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| Thank You, Mr President - Nov. 21, 2003 |
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Foreword
Although this piece is not titled as such, it really is being written under the umbrella of my "Stocks Aren't Cheap" series. As you read through it, it will be more than easy to see where the various future installments will come from.
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Introduction
The (hypothetical) scene opens earlier this week, in the Oval Office, where a conversation (hypothetical) between President George W. Bush ("PB") and Doug Gillespie ("DG") is just commencing.
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PB: Doug, welcome to the White House; thank you for coming.
DG: Thank you, Mr. President. I'm honored to be here. The only other time I was in the White House was on a tour, during my college years. That is going on 40 years ago.
PB: You graduated from college in the 1960s?
DG: In 1967, from Gettysburg College, not terribly far from here. As I recall, you graduated from Yale in 1968.
PB: Yes, I was Class of '68 at Yale. As for Gettysburg College, it is a fine, beautiful school. Laura and I were on the campus during the summer of 2000.
DG: I remember -- you were addressing the Republican National Convention via a remote hookup from Eisenhower House. It now houses Gettysburg's office of admissions, but after President Eisenhower left the White House and retired to his farm in Gettysburg in 1961, the college made the building available to him and his staff. It served for several years as the former President's office and was right across the street from my old fraternity house.
BP: Yes, we certainly sensed the building's dignity and history.
DG: Mr. President, as I said a moment ago, I am honored to be here. However, I have no idea why I am here, since your chief of staff would not tell me the purpose of the meeting.
PB: No, I asked Andy Card not to. I would like this initial chat to be as informal as possible. I figured the less you prepared, the better it would be to foster that climate. I would like to discuss some of your views on the economy, the markets and perhaps a little politics.
DG: That is indeed a broad spectrum. I doubt we will have enough time to get into all of it too deeply, considering you are about to leave on your state visit to the UK.
PB: Don't worry, we will have additional meetings and further discussions when I return.
DG: You are familiar with my work, President Bush?
PB: Let's just say we have a mutual friend who occasionally e-mails some of your material to me.
DG: So much for copyrights! But if my views can help the
country, you are welcome to them. May I assume that in this and future discussions, everything is on the table -- no holds barred?
PB: Absolutely!
DG: Well, may we begin by my turning the tables a bit, by my asking you what it is about the work of mine you've seen that is of specific interest?
PB: A few items have caught my eye. First, I was intrigued by a "political disclosure" statement you used in one of your pieces. You claimed to be a Republican "by default." I am not exactly sure what one of those is.
DG: We seem to be starting our discussion in the area of politics, Mr. President, which is fine. I do want to hash out the economy and financial markets with you, but considering it is now less than one year until the national election, this will all be very mutually inclusive anyway.
I use the disclosure statement periodically so my clients remain aware of my personal political proclivities. I try exceedingly hard to see that these do not bias my analytical judgments. I feel strongly, however, that since I occasionally write about political matters, people have a right to know what my personal views in this area are. Frankly, it would be great if mainstream media people did this, too. I believe it would certainly enhance how people viewed their intellectual honesty.
As for being a Republican "by default," I believe this is more or less explained by the next part of the disclosure statement I use, which states that I consider myself a conservative with a few libertarian leanings. To be honest, Mr. President, the Republican Party's leftward drift as well as what I view as its outright cowardice at times in recent years has increasingly turned me off. Nevertheless, I maintain my Republican registration.
PB: Of what leftward drift and cowardice do you speak?
DG: This conversation is but a few minutes old, and already, we are into tricky, sensitive territory. But since everything is on the table, I will tell you that I believe much of your domestic program has set a tone of significant leftward drift.
As for just one example of cowardice, I think the way Senate Republicans have handled the confirmation process of some of your more visible, high-level judicial appointments is an abomination! I realize the situation took a different twist last week, with the Republican leadership trying the marathon session. But I fear this was nothing more than a cosmetic charade with no staying power, an attempt to appease the "base." If so, I believe it could backfire -- badly!
Speaking of the base, I sense, Mr. President, that all this could put you at some risk regarding support from your base next November. And I would be remiss not to include your so-called "new tone." The latter has done nothing whatsoever to foster Democrat respect or cooperation, but it has bothered many of the Republican Party faithful a great deal to see how willing you have been to take such enormous abuse from the other side. Of course, I'm sure Karl Rove strenuously disagrees with my assessment.
PB: At the moment, Karl thinks the situation for next year is looking exceptionally solid. You don't, Doug?
