starts rose 9% and the market cheerleaders proclaimed that we have seen
a bottom. But not if you look at the actual numbers. New unemployment
claims were OK, but not if you look at the actual numbers. And
inflation was simply ugly, no matter what numbers you look at. However,
oil is down and there is reason to think it may have further to go on
the downside. We cover all this and more, as we first look at why the
world is not going to end.
Take a Deep Breath
is easy to find bad news these days, and the torrent that seems to keep
coming can ruin a person's summer (or winter, for my southern
hemisphere readers). The credit crisis, as noted last week, is nowhere
near an end. Housing, as we will see, is actually getting worse.
Foreclosures, auctions, government bailouts, higher taxes, inflation,
the price of energy and food - the list goes on and on.
thought, since so many think of me as a rather bearish person, I would
show you my more optimistic side. Yes, I am bearish in the short term,
for reasons I have documented at length in this letter. But long-term I
am a wild-eyed optimist.
With all the negative news thrown at us
today, why is the United States not in the midst of a deep recession?
How, many of you ask, can I be so sanguine as to suggest a milder
recession and a Muddle Through Economy?
First, things are
somewhat different now than in the '70s and early '80s. Back then, a
great deal of the US and developed world economies and their resulting
employment were linked to manufacturing, which was largely geared to
domestic sales. Exports were a much smaller part of the economy for
most businesses. When the economy and consumption slowed down,
manufacturers laid employees off rather rapidly. Unemployment would
soar and a V-shaped recession would occur.
Now, the number of
people employed in manufacturing is less in percentage terms than it
was back then, and more of what is produced in the developed world is
bought by a growing developing world. Exports from the US are booming.
The number of TEUs (the large containers on ships: Twenty-foot
Equivalent Units) moving through the ports of Los Angeles and Long
Beach is up 23% in May year over year and up 26% since the beginning of
the year. Because of the weak dollar, imports are down by 7% year to
date. It is export growth that is keeping the US from sliding into the
usual deep recession.
So, not only is manufacturing not down as
in usual cycles, it is up quite handsomely for many products, except of
course for automobiles, which are not just in a recession but facing a
depression. But that growth in exports is keeping unemployment from
going to 9%.
But let's take a longer-term outlook. My view has
been, and is, that we are in for a period of very tepid growth that
will last through at least 2009. We have to work our way through the
after effects of the twin bubbles of housing and the credit crisis
bursting. There is no magic Fed wand. That simply takes time. No
(rational) government or Fed policy is going to change the facts on the
ground (although they can make things worse). But, in the fullness of
time, we will in fact get through this.
If you look back over the
decades, things are getting better. Goldman Sachs estimates about 70
million people a year worldwide are entering the 'middle class' and
that by 2030 two billion people will be in a far better condition than
the poverty they experience today. That will also keep demand steady
for all sorts of products and services produced in the developed world,
even as our population (except for the US) declines.
The old joke
is that a recession is when your neighbor loses his job and a
depression is when you lose yours. And a rise in unemployment and lower
corporate profits are no laughing matter. But the simple trend is that
we will adjust and free markets in America and the world will grow, as
they have always done.
My daughter and business partner Tiffani
is getting married in three weeks on 08-08-08. Next year there will be
2.3 million weddings in the US, at an average cost of $30,000 (we have
helped increase the average this year considerably). That is $72
billion on weddings. And many of those new families start with the need
to find a place to live, furnish a home, and build their nest.
and her fiancee are an example. They have bought a home at a pretty
good price in an older neighborhood that is fast becoming trendy, as
there are a lot of wonderful restorations and teardowns. They have
lived rather simply and find they 'need' all sorts of items to make
their house a home. Each day sees another delivery of gifts from their
registry and a smile on her face.
(Sidebar: When I first got
married I seem to remember getting three toasters and not a lot of
other things we needed. Now, couples register online for what they need
and want, and when an item is bought it is taken off the list. How cool
Last year a record 4.3 million babies were born in the
US. Each of them will need all sorts of 'stuff' - food, education, and
places to live - in (hopefully) 20-25 years.
Yes, consumers are
cutting back, but they are still buying the basics. (See more below.)
Manufacturing in the US is starting to make a comeback, with the lower
dollar and management driven to compete globally. In free-market
economies, every economic slowdown is followed by a period of solid
growth driven by innovation. The point is that life goes on. Births,
weddings, eating, living and enjoying friends and family. It is all
part of the cycle.
The next 20 years are going to see the most
powerful wave of technologically driven growth the world has ever seen.
The accelerating pace of technological change did not slow down last
century through multiple world wars, scores of 'minor' wars, a
depression, all sorts of natural disasters, and an unbelievable amount
of government folly. Why should that trend stop now?
