To counter the rumor that I am incapable of ceding the pen, I present Ben Claremon—a.k.a. The Inoculated Investor—Cove Street Analyst.
– Jeffrey Bronchick, CFA | Principal, CIO
DO I DETECT A HINT OF OPTIMISM
by Ben Claremon | Research Analyst
I am a skeptic by nature. In addition to that component of my rosy disposition, being a disciple of the father of value investing, Benjamin Graham, I also am uniquely focused on potential downside and risk. To me, the concept of margin of safety represents more than just a framework for evaluating investments; it literally defines the way that I view the world. Given those facts, one would assume that US policy makers’ haphazard and inconsistent response to the less-than-perfect situation in the global financial markets would make me bearish about the near- and potentially the longer-term prospects for America. However, in addition to being a risk-averse skeptic, I am also (paradoxically) an optimist. And right now the optimist in me is winning out.
Specifically, our current, seemingly dire circumstances eerily remind me of late 2007 and early 2008. At the time I was a brand new security analyst, working at a start-up hedge fund. Every day the talking heads told us that the US financial system was about to collapse, all of our banks were going to fail or be nationalized and the next Great Depression was at hand. In the end too much debt among consumers and too much leverage in the banking sector proved to be too much for the financial infrastructure to handle. Then, when the liquidity squeeze began, extreme and coordinated measures from central banks and governments were required to prevent what in hindsight was a sadly avoidable calamity. As a result, we began to hear the chorus of detractors saying that America and the West were done.
The Aftermath
The acute threat has passed (at least for now) and, not surprisingly, the world did not end. But we are left dealing with the intended and unintended consequences of the policy response. For instance, the US central bank is now the proud owner of billions of dollars of Treasury debt and the government’s deficit and debt levels are threatening the long-term solvency of the world’s powerful nation. Unemployment in the world’s largest consumer nation stubbornly refuses to fall below 9% and the prospect of the US dipping back into recession has become very real. What does a recession in the US look like when the government is out of fiscal bullets and the Fed has limited ability to manipulate interest rates down even further? No one knows for sure but it looks as though we might find out. And of course it is far too much to ask for our elected officials to stop bickering and positioning themselves for the next election and figure out how to reduce all of the government-induced uncertainty that is plaguing markets and destroying the confidence of businesses and the all-important consumer.
I could go on and talk about the problems in Europe, a potential slowdown in China and the constant turmoil in the Middle East, but the sentiment of such a discussion was well summed by up our fearless leader, Jeff Bronchick, when he so eloquently said, “it just seems like the world is uniquely messed up right now.” No one who reads the newspaper or turns on the TV needs to be reminded of how quickly the tenuous global recovery could fail. Thus, the focus on these negatives likely yields very little. Instead, as Americans, what we should be focused on is not the short-term risks to GDP growth, but on the long-term risk to dynamism. Above all else if our capitalist system can no longer incentivize entrepreneurs to start businesses, create products, and lead through driving innovation, we will end up proving all America’s critics right.
Dynamism
What do I mean when I speak of dynamism? Take my very humble advice and spend a few minutes reading the 2005 Stanford commencement speech from outgoing Apple CEO Steve Jobs. Here is a man who dropped out of college (because it was too expensive for his parents) and started Apple in his parent’s garage during the 1970s, a time not so unlike the one we live in now. The late 1970s, early 1980s period was generally not good to stocks and bonds as inflation spiked and Treasury rates reached double digits. The US was in the middle of an expensive Cold War and oil price shocks were always a risk. The term stagflation is often associated with the 1970s as inflation was rising while the economy was unequivocally not growing. However, despite all of these headwinds, Steve Jobs voluntarily left college with nothing but the blind faith that things would work out. To support himself he recycled soda bottles in order to accumulate a wealth of nickels. Today, a few decades later, he is leaving Apple with the legacy of being one of the most important innovators in modern history.
While this might seem like a one in a million, improbably folksy story, somehow these rags-to-riches stories continue to show up on the public’s radar screen within the US. A cynic might say that people like Steve Jobs, Bill Gates and Mark Zuckerberg are equivalent to successful coin flippers who just happened to flip 50 heads in a row. With enough coin flippers out there, basic statistics suggest that there is bound to be a handful of people who are extraordinarily lucky. However, just as Warren Buffett articulated in his famous “The Superinvestors of Graham and Doddsville” speech in 1984, if you determined that all of the “lucky” people were from the same exact town, you might start to think that there was something in the water; or that luck was not the primary determinant of their success. In my humble opinion it is the American economic system that, at least in the past, has allowed for this degree of social mobility and generation of financial wealth. And I would argue that it is precisely the increasing government involvement in the economy—and the misplaced faith that unelected members of the Federal Reserve can sit in a closed room and magically eliminate the business cycle—that threatens American Dynamism.
The Future
Who could argue that the political and economic environment right now is conducive to the type of innovation we are going to need in order to address the previously mentioned laundry list of potential problems? Businesses are scared about future taxes, the deficit, and an army of regulators who have been known to act capriciously. Also, for many people the cost of higher education makes attending college prohibitively expensive and often leaves graduates with the noose of six-digit student debt around their necks. Given all of this, we should ask ourselves what would happen to the modern-day version of Steve Jobs. Would he even be able to sustain himself today? Instead of spending his time in a garage, would he have to take a low wage job just to help his parents put food on the table? My personal fear is that the next great innovator might be too discouraged by his or her surroundings to take such a gamble.
I am certainly not the first and will definitely not be the last person to suggest that America needs to rebuild its education system and find a way to make a valuable college education more affordable. But, I just don’t think that is anywhere near enough. I believe that life and actions can be best understood through incentives. But right now, I think the social and economic system may not properly incentivize people to take the leap of faith that is required to develop the next world-changing product or process. Maybe the billions of dollars in R&D spent each year at America’s largest companies will help reignite American Dynamism, but I am not so sure.
I will let politicians and policy wonks figure out the appropriate policies to help foster innovation. The only value I can add to the discussion is to stress how important it is for us to collectively ignore the 24 hour news cycle and the fear mongering by our afraid-to-be-kicked-out-of-office politicians. Instead of crying that the sky is falling and suggesting that something—anything—should be done right now, let us take a deep breath and figure out what American capitalism is going to look like in the future. It is only if we let short-sighted fears guide our policies and dampen our collective mood that Chicken Little’s prophecy will become self-fulfilling. The optimist and contrarian in me are screaming that this current period is just an unfortunate phase. My hope is that a young gentleman today who makes the same implicit bet that Steve Jobs did—that the American economy will provide unmatched opportunity for success—will in the end not have his dreams dashed by an overbearing and dysfunctional government system.
