| The
Great Reckoning Revisited: Part 2 |
Dateline: 10/21/97
Last week I reviewed James Dale Davidson and Lord William Rees-Mogg's prediction of the mother of all depressions to occur before the turn of the century in their book, The Great Reckoning, revised edition published in 1993.
Where have we come since the book came out? A large part of Davidson & Rees-Mogg's prediction hinges on the liquidation of debt. Certainly consumer and government debt is at an all time high. Nevertheless, the last few years have seen concerted efforts by governments to bring debt under control. In Canada (which has a worse per capita debt than the U.S.), Finance Minister Martin has come in ahead of schedule on deficit reduction. A balanced budget is only two years away.
The discussion now is not on the need to control government debt, but on what to do with the so-called "fiscal dividend" or budget surplus that will occur after the budget is balanced. The Liberal government has pledged to use at least half for debt reduction and tax relief. (I think they should use 100% for debt reduction and tax relief.) A crisis had been looming, but confidence now exists that the government can, in fact liquidate its debt in an orderly fashion.
Although the left still clamours for more handouts, the government has held the line. In fact it has cut back on expenditures. An opposition dedicated to tackling Canada's debt problem is keeping the government's feet to the fire. At the International Society for Individual Liberty Conference at Whistler, B.C. last year, I had the opportunity to sit beside Reform Finance Critic Herb Grubel (a noted free market economist) at lunch one day and asked him about his personal relationship with Finance Minister Paul Martin. He told me that Martin has told him privately that he needs the Reformers to keep pushing on the debt issue as it helps him to push his debt management programs through a sometimes reluctant caucus. Martin, he says, knows what must be done and is determined to do it.
At his annual fall economic update given in Vancouver on October 15, Martin said "We owe it to Canadians to keep our feet on the ground. Some seem to believe now that the books are near balance, it is time to set frugality and financial discipline aside. To turn on the taps. To start spending as if there were no tomorrow."
"Let me be very clear," he said in a warning to the clamourers for largesse, "The old ways are over...this government has cut up its credit card. Responsible financial management is not a fad or a phase. It is permanent."
To what extent has this success of Martin's been aided by inflation? Although official inflation figures are low, Terence Corcoran of the Globe & Mail, Canada's best writer on business and economics, wrote recently that Canada's money supply has expanded greatly and that has fueled the stock market boom. The inflation has showed up there instead of the Consumer Price Index. A retrenchment, he thinks, is inevitable. This seems to indicate an inflationary rather than a deflationary period. Has a deflation merely been delayed? Or has the government managed to avert a deflationary scenario? Time will tell.
Ironically, it has been left of center governments that have brought about moves to fiscal responsibility in much of the world. In New Zealand, a Labour government deregulated, privatized, cut spending and brought the country's fiscal house in order. In Canada, the Progressive Conservatives increased the national debt by a staggering proportion. Now the Liberals are bringing it under control. In the U.S. the national debt also grew at an ungodly rate under the Republican administrations of Presidents Reagan and Bush. Democrat Clinton has brought some measure of amelioration of the problem.
Looking again at Davidson and Rees-Mogg's prediction, I believe they underestimate the intelligence of politicians. (Since I share their particular political beliefs, I can well understand the desire to think that your political opponents are idiots. That, however, is wishful thinking.) They also underestimate the resilience of markets and the adaptive powers of the people. Their megapolitical theory is a variant of historical determinism. (Wasn't Marx an historical determinist?) And it doesn't wash. I do think a significant correction may well be coming, perhaps even a bear market. But what should an investor do about it? Bail out of equities or stay the course?
There has been much writing that stocks are trading at excessive Price to Earnings multiples. Value investment guru Benjamin Graham recommended avoiding stocks with multiples greater than 20 times the last year's earnings or 25 times the average of the last seven years' earnings. Certainly a lot of stocks fail by that standard today and segments of the market seem overvalued. Nevertheless, there are many stocks that still are reasonably priced.
My own view is that you cannot make broad sweeping generalizations about the stock market as a whole. At any given time there will be over-valued stocks and under-valued stocks and many that are priced just right (Call it the Goldilocks theory of the stock market!). The important thing is not to try and time the market and be out before a downturn. The important thing is to be wisely invested. This means being in value and growth oriented investments.
