Thanksgiving

With economic woes dominating the headlines, we sometimes forget about all we have. As you sit down with your families tomorrow to celebrate Thanksgiving, try to put aside talk of recession/depression/deleveraging/credit crisis/reduced bonuses and recall all of the gifts in our lives.

On balance, most of us are fortunate to have what we have. We live in the best country in the world, where we are free to dissent with those in power and which just experienced a historical election. Most of us have decent jobs that allow us to provide shelter, food and a pretty nice lifestyle. We may not be making a ga-zillion bucks, but we are blessed. My advice for you as we enter the heart of the holiday season is to remember all that is good in your life, not what is lacking.

My Aunt H likes to recount the following prayer: "Thank you God (you can replace with goddess, energy force or just say thanks to the universe) for giving us every single thing we need and most of what we could ever want."

Believe me, it's how I feel on a daily basis.

Thanksgiving Blessings to you and all your loved ones.

This will be the last daily “StrategicPoint of View” column. Going forward we will be consolidating our written communications into a weekly investment analysis each Monday, which will be supplemented by special articles and updates as necessary.

Crying Like It’s 1931

Despite the last two trading days and the gains seen in stocks, here is a bit of sobering news: according to the Wall Street Journal’s Jason Zweig, over the last two weeks ending November 20, the Dow Jones Industrial Average fell 16%. Over the two weeks ended November 20, 1931, the Dow fell 16%. Over in the broader S&P 500, the news is worse: only twice before this year has the S&P 500 lost more than a third of its value in calendar year—both of those previous instances occurred during the Great Depression, down 41.9% in 1931 (there’s that year again!) and 38.6% in 1937.

With these kinds of statistics, it’s hard not to think that we are once again facing a Depression. More rational heads will point out that in 1931, the US economy, as measured by gross national product, plunged by 14.7%, while this year, the economy contracted by 0.5% in Q3 and then probably by something in the range of 3-4% in Q4, which is not good, but it sure is a far cry from losses in the teens. In 1931, one of every six Americans was unemployed, while today one out of sixteen is unemployed.

This is not to say that all is well. This is shaping up to be the worst recession since the nasty bugger in 1981-2. More jobs will be lost, companies will go out of business and some families will lose their homes. For those who look to capital markets to find a clue about the future, the news is not much better. The US bond market now expects that the world’s largest economy will suffer deflation for the next decade; as noted above, the S&P 500 is on pace to suffer its worst decline since 1931; and for the first time in 50 years, the dividend yield on the S&P 500 now exceeds the yield on the 10-year Treasury bonds. Of course, if you have a strong constitution and an even tougher stomach, you might note that when fear trumps greed to the extent that we can see at present, it often provides opportunities for contrarian investors to buy cheap.

Perhaps you do not trust global markets to guide you. If that’s the case, you may try a different indicator: a psychic. According to the New York Times (11/23/08), many investors are eschewing trading cards for tarot cards. “Psychics say their business is robust, as do astrologers and people who channel spirits, read palms and otherwise predict the future…after all, the nation’s supposed experts on the economy…have not exactly been reliable.”

Maybe the psychic won’t be able to tell you whether it’s 1931 all over again or not. Even without tarot cards the end of year period is likely to see more “deleveraging”, “disintermediation” and “forced selling”, meaning that as losses mount, investors or institutions that have borrowed money will sell to avoid further losses or even bankruptcy. Unfortunately, unleveraged, long-term investors (like most of the sane world) will continue to be forced to suffer through further mark-to-market losses, but will likely be rewarded over time as markets return to more normal behavior. 1931 may or may not come back to haunt us, but one factoid that drew my attention from the year: Frankenstein, starring Boris Karloff was the top grossing film of the year. Now that seems appropriate.

A Rally for Andy

My friend Andy used to be completely obsessed with the stock market. He rode the dot-com bubble all the way up and felt the crushing blows on the way down. He found himself right back in the fray until a little over two years ago, when his 40 year old wife died suddenly. Since then Andy admits that he has become a much better investor.