DG: Please take this the way it is intended, Mr. President, which is constructively, but this was also the assessment in 1991 regarding your father's prospects for the 1992 election. I believe there could be some similarities at work.
PB: I sure hope not!
DG: May I make a suggestion? Perhaps we can get into a discussion of the economy and financial markets and leave a more intense discussion of politics for one of our future meetings. There will still be plenty of tangential overlap between the two areas anyway.
PB: Yes, that is fine. And I promise we will get together soon on the political stuff. Since your views regarding my political future are downbeat, I certainly want to hear them.
DG: Not downbeat, Mr. President, maybe just a little more circumspect than the ones you hear most often. Along these lines, let me say that I don't think you are always well served by the legion of conservative cheerleaders in the land of talk radio. And remember, this opinion comes from someone who not only is a political conservative, but who also is a conservative talk-radio junkie!
PB: Fair enough, Doug. But before we move on to the economy, please give me your quick thoughts on Iraq.
DG: This is impossible for "quick thoughts," Mr. President, and likely lends itself to an additional meeting devoted solely to the subject. In a nutshell, however, I believe Iraq poses a serious problem for you.
PB: How serious?
DG: Very serious.
PB: Well then it is a done deal ... we shall have another meeting devoted to Iraq -- soon, too.
DG: I look forward to it, Mr. President.
PB: Okay, it's off to the economy, although I'm afraid my next question gets back to domestic politics.
DG: As I said earlier, Mr. President, overlap is unavoidable.
PB: Something you wrote -- in May, as I recall -- suggested a fifth term for Alan Greenspan as Federal Reserve chairman just might cost me a second term as President.
DG: I did indeed write that -- and believed it, too. I still do believe it. In fact, since then, I refined the thought a little more, to wit: Wouldn't it be an incredible irony if the person responsible for Greenspan's fifth term were denied a second term for himself as a result of the decision?
PB: The financial markets applauded the view I expressed in April, that Chairman Greenspan deserved another term. I take it you did and do not.
DG: I definitely do not. On several occasions in my work, I have stated unequivocally the view that in the fullness of time, Alan Greenspan would become one of the great pariahs in financial-market history.
PB: That's a pretty strong statement, Doug.
DG: It is indeed, but it is not lightly made. My acquaintance with and knowledge of Alan Greenspan go way back to the late 1960s, when he was in the private sector running the economic consulting firm of Townsend-Greenspan & Company. Thus, my opinions have evolved over a long period. As for the markets applauding your April pronouncement regarding a fifth term for Greenspan, how can I state this delicately? Well, let's just say there is a reason that in some quarters, Greenspan is known as, "Uncle Al, Wall Street's Pal."
In assessing Greenspan's performance in office, I also have another yardstick -- William McChesney Martin, Jr.
PB: How so?
DG: First, Mr. Martin was Fed chairman while I was in college. In fact, as you are undoubtedly aware, he was, to date, the longest-standing chairman in the Fed's history -- 1951 through 1970. Since I had several courses in college dealing with the Federal Reserve System, I became increasingly knowledgeable about the central bank's then-chairman.
Next, a person with whom I worked very closely and with whom I became close friends at U.S. Trust Company, my first job out of college, was Dr. James J. O'Leary. Jim was U.S. Trust's vice chairman and chief economist, and just a fantastic, highly esteemed business economist.
Earlier in Jim's career, he had worked on the project to unpeg interest rates after World War II. It became known as the "Accord," since it ultimately involved a deal between the Treasury and the Federal Reserve to get rates unpegged. Bill Martin worked on the project, too. As a result, he and Jim O'Leary got to know each other quite well. One day in 1951, Jim received a telephone call from President Truman, to thank him for his contribution to the project, as well as ask him what he thought of the "young man" he had worked with. That "young man" was William McChesney Martin, Jr., and shortly thereafter, Truman appointed Martin as Fed chairman.
Next, I had the great privilege to work with Mr. Martin after he left the Fed in 1970. That involvement was an interesting one, and I want to share some additional thoughts on Bill Martin, since in my view, he was a great Fed chairman for many of the reasons Alan Greenspan is not. Let's just say that if Alan Greenspan were here right now, I would be tempted to adopt Senator Bentsen's tact when he was debating Vice President Quayle during the 1988 campaign, when the name of former President Kennedy came up. I would say: "Chairman Greenspan, I knew and worked with William McChesney Martin, Jr. You, sir, are no Bill Martin!"
PB: Very interesting, Doug. I would like to hear more about Mr. Martin. And for obvious reasons, you have seriously aroused my interest in Alan Greenspan. Can we discuss him some more?
