Patriots. The lesson from this tactic is that defense is critical not only in football, but also in investing (i.e. don’t lose money), and also that competitors learn to come up with new solutions for their problems.
My pessimism as to the outcome of the game last night is instructive and similar to my outlook on the current state of the markets. The initial pessimism about the game was based on a lot of the aforementioned facts, but similarly in reading about the long-term outlook for investing I was impressed by the litany of unsolved problems that were identified by many as a follow-up to their near-term bullishness.
Bubble of Pessimism
The much-used term “bubble” identifies a series of market disruptions that veer from an extreme of high money-making to an even bigger period of money-losing. The current bubble of pessimism is international (not only the US) and rests on five related elements.
- The first element is the absence of jobs for those who want to work.
- The second element is deficits; both in terms of governments (societies) spending more than they are collecting in taxes; as well as a banking system that has loaned more money out than it has appropriate collateral. To correct these two components of deficits there is a strident call by some to raise taxes. The problem is those who pay taxes are increasingly a minority within the society and these tax payers are the same people providing capital to create jobs.
- The third element is the value of paper money. Fiat currencies (currencies that are not backed by hard assets) are dependent on others seeing that a currency is a store of value. With the escalating rise in the price of commodities in general (and specifically in gold), some in the market place are questioning the value of the currencies.
- Then comes the fourth element: inflation. Some of this is caused by the aforementioned concern for currencies, but there are other contributors such as the scarcity of newly available natural resources as well as the US government’s attempt to induce more inflation into our economy through the manipulation being caused by quantitative easing.
- The fifth and final element in the bubble is deflation. The fear here is that lower prices will not only affect the prior identified inflation, but will cause various businesses to shut down as they cannot re-capture enough income to pay their bills.
This is a very distressing list.
The Other Side of the Coins
Just as the Jets surprised the Patriots as well as their own fans, some good things can happen.
- First, in those countries that restrict immigration (one needs to include the U.S. in this list), the absence of new immigrant employees, and to some degree their families, is restricting business and individual consumers from the options of buying goods and services at lower prices. One of the reasons that some point out that the U.S. will have a better future than “Old Europe,” is that we have some immigration and often do a reasonable job of assimilating these newcomers. The developed world (with the exception of the US) is now producing future wage earners in a smaller number than the recent past which will be compounded by those who will soon retire. Further, at the intellectual upper-end of the spectrum, the U.S. has some of the best universities in the world. But as mentioned in previous blogs, our students are not among the leaders in all subjects, specifically science, reading and math. Currently our prime universities are attracting brilliant minds as students (and where possible, faculty) but due to limited visa opportunities, these brilliant minds are not staying here. I am hopeful that the change in focus on the part of the Administration and members of the House of Representatives is such that we will start to untie the Gordian Knot of Immigration. I believe our society would be better off having people who want to work rather than carrying too many of those that are restricting their own job opportunities for one reason or another.
- The next positive element is technology, which for the most part develops labor-saving devices and procedures that allow capital to be re-deployed into higher returns, both here and overseas. From time to time there will be important technological breakthroughs that will solve, or at least ameliorate many of life’s problems. Not only will these be found through our health care innovations, but they will also aid in improving our deteriorating infrastructure and education. Currently, both use too much labor to produce mediocre results.
- Another element that makes me caution the long-term is the increase in the level of consumption in what we used to call the “developing world” and hopefully now will call “clients.” As these new world consumers want more and better products and services, they should increasingly become our clients.
- The final element is what we saw the Jets do to the Patriots. The Jets came up with new ways to play aggressive defense while the Patriots were slow to adapt. As the members of this blog community have learned, I focus an inordinate amount of time on the financial services industries, in part because I manage portfolios (both personal and for others) that invest in financial services. While we can debate the wisdom of the Dodd Frank Bill and the Credit Card Act, for the moment they are the law. I find that it is encouraging that two of our leading financial services companies, Goldman Sachs and J.P. Morgan Chase have already instituted new programs that will over time, replace threatened revenues, while also enlarging their customer set. Jefferies & Company is also filling a perceived void in the global middle markets.
Just as I was surprised on the upside by the Jets’ victory, I suggest that we should not swallow all of the bubble of pessimism, but rather we should use it to develop new ways to make money. While not cheap by historic standards, the current market is not terribly expensive either; leaving room in the long run for much higher prices.
Onto the next game.
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