Confidence leads to spending; spending strengthens the economy; and economic strength buttresses confidence. It’s a circular, self-fulfilling prophesy. Confidence can also fuel market movements. Belief that the price of an asset will rise causes people to buy the asset... making its price rise. This is another way in which confidence is self-fulfilling. But, of course, as Oak Tree Capital's Howard Marks points out, the confidence that underlies economic gains and price increases only has an impact as long as it exists. Once it dies, its effect turns out to be far from permanent. As the economist Herb Stein said, "If something cannot go on forever, it will stop." This is certainly true for confidence and its influence. As far as confidence today, Marks notes significant uncertainty is one of the outstanding characteristics of today’s investing environment. It discourages optimism regarding the future and limits investors’ certainty that the future is knowable and controllable. In other words, it saps confidence. This is a major difference from conditions in the pre-crisis years. In fact, Marks warns he doesn't remember when his list of 'uncertainties' was this long...
In the U.S.:
- Will the recovery from the recession of 2008 – long in the tooth but still halting and unsteady – ever gain vitality? Today it seems we’re experiencing “two steps forward, one step back,” as positive reports are regularly mixed with disappointments. Further, even the improvements – in areas like job creation, consumer confidence and manufacturing output – seem tepid rather than eye-popping. This is quite different from the recoveries of the last few decades.
- To what extent will the recovery be impaired by recent tax increases and the budget cuts mandated by “sequestration”?
- When will sales increases overcome businesses’ resistance to spending on plant and personnel?
- How much longer will the Fed keep interest rates low? Three months? Three years? In perpetuity?
- What will happen when it no longer does? Will rates rise? How much? Will the effect of higher rates on the cost of financing purchases and investments be enough to slow the economy? And what will be the impact of higher rates on the government’s cost of financing, and thus on the deficit?
- What are the implications of the fact that the Fed’s balance sheet has swelled to over $3 trillion? How does the Fed pay for the bonds it buys under QE? Will it have to pay that money back? Will the Treasury have to pay off the Fed when the debt matures? Where will it get the money? And where will the money go? (Think about this for a minute: do you feel you understand the workings of this process? Do you know anyone who does?)
- Will our economy ever get back to the higher growth rates of the late twentieth century, or will we be stuck in a slow-growth mode?
- Will “structural unemployment” in the future remain stubbornly above the 5% or so of the last few decades?
- Will profit margins retreat from their current record levels, and if so, what will be the effect on corporate profits?
- Longer term, can progress ever be made on cutting the budget deficit and reducing the unfunded entitlement obligations?
- What will be the social ramifications of slow growth, high unemployment and increased income disparity?
- Will the U.S. devalue the dollar, the usual path to dealing with excessive national debt?
- Will slow growth lead to Japan-style deflation? Or will high-volume money printing to make it easier to repay the debt bring on chronic inflation? (The mere fact that intelligent people worry simultaneously about both these polar opposites is in itself an indicator of the high level of uncertainty that is present.)
- Can the seeming downward spiral in peripheral Europe’s economies be arrested?
- Can Europe’s excessive indebtedness be brought down, and can the chronic deficits that led to that level of indebtedness be trimmed through austerity?
- Will richer nations continue to support poorer without insisting on the latter applying painful austerity?
- In practical terms, can austerity be undertaken at a time of economic weakness? If austerity is continued, are recession, suffering and unrest unavoidable?
- Won’t voters demand isolationism in the richer nations and relief from the pain of austerity in the poorer nations? Won’t elected leaders offering anything else be ousted?
- Will the highly restrictive regulations and labor laws be eased so as to enable Europe to compete on an equal footing with the rest of the world?
- Longer term, will the nations of Europe give a central body the control over economies and financial institutions required for an effective economic union?
- Will UK voters vote in the coming referendum to stay in the European Union or leave?
- Will the EU remain intact? Is a political union in which actions require unanimous support practical? Can governance and coordination be improved?
- Are there leaders – anywhere in the world – of the caliber we need to see us through these uncertain times?
- Can officials who seek re-election first and foremost rise to the occasion and make the tough decisions needed to apply unpopular solutions to problems, rather than palliative Band-Aids?
- Will the successors to Geithner and Bernanke prove up to the task of continuing the recovery while weaning the economy from ultra-low interest rates?
- Is it conceivable that America’s elected leaders will create an environment in which uncertainty over taxation, regulation and healthcare costs no longer discourages businesses from investing in plant and personnel?
- Will China’s credit-abetted economy experience a hard landing or a soft one?
- If China’s growth slows, what will be the effect on nations such as Brazil, Australia and Canada that have prospered by supplying it with commodities? What will happen to commodity prices?
- Will Prime Minister Abe’s monetary and fiscal program be enough to wake Japan’s economy from its lethargy?
- Will fracking allow the U.S. to achieve energy self-sufficiency? If so, what will that do to its manufacturing competitiveness and to the price of oil?
- What will happen in hot spots such as the Middle East, Iran and North Korea?
Full Oak Tree Capital letter below: