SNEAKY LITTLE RECESSIONS!

A regular reader sent the following question.

"I've been hearing that Germany, Italy, and even Japan are in a recession. But, when you look at the index charts of those countries...it looks like anything but. Germany, Italy, and Japan all look pretty strong recently in stock price performance. What gives?"


Thank you for the question. It was answered by an investor more than 100 years ago was asked his secret for making money in the stock market. He said it is easy, "I buy my straw hats in the winter."

The stocks of depressed economies are behaving exactly as one should expect. The stock market leads the economy. You don't have to take my word for it, take the word of the US Government. One of the components of the leading indicators published by the government is the stock market.

While the stock market looks ahead, bureaucrats look backward to determine if there is indeed a recession. The definition of recession is three consecutive quarterly declines in GDP. By the time most folks have heard that there is a recession the recession is over or almost over. The naïve public reads that the economy is in recession and sells at exactly the wrong time. As Warren Buffet or many another professionals have said, the time to buy is when others are too fearful to buy.

In addition to the timing and the psychological reasoning, business improves during a recession. Strong businesses have easy access to resources at low cost during a recession. These include all components of production, labor, raw materials and capital. When weak competitors go out of business, the strong competitors pick up new business and pricing power. The combination of low costs and high prices lead to improving profits. Indeed the survivors stand to make extra profits for a number of years.

You have read that I have purchased 4 of the legacy airlines for my family. The principle of buying them now is exactly the same as buying stocks during a recession. Indeed the airline business has been in a depression. Investors who put extra cash in the market in the 1930’s during the middle of the great depression made fortunes. Few can tell about it because most folks had no extra cash.

It is easy to see that the prospects for DAL, CAL, AMR, NWAC would all improve if UAL and or USAir liquidate. The risk is that if you buy DAL it might not survive. AMR and CAL are financially stronger than the other two. This is the reason they sell for higher multiples. For example, CAL sells at a price to sales ratio which is 60% higher than the DAL ratio! Can you believe that the CAL price to sales ratio is .08? In many companies, investors pay $2, $3 or much more for $1 of sales. With DAL investors are paying a nickel for a $1 of sales.

It is relatively easy to buy at the bottom. It only takes cash and a spirit of independence. You have to be able to say, I don't care that other folks are afraid of the airlines, I believe at least one of the four will prosper. In the previous cycle, USAir hit a low of maybe $3 before it went to $65.
The trick is selling enough near the tops to have the funds and confidence to buy at the bottom. One of these days, I post an investment cycle graph. I will ask my brother-in-law to do a few over-lays. One sine wave will be of the economy and another of the markets. Along the curves "events" will be posted. One of the "events" will be the peak in profits. The cycles are not precise but it is typically true that the time to get out of the market is when profits are approaching the peak. It is time to buy stocks when profits are weakest and time to sell when they are the strongest!

Again, one must look backwards to see the peak. When the peak is published, at least a month after it was hit, the chart looks great. The first data point on the down-trend is published approximately 4 months after the peak was reached. At this time, the economy is so good that investors have a hard time believing a recession is approaching. Many successful investors take their profits early. They do not want one of those sneaky little recessions to sneak up on them.