I first realized that I think differently than most people when I was a senior in high school. I was in Political Science class with Dr. Davies – one of those exceptional teachers that really made a difference in a lot of kids’ lives, including mine. Dr. Davies had asked the class to research the War Powers Act and be prepared to discuss whether it was constitutional. He began the class with a quick poll, and it turned out I was the only one in the class who thought the act was not constitutional. He allowed my classmates to make their arguments first, and they all talked about how it made sense in a modern, fast-paced world to allow the Commander in Chief to commit our Armed Forces without having to wait for Congress. They made very logical arguments. Finally Dr. Davies looked at me and asked me why I disagreed with my classmates. I told him that I didn’t disagree, and then I apologized because I must have misunderstood the assignment; I thought I was asked to determine if the act was constitutional, not whether I thought it was right. What happened next I will never forget: Dr. Davies, who had been leaning back on his desk, jumped to his feet and started to applaud. He announced to the class that I got the only “A” on our assignment, not because I was correct – I don’t recall if he ever told us the “right” answer – but because I was the only one to get the point of the exercise.
The point of reliving this story is not to start a debate with my many attorney clients and friends about our Constitution, – a debate I would surely lose; the point is that I often believe we get the wrong answers in investing, and life for that matter, not because the answers we get are necessarily incorrect, but because we are asking the wrong questions.
Yesterday the market rallied strongly based on a short speech by Mario Draghi, president of the European Central Bank (ECB). He told a group of investors that the ECB can and will do what is necessary to save the Euro. I have not seen the entire transcript of his speech, but based on the reaction I would not be surprised if he wrapped it up by thrusting both fists in the air and declaring, “I am invincible!”
Well, Draghi is not invincible, and saving the Euro may or may not be a worthy cause, but it is not going to solve the real issues. When Draghi made his statement what he meant is that the ECB still has the ability to loosen monetary policy and reduce interest rates. There has been similar talk from our Federal Reserve Bank (Fed), that they might provide some form of easing – QE3, or something new. The problem with these actions is that they miss the point. We do not have a liquidity crisis, either here or in Europe. The globe is drowning in currency as every major central bank in the world has their pipes wide open and it still has not jump-started the economy. Opening the pipes further is not going to help.
Central banks are very good at liquidity problems. If there was a lack of liquidity the central banks around the world could act, just like Milton Friedman and Anna Swartz argued they should have during the Great Depression, and it might work. Unfortunately, the economic world lost Anna Swartz earlier this summer, but before she left us she warned that policy makers were responding to the wrong crisis. It is not that their solutions are inherently incorrect – after all she co-authored this playbook – but they are simply trying to answer the wrong question.
The question for policy makers is not whether the ECB can “save” the Euro, but rather, Can Europe enact the necessary reforms to rebuild economies that can grow and be self-sustaining? For investors the right questions are, How deep is the recession in Europe going to be, how long will it last, and how much of it will spill over to our shores? Thus far this quarter 60 percent of Standard and Poor’s companies have missed on revenue, largely due to slowing sales from their European customers. Earnings have been somewhat more positive on a relative basis, but this is largely a result of lowered projections, which the market has yet to price in.
It seems like there are some bulls out there grasping on every seemingly positive straw. Unfortunately, the ECB can’t solve the problems in Europe, and the Fed cannot solve the problems here. It looks like a lot of short-term traders are missing the point: Investing isn’t about monetary policy; it is about corporate profits, which are a function of economic growth. Those who keep waiting for central banks to ride to the rescue are asking the wrong questions.
Warm Regards,
Chuck Osborne, CFA
Managing Director
