Monday, October 13, 2008

5% Becomes 10% in a Hurry

This morning, before the US market opened, based on the 5% bounce in London, a 5% bounce in America seemed probable. Over time, it seemed reasonable that the 5% bounce could turn into a 500% bounce. Today the bounce went right on past 5%, past 10% and it settled on a one day 11% bounce!

This has to be one of the biggest "melt ups" in history. The bounce included the beaten down energy and basic materials sectors. The energy sector was up 17%! Don't be fooled. The economic clock is not going to go backwards. The turn from capital goods, energy and basic materials is still upon us. The turn is to financial stocks, consumer cyclical stocks and then technology stocks.

We all understand that as the relative price of something comes down, the more of it we use and vice versus. The price to visit electronically continues to fall dramatically relative to the price of a physical visit. The price of a physical visit is coming down in terms of the price of the fuel required but time is our most precious commodity. The time it takes to visit with someone by phone, email or video feed is a tiny fraction of the time needed for a physical visit. One of the "forever trends" has been our desire to save time. Today, people have more "free" time than ever before but many feel more hurried than ever before. People are looking for more ways to save time.

Yesterday, a quick scan of the Parade of Homes showed that the great majority of fine new homes in the Winston-Salem area are being built far to the west of town in Lewisville. Leave Winston at 5 PM and one discovers a traffic jam all the way from in town to the most distant Lewisville exit. Meanwhile, sales of new downtown condos have stalled. Has the time saving trend already been broken?

A good friend travels some 40 miles 4 days a week to his job. The fifth day he telecommutes. When will his telecommute turn into two out of 5?

While forecasting the future is a fools game, there are some safe bets. For example, it is safe to bet that the long term non levered return on stocks will be higher than the non levered return on real estate which will be higher than the non levered return on bonds. It is also a safe bet that returns from recession lows will be substantially higher than average. It is time for the conservative investor to pull money from his bank CD and to invest it for higher returns.

Another safe bet is that we will use less energy per dollar of GDP in five years than we use today. Old trends continue until they are broken, the longer the trend the more likely it is to continue and energy use has declined for thousands of years. A hot bath was once a very expensive luxury. If we are going to use less energy, then we are going to stop driving to and from the Lewisvilles of the world. The jobs, schools and churches will move to Lewisville in one way or another.

A good friend has gone full circle. He worked in a downtown job before he was "encouraged" to become an independent contractor for his firm. As an independent contractor he worked from the home. After about 5 years, the contract work disappeared. He is now back at work at a downtown job. One that is done at a major medical center. His work involves a lot of time looking at a computer screen. I suspect that the work could be done from his home. Is the work being done at a central location because the medical center is largely supported by US government grants? In the long run, will it not be found that it is more efficient to do this work from home?

Working from home reduces transportation costs, but, again, it is the travel time that is precious. The gasoline consumed in a daily commute of an hour (counting parking time and time to and from ones vehicle) might be valued at $4, but the hour of non productive work might be valued at $40. Working from a computer changes the dynamics of "relationships". Computer connections are getting better. At some point, the worker at a terminal will be more connected than the office worker. Collaboration via computer networks is still in its infancy. We are perhaps a long way from deciding to hold a Wednesday night bible study via teleconference, but the day is coming.

Exxon Mobile is going to be around for many years to come. Oil is going to be a part of our energy mix for many years to come. The bounce back today of energy prices is only a bounce on a new trend line. