The Seduction of Pessimism

Ever think about what your ‘default setting’ is when it comes to how you interpret information?

Do you naturally lean towards a perspective of good or bad? Patient or tense? Pessimistic or optimistic?

I would suggest that having optimism as your own personal default setting now will pay handsome returns over the next decade or two.

Why? 

Well, back in the summer of 1982 when I first started in this business the Dow Jones was roughly 930 points. 

Yep, three digits.

Today, it’s five digits long (about 28,000), and sooner than we might think it will be six digits long.

During the entire time - and with every point covered from 930 to 28,000 (and climbing) there have been a myriad of problems, disasters, setbacks, recessions, bears, bulls, many Presidents, lots of power shifts, wars, attacks, global unrest, Brexit, Chexit, (even Megxit!), Tariffs…you name it.

And all that growth happened while those hurdles were coming at us!

Now think about this – it’s an excerpt from a great J.P. Morgan story, courtesy of Mark Skousen: 

In the early days of the Twentieth Century, when J.P. Morgan ruled Wall Street, a visitor came to the City. He was a long-time friend of Morgan, a commodity trader from Chicago. He was what might be called a “perma bear” following the Panic of 1907. No matter how high or low the stock market went, his outlook was pessimistic. Another crash, panic and depression were always just around the corner.

This was his first visit to the world’s greatest city. He arrived at 23 Wall Street and was ushered into J.P.’s spacious office overlooking the Exchange on one side, and George Washington’s statue on the other.

They immediately began talking about the markets, Morgan being bullish as ever, and his commodity friend being as bearish as ever. 

J.P.,” he said, “The news overseas doesn’t look too good.”

“A buying opportunity!” responded Morgan.

After an hour of friendly disputing about the markets, Morgan invited his guest to join him for lunch. They walked outside and started moving up toward Broadway. As they did so, his friend couldn’t help but admire the skyscrapers that dotted the Manhattan horizon.

Morgan gave him a tour of the giant buildings, pointing out the Singer Building, the Woolworth Building across from City Hall, the famous three-sided Flatiron Building, and the recently completed Met Life Tower, rising 50 stories high, the tallest skyscraper in the world at the time.

His friend was duly impressed. He said he had never seen anything like it, not even in Chicago.

Finally, J.P. Morgan stopped his friend and said, “Funny thing about these skyscrapers – not a single one was built by a bear!”

Know This...

Ever wonder how many perma-bears reside on the Forbes 400 list?  

Or the number of pessimists who run companies in the Fortune 500?

I have your answer: It’s zero.

And there’s more to the story above.

Six years before that chat took place J.P. Morgan had purchased Andrew Carnegie’s entire steel operation for $480 million.  

That’s the equivalent of hundreds of billions in today’s dollars.

You don’t do that deal and amass that kind of wealth with a persistently negative outlook.

Winners, and men and women of foresight and ambition do monumental things.

Pessimists watch them from the side-lines, always ready with a list of all the reasons things won’t work out.

The losers do get to win sometimes, too. But their victories tend to be Pyrrhic, as every calamity ultimately leads to opportunity when the dust clears.

Pessimism is intellectually seductive, and the arguments always sound smarter, especially when they dovetail with our own fears and concerns.

You think this period is more terrifying and riskier than the sixteen-month recession between July 1981 and November 1982 only because you weren’t there and so many haven’t studied that history.

Your frame of reference is here and now, not then – when the unemployment rate really was 14% - inflation really was 15% - and mortgage rates really were 17% with a prime rate of 20.5%!

I will age myself with a reference to Peter Lynch, but he often reminds us about that era with this comment, “Sensible professionals wondered if they should take up hunting and fishing, because soon we’d all be living in the woods, gathering acorns. Then the moment of greatest pessimism, when 8 out of 10 swore we were heading into the 1930s the stock market rebounded with a vengeance and suddenly all was right with the world.”

Another Falsehood...

Chatter about how our National Debt will engulf us in flaming fires from hell has filled so many pages with ink over the last 37 years.  

Let's be clear:  Federal debt is not a threat to the economy.

Many people are saying that our national debt—which now exceeds $17 trillion and is growing by more than $1 trillion per year—is a disaster just waiting to happen. Right? Well, not exactly.

Even though federal debt has soared relative to GDP in the past decade, the burden of the debt is about as low as it's ever been. Still, the growth in debt does reflect some structural problems that are working to keep the economy from achieving its full potential.

Here’s some of the latest data from the Federal Reserve compliments of our friends at Calafia Beach Pundit:

The chart above shows the swelling size of our national debt, which is correctly measured as the amount of Treasury debt that is held by the public, which now stands at $17.16 trillion.

Too often we all take in the idea that people saying the national debt is over $23 trillion are correct.  

They are not correct. 

The $23T figure is inflated since it includes some $6 trillion which the government owes to itself (i.e., excess revenues that the social security administration has "lent" to the Treasury). 

Know this too: This chart uses a semi-log scale for the y-axis, so that means that a constant slope is equal to a constant rate of growth in nominal terms. 

That’s required as numbers get larger.  

The most important element is that the slope of the line for the past 7-8 years has been flat (i.e., the growth rate has been constant). Note also that the slope was steeper in the mid-80s and in the 2008-2012 period.

The Lesson?  

Federal debt is growing, but not nearly as fast as it was growing in other times, like way, way back when we did not fear the end of the world was around every corner.  

The chart below drives home another lesson: The size of federal debt relative to the economy is far less important than the prevailing level of interest rates.  

We can see the true burden of the national debt is not the amount we owe but the ratio of interest payments on the debt relative to our national income (GDP).

Because interest rates are at historically low levels, the current burden of our national debt is about as low as it has ever been, even though the debt has soared to 78% of GDP.   

As investments picks up, so will revenues and taxes and, oddly enough, all will continue forward in a far less scary manner than many are sold on:

Note the chart above goes back to the 60's when our GDP was 5% of its current size.

And as we can see below in the next chart, US consumer households' debt burdens are also about as low as they have ever been.

Everyone benefits from lower rates, but in addition, households have eschewed debt while embracing the safety of Treasuries as 2008-2009 fears have run deep. 

Total household liabilities have only increased by 11% since their peak in 2008, according to the Fed. 

Treasury yields are low because the demand for Treasuries is strong: Households now hold over $2 trillion of federal debt, up hugely from $300 billion in 2008.  They also have over $14 trillion sitting in banks and money markets - all liquid. 

Most of our collective remaining Treasury debt is (oddly enough) held by corporate and institutional investors (as investors), sovereigns, and foreign investors in general. A massive share of that also resides in the US - from our own companies and insurance industries.  

In other words - we owe it essentially - to ourselves.