Good Times Are Coming!

By Bill Miller

Sir John Templeton is reputed to have once remarked that bull markets are born in pessimism, grow on skepticism, mature on optimism and die of euphoria. I don't know if he actually said that, since I've never seen it documented, but it sounds like him. And if he didn't say it, he should have, and I will give him credit for it anyway.

This bull market was born in the pessimism gripping the investment world after three years of declines, recession, bankruptcies and corporate scandals. The broad bottom was made in the summer of 2002, with a further intermediate bottom in October of that year and a final test in March of 2003.

Despite a 29% increase in the S&P 500 in 2003, an almost 11% increase in 2004, and now record profits, record cash flows, record returns on equity, record cash as a percentage of assets, low inflation, low interest rates, solid economic growth in the U.S. and excellent growth in most of the world, skepticism reigns.

I have seen investors more bearish than they are now, but I have never seen more angst amidst such opportunity as there is today.

I am quite optimistic about 2005. Valuations are not demanding, especially in a world of low inflation and low nominal interest rates. Mergers and acquisitions should boom this year, providing windfalls for the shareholders of takeover targets. I would expect corporate share buybacks to accelerate and dividend growth to remain strong. High returns on equity and low nominal growth mean lots of excess cash available for shareholders' benefit.

If everything is so good, why are investors so glum? Those who fail to take advantage of today's opportunities because of a sense of foreboding and fear of loss remind me of John Marcher, protagonist in Henry James' novella The Beast in the Jungle. Certain that some great misfortune was about to befall him, he failed to marry the woman he loved (lest she share his fate), or to do much of anything, only to realize too late that the great misfortune fate had in store for him was to throw away his life and opportunities because of his excessive caution and fear of the future.

Exemplifying the fears bedeviling investors today is the daily (hourly) drumbeat about the dollar and the deficits, especially the "unsustainable" current account deficit. The mantra should be familiar: the U.S. saves too little and consumes too much. We are mortgaging our future, consuming our seed corn. If foreigners stop buying our debt, the dollar will collapse and interest rates soar. The only direction for the dollar is down, and so on. It was reported that former Federal Reserve Chairman Paul Volcker puts the chances of a financial crisis at 75% over the next few years.

Is all of this or any of this right? Well, it could be. But here is the way I see it. The rest of the world saves too much and consumes too little. If the U.S. had not gone on a relative consumption binge from 1998 to today, wherein consumption went from 67% to 71% of GDP, we would have suffered not a multiyear bear market but a global deflationary depression precipitated by the Asian collapse, the Russian debt default and the failure of Long Term Capital Management.

Instead, U.S. "overconsumption" saved the day, providing demand for the world's goods and keeping emerging economies from imploding due to their own domestic consumption collapse, high debt, and excess production capacity. Our consumption was fueled first by a strong domestic stock market, and when that gave way, by falling interest rates and ample liquidity supplied by the Fed. Still, we suffered a brutal bear market and a recession before things began to improve in early 2003.

Any unilateral withdrawal of the demand for goods resulting from a significant rise in our savings rate, unaccompanied by a proportional increase in consumption outside the U.S., would put us on a path to pain again. As my good friend Paul McCulley, the endlessly creative monetary guru at PIMCO, has said, the rest of the world needs to shed the hair shirt of denial and embrace hedonism.

The Asian developing countries are not buying our dollars because they like us (as McCulley also notes); they are doing it because they believe it is in their interest to do so. They are practicing mercantilists, employing an economic philosophy popular in Europe hundreds of years ago, which roughly equates a nation's strength and economic security with how big its pile of currency reserves happens to be. Call it the Scrooge McDuck approach to national well-being.

It would be useful to think about how one would characterize the U.S. situation were the entire world to go to a dollar standard, so the dollar couldn't decline against other currencies because there wouldn't be any. The world would then resemble the U.S., which only has one currency. China would be like a state with a lot of money in its coffers but which might need all that cash to bail out its shaky state banks, for example.

My friend Chris Davis [head of Davis Financial Advisors] told me he was once concerned about how much the U.S. spends on health care as a percentage of GDP. Surely 12% or 13% was unsustainable? He asked Charlie Munger, vice chairman of Berkshire Hathaway. "Who knows?" Charlie said. "How much is the right amount for a rich society whose population is aging and whose material needs are being met? Fifteen percent? Twenty? Thirty? Fifty? We have no idea."

I also think we have no idea how sustainable the "unsustainable" current account deficit might be. Current account deficits even higher than ours as a percentage of GDP have not prevented the currencies of Australia and New Zealand from soaring the past several years.

Do we really consume too much and save too little? Fed data show that while debt has been rising, so has net worth, and debt as a percentage of net worth does not look overstretched. I am not unmindful of the risks. But I do think most of the analysis wildly oversimplified, particularly when the problem is identified as "imbalances," as though the economic system's natural state had been perturbed and until returned to balance it was out of whack.

My point is simple: this is just one of the things people are worrying about while the broad economic picture could hardly be better. General Electric just reported strong earnings and is confident of double-digit growth. IBM did the same. Citigroup chief financial officer Sallie Krawchek said recently on CNBC that it was "credit nirvana," the best environment they had seen in almost 15 years, and Citigroup raised its dividend another 10%.

Who would park their money in cash at 2% and pay taxes when they could get 3.7% in tax-advantaged dividends in Citigroup stock and own a piece of the world's largest financial-services firm, one that is perfectly well-positioned to be the banker to the developing world's burgeoning consumers?

Who would stay away from equities when we have just finished a prolonged bear market and have entered a period of perhaps sustained prosperity because they are worried about all the misfortunes that might occur?

I suppose John Marcher would.