Interest Rates: Higher For Longer Beware Of Institutional Myopia
The country is saddled with a wimpish FRB chairman. He talks about quarter point, even half point bumps in Federal Funds rates which rest close to zero. But, the economy roils with near $100 oil futures and wages escalating at 7%. Operating costs of running a business range at a 7% clip with no signs of ebbing or even peaking out.
Wall Street holds its breath, hoping for the best of all possible scenarios. But, this is foolish optimism as the Western world attempts to face down Russia’s threat to invade Ukraine.
Lemme take you back to 1962 during the Cuban missile crisis when we last faced a nuclear threat. Today’s money managers weren’t around for that press. They probably weren’t operative for Paul Volcker’s lavage rapide which rid the country of its inflationary expectations in 1982. I’m talking about 15% interest rates and a market that sold down to book value, 10 times earnings and yielded 5%.
What I remember as the Russian freighter approached our waters laden down with medium-range missiles on deck, was that Wall Street wasn’t fitted out with electronic infrastructure to handle the selling deluge. The tape was an electromechanical contraption that ran across your desk with an obnoxious clatter, spitting out stock symbols and prices. By mid-afternoon the tape was running 4 or 5 hours late, down hundreds of points.
Maybe, today’s operators were around for the financial meltdown of 2008 - ‘09 when stocks retreated to book value, yielded 5% and sold at 10 times earnings.
Today there’s no valuation cushion. The market sells at over 20 times earnings, twice book value and yields 1.5%. Think about it at least conceptually. If pessimism takes hold, our market could be cut in half before you could make a valuation case for stocks.
How many money managers were around when Paul Volcker in 1981 decided to rid the country of its inflationary expectations? Wages were compounding at a 7% rate, the country practically uncompetitive with Japanese and German manufacturers, specifically in autos.
I don’t hear anybody talking about double-digit interest rates. Today’s pundits mumble about whether Fed Funds go past 2% next 12 months. With inflation in the country presently around 7%, talking about 2% present interest rates is rank foolishness.
Going back to the sixties, even the fifties, I remember FRB chairmen putting up Fed Funds at least as high as the inflation rate. They took the speculative force out of the stock market by raising margin requirements to 90%, even 100%. Today nobody ever mumbles about higher margin on stocks. Why not? Is our FRB chairman afraid to cross the Street? Detroit today is production limited. Good used cars sell for more than new cars where the waitlist elongates.
When I referred back to my trusty financial charts, I found that the trendline on Fed Funds comes in close to 6%, not the 1% we talk about today.
The country changed for the better after Paul Volcker’s lavage rapide in 1982. Labor givebacks began. Jimmy Hoffa’s ghost could no longer threaten to paralyze the country’s interstate commerce. Membership in the UAW peaked, and General Motors closed down their 2nd floor cafeteria in the General Motors building on Fifth Avenue, a profligate utilization of high-priced square footage. I’d breakfast there on enormous toasted corn muffins bathed in butter.
Unskilled labor no longer made $15 an hour (2001). I remember several dissenters at the Federal Reserve Board on monetary stimulus in the 2008 economic meltdown. Don’t ever expect our government to do the right thing in the economic sector.
Consider the concept of “necessary fallibility.” Charts can’t isolate inflection points like Black Monday, 9/11, the Cuban missile crisis and Volcker’s strong medicine. None of these events were readily predictable. Sometimes, it’s a vague, queasy feeling around your belly button that’s the best leading indicator of big trouble ahead. I’ve learned to respect this feeling and act upon it. Axiomatically, politics leads economics, where we rest, currently.
Looking at the record of our GDP momentum, quarter-by-quarter for the past 35 years or so, you never get trendline growth more than 18% of the time. If you exclude quarters with negative growth, our economy grows at a 4.6% rate, not 3%. Year-after-year forecasts fluctuate around 3%, safe but inaccurate.
But, changes in interest rates can be large and long-lived. After Paul Volcker, the market didn’t peak until 18 years later at 1,400. For a while, technology sold as if the Gilded Age would last 40 years, like the old one that ended on the eve of World War I.
Some 21 years ago, Microsoft’s market capitalization stood at $291 billion with Exxon Mobil right below it at $281 billion. Today, Exxon is pretty much unchanged while Microsoft sports a market cap in the trillions. Being right counts up over the years.
In 1961, I was a young analyst with just a couple of years under my belt and maybe $25,000 to my name. Thirst to be rich? You do whatever you have to do. In the Cuban missile crisis, I pushed my gelt into the pot, even over-buying in my margin account. If wrongfooted, it wouldn’t matter. The East Coast would go up in smoke. I picked out the usual suspects - Polaroid, Xerox, even IBM.
Hours later, the Russian freighter, missile-laden, heaved to on our navy’s command. The crisis ended. Next morning, I was soundly reprimanded by the firm’s manager of margin trading. He warned me. Next time they’d put a letter in my personal file.
I miss old Wall Street which was like a small village.