'WHAT'S GOING ON?' "What does it mean?" "What do I do now?" I am constantly asked to explain and predict the financial markets to an ever-growing number of friends in light of Wall Street's last nine months.
The answer is simple. Hang on to your hats. You ain't seen nothing yet. Buy as many non-oil stocks selling under $5 as you can. We are having and will continue to have an investment climate that comes along rarely. There is a whole generation out there that has never seen a wild, speculative market such as this is going to be. None of them will believe what is about to happen, nor will most seasoned investors who have been deadened by the investment climate of the 1970s. Exploit it while you can, because this kind of market hasn't existed for 15 years. We have at least another 18-24 months to go. By late 1984 we can decide whether the boom will last for the rest of the decade or will wind up in a huge bust, but don't worry about all that now. Just participate.
The past 15 years have been depressing economically and financially. The prosperity of the '50s and '60s was replaced by the stagnation of the '70s. Pessimism and worry replaced the previous confidence and optimism. Businesses focused on hanging on while investors turned to inflation hedges such as oil, gold, etc. But the tide has turned.
Inflation is no longer a nemesis. Supply/demand factors, aided by the U.S. Federal Reserve Board, have joined forces to kill inflation for at least the foreseeable future.
No one has yet repealed the laws of supply and demand -- not even the Democrats or Republicans. Skyrocketing prices of oil, silver, real estate, soybeans, etc., have had the same effect that high prices have had for thousands of years. People cut back on consumption (i.e. demand) while entrepreneurs rush out to provide (i.e. supply) more of the high priced goods. Supply and demand come back into balance and prices stop increasing. But the forces set in motion do not stop abruptly.
Even at lower price levels, demand does not immediately increase, and new sources of supply continue to flow into the market. Consumers don't turn up their thermostats or scrap their energy efficient appliances just because the price of oil stops rising. Nor do new oil wells close down because prices go down. On the contrary, most oil producers have to increase production continually as prices decline in order to maintain their new lifestyles and/or to pay debts incurred during the boom periods.
Mexico and the OPEC nations are notable examples. After equilibrium is reached, prices turn down and they always reach tremendously oversold depths. I expect oil to sell at $10-$15 per barrel by 1987. The same has and is happening in most other commodities throughout the world today.
While inflation was in its last spurt in 1979 and 1980, the Federal Reserve reacted to the fears of the American public as well as its own fears and set out to kill inflation with a tight money policy. They were encouraged and supported by President Reagan. They meant it and it worked. The prime lending rate rose to 21 percent in 1980 and 1981. An extended period of tight money combined with the supply and demand equation's changing from scarcity to surplus eliminated inflation with a vengeance.
Now the Fed is printing money with the same vengeance. But there's no place for it to go. The economy is still weak and demand for goods is down. Raw material prices are low and supplies plentiful, so there is no incentive to stockpile. All this money is sloshing around, but it's too soon for business to use it so it is funneling into the financial markets.
After 15 years of stagnation, stock prices were very cheap -- especially for a world which might see low inflation combined with a strong economy. Easy money, huge tax cuts, and overly stimulative fiscal policy all insure a very strong economy for 1983 and 1984. We don't have to worry about raw material inflation nor productivity inflation. Factories are operating at only 71 percent of capacity; output can rise dramatically before bottlenecks appear. Inventories are low so any increases in demand will be felt immediately. Profits will soar.
Labor still has its tail between its legs. People are still more worried about working than getting raises. In fact, givebacks are more common than strikes. Labor has priced itself out of several markets, such as steel and automobiles, and is aware of it.
All this is hog heaven for Wall Street: excess capacity, cowed labor, surplus raw materials, easy money, and a reviving economy. This is not just a financial bubble, however. We are about to have the strongest economic recovery in many years. As it materializes, stocks will go higher still. As the economy recovers without inflation, the budget deficit will shrink beyond expectations. More good news. Reduced deficits with a strong economy, but no inflation? Nirvana for the bond markets. The bond market will surge again.