How could such a tragedy transform his financial acumen? The answer lies in the deep emotional current that swirls in every investor’s mind and belly. In the past, Andy would watch each position, tick for tick. He would often experience a kind of euphoria when a trade went well, only to second-guess himself when it went sour. He knew that it was a debilitating cycle, but he could not get out of it.

Then the unimaginable occurred, putting him and his whole family through a nightmare. After his wife’s death, Andy did not have the same passion for investing. He stopped watching CNBC every day and monitoring his accounts on a minute-by-minute basis. Instead, he would call me every quarter or so to discuss the overall economy and asked for advice about general market trends. He no longer purchased individual securities, turning instead to index funds and even began to use bonds and commodities in the portfolio to help diversify some of the risk. Interestingly enough, his performance improved, both on the upside and the downside.

When we met for lunch on Friday, he said that he was not worried about the stock market or even the economy. “Of course it’s terrible for people to lose jobs and for families to suffer, but I am convinced that we’ll get through this period. This country has been through worse—heck, I have been through much worse and you know what I found out? That I can survive the worst and still wake up the next morning to see the sun shining and the world turning. Tell your blog readers, radio listeners and everyone on TV that Andy says that everything is going to be OK.”

It seemed fitting that when Andy and I were having lunch, the stock market was down a touch, but by the end of the day, it reversed course and experienced a powerful rally. The Dow closed 494.13 points higher, up 6.5%, at 8046.42 and the S&P 500 was up 6.3% to 800.03. Yes, it was a terrible week, but for at least one day, Andy was right: everything was OK. It’s not a bad lesson for the rest of us: a little distance might help everyone get through this with more of our wits about us.

1997 All Over Again

Ah 1997…it seems like only yesterday when Jewel was on the Billboard charts, Frasier dominated network television, the movie Titanic swept the Academy Awards and the dot-com bubble had not yet fully inflated. 1997 was also the last time that stocks were at these horrifying low levels. Yesterday investors continued to sell stocks as fears mounted that commercial real estate would be the next shoe to drop as the economic outlook darkens.

The S&P 500 plunged to its lowest level since 1997, sliding 6.7% to 752.44, under the low point of 776.76 reached during the bear market nadir in October, 2002. The index extended its 2008 year to date loss to 49% and is poised for the worst annual decline in its 80-year history. The Dow Jones Industrial Average sank 444.99 points, or 5.6%, to 7,552.29. The Nasdaq Composite decreased 5.1% to 1,316.12. Financial companies led the way again, with Citigroup down another 26% to $4.71 (yes, that’s Citi under a fin!), JPMorgan Chase lost 18% to $23.38, Bank of America tumbled 13.86% to $11.25 and Morgan Stanley was off 10.24% to $9.20.

Yesterday’s catalyst was more of the same—data that indicated that we are in a bruising recession. Weekly jobless claims approached the highest level since 1982; the index of leading economic indicators fell for a third time in four months; and the Federal Reserve said manufacturing in the Philadelphia area shrank at the fastest pace in 18 years. As investors rushed for the exits, they poured money into US Treasuries, driving prices to historic highs. The yield on the two-year note fell below 1% for the first time, while ten year yields fell to 3%...my friends, you can now lend the US government money for ten years and earn a whopping 3% for your troubles!

A client asked me, “How do you know when to just get out?” My answer is that when fear is shaking you to the core and it feels like all confidence is lost is usually when long term investors should be dipping their toes into the water. I am not suggesting that you sell the farm (how much could you actually get anyway?) and jump into stocks, but there are some compelling values out there. It is likely to remain pretty messy in this period, but that does not mean that you should throw in the towel on capitalism. Gather your thoughts, chug a little Pepto Bismol and don’t run for cover just yet.

