Monday, March 02, 2009

And The Day Isn't Yet Over

So alright. On February 19, I reiterated my commentary regarding yet deeper declines in the stock market. So, sadly, this morning's decline to lows not seen 1997 is no surprise.

We have yet to see the worst of the bad economic news. Safe havens, such as healthcare stocks, dividend yield, etc. in the equities markets, are pretty much as weak as all other sectors. Sure I can make the argument that long-term investors should take advantage of these declines and average down. But I can just as easily make the argument that people should simply take advantage of any semblance of rallies to sell equities and just wait out the ongoing financial carnage.

In recent months and weeks, so-called professionals have been arguing for investment in corporate bond and other fixed income sectors, including U.S. Treasury securities. I have to admit. After spending more than forty years investing, not to mention my educational and professional training and experience, that strategy in this climate leaves me scratching my head.

Managed corporate bond funds, in particular, do not have a great history of investor returns. Sure, you can find and/or develop portfolios of "high quality" bonds - whatever that still means - that produce "respectable" current yields. However, at some point in the not too distant future - and as usual before naive investors see it coming - those yields will be more than offset by an environment of rising interest rates and declining principle values of those wonderful bonds.

As far as the safety of U.S. Treasury securities, a few voices in the media have been cautioning about a developing "Treasury Bubble." Yields are too low and not reflecting risk, but rather reflecting the relentless flight to safety, nor are they reflecting the real possibility of damaging inflation...once we conclude the current deflationary spiral. The only "Treasury" investment strategy that seems to make any sense is to keep maturities short. And I mean short.

A 90-day Treasury bill currently yields less than 0.25 percent annually, six-months 0.4 percent, a ten-year maturity yields an anemic 2.92 percent. Any glimmer of strong inflation, oh perhaps driven by multi-trillion dollar federal deficits and record expansion of the money supply, will drive those yields higher by orders of magnitude. An increase in 10-year yields to say 8 percent - not out of the unpredictable - would drive the principle value of those 10-year Treasuries down by 64 percent. Sound familiar?

We've seen it all before. Well, some of us did. Some of us simply read about these cycles in textbooks, too often in academic passing. Perhaps fewer of us managed investors through these cycles. How many fixed income fund managers were actually managing these instruments, say in the 1970s and 1980s? How many were preparing to complete high school or college in those years? How many were trained at the same "B" schools that produced the very same management geniuses that have led us to our current circumstance?


For years, I've retained a yellowing newspaper article in my desk. Dated July 3, 1998, it's an Associated Press story titled "Study: Blunders kill new airlines."

Subtitled "Big carriers' tactics not to blame, institute says," it was based on a study conducted by George Washington University's Aviation Institute. In short the article points directly at the recycling of senior management in the airline industry, with "famous names" ans "properly educated" executives moving from one failed airline to another. The study examined 129 airline bankruptcies from 1979 through February 1998. It found that more than 97 percent of the 39 airline bankruptcies in the 1990s had senior executives who had been involved in a previous Chapter 11 bankruptcy - in the same industry! Further, the study found that "more than 75 percent had executives who had been involved in at least TWO Chapter 11s, 50 percent had top officials in at least three bankruptcies and 15 percent had executives who were involved in at least four bankruptcies."

Past is precedent. Today's "airline" industry is the financial industry, is it not?

Universities need to drastically rethink how they "construct" business leaders. Businesses need to rethink how they retain and hire future business leaders.

Now is this simply sour grapes coming from a former business executive who graduated from Michigan State University rather than the University of Michigan, or Harvard Business School, or Wharton, etc.? That's for my readers to judge, of course. To preempt your judgment, however, I'll simply say no. But the Ivy League of "B" schools has "educated" us to where we are. Corporations have supposedly sought out the "best and brightest" from these fine institutions, as government has sought the same "rocket scientists" from Goldman Sachs and Morgan Stanley, et al to lead us out of this generational catastrophe. We are caught on a hamster wheel, are we not?

Someone needs to begin thinking outside the box, or at least reflecting very seriously on financial and economic history. Are we doomed to condemn the entire U.S. economy to the fate of the airline industry? Seems like that is where we are navigating.


So many stocks are "cheap" says the conventional wisdom of the financial establishment and CNBC talking heads crowd. General Electric (GE - NYSE) at less than $8.00 when it was happily trading at more than $30 less than a year ago? That list is inexhaustible. Price in a vacuum does not reflect "cheapness." Price must be based on earnings power. And no one, I repeat no one, is in a position to estimate corporate earnings power over from here for the next two to three years. There may be some good guesses. But will you base your financial future on guesses?"

Let's look at the S&P500 Index, shall we? Last fall, I suggested downside risk to 700 on the S&P500. Depending on when you caught up with me, the S&P500 was trading at somewhere between 1,000 and 900, anywhere from 20 to 30 percent ago. On February 19, well a possible "bottom" looked more like 650 - 600 than 700. But all of that is based on earnings declining to perhaps a core of $60, with a price/earnings multiple (P/E) of no more than ten.

When the market last traded at these levels - bordering on 1996 - the S&P500 Index traded at a P/E of about 17 or so. Earnings were a mere $40 - 44. Assuming that earnings collapse to those levels - which is not unreasonable - would you pay 17 times those earnings in light of all the economic uncertainty? Or would you be more willing to pay something closer to 10 times?

450 on the S&P500 Index? Keep in mind: 10x multiples were far from uncommon in the 1970s and first half of the '80s. By the way, that period followed a fairly lengthy market earnings valuation in the teens and greater during the 1960s and early '70s. What goes around comes around? History repeating itself?

The stock market has nothing to grasp onto at this point. As I have been writing this piece, the market has declined from 720 to 704, the DJIA around 100 points. Oh it may rebound somewhat before the end of the day. But that'll simply be short sellers taking profits, not necessarily bargain-hunters.

Myself? The thought of earning less than one percent annually disgusts me. But it just may be reality for most investors for the next year, or two, or three, at least until the giant cloud of uncertainty is resolved.


Our economy has been dominated by consumer spending, driven by debt accumulation, for well over a decade now. You can blame people for being imprudent, for living above their means, yada yada. But the truth is that business has driven people to become consumer animals rather than production engines or, god forbid, savers and conservative investors. Jobs are disappearing as business contracts, leaving us consumer animals either with less money to consume with or greater fear that their ability to consume will just evaporate.

The Harvard MBA crowd has shipped job category after job category overseas to take advantage of lower costs, creating higher profits - profits for the few. How many good paying manufacturing or product development jobs have we created here in the U.S.? How much of those higher profits from cheap foreign labor has found its way to higher wage rates for our fellow Americans?

When the economy turns, and it surely will, how much of that next round of higher profits will find its way into the pockets of workers here at home? As opposed to yet fatter profit margins for the few?

General Motors prays that $40,000 (god! $40,000!!!!) Chevy Volt plug-ins will save it. Forget about the absolute lack of economic rationale for paying $40,000 for a Chevy Volt for a moment. But the greater question to ask is how many Americans will be able to afford - let alone qualify to finance - that Chevy Volt?

The Chevy Volt represents the lack of genius that has created this mess. Is this the business management that we want to lead the nation in the future? In business or government? They don't get MY vote. It's the airline industry all over again. Only this time, the airline industry represents the entire economy.