Wednesday, May 4th, 2011




In his widely anticipated press conference on April 27th-the first ever by a Fed Chief-Ben Bernanke uttered the word “inflation” thirty-one times.  Not far behind was his use of the word “transitory” to describe almost everything, including inflation, unemployment and the slow, bumpy pace of the recovery. In response James Grant, the often acerbic and highly respected publisher of the Interest Rate Observer remarked: “Paper money is transitory.”  That certainly holds true for the value of the dollar which last week hit a three year low against major currencies. Most have praised the Fed Chief for his response to the financial meltdown and his ability to “make bullets out of thin air.” Yet as several commentators have pointed out, not everything Mr. Bernanke mentioned in his press conference can be transitory, especially the level of US Government debt.  Legendary investment manager, Seth Glickenhaus, still managing over $1 billion at age 97 began his career during the Great Depression and provides some much needed perspective. Mr. Glickenhaus-a self described “optimistic pessimist”– simply noted last week that, “We have far more debt than we can pay back.”


Nevertheless, the equity markets during the first quarter of 2011 and through April largely shrugged off these concerns with the S&P rising 5.4% for the first quarter and adding another 2.8% in April. What lurked behind the good returns during 2010 continues so far in 2011:  political unrest and turmoil in the Middle East and the time bomb of debt in Europe and the US.  The confusing tug of war between headline grabbing geo-political events, macro economic concerns and improving corporate balance sheets in the US still shows no sign of abating, and is reflected in the monthly returns:  January and February were both positive, showing 2%+ gains, but during March the S&P went below it’s starting point for the year and only after a furious charge in the second half of the month ended flat. US unemployment remains high and home prices remain low, European countries try to implement austerity programs without restructuring sovereign debt; but for the time being the financial markets appear to be forgiving on those two issues. On the currency front, however, the markets have been less forgiving with the dollar substantially weaker as the mounting US debt issuance creates fiscal anxieties.  It is always important to remember that much of the money flowing in and out of US equities and bonds comes from outside the US.  Since the beginning of the year the dollar has declined more than the S&P has gone up which is not an attractive proposition for foreign investors.  Currency hedging is complicated and expensive and it adds an additional layer of risk.   Having worked with institutional investors in London in the 1980’s and ’90’s, it is clear that hedged or not, they need to be convinced that the growth prospects of US companies like Apple and Caterpillar will offset the decline in the dollar. This has been the case for the past couple of years, but will it continue? Inflation fears have also entered the picture in China, India and other emerging markets, and perhaps contributed to some of the strong performance this past quarter in commodities, energy, and precious metals. Still the main driver is supply and demand, and at a high profile investment meeting in Los Angeles, some of the largest Private Equity investors say they are still very sanguine about putting money to work in China, emerging markets, mining and energy.  Despite all of the caveats the appetite for equities and risk assets moves along apparently unfazed by upheaval around the globe and lack of convincing growth at home.  But to quote Arthur Miller’s line in Death of a Salesman, “Attention should be paid,” to market volatility and the weak dollar in the form of appropriate diversification, opportunistic investing and risk management.






They live off the income of their income.    Mary McCarthy, The Group 1963



Mary McCarthy’s satiric novel The Group (1963), far ahead it’s time in many respects, follows eight Vassar friends from their graduation in 1933 (the year McCarthy herself graduated) through their intermingled lives, love affairs and ensuing complications.  Out of the eight, six are from families on the Social Register. All desire independence from parental guidance and interference in life style, romance and politics, but do not mind the attachment when it comes to funding their post-graduation experiments in self-absorbed living.  Mary McCarthy, who grew up poor after her well-to-do parents died in the 1918 flu epidemic, and made her own way successfully in tough circumstances enjoys calling out the discrepancy. The fictional family cited in the quotation has gained wealth and prominence through success in the steel alloy industry, and their daughter Helena, the class valedictorian is an outspoken liberal who spends the family money freely and much to her parent’s chagrin decides to teach nursery school. “Did we send her to Vassar to teach finger painting?” her exasperated father asks.


There is an old joke in Switzerland about someone who attends a prestigious social gathering where no one will speak to him. One of the newer guests asks why and is told in a hushed whisper, “Of course no one speaks to him. He spends his capital.” 

In Thomas Mann’s novel The Magic Mountain (1924) the protagonist Hans Castorp goes to visit his tubercular cousin Joachim at a sanatorium in Davos. Long before Davos became the annual gathering place for global economic ministers, it was best known for expensive ski resorts and sanatoriums-a destination for the very healthy or the extremely ill.  Hans Castorp, orphaned at an early age has been raised by a wealthy, very prudent and straight-talking uncle who imparts the following advice to his nephew about the inheritance he will receive:


Hans, my boy–you really don’t have that much—the lion’s share of my money stays in the business.  What belongs to you is invested quite nicely and will yield a secure return.  But it’s no fun nowadays trying to live off interest unless one has at least five times as much as you have, and if you fancy living a nice life here in the city, like the one to which you’re accustomed, then you’ll have to earn a tidy sum yourself—take note of that my boy.  



Sage advice for any era and especially now when the challenge of living off interest income in the current Fed engineered low rate environment has become a source of concern. Thomas Mann’s own life experience in his early years was close to the fictional family cited in Mary McCarthy’s novel who “live off the income on their income.” But during his teens the family shipping business went bust, mostly on account of bad management (recounted in his first novel, Buddenbrooks), so he certainly knew both sides of the coin.


On the front page of the Wall Street Journal of April 4 we find the following headline:  Fed’s Low Interest Rates Crack Retirees’ Nest Eggs.   The Federal Reserve has kept interest rates low to stimulate the economy but most of those benefits have accrued at the corporate level with many of the Fortune 500 boasting great looking balance sheets.  But this is hardly a boon for the fastest growing demographic in the US, people north of 55 years of age, who typically self-identify as savers rather than investors. With short term rates down to zero per cent their CD’s and savings accounts have been producing a net negative return for the past couple of years which not surprisingly is having a noticeable impact on this group’s spending.  Most investors see continuing low rates as a positive signal, but last year  Charles Schwab wrote an Op Ed for the Wall Street JournalEnough With the Low Interest Rates (10/02/10)  urging the Fed to raise rates so that the legions of retired savers would not suffer.  As is often said, “Be careful what you wish for.”  According to the more recent article, some of the savers wanted to have it both ways and are now in trouble according to a debt counselor in a retirement village in Florida:  “In some cases…retirees took out mortgages and ran up credit card debt on the assumption that their interest income would help cover the payments…Older people tend to hide their troubles as long as they can.  People are very prideful.”  While recognizing the differences between today’s retirees and the literary examples cited above, all are in the position of needing to do something to change their respective modus operandi and learn to adapt to changing circumstances.  In the case of savers needing to replace what had been predictable yields and streams of income, they will need to become investors and expand their horizons in order to generate yield that used to be more readily available.



 And finally, the US and its allies were ecstatically praising the bold and successful operation by the Navy Seals that killed Osama Bin Laden just a few months before the 10th anniversary of 9/11.  To what extent this disables Al Qaeda remains to be seen, but it will likely significantly eradicate the financial support for the terrorist network which came from Bin Laden. Whatever it’s broader meaning the impact on the US and global financial markets will be negligible-far less, for example than last quarter’s GDP report which showed growth at a disappointing 1.8% and testifies to the bumpy and uncertain pace of the recovery.  One hopes that this report-to use Chairman Bernanke’s favorite word, is indeed “transitory.”

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