The meltdown of former high-flying "momentum" stocks has accelerated recently, and investors are being treated to a barrage of bearish commentary declaring that the plunge in these stocks is just the leading indicator of the arrival of a long-overdue catastrophe.
In particular, there is a contingent of commentators whose stated view for the past seven years has been that any supposed "recovery" from the economic crisis of 2007-2009 has been an illusion built upon another massive expansion of credit, engineered by the US Federal Reserve and other central banks around the world, and that the illusion could not go on forever. Many of these pundits are now pointing to the ongoing "momentum meltdown" as a sure sign that the "credit party is over" and that a severe and prolonged recession must be right around the corner.
An excellent representative website where such contrarian opinion is on full display is David Stockman's Contra Corner, where former Congressman and Reagan administration cabinet member David Stockman publishes articles with his own analysis and articles from his guests, all of which generally share the diagnosis of the economy described above. In addition to his experience in politics, Mr. Stockman also worked at Wall Street investment bank Salomon Brothers, was one of the original partners of the Blackstone Group, and started his own private equity fund, and so investors should consider his insightful analysis of the current situation very carefully.
In a recent article entitled "It Didn't Snow in San Jose: the Q1 Housing and GDP Rollover is Not Due to Weather," Mr. Stockman argues that "the US economy is freighted down with 'peak debt' and is incapable of the kind of credit-fueled rebound cycle that the Fed has orchestrated in the past," and concludes by saying:
In short, this time it is different. The debt party is over. The era of financial retrenchment and living within our means has begun. It might even be that "selling the dip" is about to become the new normal. Even this morning's Wall Street Journal could not powder the pig.
Another article on the same website, this one written not by David Stockman but by syndicated writer Wolf Richter and entitled "The Accelerating Momo Reversal: Crashing Like Its 2000 All Over Again," points out that web-radio company Pandora "has plunged 42% in six weeks, taking it back to where it was in September," Twitter is down 44% from its high in late 2013, and network security company Imperva "has crashed 64% from its peak last year."* He implies that the plunge in the "momentum" names will soon make its way to everything else, saying:
It's different this time, we're ceaselessly told, even on NPR. For one, the "Tech Bubble," as it's officially called now, is not tied to the larger stock market this time. So its implosion will be contained. I remember hearing the same in 1999.He too concludes that the Fed's easy-money rampage of the past seven years will eventually lead to certain disaster.
Before we discuss a few points where we differ with the arguments made in these two articles and others like them, we would first like to point out that there are many points on which we agree with the general tenor of these arguments and with their frustration at the Fed's and the government's increasing interference with the system of free enterprise, as well as with their assessment that such interference is almost always harmful to the majority of the citizenry and almost always leads to negative consequences of some magnitude.
We have published many criticisms of the Fed's attempts to "over-steer" the economy (see this previous discussion entitled "Fed over-steering, 2008 through 2014," which contains links to other criticisms we have posted of the Fed's over-steering, beginning in 2008).
We have stated many times that the Fed should have long ago gotten out of the "emergency" mode which they have maintained since 2008 (see for example this previous post).
We have labeled the excesses of the welfare state, which are directly connected to the easy-money policy of central banks, "The Question of Our Time" and discussed that subject in numerous previous articles such as this one and this one.
We have pointed out the serious risks to fixed-income investors created by these welfare-state excesses in posts such as this one and this one.
And, we have argued that crony capitalism, which is intimately related to all the above problems and which features prominently in the discussions on Mr. Stockman's Contra Corner, is a huge problem that robs the general public in order to deliver profits to a well-connected minority, in previous posts such as this one and this one.