As the deficit declines, interest rates will come down more. Profits will rise, stocks will gallop. Fortunes will be made and your elevator man, etc., will open brokerage accounts. Speculation will feed on itself and every dog imaginable will have its day--and then some. In periods like this people always find logical, rational, meaningful explanations for the boom, and reasons for the "new era" to continue. Technology is often the focal point. Earlier episodes of market euphoria have been caused by the building of the western railroads in the 19th century; automobiles and home electrical applicances in the 1920s, and the computer in the late 1960s.
These days technology is doing its part to rally expectations (and stock prices) once again. The change from analog to digital technology is sweeping every aspect of society and bringing vast economic changes. Investors are once more finding "sound reasons" for stocks to go higher and higher.
So buy stocks: the cheaper and more marginal, the better. Don't forget that it'll end eventually, but more on that later.
What about other areas? Generals always fight the last war and investors always return to the last bull market. Don't bother with commodities, real estate, art, collectibles, etc. Those were the investments of the 1970's -- not the 1980's. Some will do well, while most will do badly. Even the few that do well will not come close to the returns to be reaped in the stock market.
If you can't bear to invest on Wall Street, look abroad. Stock markets nearly everywhere will participate. Avoid share markets in oil nations, but otherwise, call your broker and have fun.
The German market is going to be the best bet during this period. Despite Germany's economic boom, a lively stock market has never developed there. But that should change under a newly installed Christian Democratic government that wants to draw money out of bank accounts and into investments in new "high tech" industries. A revived stock market will be essential. Few Germans alive today have ever participated in a speculative boom. The market they are about to have is going to boggle their minds!
About this time, most people decide I'm mad. The ones who haven't left the room jump in with questions about Mexico and the potential collapse of the international banking system. There are two answers. The first is that the IMF, Congress, et al, are papering over the debt crisis by pouring several billion dollars of American money into the faltering international banking system. More and more money is being produced. No one will have to default. Even if a major debtor or two should collapse, the system will survive because everyone else will be making so much money as economies surge worldwide. The world has muddled through this time. I don't know if we'll survive the next round of problems, but that's down the road.
The more important answer concerns Mexico, as well as Nigeria and other oil producers. The best thing that could happen to the world economically would be for oil prices to collapse, even if this should cause a major oil country to default. If oil collapses, Brazil will boom, as will many, many other third world nations which import all their oil. If the bankers lose Mexico, the renewed solvency of innumerable other credits will more than compensate. There are lots more consumers of oil than there are producers. Think about Brazil, Yugoslavia, Poland, South America, Africa, Europe, Eastern Airlines, Pan Am, you yourself. We are all better off with cheaper oil -- even the bankers.
The other item that worries the few people left in the room is interest rates. If the Fed prints money while the deficit is so large, will the market not anticipate a new round of inflation and/or crowding out by the Treasury?
Real interest rates are still extremely high by historical standards. A rise from these levels could cut off the reovery and make everything I've forecast fall apart. I am well aware of this, but I actually do hope rates rise modestly for a while. I'm not just being cute. If rates go up from here, it will have two effects. First, a fresh whiff of tight money will insure that inflation remains dead, and second, it will scare the financial markets. Both effects will make any case better in the long run. Inflation is terrible for financial markets. So is a rise that takes place without any setbacks; we need and will have a few corrections. Investments that go too far too fast collapse just as quickly. A strong, steady recovery with a good base will guarantee that my scenario becomes reality. Small, temporary rises in interest rates along the way insure even lower rates later on.
This is all going to go on until at least early 1985. At this point I do not know if 1982-1984 will be similar to 1922-1929 or whether it will be like pre-prosperity 1953-1955. If Congress gets the deficit under under control and inflation really is beaten, we will have prosperity throughout the 1980s. Stock market profits will then go on for years.
However, if inflation really isn't dead, and the Fed has to tighten up strongly again in two years, we will have a replay of 1929. The world probably won't survive the next tight money period since it will have to be very severe if inflation is still around. Balance sheets are stretched too far. Economic recovery would not be solidified sufficiently to survive another tightening so soon.
A third scenario could occur if inflation does rear its ugly head in a couple of years and no action is taken. That, too, would lead to some wild times in the stock market (both up and down) with a final result similar to Germany in 1923, when a wheelbarrow full of money was necessary to buy a loaf of bread.
But I am getting ahead of myself. This year and next will be terrific for all of us. Don't miss it. I'll worry about 1985 and beyond later.