For Canadian mutual fund investors like myself, this mean being in solid value oriented funds like Templeton Growth or Trimark Fund or any of the many other funds with solid track records and solid management. During the great bear market of 1973-1974 (the worst bear market since the 1930's), Templeton lost 9.89% in 1973 and 12.6% in 1974. Templeton's two year loss was about 21.25% compared to the S&P decline of 48%. Someone trying to avoid a predicted downturn could well have missed out on Templeton's 67.5% gain of 1972 to avoid the 21.5% loss of the subsequent years. Better to ride it out.
Templeton went on to rack up gains over the next six years of 41.23%, 45.05%, 30.9%, 29.1%, 24.5% and 28.6% before losing 0.9% in 1981. Mistiming getting back into the market could have cost an investor a good chunk of those gains as well. If you have confidence in the talents of the management of the funds you own, buy and hold makes great sense. Templeton, incidentally, is 20% in cash right now, indicating they expect a downturn and are waiting to pick up some bargains in the process. The good fund managers are not stupid and will be in an appropriate amount of cash on your behalf if you hold their funds.
My personal favorite mutual fund is AIC Advantage, which is managed by people who use a Warren Buffett, Benjamin Graham philosophy of investment. Their track record has been superb. (See my Monthly Mutuals Analysis of September 23). Diversification is also a good idea. Some assets in small caps, resources and precious metals is prudent. And perhaps 5-10% in cash for a possible downturn. (Belying the notion that we are in an unprecedented bull market, my precious metals, small caps and one of my resource funds have all dropped 20-30% in the last year, thus verifying my Goldilocks view of the market. I expect that if there is a major correction in the blue chips, these funds could well come through and counteract that decline.) Avoid Index Funds, which I consider to be investments for the hard of thinking and which will get thoroughly hammered if Davidson and Rees-Mogg's predictions come true.
Suppose there is a major correction? Can we predict when it will happen? In October? As Davidson and Rees-Mogg point out, of the fifteen largest one day declines in the Dow-Jones average since 1928, ten have occurred between September 24 and November 11 But then again, on similar logic, one would have bet that President Reagan would have died in office as every president elected every twenty years since 1840 has died in office. This little tidbit was well publicized when President Kennedy was assassinated.
I should mention at this point that I have not read Davidson and Rees-Mogg's more recent book, The Sovereign Individual and do not know if they have modified their stance. From the calendar for the New Orleans '97 Investment Conference in November where Jim Davidson will be a speaker, that does not appear to be the case. They still think the "worst stock market crash in history" is imminent. Are they right? Are they right about an impending depression? If they are, it's taking a jolly long time arriving!
Since reading The Warren Buffet Way and Value Investing Made Easy, I have adopted Buffett's view of not worrying about the market. If the market takes a beating, so what? It is an opportunity, not a tragedy. If your investments are solid, they will recover.
Despite my reservations about
their predictions and their advice, The Great Reckoning is
still a superb book. I recommend it highly as a thought provoking
challenge to your pre-conceived notions and for its sweeping
analysis of contemporary history. However, if you are easily
swayed by other people's opinions and worry a lot about your
investments, don't read this book as it will scare the bejeebers
out of you!
Agree? Disagree? Send me a note! I may reprint it in a future column of readers' comments.
Another Marco's Musing:
Davidson and Rees-Mogg are political libertarians. So am I. Much
of their thinking is coloured by what I call libertarian
orthodoxy. One of these credos is that gold is, or at least ought
to be, money and that fiat currency is actually counterfeit
money. I used to hold that view myself. Harry Browne, last year's
Libertarian candidate for President, made a very powerful case
for it in his 1971 book How You Can Profit From the Coming
Devaluation. However, since then I have come to the
conclusion that money is what people want it to be. In other
words, the market determines what is money. And the market has
resoundingly chosen the greenback as the benchmark of what
constitutes money. Since being demonetized, gold has become a
commodity like any other. And as such, I believe the price of
gold, barring political interference, should fall in the long
run, as indeed should the price of all commodities. My view is
based on the work of Julian Simon, author of The Ultimate
Resource and another economist popular with libertarians.
More on him in a future column.
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