Where we differ with the general tenor of the analysis written by many of those who share our views about all of the above problems, is that these egregious problems have been central features of the US economy since at least 1913 and of most other supposedly "free" economies in the world as well over the same time period. Aspects of crony capitalism, credit expansion, Fed over-steering, and the rest have always been at work to enrich certain well-connected groups at the expense of the economy at large -- and while these factors have certainly led to unnecessary and painful recessions and financial crises, it would be a serious error to say that all of the innovation and all of the good businesses that have been created by individuals on their own or working together over the years were the illusory products of credit bubbles and cronyism. We believe that economic growth happens in spite of the often-deleterious actions of government meddlers and central banks, not because of it -- and we would include the recovery that has taken place since 2009 as well.
While we agree that the current public sector "credit bubble" is far more egregious than anything seen in previous decades, we disagree with those who say that this central bank-induced "easy money" is solely responsible for all of the economic growth of the past eight or twelve or fifteen years, and we are really no further today than we were in 1999. On the contrary, we would argue that even a moment's reflection will show that it would be ridiculous to argue that technology has not changed much since 1999 or even since 2005 or 2006 -- there have been tremendous changes, changes which have added demonstrable value to many consumers (who don't buy technology products because they are forced to but because they want to) but also to many businesses, large and small.
In fact, in the article by David Stockman linked earlier, he mentions corporate profit margins, which he notes are "already way above their historic range," and he argues from this that the current multiple on the S&P is too high. However, we would argue that one of the real differences between the situation in 1999 and the situation today is that corporations (and businesses of all sizes) have been forced to become much more efficient and much more disciplined on spending, and that technological advances (which have been astonishing since 1999) have contributed to this in a very real and measurable way. The businesses which have created those technologies have real products and add real value -- it would be a mistake to say that they are all just a "credit-bubble illusion."
To be fair, Mr. Stockman is not saying that they are, but articles such as the second one linked above, which describe "anything in the social media space where the business model, if there's one at all, is based on collecting and monetizing personal data," implies that the high valuations some of these types of companies have been receiving is the sure sign that we are in a 1999-situation and getting close to the end of the party. Once again, there are points of this argument which we agree with, and we have written about companies whose leadership have made the business decision to put growth ahead of profit quite recently (see this post, for example), but while we agree that some of the valuations in that space are highly debatable, we would disagree that this necessarily signals a "return to 1999," or that this fairly specialized part of the tech market is indicative of every other company investors can choose to own.
In short, we believe that this investment climate calls for the same discernment that investors have had to exercise in previous decades, and that it is very rare to find a period of time in which things were so good that careful consideration on a company-by-company basis was not important, or so bad that there were absolutely no innovative companies which were bringing new value through new solutions which investors could be rewarded for owning. We have written before that the 1970s was a time of incredibly erroneous monetary policy from the Federal Reserve, as well as extremely intrusive government policy including price controls and all sorts of cronyism, and yet there were opportunities during that period which could lead to tremendous returns, as the late Dick Taylor, who managed money during that decade and during the 1960s, often explained.
We believe that in reality, ownership of stocks in well-run, innovative businesses is really one of the best defenses against misguided government and central-bank policy -- and that such ownership is virtually necessitated by the very same inflationary policies created by the "credit-bubble" activities Mr. Stockman and the other writers are describing. Stocks have proven to be a much better defense against such policies than even ownership of gold, as we discuss in this previous post.
These are certainly very unsettling times for many investors, and the "momentum meltdown" of the past several weeks has hit the stock prices of many companies which we own as well, companies which we feel should not be unfairly lumped in with some of the others whose business models (or lack of a business model) are easier to criticize. We agree that the "emergency" policies that have been in place since 2008 are damaging to the economy at large, and that cronyism and the other problems which Mr. Stockman and the writers in his Contra Corner decry are real problems of which everyone should become more aware.
Nevertheless, in this situation as in those we have faced in the past (and we managed money through the crash of 1987, the 2000-2002 bear market as well), we believe the only real solution which works for the long-term accumulation of wealth and the protection of purchasing power is a return to what we call "real investing" -- the ownership of well-run businesses which are creating innovation and adding value to their customers.
* At the time of publication, the principals of Taylor Frigon Capital Management did not own securities issued by Pandora (P), Twitter (TWTR), or Imperva (IMPV).