As we add
two billion people to the middle class, we are also going to bring the
internet to even billions more. The explosion in information and
creativity that we have seen in the last 20 years will double and
double again. A small percentage of those people are going to invent
amazing new technologies, new drugs, and create companies that will
make life better for all of us.
That is one reason that
technological growth will continue to accelerate. We will simply be
throwing more people at an ever wider array of problems, and they will
be able to share their discoveries at the speed of light.
on the verge of a revolution in biotechnology that is going to truly
revolutionize medicine. No one in 20 years will look back on today as
the good old days. And it will probably create yet another stock market
bubble, but that is a story for another letter.
US diplomats are
talking to Iran. Iraq may actually work out. In most places of the
world, most people are better off today than they were 20 years ago.
There is still a lot of progress to be made, but the point is that we
are making it. There is a ton of opportunity for those prepared to look
for it. It may not be in the usual places, it may not be where we would
like it to be, but it is there. World GDP will have roughly doubled (or
more) by the end of the next decade.
Yes, I know there are a lot
of problems. Really big scary ones. I write about a lot of them all the
time. But go back to any year ending in 8 for the last 100 years. When
were there not problems? And in most times and places, the problems
were bigger. And in the next ten years? There will be lots of problems.
Some will be the same old problems and some will be new. I am not
certain why mankind seems to have a need to find new ways to create
mischief and lose money when the old ways work so well. But those too
So, when you read about current problems - and I
will point some out in the next few pages - just remember that things
will work out. Markets will adjust, and the world will be a better
place. Things will work out better for you as an individual if you
anticipate the problems and make the proper adjustments, as much as
possible, in advance.
The next 20 years are going to be the most
exciting time that the human race has experienced. Yes, there will be
issues, but we will adjust. That is what we do. And now, let's look at
some of the adjustments going on in the markets.
9% Growth in Housing or a 4% Loss?
the news flashed on my screen that housing construction had jumped by
9%, I raised an eyebrow. That did not make sense given other data I was
looking at. Immediately the media was full of talking heads and stories
about the turnaround in housing and the end of the slowdown. I must
admit to being a little confused.
Then we find the rest of the
story. Asha Bangalore from Northern Trust actually took the time to
read the details. It turns out that New York City had a change in its
construction codes, and that affected what is considered a housing
start in the Northeast, especially in multi-family construction, which
'jumped' 42% because of the code change. If it were not for the change,
housing starts nationwide would have fallen by 4%. Because of the code
change, housing starts jumped 102% in the Northeast. However,
single-family starts nationwide declined 9.3% in June, to an annual
rate of 647,000 units. That level of single-family starts is the lowest
since January 1991. Look at the following chart from Northern Trust.
Does this look like a 9% increase?
More Government Statistical Fun
week we see a release of initial unemployment claims. This week initial
claims jumped to 366,000 on a seasonally adjusted basis. But what are
the real underlying numbers? Every Thursday, I get a thorough review of
the actual data from John Vogel, going back and looking at trends over
the past 8 years in the non-seasonally adjusted data. That can be more
This week the actual number of initial claims of
unemployment was 475,954, compared to 383,839 last year (2007). And the
number of actual claims has been trending up. Taking the three first
weeks of the current quarter, we are still below the recession years of
2001-3; but the trend is not what you would like to see, and given the
decline in consumer spending (see below) it is likely to continue to
The actual data is very 'noisy' and jumps all over the
place, hence the use of seasonally adjusted numbers for public
consumption. Economy.com thinks the difficulty may be in accounting for
auto-related plant shutdowns in the seasonally adjusted number. Vogel
speculates that employers are no longer waiting until the end of the
quarter to lay personnel off but are doing it at any time in the
Given the issues, it is likely we will see a rise in the
number back toward the 400,000 range (SA) that we saw earlier last
month. But just be aware that there can be something really different
in the actual numbers.
Below is a graph from economy.com showing
where the employment problems are. The majority of the states are
seeing payroll employment drop.
Fannie and Freddie and Bears, Oh My!
me see if I have this straight. It is OK to short oil but not OK to
short Fannie Mae? Or is it that it is OK to be long Freddie Mac but not
Oh, those evil speculators. As Barry Ritholtz points
out, why is it that management blames speculators when their stock is
being pummeled, when the usual reason is that management made some very
And let's not forget the importance of rumors. We
all know rumors can bring down a stock. So, let's start one. Let's
start a whisper campaign that Goldman Sachs is going to have to take
down $100 billion in losses next quarter, and then we can all short the
stock. What would happen is that we would all lose our money when we
had to cover, because there was no basis in fact.
