Centre Street Cambridge Corporation

Private Investment Counsel


October 2018

The third quarter was a time for reflection on Wall Street as the three-month period witnessed a number of milestones. At the top of the list for the chattering classes was the tenth anniversary of the collapse of Lehman Brothers into administration on September 15, 2008, the largest bankruptcy in U.S. history. So dramatically was the event impressed on the collective memory that it seems like only yesterday when the investment bank, founded in 1850, succumbed to the era’s rampant speculation in real estate and the products of financial engineering, not to mention over-indebtedness, to be subsequently sold off in pieces to Barclay’s Bank of the UK, and Nomura of Japan. However, while its demise was the most breathtaking, Lehman was not the only major financial institution to fail that eventful quarter: shortly thereafter, Washington Mutual, the largest Savings and Loan institution, was seized on September 25 and fell into the arms of J.P. Morgan. We should also recall that the events of that September did not come out of the blue. The crisis of confidence that almost engulfed the entire financial sector had begun earlier. Troubles with mortgage securities popped up the prior year. Then, in March of 2008, Bear Stearns, another old Wall Street firm that had survived the Crash of 1929 and had only recently been considered one of the “most admired” firms in the industry, merged into J.P. Morgan at a vastly reduced share price (not low enough for some observers) of $10, down from $93 just the previous month (and $172 in January 2007). We lived through interesting times, indeed.

Another milestone happened this past quarter that saw the string of advances in U.S. stocks since 2009 gain the status of the longest bull market in history. Who would have thought that on March 9 of that year, in the midst of a market collapse spawned by the Lehman debacle and the financial crisis that ensued, market averages would reach a bottom, after which they began to rise and never looked back. Market routs of this magnitude are usually, though not necessarily quickly, followed by recovery. Those possessing knowledge of this history, and the skills and stamina necessary to take advantage of it, stood to enjoy large gains in the decade to come.

One more milestone was reached when, for the first time since 2008, one-month treasury bills sold at a price to yield over 2% annualized to buyers. Rates on long-term bonds reached several-year highs as well. During the financial crisis, monetary authorities around the world took unusual steps to stem the panic and protect the real economy (the economy that produces things and services and provides employment). Among these policies was the suppression of interest rates to very low, even negative levels. (Many do not realize how extraordinary these efforts were—they produced the lowest rates in history according to one study). The aim was to incentivize investment and risk-taking—activities that promote enterprise and “animal spirits.” 2%, while still low, represents a significant reduction in stimulus, and a significant step on the way to a return to “normalcy” as the economy has recovered.

Also noteworthy during the past quarter: Apple Computer became the first public company to reach a market value of $1 trillion. In a sense this was inevitable—as economic growth and inflation over time expand corporate values—but it is also a tribute to a company that has created products that engage consumers, and attracted large, influential investors. Of course, it helps to be in a popular market sector as well, one that has led the entire market to new highs.

It is clear that all of these milestones are connected. The Lehman collapse triggered the monetary and fiscal responses aimed at averting economic catastrophe a decade ago. The stimulative actions taken subsequent to the event contributed to the large rise in stock values and to the eventual return to economic growth that we still enjoy in the U.S. A stronger economy has, in turn, brought about a rise in interest rates, normal under such circumstances. Finally, while the appearance of the world’s first trillion dollar company is an outstanding success for all parties involved, such an achievement owes much to the favorable business and financial environment prevailing over the past decade.

