Is That An ELEPHANT I Smell?

As a perma-bear on most things economic these days, i seek out others with similar thoughts of doom and gloom. as there is a distinct minority of us pessimists, i always like to share my more mainstream findings. Morgan Stanley has a conference each year that brings together its clients, analysts, fund managers and others to discuss the state of the world economy and forces that may be important in the upcoming year. Stephen Roach wrote the following piece after the conference. i found it heartening to my thought process and intresting in its comments about the nervousness out there regarding the more macro decline of the U.S. and its world dominance financially and militarily. i have read it and i am equally as nervous as the people at the conference.

Global: Macro Passion

Stephen Roach (New York)


Our annual global investment conference in Lyford Cay has become an important milestone in my own macro journey. Client sentiment at this gathering provides those of us at Morgan Stanley with invaluable insights into the markets and offers a unique sounding board for our own views. But this isn’t just any conference. After 19 years, it has taken on a special character. Most of the attendees are repeat participants. And with that repetition comes familiarity -- almost like family. The feedback is fair and direct -- and often intense. Over the years, the dialog at Lyford Cay has become the marker by which I have learned to set my personal macro compass for the year ahead.

The mood this year was cautious, risk-averse, and introspective. Largely an equity crowd, you would have thought that the surge in global stock markets over the past eight months would have put the group in a giddy mood. That was not the case. Yes, by a margin of two to one, the group thought 2004 would be an up year in equity markets. But it was largely envisioned as a dull year of single-digit returns. I’ll leave it to our market strategists to comment on the specifics of the recommendations that came out of the round-table at the end of this event. But from my perch, there was nothing “early-cycle” about the collective insights of this seasoned crowd; in particular, there was little interest in consumer durables and capital equipment. More focused on pharmaceuticals and healthcare, this was a group that was enamored of defensive, late-cycle ideas. It was almost as if it was time to play the downside of an economic recovery -- a recovery, of course, which has barely begun.

Don’t get me wrong. This was not a group that was willing to endorse my bleak view of the world. There wasn’t an investor in the crowd who thought the US economy would grow by less than 3% next year. The case for deflation, which had blindsided this group just a few months ago, never even came up in the macro discussions. At the same time, few looked for a meaningful acceleration in inflation; instead they favored a scenario that depicted more of a gradual and relatively benign updrift in pricing (see Dick Berner’s dispatch in today’s Forum, “The Inflation Conundrum at Lyford Cay”). Reflecting that view, the group was on the fence insofar as Fed policy was concerned; however, of the 50% that were looking for a tightening next year, three-fourths thought any such action would be deferred to the second half. Nevertheless, the bond market was viewed as largely a one-way bet: By a margin of four to one, the consensus looked for yields on 10-year Treasuries to exceed 5% by the end of 2004. None of these are extreme views that threaten to derail financial markets. That didn’t surprise me. This is a group that is paid to be fully invested. As such, it invariably favors soft landings in downturns and soft takeoffs in an upswing.

As the house skeptic, with a seemingly chronic case of jetlag, maybe I’m guilty of selective recall. But as I attempted to back out the risks to the macro overlay from three days of discussions, I sensed far more concern than optimism. In the interest of full disclosure, I’ll be the first to admit that I’m reading between the lines in drawing that conclusion. But over the years, my experience has taught me that that’s exactly what you have to do to get the real message of Lyford Cay. The best economic scenario that emerged for the United States was a last-gasp surge in early 2004 driven by the second installment of the recently enacted fiscal stimulus. After then, even the growth bulls on the economy feared a sharp deceleration. At the same time, there was nearly unanimous sentiment that the dollar was headed lower. Byron Wien made an impassioned presentation of the bull case for the US currency, but there were no takers. The general sense of the group was that America’s gaping current-account deficit had left the dollar in the early stages of a multi-year downtrend. Against that backdrop and in the context of the potential perils of competitive devaluation that a weak dollar might trigger, there was considerable interest in gold -- more so than I have seen at any year in this conference.