Slip-Sliding Away

Remember when we thought the financial system was on the precipice of disaster? Well, fears of widespread systemic failure may have passed, but investors are now worried about the economy—big time. It seems that all of the TARPs, EESAs, rate reductions and bailout plans have left us exactly where we were a month ago—at the depths of market lows with little confidence that relief is coming.

Despite massive government interventions, stock prices fell to 5 1/2 year lows yesterday as fears of a deep recession plague the investment horizon. The Dow plummeted 427.47 points, or 5.1%, to 7997.28, the lowest close since March 31, 2003; the S&P fell 6.1% to end at 806.58, well-below this year’s previous low of 840 and on pace for its worst year since 1931; the NASDAQ was tumbled 6.5% at 1386.42; and the small-stock Russell 2000 fell 7.8% to 412.38. I don’t know how many days that I have written “ouch” in response to these types of numbers. Suffice to say that the pain is actually becoming less acute and more chronic, as we all get used to these massive sell-offs.

Some said deflation was the catalyst for the selling—the Consumer Price Index fell by 1% in October, the biggest one-day drop in the 61-year history of the index. I don’t buy the deflation explanation as the reason for the fall. I think that investors are realizing that things will not turn around any time quickly and as a result, many are throwing in the towel and waiting it out. Maybe that’s why Henry Paulson essentially took a mulligan on the TARP and will let the next administration play out the round.

It’s probably a safe bet that the government wishes that it could go back in time and save Lehman Brothers – indeed, it was that company’s failure that sparked the massive slide. Since then, the Dow has plunged 30%. Yesterday, selling in the financial sector once again led the way. Citigroup in particular ran into a brick wall, falling 23.4% to $6.40, a 13-year low, after announcing that it will purchase the final $17.4 billion of assets still in structured investment vehicles; Bank of America dropped $2.13, or 14%, to $13.06; and Goldman Sachs fell $6.85, or 11%, to $55.18, the lowest close since the company's initial public offering in 1999.

Additionally, there was selling pressure in some of the larger insurers, many of which are busy buying banks so that they can tap the TARP. Lincoln National plunged 40%, the steepest decline in the S&P 500, to $7.31, after saying that it expects a charge of as much as $300 million because of declining equity markets last month; Hartford Financial dropped 24%; and good ol’ AIG fell 15%. Adding market woes is the uncertain fate of the automakers -- GM fell 9.7% to its lowest price since the 1940s, while Ford lost 25%.

Here is what I think is going on: everyone is waiting for some good news and it’s just not there. Every time we turn around, there is more disappointing data about housing or retail sales or confidence. At some point, people are going to examine the valuations of companies and realize that not every single one of them should be tossed aside. Until then, we are slip-sliding away.

Three Blind Mice

There they were yesterday, testifying before a Senate panel -- Ford's Alan Mulally, Chrysler's Robert Nardelli and GM's Richard Wagoner. They were on bent knees, arguing that without $25 billion, the US auto industry would die forever. As I watched them in their natty suits, crying the blues, I thought that they are our own version of “Three Blind Mice,” the leaders of an industry that seemed blind to improving innovation and the challenges of globalization.

Two of our mice say that their companies, GM and Chrysler, are on the brink of disaster and without government handouts, they will fail. Perhaps you are sick of hearing about corporate failures and their disastrous effect on the broader economy—I know that I am, but this is where we are -- no amount of wishing it weren’t so will get us out of this mess, so let’s talk about what we can do now.

The first question to ask is whether a bankruptcy might help the auto industry get its act together after 25 years of fighting the larger trends of globalization (which created enormous competition, especially in the form of cheaper labor) and fuel efficiency/smaller cars. The pro-bankruptcy camp cites the ability of the airline industry to file, reorganize and renegotiate long-term contracts (slashing pension plans and health benefits for the large union employee base). Many airlines successfully re-emerged from bankruptcy stronger and better able to compete. The bankruptcy advocates note that handing over $25 billion to the Three Blind Mice would lead to the same conclusion—bankruptcy, but in the bailout scenario, taxpayers lose $25 billion for the same outcome.

