Sunday, September 11, 2011

September 11th, 2011 -
Can We Overcome Fear?

I was born in New York City and worked in the Wall Street district for about 40 years. Though I now live and work in New Jersey, I still view myself as essentially a New Yorker. Thus the attacks on the World Trade Center (WTC) on September 11, 2001 were a particular affront to my being. Many of these feelings were brought back to me on Saturday, September 10th, when my wife Ruth and I attended the dedication of a remarkable piece of architecture, the two memorial walls dedicated to the 746 New Jersey residents who perished from the attacks ten years ago.

The memorial named “Empty Sky,” points directly to where the WTC towers used to stand. The dedication was led by a very moving speech by Governor Chris Christie, with talented musicians from the New Jersey Symphony Orchestra playing the National Anthem. A number of the special guests were once fellow commuters with me when they worked in “The Street,” before they answered the call to public service. The current chairman of the Port Authority of New York/New Jersey spoke, stating that they are rebuilding and expanding the World Trade Center not only as a monument to the nearly three thousand that died, but also to optimism; that we will be even more successful in the future than we were in the past. Because of my personal history, that optimism struck a note with me.

Very early in my business career I commuted by ferry boat from New York across the Hudson River to a train to take me to my then-home community. As usual, I was using the relatively few minutes on the boat to catch up with my business reading and to be in position to be one of the first to get off and to get a good seat on the waiting train. I did not hear from the stern (rear, for you non-nautical types) some excited chatter. When I got to my commuter station I found out that I was on the last ferry to leave Manhattan. That was the afternoon in 1965 when most of the Northeast US, and some portions of Canada, lost electrical power. Along with others, my immediate reaction was to focus on the expected return to normality, and the opportunities that this disruption to our daily lives brought. Less than a year later the official ground-breaking ceremony for the World Trade Center occurred.

From my office windows I watched the building of the North Tower, which was completed in December 1972. With the South Tower finished in July 1973, the total elapsed time between the ground breaking and the finished construction was approximately seven years. The last building of the new World Trade Center will not be completed until 2014. The actual construction time of the WTC’s rebuilding will probably be only a little longer than the original schedule, but due to recovery efforts, litigation, and bureaucratic red tape, the elapsed time to build is about double the original. (As president of the New York Society of Security Analysts, I moved our headquarters into the North Tower in 1992. Luckily all of our employees and members who were in the office that fateful day in 2001 walked down the 40 floors successfully. Without the quick thinking of our executive director we could have wiped out what was at that time, one of the critical organizations to the financial community.)

The key to this history is that smart people are once again committing their lives, professions and capital to a future for lower Manhattan. They are showing their optimism.

Pessimism is Leading to Fear

The recent declines in many stock markets around the world have gone beyond discounting a normal cyclical recession. One of the many lessons that I learned from John Neff, who was the great portfolio manager of the Windsor Fund, (now known as the Vanguard Windsor Fund), was to focus on the earnings power of a company under normal business conditions and not what was thought about the current level of earnings. Thus for him, it was the comparison of earnings power to current price to determine the attractiveness of a stock. Using this kind of analysis, he was brilliantly correct in his purchase of what is now Citigroup. He made multiples on his original investment. Many sophisticated portfolio managers believe that the current earnings projections represent cyclically peak earnings, as margins are at record levels and sales expansion is slowing down. I would submit that this recognition is already in the prices of the shares that they own. If my assertion is reasonably correct, when reported earnings turn down there is not a good reason to further discount current prices. I believe that the general price levels of many stocks presume a decline on the order of 25%, and thus many stocks are selling at perhaps 15X their earnings power and therefore there is no pressing need to mark stocks down further.

However, that is not what is happening currently. We are talking ourselves into a recession by curtailing our expenses where we can, and not taking advantage of the huge talent bank that is available for us to hire. We are afraid of potentially massive disruptions to our global financial structure. Many are focused on the belief that the German government is getting prepared to bailout its own banks on the presumed default of the Greek government. If the Germans are slow to approve increased purchases of Italian debt by the European Central Bank (ECB), Italian interest rates will rise beyond the ability of the country to just pay interest, let alone service its debt. Spain’s problems have to do with weak internal banking structure and too much available real estate underlying its debt. The change in government in Japan is not generating enthusiasm. Both Australia and Canada are showing some signs of strain, etc., etc. The renowned thinker and investment manager Howard Marks of Oaktree Capital points out that markets can handle a single crisis reasonably well, but when there are concurrent problems, the markets go into a chaotic phase. I am hopeful that since the root cause of the structural imbalances is the same lack of political will that I discussed in my Blog post of August 28, 2011 entitled Storms on Both Sides of the Atlantic; that we are dealing with a single problem that plays on many stages, and thus the period of adjustment will be short.

The Lesson from 9/11/2011

Over the last ten years we were alert for a third attack, (I am including the first assault on the WTC in 1993, which I just missed by 15 minutes). At considerable expense and bother, we foiled known and unknown attempts. Up to this point, we have survived and are rebuilding. Perhaps the ten years of a flat nominal stock market in the US is coming to a close. As of today, we have suffered but survived in lower Manhattan. The substantial structural imbalances caused by people in many countries, demanding from pliant politicians more than we are willing to pay for through fees, prices, and taxes, will be addressed painfully and hopefully soon. Nevertheless, I take my hope from the “Empty Sky” memorial, and believe prudent, long term equity investment will see no fixed limits to our eventual returns. Hopefully the waiting period is getting shorter.

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