DG: Certainly, Mr. President, but how are we fixed for time?
PB: Actually, not too good, since I have some briefings in a little while in connection with my trip to England.
DG: Well if it is okay with you, President Bush, let's do this. Let's finish today's session by my outlining several thoughts in as much a summary fashion as possible. I see that you have been taking copious notes, so we won't have any difficulty coming back to these, as well as the earlier material, to discuss it all in greater detail, when time permits.
PB: That's a good idea, Doug.
DG: I'll try to keep the following in a logical chronological order. Pardon me, however, if I do not succeed.
* With respect to the stock market, I entered the "secular bear" camp in 2000; that is where I remain.
* In this regard, I have believed the secular bear could wind up playing out a lot like the 1965 to 1982 experience. While the current episode might not run that long, I believe it probably still has years yet to go. Thus, I do not at all buy into the consensus view that the next long-term bull market is currently in progress.
* This said, I think you have to be careful with terminology. During the summer of 2002, very close to the July lows, I became highly constructive on the stock market. I emphatically reiterated my positive views as marginal new lows were made in October of 2002, and I did so again when the market was being taken apart in March of this year. In fact, in March, when most of Wall Street was extraordinarily morose and many analysts were predicting that 2003 would be the first time since the horrible days of 1929 through 1932 that the stock market would decline four calendar years in a row, I went vociferously in the opposite direction. I'm pleased to report that I turned out to be correct -- and for mostly the right reasons, too!
* So how could I, a secular bear, be a bull? This is where terminology comes into play, since a secular bear market will experience cyclical bullish episodes. That is all I think we've been having. I also believe it has run its course or is just about to. In fact, President Bush, from a purely selfish, political perspective, you should be rooting for a pretty severe correction ASAP. I realize this probably sounds peculiar if not anathema, but I will get back to why I think this is in a moment.
* When I opted for the secular bear case in 2000, I opined that before it was over, there would -- at minimum -- be a reversion to the mean when it came to valuations. But I also invoked Charles Dow's work of the late 1800s, which stated in general terms that long periods of overvaluation had a tendency to be followed by a period in which stocks became undervalued, all based on historical norms. Furthermore, the degree of overvaluation somewhat dictated the subsequent degree of undervaluation. And no one really disputes that at their peak, valuations in the present situation were extreme.
* But valuations were and remain even worse than they appear, because of the formidable controversy surrounding the quality of reported earnings. I am sure I need not tell you, Mr. President, that versus a couple decades ago, the accounting conventions producing today's earnings stink! It is way more than "aggressive" accounting, as many of the unfolding scandals are illustrating, and these abuses have tended to make valuations look a good deal more temperate than they really were or are.
* A key ingredient swinging me over to the secular bear camp in 2000 were the many excesses that had developed in both the US and world economies. Worldwide overcapacity and the huge debt overhang here in the United States were just a couple factors. Another one, and a huge one at that, was what by mid 1999 I had classified as the "Y2K hoax." Alan Greenspan's imprimatur on this was enormous, as were the economic consequences.
* I could go on at considerable length in this area, Mr. President, but I shall leave that to your wishes in future meetings. Let's just say that the kind of excesses that developed -- the several "bubbles" put in place by what I believe were bad monetary-policy decisions that were often politically driven -- simply do not get worked out of the system either easily or fast.
* What primarily is it that redresses these structural impediments? In my view, it is the passage of time and the operation of free and open markets. For instance, corporate bankruptcies, then the tedious process of reorganizations, etc.
* But as I said earlier, this takes time, which can and frequently does put the process at odds with political considerations and schedules. I believe decent progress was being made, but I also think Greenspan's behavior earlier this year has helped create new bubbles -- or maybe just aggravate old, still-unresolved ones would be a better way of stating it.
* And this is where you likely played a role, President Bush. I realize you wanted Greenspan on board to help with getting the tax cut through. April's nod on a fifth term accomplished this in quick order. And I emphasize "quick." I must tell you, though, that I was not impressed with how fast Greenspan flipped from speaking against the tax cut to becoming a champion of it. It spoke volumes about how easily a quid pro quo could change his personal convictions, not to mention what it said about how little if any of the Federal Reserve's historical independence remained intact.
Which gets me back to the stock market for a moment, as it relates to your personal political interests.
* Unfortunately, Americans do not possess a high level of basic economic knowledge. Even more unfortunate is that much of this results from the general dumbing down of the nation's educational system. We'll leave that for another discussion, however.
