Green Shoots? Not So Fast…

Indicia:

• Is
  This Bull Cyclical or Secular in the WSJ, which contains
  the following observations as well as the following chart:
  • Many
    investors are now calling the rebound in stocks since early March the
    start of a new bull market. But it could be only a temporary respite
    from a longer-term bear market dating back to the beginning of this
    decade.[…]

    Historical
    data and the still struggling economy seem to point to the latter case,
    called a cyclical bull market in a secular bear market.

  • In late 2001, Ned Davis Research, a market analysis and money-management
    firm, raised the idea that stocks had entered a secular bear market,
    a long period of flat or declining stocks. That idea gained traction last
    autumn as stocks fell below levels of a decade ago [and the firm now] considers
    this the fourth secular bear market since 1900. The last one, from 1966
    to 1982, ended when the Federal Reserve moved to aggressively crush inflation.

    

    These “secular” cycles run for long periods; secular bull
    markets have lasted from six to 24 years and bear markets 13 to 16 years.

    [They also say] the rise in stocks since March 9 qualifies as
    a bull market, but [not] as marking a transition
    into a new secular rally. That is in part because, according to the firm’s
    calculations, market valuations didn’t fall far enough during the sell-off.
    [Based on Ned Davis’ calculations], the S&P fell
    to a P/E of roughly 12 in early March and is now just shy of 16, which
    compares to a 40-year median of 16.5.

    “You compare that to the 1970s where we got down to
    P/Es below 10 and stayed there until 1982,” says Tim Hayes, chief
    investment strategist at Ned Davis. The current secular bear market,
    he says, “is
    mature but it can go on for another several years.” […]  For
    now, at least, those who think this is the beginning of a long-lasting
    bull market are few and far between.

    

• The ever-verbal Paul Krugman (I refrain from characterizing him further,
  even though he’s a Nobel Prize winner from the Princeton economics department,
  which alone should put me in the blindly celebratory camp), wrote in today’s Times under
  the heading Stay
  the Course, that it’s far too soon to declare victory over the economic
  downturn and that those who believe “the economy is already turning
  around”
  “should be ignored” because at best the recovery policies “have
  pulled us a few inches back from the edge of the abyss.”  He believes
  we’re at profound risk of falling into the notorious “liquidity trap”–think
  Japan in the 1990’s.  (“Liquidity Trap 101:”  When a
  country’s nominal interest rate has been lowered to or nearly to zero without
  resulting in appreciable stimulus.  Since interest rates cannot go into
  negative territory, monetary policy is thus exhausted and a deflationary
  mindset can set in.  It ain’t pretty.)

• Far more impressively, Wharton Business School (Are
  Happy Days Here Again?) says, among other things:
  • Several Wharton experts express fairly pessimistic views about the
    recovery — predicting that positive growth may not be here yet,
    and that even when it does arrive, it will probably take several
    years for employment rates to return to so-called normal levels.
    Even if the U.S. gross domestic product turns positive by the end
    of 2009, they note, the American economy will remain close to the
    bottom of the large trough that began in late 2007, with a long way
    to climb for jobs, home prices and other key economic indicators
    just to get back to where they were.

    “Many of the underlying problems remain — and we still haven’t
    seen the worst in terms of consumer problems.”  It gets
    worse:

    • 12% of US homeowners are behind on their mortgages or in foreclosure
    • Consumer credit card debt may be the next shoe to drop
    • Commercial real estate hasn’t even begun to come out of its swoon
    • The country as a whole is over-store’d and over-mall’d
    • Wharton finance professors tend to believe more banks need to
      fail.  In this regard, it’s interesting that the “stress test”
      assumed under the worst case that unemployment would hit
      8.9% this year.  Of course, it’s already at 9.4% and (for
      my money) headed to double digits.
    • “Structural” joblessness may linger even when some leading indicators
      turn positive.  According to the BLS, 27% of the country’s
      12.5-million unemployed have been jobless for more than six months.  If
      sectors such as manufacturing, including the 800-pound gorilla
      in that sector, autos, don’t recover to where they were, “many
      people in their late forties and early fifties may never get jobs
      again.”
    • Consumer savings rates are now at 4.2% vs  0.9% in 2004
      through 2007. 

