In the spring of 1982 we were glued to the TV. Not to reruns of “Hogan’s Heroes” or “M*A*S*H,” but to a real, live war. 

Argentine dictator General Leopoldo Galtieri believed Argentines needed a little patriotic diversion from the grim stories of murder, mayhem and economic mismanagement that plagued his leadership. 

Britain had ruled the Falkland Islands (Spanish: Islas Malvinas) since 1883. But undefended… and perhaps not worth defending… Argentina had been claiming sovereignty over the tiny islands ever since the days of Juan Perón. 

After negotiations between Buenos Aires and London over the sovereignty of the islands collapsed… on April 2, 1982, Galtieri sent in troops to claim them for Argentina. This triggered the Falklands War (what many Argentines still refer to bitterly as the Guerra de las Islas Malvinas). 

The world watched. We believed the US would intervene and broker a settlement between the Thatcher government and the Argentines. The islands (current population about 3,000 souls) were not worth bloodshed. 

But instead of negotiating, Britain’s “Iron Lady,” Margaret Thatcher, decided to strike back… with the not inconsiderable might of the British Navy. Britain prepared a task force under Admiral Sir John Fieldhouse. And its fleet sailed with the tide for the southern seas.

US investors watched the news and sold stocks. The outbreak of war tends to raise doubts and lower stock prices. The Dow duly fell. It continued to fall even after the last shots were fired, in June. Finally, in August, the Dow dropped to 776. 

That was the bottom of a bear market that had begun 16 years earlier. In inflation-adjusted terms, a generation of capital gains had vanished. 

But it was in this unhappy and barren ground that the seeds of the greatest bull market of all time were planted. Including yesterday’s 189-point loss, the Dow is still ahead by about 15,000 points. 

But that was a nominal gain, not an inflation-adjusted one. It comes to us in a gust of other facts and figures, all of them similarly swept aloft in a great blinding blizzard of misinformation. 

Each measure – from inflation to unemployment – is a snowflake of detailed and intricate workmanship. But each one melts away as soon as you put a lamp on it to have a good look. 

How much is the Dow worth when properly adjusted for inflation? How much of the GDP is useful output? How many of those 15,000 points of Dow gain will be left when the big reckoning finally comes? 

Answers to these questions were easier to give when Maggie’s battleships were under full steam in 1982. Compared to today, the figures were simpler. They told a story that made more sense. 

GDP showed a sure and steady increase since the end of World War II. Wages, too, showed substantial gains. Household net worth confirmed the trends: Real output, wages, and wealth were all going the right way. Total debt remained steady – at about 150% of GDP. 

The typical American was probably far more worried about the rise in consumer prices in the US than about war in the South Atlantic. He had made gains – more or less – for the last three decades. 

We baby boomers are especially fond of those years. We found jobs easily. Houses were cheap. Even after the “oil shocks” of the 1970s, gasoline was still inexpensive. 

Stocks were bargains, too. At the 1982 bottom, you could buy almost any company in the country for five to eight times reported earnings. You could have bought the 30 Dow Industrial components for an ounce of gold. (This, in retrospect, would have been the Trade of the Century.) 

But something important happened in the early 1980s. The healthy economy of the postwar period split in two – one real… one unreal. 

In one, people got rich. No special knowledge or skills were required. You just had to buy US stocks and wait. If you put in $100,000 in 1982, you’d have about $1,500,000 today (not accounting for compounding). 

Or you could have made about the same amount from the bond market. Again, no sweat. 

But better even than buying stocks and bonds – much better – was selling them. This created a new class of rich people. A financial elite who got MBAs or degrees in math and finance and then went to work for Goldman Sachs, JPMorgan, Merrill Lynch and other Wall Street firms. Soon, these folks were earning salaries and bonuses that made your jaw drop.

“Bankers’ Stock Awards Jet Higher,” declared a Wall Street Journal headline last week. “Goldman Sachs employees are sitting on more than $600 million in extra bonus money, for the past year alone.” (We did not feel the need to underline the word “extra.”) 

Today, you can go to Aspen or the Hamptons and see the results. Bankers, stock brokers and hedge-fund managers now live in the mansions that used to be owned by families who made things. 

But most people did not make it into this unreal economy. Most stayed in the old economy. This was the economy of real things… and real wages… 

…and it sucked. 

More tomorrow… 

Regards,

Bill

From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners

One of the knotty questions we’ve been trying to untangle over the past few days is the extent to which convulsions in the emerging markets might affect the US stock market. 

As I told members of Bonner & Partners Family Office yesterday: 

About 15% of S&P 500 revenues comes from the emerging world (10% if you exclude China). But capital flight from the emerging markets could have the effect of sending inflows into US assets, making up for a drop in corporate revenues coming from the emerging markets. 

Meanwhile, US exports to the emerging markets make up just over 3% of US GDP. So, I don’t see the US economy suffering too much as a result of turbulence in the emerging world.

Although the current turbulence in the emerging markets is not quite at the levels we saw during the Asian crisis in 1997-98, comparisons between then and now are nevertheless illuminating. 

Throughout the upheaval in Asia during this time, real US GDP growth averaged 4%… and the US unemployment rate fell to 4% from 4.5%. 

The big wobble came in 1998, after the blowup of Long-Term Capital Management – an event triggered by the 1998 ruble crisis. US credit markets froze… and a 20% correction in the US stock market ensued. 

Today, there is little evidence that the mini-crises in Turkey, India, South Africa, Thailand, Ukraine, Brazil and Argentina are having any major effects on the US economy. 

One indicator to keep an eye on is the Cleveland Fed’s Financial Distress Index. This incorporates information from 16 metrics across credit markets, equity markets, foreign exchange markets and interbank markets to track US financial system stress.

As you can see from the chart above, the level of financial risk in the US economy, as measured by the Cleveland Fed, is lower today than it’s been since 1992. 

This doesn’t mean stress in the US financial system won’t build. Or that US stocks will continue to rally. But there are no signs just yet that we’re anywhere near a repeat of the Long-Term Capital Management and Russian ruble crisis.

One tradition the bond and equity markets tend to maintain is the testing of the resolve of a new Fed chairman relatively early in the first term.  Normally, there is a little bit of a honeymoon period, but current circumstances appear to have accelerated things.

The spike in volatility and the crisis in Emerging Markets were not enough at this point to get a reaction from the Fed yesterday during their every-six-weeks FOMC meeting.  Even though Janet Yellen did not interfere with the current QE Taper schedule, we still don’t know for sure whether there will, or will not be, a “Yellen Put”, just as there was a “Bernanke Put” and a “Greenspan Put.”

The markets have become accustomed to dovish central bankers coming to the rescue at almost any sign of trouble.  Given Yellen’s past, we know that she is very dovish.  However, she might want to prove that she is a little different that we think.  If the markets sense this, things could get very volatile over the next couple of months to see just how much resolve she has.

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