I glanced over at Murph and was surprised to see that he was not talking with anyone, but listening to one group and then another and scribbling notes in a tiny spiral notebook. Every now and then, he pursed his lips pensively and stared blankly out the small window.
To Murph's right, a strategist and analyst were heavy into the inflation/deflation controversy. "Well, the Fed is clearly concerned," said the analyst, a younger guy still earning his spurs at a large wirehouse. But someone thought enough of him to invite him, so I listened in as he continued. "Their speeches point to low rates as long as necessary, strong money supply growth and no interference with the dollar's fall. Add that to aggressive fiscal policy, and how do we avoid re-inflation? I say we have to reduce our bond positions because of the increased interest rate risk and raise our stock allocations as the only reasonable defense against inflation."
Bill, a balding strategist with a gentle face, listened patiently while the younger man finished. Nodding, and matching the tips of his fingers and thumbs in a kind of pyramid, he offered his opinion in tones so quiet I had to lean forward to hear him. "It's an interesting dilemma, Tim. But it might be a little premature to base your portfolio strategy on an early resumption of inflation. Sure, Fed wants to head off any possibility of deflation because it is a terribly frightening possibility in a culture as dependent on borrowing as ours is. Once deflation gets into the national psyche, it can be nearly impossible to stop without destroying a great many lenders and borrowers alike. On the other hand, they know how to deal with inflation, so the Fed would much rather take that risk. But remember, they might not be able to pull it off."
"What do you mean?" said Tim. "Well, with real interest rates already negative, the economy is still flat-lining. The yield curve is steep, so the next step will be to put some pressure on the long end in the hope of stimulating business borrowing and spending. Fed officials have said they could even let banks use corporate paper as reserves to increase demand for long bonds. A good case can be made that even this will not boost end demand for capital goods; maybe all we'll see is a decline in the carrying cost of debt. This could give corporations more room to trim their selling prices in their struggle for a share of declining demand. Sounds deflationary, doesn't it?"
A little troubled, Tim said, "Yes, but when they run the printing presses faster than the economy can absorb money, doesn't it have to pop up somewhere?" "You are right," said the older man. "It shows up in house prices. They've boomed 38% in five years, versus about 11% for the CPI. But because interest rates are such a dominant variable, the monthly cost of shelter isn't much impacted, so core inflation is still around 1%." These two were still at it when my attention wandered to a pair on the other side of the table tilting about the significance of the rally.
"We've seen the lows," said the chief investment officer of a big investment banker. "It's a clear case of the market anticipating the economic recovery. You know, bull markets climb walls of worry." "Sure feels that way to me," the trader interjected. "And tech names are leading the charge." "Isn't it generally true," I asked, "That new bull markets begin with new leadership? Isn't the resurgence of the old names a sign of weakness?"
"And what's the engine for this economic recovery?" a portfolio manager asked. Just then there were three or four loud clinks of a spoon on a water glass. All heads turned toward Murph and the conversations stopped abruptly. As the big guy put the spoon down and cleared his throat, all the people seemed to settle back in their chairs, and he began.
An Extraordinary Time
"Friends, this is a deviation from the way we usually conduct this gathering, but I would be grateful if you would lend me your ears for a few minutes. I have been taking time off in recent months to think about the comings and goings of the capital markets. And I have arrived at several convictions that I would like to share with you for whatever value you may find in them. Perhaps you could poke at these ideas during the rest of the afternoon. Then I would like to propose an unprecedented second meeting after Labor Day to talk about specific strategies.
"First, let me say that I believe the current environment is the most challenging, the most exciting, the most interesting, the most dangerous and potentially the most profitable of any I have experienced in nearly 50 years on the Street.
"All of us are assaulted daily by waves of fresh data, each promising new insights, yet rarely delivering. We've become accustomed to sorting and analyzing this endless stream of information on the fly, making decisions and taking action, only to return to our homes exhausted each night, no wiser for all our efforts. We've become reactionary and have little time to reflect on the possible meaning of all this information on a big-picture basis. And I think that mass communication and instant data have tended to make professional money managers more clone-like, less willing to take the risk of being different, and perhaps therein lies a great opportunity.