• Martin Wolf in the FT writes under
  the head, “The recession tracks the Great Depression:” 

  Green
  shoots are bursting out. Or so we are told. But before concluding that the
  recession will soon be over, we must ask what history tells us. It is one
  of the guides we have to our present predicament. Fortunately, we do have
  the data. Unfortunately, the story they tell is an unhappy one. …

  First, global industrial output tracks the decline in industrial output during
  the Great Depression horrifying closely…

  Second, the collapse in the volume of world trade has been far worse than
  during the first year of the Great Depression…

  Third, despite the recent bounce, the decline in world stock markets is far
  bigger than in the corresponding period of the Great Depression.

  The two authors sum up starkly:  “Globally we are tracking or doing
  even worse than the Great Depression …  This is a Depression-sized
  event.

  

  The question is whether governments will be able to navigate between “two
  opposing dangers,” one that stimulus is withdrawn too soon, prompting a relapse,
  the other that it’s withdrawn too late, leading to a crisis of confidence in
  the sustainability of public debt levels and an invitation to stagflation.

• Then we have the enormous question of whether interest rates will
  rise as investors (see:  China) decide that spiralling federal deficits
  as far as the eye can see demand higher returns.  Higher interest rates
  are of course the worst of all possible worlds at the moment:  Cyclically
  reinforcing higher deficits at the same time they tamp down what private
  sector investment may be left.  US Treasuries yields are currently at
  a six-month high (the 30-year bond is above 4.5% whereas as recently as January
  it was at 2.5%–an 80% rise).

• Finally, permit me to add my own favorite risk:  That we are embracing
  “too big to fail,” and that we will adopt such a super-precautionary regulatory
  structure that we will end up getting neither “destruction” nor “creativity”
  in our financial system. If we go down that politically tempting and
  incumbent-friendly path, we will delay our recovery by untold years and its
  vigor by the stunting or loss of unknowable innovations.

And yet.

As I talk to senior law firm leaders domestically and abroad–I am chastened
to report–one of the most widespread sentiments I hear is, “We’re coming
out of the woods.  Aren’t we?  Aren’t we??”

To be sure, I understand the strong, almost desperate, desire to hope that
a return to the good old days is just around the corner.  Life was simple;
life was good. 

Yet the more I see first- and second-hand of organizations in distress, the
more pivotal I believe is the power of collective denial.

Do we need to fundamentally re-examine our business model?  Can leverage
grow to the sky?  Will clients huff and puff about rate increases but
ultimately (and quickly, in fact) submit?  We prefer the easy and familiar
answers to these questions, not the clear-eyed and unblinking answers.

Medicine teaches that in the human body pain serves a purpose; it alerts
us to something that needs to be attended to. 

Perhaps our world is not
so different.  And fundamentally denying the message that pain may indicate
the need for some change leads to the antithesis of a cure.  The morphine
drip, the third glass of wine, the wishing and hoping for a return to “normal,”
the espying of
“green shoots” while the thunderheads are rising:  None of these
is healthy. 

Have I become the anti-optimist, then?  Au contraire.  Few
things are more certain in my mind than the long-run demand for sophisticated,
bespoke, and yes, costly, legal services:

• Globalization is not ending, it’s accelerating.
• Worldwide capital flows have not stopped, they’re sluicing in new directions.
• Cross-border projects will grow.
• Regulatory regimes are not getting simpler, they’re getting more complex.
• And yes, financial innovation will–I promise you–return.

But I’m a worried optimist, and right now the
emphasis is on “worried.”   I’m worried that we’re not
doing enough to remodel our firms for the post-Cravath System order.  I’m
worried that we will not get serious about re-inventing the seriously broken
associate career path model.  I’m worried that we will scurry back to
the familiar dominance of the billable hour without thoughtful and heartfelt
experimentation with alternative billing.  I’m worried that we will embrace
complacency.  I’m worried that we will face the New Normal with a resolute
stance of denial.

Joseph Schumpeter taught us that the genius of capitalism is creative
destruction.  Too many of us are focused exclusively, paralyzingly, on destruction.  To
accelerate the dawn, we need to focus on creativity.