The point here is that many people key off the stock market as a measure of how well the economy is doing in current terms. Or how well the economy is not doing. Thus, the market's rally clearly is creating some of the better attitudes in this area. But the converse would surely be true. A substantial setback in the market would influence attitudes about the economy in the reverse direction, which would likely have an adverse political impact on you.
Much if not most of Wall Street is out propounding the idea that on balance, the stock market will simply keep on going up, certainly through next year's election. Maybe, maybe not, Mr. President, but my personal view is quite different. I believe there will be no new highs in the popular, visible bellwether measures possibly if not probably for years, measured against the year-2000 record highs. Moreover, I can easily envision a setback of at least 15% to 20% from the recovery highs in these measures in coming months.
These highs were generally made just last week or the week before. To put them in statistical perspective, let me call upon a seven-measure tracking group I constructed a few years ago, a proxy that is broad and quite representative of the stock market as a whole. From the respective October 2002 lows through recent highs, this group's average gain, excluding dividend returns, was a steamy 50+%, with a median gain of almost 41%. The best performing of these seven measures -- the NASDAQ 100 -- was up almost 79%, while the worst performer -- the Dow Jones Industrial Average -- was up more than 35%.
If I turn out to be correct about the 15% to 20% setback, when it occurs could be highly critical to you. As a purely selfish political consideration, the sooner the better! Because were it to occur, say, in the late spring or early summer of next year, I believe the event would bring with it onerous political consequences.
* At some point, Mr. President, we should speak in more depth about the Wall Street scandals. In a nutshell now, they are pervasive, alarming, cannot be swept under the carpet, and despite individual investors' current blase reaction to them, the scandals represent a huge threat to the well-being of the financial markets.
* I will wrap today's session up with some terse views on the economy.
* I believe many analysts took the +7.2% advance estimate of third-quarter gross domestic product and ran much too far too fast with it. Even now, some are beginning to throttle back a little, which I believe is the right thing to do.
* Nevertheless, there are many folks using a 5% estimate for real GDP growth next year. on a Q4-over-Q4 basis, this would require upwards of a $500-billion increase in real gross domestic product, in turn, requiring growth of something around $350 billion in personal consumption expenditures. Look as I might, Mr. President, I cannot come up with either figure.
* In addition, there is something of a mathematical Catch-22 at work. This magnitude of growth would require massive inventory rebuilding. In turn, since we as a nation import so much of what we consume, this level of inventory rebuilding would be consistent with sizable growth in imports, thereby likely producing a large increase in the trade deficit. In turn, each dollar of growth in the trade deficit becomes a dollar subtracted from GDP.
* It is my personal view that much of what contributed to the reported third-quarter spike in growth was at least partially nonrecurring. Certainly much of the influence from the tax cut was. And there was also a major contribution from mortgage refinancings during the quarter, resulting from the interest-rate cabal Greenspan unleashed during the second quarter. We'll discuss this "cabal" in more detail in the future.
* There has been much talk of and concern about deflation in recent months, a lot of it being inflamed by Greenspan's just-mentioned cabal that took place back in the late spring and early summer. Deflation might become a serious problem down the road. But if there is a surprise in coming months on the inflation/deflation front, I suspect it will be coming from the former, not the latter.
* In this regard, the Federal Reserve is probably not being too judicious in keeping the Federal Funds Rate pegged below even the current inflation rate, as measured by the Consumer Price Index. And the CPI has been pretty badly butchered over the last decade. I certainly don't think it measures very well the average family's actual experience with rising living costs.
* I believe it is more than interesting that two Western central banks -- the Reserve Bank of Australia and the Bank of England -- have actually raised their administered interest rates in recent weeks. In both instances, the banks cited concerns about future inflation as one of the reasons they acted.
* Of one thing I am reasonably certain, Mr. President. Were the Fed not pegging the Federal Funds Rate at 1%, the general level of short-term interest rates would be higher than it is. I'm not out championing the cause of higher interest rates. On the other hand, we preach incessantly about the virtues of free markets to all the world's developing nations. You will pardon me, sir, for seeing just a touch of hypocrisy in this.
* And something to consider on the interest-rate front is the devastation that short-term interest rates that all but certainly are artificially too low have caused to savers -- particularly older one -- as well as to endowed institutions such as colleges. I wonder if there might not be some political price for this?
Well, President Bush, I see your secretary beckoning you for your next meeting.
PB: Yes, Doug, I must run along now. But this has given me a great deal of food for thought. I appreciate your candor, and I very much look forward to our next get-together -- perhaps next week?
DG: I will make myself available.
PB: Thanks very much, Doug.
DG: Thank you, Mr. President.
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