Bill Bernstein: Stock Prices Reflecting Fear

July 22, 2011

Investors are scared, but they’re getting paid to take on risk, investor-author William Bernstein says.


William Bernstein, a trained neurologist and the author of several books on investing including “The Investor’s Manifesto,” says people are scared by the uncertainty surrounding the eurozone’s debt problems and the logjam surrounding resolution of the
U.S. debt ceiling.

He also told Managing Editor Olivier Ludwig that great dangers lurk in the fact that little has been changed in terms of regulation in the wake of the market crash of 2008-2009, and that Medicare looms as a threat to the
American Republic as great as the Civil War.

But all in all, he still thinks stock prices reflect many of the current risks, and that while this isn’t a buying opportunity like the one in March 2009, investors are being paid to take risks.


Ludwig: Have you given a whole lot of thought to the possibility of a double-dip recession or at least a protracted period of sluggishness?

Bernstein: Three things are out there, and two are short term. One is the European debt crisis and the euro. There’s no way that the Greek debt is not going to get restructured. And there’s an excellent chance that the contagion will spread to nations that are not only too big to fail, but too big to rescue. I’m thinking specifically about Italy and
Spain. Germany can’t rescue
Italy; it’s that simple.

The second thing that’s out there is the Aug. 2deadline on the debt ceiling here in the
U.S. We seem to have an entire wing of a major political party that is suicidal and dangerously theocratic.

Ludwig: We’ve spoken about the U.S. fiscal situation before, and you expressed some optimism that politicians were up to the challenge of fixing it. Are you reconsidering that optimism?

Bernstein: No, I’m still optimistic. And I think my optimism is that the adults in the Republican party are going to realize that they’ve got a suicidal wing, and they just might have to cut it off. John Boehner is approaching a moment of truth right now in that regard.

Ludwig: So you’re saying Boehner will rise to the challenge?

Bernstein: I think so. And so I’m reasonably optimistic. Even Mitch McConnell has a weasel way out, but it’s a weasel way that avoids default. And so that’s another piece of risk that’s in the market.

And then finally there’s a long-term piece of risk that’s in the market, which is that we have this
Chernobyl sitting in the middle of our financial system.

Ludwig: And what exactly is that Chernobyl you’re describing?

Bernstein: A very highly linked, leveraged, complex financial system that can very rapidly spin out of control. One failure mode, for example, occurred in 2008 and 2009 when a large number of hedge funds and investment banks underwent forced deleveraging  And that’s just one possible failure mode of many.

The problem is nothing’s been fixed. We had banks that were too big to fail, we now have fewer of them and they’re bigger. We have an inherently unstable financial system.  And it’s unstable because it’s completely unregulated. To me that’s the most discouraging thing. Almost none of these banks would be here today if it weren’t for the federal government, yet in the past two years, they’ve recaptured the regulatory apparatus.

Ludwig: Anything else worry you?

Bernstein: The greatest threat to our Republic since the Civil War is Medicare. Obviously, we shouldn’t eliminate Medicare. It’s a central part of the social safety net. But medical care in the
United States has to be reformed. If it doesn’t, it will bring us down.

Ludwig: Don't get me wrong, I’m not being political here, but you’re nibbling around the edges of what Sarah Palin called “Death Panels,” aren’t you?

Bernstein: At some point, you have to take dialysis away from 80-year-olds so you can give it to 30-year-olds. Obviously, no one wants to deny treatment to very elderly people. But at the same time, that is preferable to what we’re doing now, which is denying treatment to young people for critical conditions.

In my practice, I once saw a 20-year-old woman die because she couldn’t afford her anti-convulsants. That should never, ever happen in a civilized nation. I can see denying dialysis or a heart surgery to an 80-year-old. But I can’t see denying seizure meds to a 20-year-old, which our current system does every day.



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