Among the Last Skeptics Standing

The future hinges on forces not easily seen among all the news clutter. Like the 1930s, the “experimenters” in Washington are unquestionably bright but so inexperienced as to often be inept. Their mental models have proved time and again to be too small for the huge task at hand. The factors that make headlines—growth vs. stagnation, inflation vs. deflation, the cost/benefit trade-offs of multiple monetary and fiscal stimulus packages, fiscal budget and trade deficits, dollar devaluation—fall substantially into the realm of the unknowable. Those factors that get little public attention (Will the growing segment of the population that feels disenfranchised be made to once again feel empowered? Will business shake off the burden of leftist government intervention and higher taxes and become spontaneously optimistic?) are the ones that will determine whether employment and the economy generally rise or whether they stagnate. Will the “great moderation” be followed by the “great malaise”? I wish it weren’t so, but I wouldn’t bet against it.

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Fireside Chat -- Deflation … or Reflation?

Back to the present moment … We raised doubts earlier about “reflationary” efforts to boost the prices of impaired bank assets and the still falling home prices. We now raise the question: Are there limits to the equity market’s attempt to reclaim its past heights and restore its past glories, the one market still standing that isn’t directly under the government’s thumb? Lest we forget, the Shiller Graham P/E ratio, to which we referred at the outset, has been as high as 25 in 1901 and 1966 (excluding 1931, when earnings vanished, and 2000, when technology and the Internet were priced for eternity) and as low as 6.5 in 1921, ’32, and ’82. If the market marches upward (unrestrained by deteriorating corporate earnings to which it is ultimately tethered) to the optimistic heights of, say, 1966, then the S&P 500 could rise to 1380, a further gain of 480 points—or 50% above current levels. If, on the other hand, the current reflexive optimism proves misplaced, and the pendulum swings back toward the other extreme, the S&P could theoretically sink to 360, a decline of 540 points—or 60%. The end of reflation in equity prices would have profoundly negative effects on other asset markets, which, of late, have followed the lead of common stocks higher. If you haven’t reflected recently on the relevance of Pascal’s wager, now is the time to do so. (In a nutshell, and as it might be applied to the equity markets, it says that even if the probability of a decline to lower extremes is only 5%, the consequences are so disproportionately calamitous that all precautions should be taken to avoid it. ) Whether the S&P moves up or down roughly 500 points, the mathematical symmetry doesn’t begin to explain the intensely disproportionate influence each would have on investor, consumer, lender, and borrower sentiment. Even the current reading of 65.1 for the Consumer Sentiment Index also must be viewed in its historical context: It fluctuated between 100 and 110 from 1998 through 2000.

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Fireside Chat -- Martin Capital Management

As value investors, our perspective is more patient and measured, no doubt out of respect for the difference in the character of bull and bear markets. The big bull markets typically begin deep in the hole and then spend years climbing what market commentators have called a “wall of worry,” as memories of what created the hole in the first place slowly fade. The emotional forces motivating investor behavior are comparatively mild in generally rising markets, unless or until the bull phase reaches the stage where rising prices themselves become the primary exciting force propelling further advances. At that point prices effectively detach themselves from the traditional tethers to value.

We can’t call markets, but we can observe human behavior. We suspect that this secular bear market will end with a whimper and not a bang. Futile attempts to pinpoint some elusive bottom will eventually give way to despair. When buying bargains on the sale rack yields nothing but disappointment, when patience wears thin, and when hope is finally abandoned, opportunity
clothed in black will be abundant. While nobody knows to what levels the popular indices might sink—and when—like the flipside of the bull market just passed, one need only be generally right to sleep peacefully at night and earn low-risk, wealth-building rates of return.

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