The Tycoon Report

Putting the Economy into Perspective

I know a lot of you are nervous, scared, or one of many negative emotions. Some of you believe the economy is in real trouble the likes of which we have never seen before. I am here to assure you today’s situation is nothing new and just part of the normal business cycle.

I have been on the phone with very smart people who I can tell by the conversation are too emotionally involved. One specifically told me we are in real trouble, “this hasn’t happened since the great depression.” “Great”, I say. The great depression laid the groundwork for one of the largest economic expansion the US has ever known.

Expansion and contraction, boom and bust, bull and bear. Very common terms for investors but do you truly understand their meaning?

“Markets go up because they went down and vice versa,” said James Grant, “they over-invest then under-invest. The underinvestment is dealt with constructively with new business, bull markets, and initial public offerings. The overinvestment is dealt with constructively as well, but maybe not in a way that makes you happy or money. Overinvestment is dealt with by demolition; bankruptcies, bear markets, consolidations and liquidation”.

In 2004 Gail Dudback wrote these insightful words on 4 stages that lead to a bust. I will paraphrase. This is very important pay close attention.

1) First stage is mania, usually a tremendous shock to the financial system. Whatever the source it is usually sufficiently large and pervasive that alters the economic outlook by changing profit opportunities in at least one important sector of the economy.

2) The second faze is called “easy money” (mismanagement of credit) credit cards are iniquitous, sub prime lending has been phenomenal and mortgages are available for 105% of the home value.

3) Third ingredient is conman, fraud and cycles, bubbles and swindlers, as she warned these signs usually don’t come up before the crash.

4) The final stage is faith in the central banker (in this case the fed chairman) feeds complacency. Investors believe that if things fall apart, he will rescue them, and as a result, the mania is likely to go on longer and much further since there is little perception of risk by investors.

DOES ANY OF THIS SOUND FAMILIAR TO OUR PRESENT SITUATION? How could she see the future? Well she couldn’t, she was talking about past busts and the factors that created them.

Recently during the tech boom and bust we saw the characteristics laid out by Dudback. In the book “Bull” by Maggie Mahr she points out, “by the end of 99, 40% of all retail securities trades were done online. By 2002 100 million individual investors had lost $5 trillion or 30% of their wealth. The Dow went from 11,722-8341 and the NASDAQ from 5048 to 1335. From 97-02 1000 companies had to admit false earnings reposts. We haven’t even faced this type of contraction; nevertheless our economic position is described as dire, something completely new and terrible.

The “swindlers” were the advisors getting unqualified investors into risky tech stocks, similar to the swindlers getting unqualified investors in mortgagees.

We hope cycles drive markets three steps forward and two back. Without the alternating expansions and contractions, rising prices and falling prices, there would be no movement in the markets. Grant said, “a boom is capitalisms way of setting up the next bust and vice versa. The errors of a cycle are sorted out, reorganized, and auctioned off. The correction clears the way for another cycle”.

The history of past cycles is dismissed as irrelevant because “things are different now.” This time we have the fed bail out which is historical and to everyone a fundamental changing event. But is it, hasn’t the fed been bailing us out since its inception? For example, how many airlines have been bailed out by the fed?

The key for the next cycle is cash liquidity. The fed taking debilitating investments off the books of our financial institutions is a step in order to free up liquidity.

Obviously we are going through an important political race and many would have you believe the economy is facing a contraction different then anything else we have seen.

I am here to tell everyone this is a normal economic cycle trucking through a bust created buy a boom. Like many cycles before it, this bust will create a future boom.

In the 80’s when Buffett began picking up discounted companies the mood was so negative, everyone though he was moron. Then the market began a bull cycle lasting from 1982-1999. During the late 90’s Buffett began to sell and people were saying he was out of touch with the new market, that was until the crash of course. Now he’s considered the greatest investor around. Last month he started investing in companies he valued cheap, is he now a moron again, is he out of touch with today’s market, or does he have a better understanding of the cycles as they present themselves?

Technology and the Internet, the creation of the airplane, the car, China’s GDP growth, were all going to reinvent the economic wheel. That is of course, until they didn’t. Maybe the mortgage crisis is the start of a new economy; I tend to believe its juts another cycle, business as usual. I see the markets laying the groundwork for a future bull cycles creating vast buying opportunities in undervalued securities.

John Micheline