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While the anniversaries of market events and notable corporate achievements make for entertaining commentary in the financial press, we find the real value of such discussions lies in stimulating thinking about larger issues which can have important implications for corporate and market behavior going forward. What, for example, has been the aftermath of the Lehman collapse for the financial industry and markets? Well, fundamentally, not much has changed. Following a lot of talk about “too big to fail,” banks are bigger than ever. Compensation schemes remain as before, and big payouts are back on Wall Street. As some observers foresaw even during the worst days of the financial crisis, crisis-era regulations, introduced to reign-in bank risk-taking with publicly insured funds, and reduce the likelihood of future crises, have been partially scaled-back under persistent industry lobbying pressure. As for the markets, while the rise in stock values has been long and steep, it has also been “unloved.” Even as stocks soared, the allocation of pension fund assets to public equities has fallen, continuing a trend that began in 1999. And the increase in public enthusiasm for stocks that usually accompanies a bull market seems absent this time, although it is possible that public interest in the markets is now reflected in the vast flow of money into “passive” vehicles, such as exchange traded index funds.

“Will another crash happen?” has also been the subject of much debate. In light of the experience of 2008-2009, and the subsequent rise in securities prices to new highs, commentators have been positing what the next “black swan” (something totally unexpected) event will be that will bring on another crash. That another market dislocation will occur at some point is not subject to doubt—to do so would ignore the lessons of history. When it will happen is unknowable, as is the cause. Despite the talk of “black swans,” it is the nature of such unknowable and unpredictable factors to be, well, unknowable and unpredictable. The next crash could be caused by something beyond our current perception, or it might be right under our noses—the immense amount of debt in the world, for example—or it could be a combination of many small causative factors, as some economists have suggested. At any rate, it is not what you do in reaction to market ructions that will prevent damage to your wealth—by then it is usually too late—it is instead the consistent, rational behaviors that you engage in at all times that will save you from disaster.

Another notable phenomenon has been a dramatic decline the in the number of listed companies on the U.S. stock exchanges. Mergers, bankruptcies, and “taking private” transactions take companies off the stock exchanges, while a dearth of initial public offerings has failed to replace them. The result was a 50% decline in listed U.S. companies between 1996 and 2017, despite the rise in stock prices to new highs. This phenomenon is also, indirectly, at least partly a result of low interest rate policies over the last decade. Borrowing became so cheap that taking companies private became more attractive. Low rates and a lack of alternatives also prompted those controlling large pools of capital to seek out “alternatives” to the public stock and bond markets. Hence, large amounts of capital became available to “private equity” and hedge funds to be used for funding private companies, or in mergers involving public companies. Some observers have expressed concern over the impact that the enormous shift of funds into passively managed investment vehicles may have on the proper functioning of capital markets. The significant decline in publicly traded investment securities could magnify this effect.

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Oil prices have climbed to their highest levels in four years (about $77 per barrel in the U.S., $85 internationally at publication time), nearly tripling the lows reached early in 2016. The oil markets have been a classic example of supply and demand during this decade. After trading above $100 in 2014, prices collapsed after OPEC unleashed production and flooded the global market, attempting to cripple the U.S. unconventional oil (shale) business that had come to threaten OPEC’s hold on the market. However, low prices put such a strain on producer economies that they reversed course and reduced production to soak up the glut. Prices rose accordingly.

Subsequently, demand has come into play. Growing world economies (helped in part by the lower energy prices) have boosted demand for oil, which is now growing by more or less 1 million barrels per day of consumption, to about 100 million bpd currently. Curtailed exports from producers such as Iran, Venezuela, and Libya have further tightened the market, while the shale boom in the U.S. has run into labor and infrastructure bottlenecks that have slowed the growth of its contribution to world supply. Demand and supply seem roughly balanced at present, but with demand growing and spare production capacity reaching limits (excepting Iran and Venezuela), prices could continue to be firm.

Since the collapse in oil prices in 2015-2016 we have been convinced that the sharp drop in investment activity in the industry resulting from low prices would eventually lead to an unbalanced market, with new resources failing to keep up with the depletion of existing reservoirs. We still expect this process to eventually play out, perhaps over the next five years. There has been some revival of interest in exploration and drilling as prices have firmed, but investment still remains far behind what is needed in order to meet future demand. Despite the attention given to renewable sources of energy in recent years, a transition to a greener future will take years. Oil as an energy source will be with us for a while to come.


Dennis Butler, MBA, CFA