Portland Private Wealth Management Blog: December 2009

It Is Different This Time

Potentially one of the most costly trappings for investors is succumbing to a belief that ‘it is different this time’. For instance, assuming that the economic engine of the United States is permanently broken or we are destined to the Japanese experience of permanent malaise may lead us to make the wrong choices when it comes to investment strategy. Just over a year ago we experienced a ‘financial panic’. It was not the first and it will not be the last. A financial panic is characterized by a ‘run on the banks’. Our recent experience was a ‘run on the system’. What happens in a financial panic is that all financial players move in unison to ‘safe assets’ leaving financial institutions without risk capital to operate.

Banker Panic of 1907

While the Great Depression was kicked off with a series of ‘bank runs’, the most similar episode to recent Panic of 2008 was the Banker’s Panic of 1907. The stock market peaked in 1906 and fell 40% over the next year during a time of recession. In the fall of 1907, with the economy and financial markets already on shaky ground, a number of financial institutions extended money to a group of investors (think subprime lenders) making big one-way bets. When the investor bets soured (think housing bust) it led to the collapse of a prominent broker dealer in New York City (think Lehman) that caused another and much larger financial institution to fail (think AIG). As news spread, depositors across the nation became nervous and began withdrawing their funds from all types of institutions (think of the mass exodus from money market funds after The Reserve Fund, a money market fund with a small position in Lehman, ‘broke the buck’.) From there, the entire system began to unravel.

John Pierpont Morgan, the wealthiest and most prominent banker of the day (before the Federal Reserve Bank existed) stepped into the fray by making capital injections into several prominent banks (think Bernanke/Paulson with their Maiden Lane loans to AIG and the $250 billion TARP injections into the largest U.S. financial institutions.)[i] John D. Rockefeller, the wealthiest person in America at that time, made a large deposit into Citigroup’s predecessor (think Warren Buffet investing in Goldman Sachs and GE Capital). After these initial injections, over the next few weeks, and through some serious banker wrangling, Morgan was able to pony up enough bankers and money prevent the total implosion of the financial system (think of the $500 billion in the 2^nd round TARP, as well as the TALF, CPFF, PPIP).[ii]

Past Performance Does Not Predict Future Performance

The economy did shrink in 1908, but it grew again until it was stymied by the outbreak of World War I in 1914. And in the aftermath of the 1974 ‘Great Bear Market’, the economy grew until 1980 despite double-digit interest rates and double-digit inflation during that time period. It is hard to say if the Panic of 2008 was any worse than the Panic of 1907. Or the economy of 1975 was more resilient or in better shape than the economy of 2009. Whatever the case, unprecedented is not a word I would use to describe the events of the last year or so.

Looking forward, a belief that America is permanently broken, or on the wrong path, or is an empire in decline is generally a bad bet in my view. In 1989, the Nikkei would peak at 38,000. Japan was on a roll. It had a vibrant economy, great manufacturing acumen, they were buying up the most precious real estate in America, and everybody wanted a Sony Walkman. In America, our financial system was in shambles as we shuttered thousands of S&Ls, Citigroup fell to less than a $1, Michael Moore made his first movie about a dying U.S. auto industry, and Apple’s first portable computer was a piece of crap.[iii] Over the course of the next decade, the Nikkei would lose 66% of it value and U.S. stock market would rise 450%. Do you think most pundits were betting on Japan or America in 1989? Perhaps I am wrong, but I caution those that think it is different this time.

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If you would like to contact us feel free to email as at jason@portlandprivatewm.com or we can be reached at 503-703-4067. Thank you.

[i] TARP - Trouble Asset Relief Program

[ii] TALF (Term Asset-Backed Loan Facility), CPFF (Commercial Paper Funding Facility), PPIP (Public-Private Investment Program)

[iii] The Citigroup low is a split adjusted number. Source: Goldman Sachs

One editorial writer for Bloomberg suggested that unprecedented was the most overused word in 2009. I think she was probably right. 2008/2009 was a year of tumultuous financial events. But was it unprecedented?

This year is ending with much of the nation in a state of deep anxiety over the course of the economy. Wall Street is flooded with red ink, but some of the biggest investment banking houses in the country are nevertheless paying year-end bonuses.[i] The recession will represent the longest slowdown since the 1929 – 1933 experience.[ii] There has been nothing like the present degree of apprehension since 1930. The question on everybody’s mind is whether years like 1931 and 1932 lie ahead. If the nation is to avoid another Great Depression, it has to face up to the real problems and dangers that lay ahead.[iii]

Feeling the Pressure

Many individuals are cutting their expenditures because their pocket books are pinched, they don’t have the means to dip into their savings, and unemployment rolls are lengthening. Businesses see new orders shrinking, unsold inventories piling up, costs rising and profits eroding.[iv] Last week, the largest airline in the nation said it would be forced into bankruptcy without a federal subsidy.[v] The Mayor of New York City has launched the toughest austerity measures since the Depression laying off thousands of employees and is seeking help from Washington.[vi] The depressing economic news has sent the stock market to the lowest levels in more than 12 years, as the government’s index of leading business indicators fell to its lowest level in 24 years and the unemployment rate reached its highest level in 13 years.[vii] [viii] [ix]

Negative Wealth Effect

There is a real sense of wealth lost from the roughly 40% drop in the stock market since last year. To the extent is impossible to quantify, this loss of wealth cuts into consumer spending, therefore total demand and production in the economy. The drastic decline in the price of stocks (which some argue started at the beginning of this decade) eventually has an effect on the process of ‘capital formation’ in the American economy. This is the means by which savings is transformed into the creation of new businesses and increased investment in plant and equipment.