Perhaps the most surprising commentary came from one of the perma-bulls. As a long-time attendee at the conference, he has repeatedly stressed the inherent resilience of the US economy and its financial markets. He was one of the first to grasp the powerful implications of 20 years of disinflation and the extraordinary ability of Corporate America to take advantage of that trend -- initially by lowering its cost of capital and eventually by riding the wave of accelerated productivity growth. His optimism is now gone. He is deeply concerned about an America that has lost its way. The excesses of debt and the shortfall of saving are at the top of his list. But he also waxed eloquently on the perils of massive trade deficits and the job losses they spawned. He found the erosion of America’s manufacturing base especially disturbing. He was also convinced that Washington had gone past the point of no return in creating a fiscal train wreck. This was a minority view, to be sure. But it came from one of the savviest investors I know. And he swears he doesn’t read my research.

Those troubling views were expressed in the very first session of the conference. But they didn’t really resonate with the group at large as the debate unfolded over the next few days. That was certainly the message from the macro conclusions described above. But the bearish view resurfaced with a vengeance in the final session of the conference -- our Saturday night rump-session at Lyford Cay. With the roundtable completed at midday, we had set aside some time before the final dinner to reflect on our collective discussions. About half the group remained at that point. The converted perma-bull had left for home. But the group picked up where he left off. With an emotional intensity that I have rarely seen at this conference, there was a deep sense of concern expressed about America’s future.

The elephant that had been in the conference room the whole time finally stomped out into the open. There was widespread fear that many of the most important icons of the American system were at risk of crumbling in this post-bubble climate of vindictiveness. It wasn’t just the Wall Street scandals. It was also the Enron-led accounting scandals and the damaged credibility of the New York Stock Exchange. The litany of a seemingly open-ended crisis in corporate governance and the political backlash it has spawned deeply troubled these investors. So, too, did America’s mis-adventures in Iraq, the latent fear of another terrorist attack, and the ominous rumblings of protectionism -- especially America’s politically-inspired imposition of steel tariffs and the more recent outbreak of China bashing. I will confess to playing the role as something of a provocateur in that part of the discussion. But it didn’t take much to open the floodgates of angst. There was also a philosophical discussion of the deep flaws of America’s debt-driven culture. Related concerns were expressed over the post-bubble response of the Fed -- interest rates that are far too low to inhibit the appetite for excess leverage. Another investor stressed that the American consumer -- long the mainstay of a US-centric global economy -- was literally living on borrowed time. With the last of America’s five home mortgage refinancing cycles behind us, he suggested there’s good reason to worry about the staying power of increasingly wealth-driven American consumers.

That unleashed a torrent of counter-attacks in defense of the American way. The most passionate case seemed to borrow a page right out of “The End of History and the Last Man” by Francis Fukiyama (Free Press, 1992). With the demise of communism, the triumph of market-based capitalism was argued to be the functional equivalent of permanent support for the US-centric growth model of the global economy. US current account deficits were depicted as being only symptomatic of how feeble the rest of the growth-impaired world really is. Even if it takes more debt for America to continue to pull the rest of the world along for the ride, so be it. After all, claim the optimists, the one thing non-US economies can do is fund America’s external imbalances and keep US interest rates down. If that’s the case, never mind the so-called excesses of the American consumer. As one investor quipped, “We can always be counted on to go down to the mall and support the global economy.” In the end, it turned out that by a thin margin, even the sentiment in the rump session was skewed toward a US economy that continues to finesse its ever-mounting twin deficits.

Maybe I’m making too much out of all this. But over the years, my experience has taught me to pay much greater attention to the body language of the most passionate investors than to the results of the various polls we conduct in an effort to glean insights into consensus thinking. Of course, it’s always easy to “game” the consensus at this conference. The now infamous “Curse of Lyford Cay” suggests that the consensus is invariably wrong on the big views in which there is most agreement. To the extent the curse is alive and well, that points to two possibilities -- a sharp further upside move in world equity markets or an equally sharp downside breakout. I know where I’m leaning. END>>

My take on mr. roach's tilt is toward the dark side of the spectrum. maybe the stock market is just fine ignoring the real things that are going on around the world and within our own country. some seem on the surface to reflect the freedoms and joys of living in a free and democratic society. too much of a good thing may not be good for the U.S. or us.

have a grateful day!

larry