I want to start by saying that I’m glad I missed the recent earthquake (I was on a plane to Denver, and was lucky enough to miss a temblor there the day before) since, like everyone else, I’m already dealing with enough things that are making me shaky these days. Only the calmest market watchers among us have been able to maintain our equanimity over the past few weeks, and markets seem to accept only assets like gold and Treasuries, rightly or wrongly, as “risk free”. With the proliferation of in-flight TV, I can’t even fly in blissful ignorance anymore!
Although I don’t put much faith in tracking charts—laying one trend line on top of another in hopes of finding a repetitive pattern—the chart below, which compares U.S. stock market action during the 1970s with the past few years, is probably telling us something. In both cases, stocks plummeted, recovered sharply, and then whipsawed for several more years. While I wouldn’t recommend using these charts to “time the market,” they clearly suggest that the equity markets reflect underlying economic problems. During the mid- to late 1970s, it was inflation; today, it’s deleveraging. When businesses don’t believe they can reliably forecast profit growth—in the 1970s, it was because the price of labor and materials were highly uncertain and today, it’s because businesses don’t know if consumers will have the wherewithal to buy things—investors see those businesses as riskier. When investors see businesses as riskier, they’ll buy shares only after the share price has fallen. That’s what’s going on.
One big difference between the 1970s and our present situation is that there was a policy solution, albeit painful, for the problems of the 1970s—a tight money supply for a sustained period. Maybe in 1977, no one knew what effective monetary policy could accomplish, and perhaps one of the ideas appearing in today’s op-ed pages is a comparable silver bullet. But I tend to think that today’s economic and financial market cures have more to do with the passage of time than the passage of legislation.
Through a combination of higher savings and debt defaults, U.S. households are getting their finances in order. By and large, U.S. businesses have strong balance sheets and solid earnings, and maybe the current dysfunctional federal budget debate will result in constructive measures. And when all of that happens, we’ll all shake a lot less.