Prognosticating

There are some people on Wall Street that recommend investors should stay away from stocks all together.[x] One of the President’s top economic advisors suggested the recession would continue into the middle of next year.[xi] Another prominent economist said his personal view was that a new bull phase in stocks would not occur until spring at the very earliest.[xii] On the flip side, gold prices have soared. This clearly reflects a wave of private demand by people worried about the state of the world economy and particularly about inflation. Some people regard gold as the only safe store of value at a time of global inflation and depreciating value of paper money.[xiii]

So Goes The Auto Sector, So Goes The Economy

Automakers have been under heavy pressure as new car sales have slumped.[xiv] The problems with the auto industry are not limited to Detroit. Employing some 750,000 people directly, it is estimated that indirectly the industry creates another 13 million jobs in steel, aluminum, glass, fabrics, electronics as well as a whole host of other industries. One automotive executive said the biggest deterrent to new car buying has been the sharp rise in the cost of vehicles because of federally mandated safety and emission standards. On the other hand, some experts have argued that auto companies would be more profitable if they simplified their offerings and made fewer kinds of cars.[xv]

Politics in Flux

The country is eagerly seeking Presidential leadership, not more of the same rhetoric it has ceased to believe or respect.[xvi] The President has said he would be willing to revise the current economic program he has presented to Congress if economic conditions worsened.[xvii] The Administration should have the courage to stimulate the economy through tax cuts and socially desirable expenditure increases.[xviii] What inhibits the present Administration is the double fear of increasing the budget deficit and regenerating inflation.[xix] The Chairman of the Ford Motor Company has suggested a gas tax to benefit those hit hardest by the recession – the poor and unemployed.[xx]

Energy Policy: Getting Off Foreign Oil

Measures to strengthen the domestic economy will require a strong national energy policy, whose centerpiece should be to conserve energy and reduce uncertain foreign oil supplies. Doing without foreign oil supplies will reduce our trade deficit and avoid another Middle Eastern war. As abundant as the supply of petroleum may seem, it is ultimately a wasting asset that will ultimately vanish. It is time to consider new technologies like solar, wind and hydrogen.[xxi]

Don’t Know How Good You Have It

Despite the economic gloom in America, foreign observers ask – ‘Why should so vast an economy such as ours, which depends to such a relatively small degree on exports, be more nervous than its trading partners who are wholly dependent on foreign trade to survive?’ The United States has immense natural wealth and requires only minimal discipline to regain its self-sufficiency.[xxii]

Plagiarizing

The paragraphs above have been cobbled together directly from newspaper articles written during the last months of 1974 with minimal change except to improve the readability. It has been just over one year since I printed out and highlighted these articles, but it is still a worthwhile exercise to examine these writings as though they were current news to potentially help investors gain a deeper understanding of market psychology. In early 1973, the stock market peaked and fell over 45% over the next two years. It was a slow, grinding bear market called the ‘The Great Bear’ that ended in December 1974 around the time the articles referred to above were written. The economy would contract the first quarter of 1975, but it started growing again until the recession in 1980 (the last great housing bust in the U.S.). And the stock market would find a bottom in first week of December, 1974, and rally 73% returning to its the old highs by 1976. While we do not know what may lay ahead in 2010, listening to the media or pundits may not help very much. What we do know is that the events of recent months were not unprecedented and it is difficult to predict the course of future events.

If you would like to contact us feel free to email as at jason@portlandprivatewm.com or we can be reached at 503-703-4067. Thank you.

[i] Cole, Robert J., Wall Street in Red, But Bonuses Flow, The New York Times, December 18, 1974.

[ii] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[iii] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[iv] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[v] Stocks Decline in Heavy Trading, The New York Times, August 29, 1974.

[vi] The Major Events of the Day, The New York Times, November 23, 1974.

[vii] Hammer, Alexander, Dow Stock Average Drops 9.46 Point to a 12-Year Low as Volume Increase, New York times, December 7^th, 1974.

[viii] Sears, Roebuck Planning Layoff, New York Times, November 6, 1974.

[ix] Dow Soars 25.5 as Volume Rises, The New York Times, October 30^th, 1974.

[x] Vartan, Vartanig, Analysts Pick Some Winners for 1975, December 29, 1974.

[xi] Hammer, Alexander, Economic Gloom Weakens Stocks, The New York Times, October 27, 1974.

[xii] Vartan, Vartanig, Will 525 Be the Bottom?, December 8, 1974.

[xiii] Dale, Edwin, Gold for Sale: It Probably Will Make No Difference, December 29, 1974.

[xiv] Dow Soars 25.5 as Volume Rises, The New York Times, October 30^th, 1974.

[xv] Mullaney, Thomas, What Will Help Detroit?, November 3, 1974.

[xvi] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[xvii] Hammer, Alexander, Ignoring the Bad News, Market Advances on Broad Front, October 30, 1970.

[xviii] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[xix] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[xx] The Major Events of the Day, The New York Times, November 23, 1974.

[xxi] Sulzberger, C.L., Let Them Eat Petroleum, November 13, 1974.

[xxii] Sulzberger, C.L., The Gods That Are Failing, The New York Times, December 1, 1974.

Friday, December 25, 2009

Unprecedented - Part II

Monday, December 21, 2009

Unprecedented - Part I

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