The best way
for a company to deal with short selling is to increase earnings and
blow the shorts out of the water. Good management trumps rumors.
week the SEC has made it more difficult to short Fannie Mae, Freddie
Mac, and other large financial firms. They are actually going to
enforce the rule already on the books that says you must actually be
able to deliver the shares you are shorting.
selling has been against the rules for some time. (That is, short
selling a stock that you cannot actually borrow to sell.) Institutions
make rather tidy sums offering the shares they own to short sellers for
Making it more difficult to short Fannie or Freddie is
not going to do one thing for their balance sheets, which is the real
source of their problem. As former Fed governor William Poole said a
few weeks ago, they are basically insolvent. Five-year bonds sold by
Fannie Mae yield 90 basis points (0.9%) more than US Treasuries of
similar maturity, almost double the average over the past 10 years,
according to data compiled by Bloomberg. That spread, which translates
to $90,000 in extra annual interest per $10 million of bonds, exists
even after Treasury Secretary Paulson signaled the US would ensure the
debt is repaid by offering larger amounts of backup financing and
potential capital infusions.
Given Paulson's guarantee, why would you buy US bonds when you can get the same guarantee and almost 1% more?
and Freddie are private companies where the profits go to shareholders
and losses go to taxpayers. There are a lot of people (including your
humble analyst) who have complained about the current set-up.
Basically, they were allowed to leverage their capital beyond what even
your most leveraged hedge fund would think prudent. How could the value
of homes go down? Leverage up and show huge profits, pay monster
salaries and bonuses to management who did nothing but increase risk,
and spend $170 million on lobbyists to make sure that no one changes
Paulson had no realistic choice but to do what he did.
But the true point is, he should have never had to make that choice. A
real regulator would not have let them leverage their capital to the
extent they did. If taxpayers have to invest one penny before
shareholders are wiped out, then there is no justice. Fannie and
Freddie should be broken up into several much smaller firms which are
not too big too fail, their shares floated to new owners, and taxpayers
should get preferred shares until they are made whole. And the
implicit, but now explicit, guarantee should be taken away.
while we are on regulators, it is time for Bernanke and Paulson and SEC
chairman Cox to force the credit default swap (CDS) market to move to a
regulated exchange. If there is a major risk to my happy news scenario
at the beginning of this e-letter, it is the credit default swap market
collapsing. That is why Bear Stearns had to be rescued, and why other
firms like them are too big to fail.
If the CDS markets were on
an exchange like any futures contract, Bear could have been allowed to
fail. It would have been a sad day, but the Fed would not have had to
risk $30 billion. Greenspan was wrong when he said these derivatives
did not need to be regulated. They are good for the markets, and I
think they are necessary. But let's put them on an exchange where there
is clear transparency and the entire economy of Western Civilization is
not put at risk by some cowboys who decide to leverage up.
A Little Stress
is my first really big wedding. As I said, it is as carefully planned
as the Normandy invasion and about as expensive. I can really
understand now when brides talk about stress. But poor Tiffani has had
a triple dose. She moves next week into their new home (kind of). But
then, there is not a lot to move.
Of course, we have also started
on our new book project, and the response to our survey has been rather
large. For those of you who want to do personal interviews, we will get
back to you. As a reminder, we are doing on online survey about
investors of all sizes and backgrounds. If you take the ten minutes to
fill out this thought-provoking survey, we will give you a link to a
recent speech I made about what I think is a new asset class that is
being created because of the credit crisis. The link is here: http://survey.frontlinethoughts.com/index.php?sid=12431&lang=en
then the real stress started a few weeks ago when FINRA (the former
NASD) called and said it is time for an audit. We get one about every
3-4 years. It is about as stressful as any part of the investment
business, and Tiffani has to deal with 98% of it, as Dad is clueless.
So, she has spent very long hours getting ready for the audit.
Yesterday, after three and a half days, we had our exit interview, and
it went about as well as we could have hoped. But the timing would have
been better either earlier or after the honeymoon. Oh, well.
have had an audit from some regulator every year for the last five
years. Just part of the business, but it does create some stress. We
are due for an NFA audit sometime soon. I just hope they do not come
when Tiffani is on her honeymoon in some fairly remote places in South
Below is a picture of Tiffani and Ryan in front of their
new home. Dad is proud. You can see a lot more pictures (some VERY
funny ones) if you care, at their wedding web site at http://www.fatedlove888.com/Site/888.html
It is time to hit the send button. I see a Batman movie with the kids in my future. It should be a great weekend.
Your having fun being an optimistic analyst,
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