Signature Update

February 25, 2009 Edition
Volume VII

Inside this edition of Signature Update
- Some Sage Advice
- An Interesting Set of Statistics
- Flirting with a Bottom?
- Rage Against the Machine
- Oil and Automobiles – Consumption Leads the Way


Some Sage Advice

“Some people say they want to wait for a clearer view of the future. But when the future is again clear, the present bargains will have vanished. In fact, does anyone think that today’s prices will prevail once full confidence has been restored?”

That comment was made 76 years ago by Dean Witter in May of 1932 — only a few weeks before the end of the worst bear market in history.

Have courage! We have been here before — and we’ve survived and prospered.


An Interesting Set of Statistics

Between 1871 (after the post Civil War reconstruction period) and 1900, the US economy was mired in recession 48% of the time.

From 1900 to 1950 recessionary periods amounted to 37% of the fifty-year time frame.

And from 1950 to 2009, we’ve experienced recession only 13% of the time.

Not only have the frequency of recessions decreased substantially, but the duration of recessionary periods since 1950 are less than half of what they had been in the prior 100 years (data source www.nber.org/cycles.html).


Flirting with a Bottom?

As the DOW Jones Industrial Average began a steady decline following the January Presidential Inauguration, many feared we would retest the November 2008 lows before hopefully rebounding back above the 9,000 point level. On February 10th, the DOW closed at less than 8,000 and then hovered for several days within a few hundred points of the November 20th low of just over 7,500 points. ‘Testing’ or ‘retesting’ a bottom means a market pull back towards a previously established lower level and then recovering to higher levels without piercing, or breaking through, the lower level. The longer a market hovers near a low, the greater the likelihood that the bottom will not hold and lower levels will be experienced.

And that’s exactly what happened as the markets fell below their six-month lows late last week, and then slid further on Monday to levels not seen since 1997. It was a dismal day for the markets and accurately reflected the frustration investors and traders have felt as the economy has floundered this last year. Tuesday’s rebound of over 236 points was a welcome relief but may not mean the worst is behind us, as the DOW is still below 7,400 points.

Many thanks to Federal Reserve Chairman Bernanke for affirming his solid support of the banking sector during his remarks to Congress. Amid concerns over the possible ‘nationalization’ of major domestic banks, Bernanke not only made clear the Federal Reserve’s position but also discussed the nature of the equity investments the Treasury has been making in our banks. He described these equity investments as convertible preferred stock that would only convert to common shares (the basic form of ownership in a publicly held corporation) in the event that the capital structure of the bank required additional equity capitalization to meet regulatory requirements. In other words, ‘nationalization’ would only occur if a bank were in such a position as to require federal capital intervention in order to remain solvent. Just as banking stocks suffered based on concerns over ‘nationalization’, these same stocks rebounded following Bernanke’s remarks.

The content of Bernanke’s remarks was sufficient to bolster the entire financial services sector. He made it clear that the Federal Reserve’s primary goal at this stage of economic recession is to bring stability to domestic banks and that the economy will only recover after banks have stabilized. He admitted his optimism for a late 2009 recovery, assuming banks are able to resume normal lending and investing operations. He also made it clear that there are still many risks in front of us and expressed his fears over what may occur if the Federal Reserve and Treasury’s efforts are thwarted.

Congressional representatives questioned Bernanke on the shape of a recession/recovery pattern, commonly expressed in terms of ‘V’, ‘U’, and ‘W’; but the chairman avoided a direct answer and suggested that attempts at forecasting this particular economic period’s makeup had been unsuccessful at best.

All of this is consistent with our view of what’s taking place in the economy. Last week’s issue of Signature Update discussed early signs of recovery and Bernanke supported that view based on the presumption that the banking sector receives crucial support. Further, the negative sentiment in the markets is a common indicator of an economic low point, though recovery may take many months; and in the midst of many ‘doom and gloom’ prognosticators, we remain confident in and optimistic for our economy’s eventual recovery.


‘Rage against the Machine’

Okay, so I think that’s the name of modern punk rock group, and no… I wouldn’t recognize even one of their attempts at lyrical expression, but I can’t find a better term to represent the sentiment of most responsible homeowners across the country as they respond to some of the ‘mortgage bailout’ proposals working their way through the executive and legislative branches of government. Massachusetts Representative Barney Frank accosted the heads of the nation’s major banks a few weeks ago as he asserted that these leaders simply cannot be capitalists as the markets thrive and then become socialists during protracted declines - referring to accepting federal resources during difficult periods while seeking unencumbered autonomy and profitability during more prosperous times. However, Frank and his associates are pleased to defend a federal ‘mortgage bailout’ in which troubled homeowners may accept a reduction in the principal balance of their mortgage in the face of declining real estate values, but would not be required to return anything to the taxpayer in the event that the home is sold in the future for more than its value at the time a principal reduction had been made.

There may be more than a little hypocrisy in this position, and these elected representatives are successfully rallying their less fortunate constituents at the cost of the taxpayer. Virtually everyone with whom I have discussed these proposals, including certain self-described ‘liberals’, are hard put to understand what our elected officials are thinking. To date, the federal bailout proposals for banking and business have included incentives for the tax payer in the event that these corporations prosper as a byproduct of receiving federal funds. Isn’t it only reasonable to expect homeowners who may directly benefit from government resources to be held to the same standard? Some suggest that we all will benefit from reduced foreclosures and the attending stabilization of the housing market, but the same case can be made for the overall economic benefits of a more stable banking and business climate. Both positions have merit, of course, but that doesn’t mean that we should ignore prudence and accountability.

It has become dangerously convenient for us to look to the federal government during this time of crisis; and while I would argue that the enormity of the problems we face have required the equally enormous resources of the Federal Reserve and Treasury, we simply can’t succumb to the same lack of accountability and irresponsibility for which we have expressed open disdain when observed in corporate boardrooms.


Oil and Automobiles – Consumption Leads the Way

Recent US Department of Energy reports represent oil inventory declines in January of over 200,000 barrels versus an expected increase of nearly 2 million barrels. Consumer demand increased by 2.6% representing the highest consumer fuel demand in over twelve months. This rise was consistent with higher retail sales figures for January and reflects an overall increase in spending in the face of increasing levels of unemployment.

This data follows Consumer Price Index (CPI) and Producer Price Index (PPI) increases for the first time in several months of .4% and .8% respectively. These increases, though neither significant nor representative of a certain trend, offer welcome relief to deflationary concerns brought on by a weak domestic and global economy.

Of note is one of the worst Consumer Confidence Index (CCI) reports in recent memory. With 1985 representing a baseline index of 100, and a January CCI of 37.4, the most recent index level of 25 is troublesome. It stands juxtaposed to other consumer indicators but most often reaches its lowest levels 2-3 months before an economic recovery.

As US automakers, particularly GM and Chrysler, continue to flirt with financial disaster, there are indications that domestic automobile demand may surge even before the economy shifts into recovery mode. Consumer and industrial automobile demand fell to unsustainably low levels in the late fall and winter months and will ultimately give rise to a surge in demand as fleets age and consumers are forced to evaluate the cost efficiencies of repair versus replacement.