Those who support helping the automakers with government aid note that the industry is vital to the national interest as both an employer and as the base of the nation’s manufacturing sector. GM Chairman and Chief Executive Richard Wagoner said that "This is about much more than just Detroit, it's about saving the U.S. economy from a catastrophic collapse."

On this point, it is important to understand where we are in the economic cycle. In more normal circumstances (i.e. if we were simply experiencing a mild recession), I would probably be in the “let them fail” crowd, but these are not normal circumstances. The economy is fragile from the effects of the housing and credit busts and after already losing 1.2 million non-farm jobs this year, my concern is that the failure of GM and Chrysler (it looks like Ford is going to survive) may simply be too much for the economy and perhaps of greater importance, the national psyche, to handle.

It seems reasonable to help the Three Blind Mice see their way through for another couple of quarters, so that they can restructure accordingly. This may mean a government-orchestrated bankruptcy down the line, whereby the companies can reorganize and potentially survive. This middle ground might mitigate some of the obvious near-term economic ripple effects, while allowing the Three Blind Mice to see their way through the crisis.

Adios Carrie Bradshaw

Watching re-runs of “Sex and the City” seems so retro amid the financial melt-down of 2008. The program that debuted in 1998 and concluded in 2004, followed the lives of four single women in New York City, as they obsessed about men (well, that’s actually not retro, that is thoroughly now) and spent hundreds of dollars on shoes. The program that put shoemakers Manolo Blahnik and Jimmy Choo on the map (see Season 6, Episode 9: A Woman's Right to Shoes, original air date 8/17/03) now seems positively passé as Americans alter their spending patterns to meet the new reality of a recession.

Last week, the Commerce Department reported that retail sales fell by 2.8% in October, surpassing the old mark of a 2.65% drop in November 2001 in the wake of the terrorist attacks. It was the largest drop on record and the fourth consecutive monthly decline. The weakness in retail sales was led by a 5.5% plunge in autos, the biggest drop since August 2005. Carmakers said that last month was the worst in 17 years as potential buyers were spooked by the financial crisis and tightening credit conditions. Even without cars, sales of everything from furniture to clothing dropped off a cliff. Excluding autos, retail sales fell by 2.2%, also a record decline, underscoring the widespread weakness. Sales at general merchandise stores like Wal-Mart and large department stores fell by 0.4%, while sales at specialty clothing stores (the kinds that the women in “Sex and the City” used to frequent) were down a bigger 1.4%.

There were only slight glimmers in all of the gloomy data: mega-discounter Wal-Mart has fared better than most as its massive size allows it to pressure vendors for even cheaper prices. According to the International Council of Shopping Centers, for every dollar spent on goods other than cars in the US over the last twelve months, 8.2 cents went to Wal-Mart or its warehouse sister store, Sam’s Club. That is a staggering market share, but it’s certainly not surprising that with house prices in the toilet, the stock market down 40% and 1.2 million jobs lost in 2008, that consumers are in full-fledged retreat. These folks are seeking the cheapest possible alternatives and thus far, they are finding those values at Wal-Mart.

Here is another glimmer of hope: the data confirms that consumers have woken up from their drunken stupor and have FINALLY stopped spending. With all due respect to the characters on Sex and the City, one has to wonder how a struggling freelance writer like Carrie Bradshaw could afford the $495 pair of shoes. If Carrie were with us today, she would be paying down debt and saving money to rebuild her balance sheet. Of course that is not the stuff of a particularly entertaining series, but it would help curb the excesses of the past two decades and allow our start to take control over her financial destiny. The never-to-be-produced sequel to “Sex and the City” would be “Parsimony across America”…not too catchy, but indeed, the bitter medicine that will help cure the nation’s economy. Adios Carrie Bradshaw!