Dan Alpert is a founding Managing Director of Westwood Capital LLC and has more than 30 years of international merchant banking and investment banking experience domestically as well as in East Asia, the Middle East, and Eastern Europe.
H.L.: In light of the most recent data, are the economy and the stock market peaking for the time being before either continuing upward or stalling out?
D.A.: The post-December rally in the equity and commodities markets is liquidity-, not fundamentally driven. The Cyclically Adjusted Price/Earnings Ratio is at 23+, and the gap between 10-year Cyclically Adjusted Earnings and the next 12 month’s projected earnings is forecast to be the most since 1951, according to Bob Shiller’s recent data analysis. And the markets have fully priced in record per-share average S&P earnings. So it will be great to see that all happen – and if companies can control pricing and expenses it could – but relative to the other pressures I see on purchasing power in the developed world, I am not betting on it.
In fact, I believe that price and wage deflation will be what we are talking about in 12 months, and while corporate margins may remain decent (unless wages stick more than prices – which is not unlikely), nominal values may not.
H.L.: You say the U.S. is experiencing enormous deflationary pressures. How does that affect measures to fix the economy?
D.A.: There are two ways of approaching this. You can absorb the deflation, and that makes you more competitive, because prices drop and your goods are cheaper internationally, which is what the Japanese have done. They’re still shipping silicon wafers and all sorts of goods that people need to buy, notwithstanding the earthquake’s interruption in supply lines. And after taking their intermittent deflation into account, while wages have fallen, real wages have been flat due to increased purchasing power.
Or you can do it our way, which is to indebt yourself to your trading partner, in this case China, and pretend that you are able to raise nominal wages, but at the end of the day you haven’t done anything for your people, because wages are currently falling on a real basis, and unemployment is “banking” nominal wage deflation temporarily.
We have been inculcated with fears of deflationary spirals, and, yes, deflation is not good for those with capital invested (although great for those with capital saved), but there has not been spiral or spiral-like activity in Japan. I believe that moderate deflation is as legitimate a mechanism of rebalancing global competitiveness (helped along by a tad of inflation in the developed countries, all the better) as is currency devaluation. As to the latter, the Chinese and other emerging nations are pegging to our currency, so that is off the table.
H.L.: What do you predict for the U.S. economy in 2011 and 2012?
D.A.: I think we’ll be constantly battling the debt overhang. I see additional pressures emerging in the housing market as housing prices continue to fall. I see that affecting the banking sector, because the four largest banks are holding $1.1 trillion worth of whole loans – residential mortgages – in their portfolios, and $400 billion of them are home equity lines of credit, all of which are pretty much under water. So a continuing deterioration in home prices is going to continue to affect people’s willingness to pay debt service on something that is under water, and eventually you’re going to have problems.
There are two possible outcomes. One is that eventually we’ll be forced to clean it all up, and the markets will decline considerably because of that, but we will live to fight and grow another day, or we’re going to experience the Japanese outcome: Growth will stall, and deflation will take its pain over many, many years.
H.L.: Do you expect Congress to effectively deal with our financial problems in a timely fashion, or will it blow it and seriously hamper the economic recovery?
D.A.: We basically have a non-governing government at this point. We have complete stagnation in Congress, with the Senate being controlled by the Democrats, and the Republicans controlling the House. The Republicans who were elected in the last go-round, these newcomers have some pretty odd ideas about how to fix the economy. The bigger problem is not the people in Congress. I’m sure they’re nice people, but the fact is they have a very poor understanding of economics. They were elected by people who very much like the entitlement programs that we’ve created over many years. Nobody’s out there looking to get their Medicare slashed. Nobody’s out there looking to get their Social Security cut, and the people whom we’ve elected are not going to do those things.
The issue really comes down to a choice: If you’re going to spend on entitlement programs, which is the vast majority of our budget, you need to tax people to pay for them. So we have wonderful policy alternatives out there from people who won’t raise taxes and will continue to spend. It’s a fantasy world. We’re not going to make progress on the deficit. We’re going to have taxes go up to pay for everything, and the rest will be history.
We borrowed against our future. We woke up on Jan. 1, 2000 with about $25 trillion in aggregate debt outstanding in this country. In February 2008, we had $52.5 trillion of debt outstanding. That was based on assets in a bubble and housing prices going to the moon. And housing prices have fallen back and continue to fall back, and the debt still remains. So until we resolve the debt, not a whole lot is going to happen. It was pretty stupid, since we were doing it in reaction to the emerging nations’ taking away our jobs and our global customers. We actually had no way of maintaining our standard of living except by borrowing. While we were doing that we also followed policies that for decades have resulted in the concentration of wealth in a very small number of people in this country. So we have engineered a very well-off oligarchy, and huge number of folks in debt up to their ying-yang.
H.L.: The banks are lobbying against increased regulation in spite of the lack of it, which was a major factor in causing the financial disaster that began in 2008. If Congress goes along with the banks, won’t that risk yet another crisis?
D.A.: Yes. But I don’t know if Congress really has much of a role to play at this point. There’s a lot of squeaking and squawking and people writing letters, but at the end of the day, the good thing about the Dodd-Frank Act is that it requires the regulatory bodies to promulgate regulations in order to comply with the law, and that process is well under way.
Notwithstanding the enormous amount of noise coming from the Hill and the business media, my take is that, especially with regard to the FDIC and the Federal Reserve, this process is proceeding responsibly with far less political input than some believe. Let’s hope that the OCC, the SEC, and all the other C’s proceed in an equally responsible way.
I don’t think there will be any groundswell to revoke aspects of Dodd-Frank, certainly not in the Senate. I think that would be very unpopular. I don’t think the House (despite Eric Cantor’s recent strange utterances about the House being able to write laws unilaterally!) can really stop it at this point, and the balance of the year will see enough continuing economic disruption to make stopping re-regulation an act of political suicide.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.