The Wall Street Journal Op-Ed: The Stock Market and the ‘Tina’ Factor- April 3rd, 2013

 Ernest Hemingway once said “the first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin. But both are the refuge of political and economic opportunists.”

Papa Hemingway saw more than his share of political fraudsters in his day, and he captured a central truth—profligate fiscal policies have generally led countries to extricate themselves from their difficulties through sleight-of-hand rather than true reform. A more modern form of inflation—financial repression—is being undertaken today.

Here the wayward state seeks to pay negative real interest rates on its debt and thus, it hopes, allow inflation to chip away at its principal over time. Savers pay the price. Today, the Federal Reserve is the instrument of this surreptitious wealth tax—buying roughly 60% of the net new issuance of Treasurys in 2012—and the main reason why an investor in a money-market fund can only get 0.02% on his cash while inflation is close to 2%.

That helps explain why the first quarter of 2013 saw both the Dow Jones Industrial Average and the S&P 500 hit record highs. Investors are taking the “Tina” approach to common stocks: In the late 1970s British Prime Minister Margaret Thatcher was nicknamed “Tina” for her response to critics of her steadfast support for free markets—”There is no alternative.” With the world’s global central banks closing off all other exits, savers are turning into Tinas. Ultimately there may be no alternative for investors seeking returns above the rate of inflation.

The good news is that there are more than a few common stocks that can realistically be seen as good proxies for what was previously thought to be unassailable returns on sovereign debt. After Uncle Sam’s debt was downgraded in August 2011, insuring the bonds of 55 private companies was cheaper than insuring U.S. Treasury debt. Today, 27 companies could claim to be better credit risks than the U.S., and a stunning 126 have lower bond-insurance rates than those charged for French sovereign debt.

With the number of public companies shrinking and the pool of triple-A credits dwindling, it wouldn’t be difficult to see a new “nifty 50” of sorts, with investors putting more and more money to work in a relatively narrow list of companies that can provide what the Fed and other central banks are taking away. Companies like Merck and McDonald’s might not have the authority to tax American citizens or possess nuclear weapons, but they do possess something the federal government doesn’t have—money. All can boast of dividend yields that greatly exceed what an investor can earn on 10-year U.S. Treasurys. For Merck and Chevron, the yields are greater than for 30-year government paper.

There has been much recent talk of a “great rotation” into equities from other asset classes, but such a rotation is in its infancy, if it is truly happening. The weekly data for 2013 indicate that equity-fund sales are up meaningfully in the early part of this year, but the phenomenon would have to last longer than three months to signal a bona fide shift in the attitude toward risk.

There is even less evidence to suggest that fiduciaries like pensions and endowments have started to use the long equity portion of their portfolios to make up for some high-profile, short-term misses. It is not uncommon to see large public-pension funds and endowments with allocations to alternative assets of 40% to 50%, while less than 30% rests in public equities. The argument can be made that private equity is equity too, but there are limits about what one should expect from largely illiquid investments with “take my word for it” valuations. All of this suggests that the length and magnitude of the current rally might be far greater than what a skeptical public expects. It’s hard to say what would be an appropriate multiple for the broader stock market when risk-free rates are negative in real terms. But here’s the likely answer: higher than you might think.

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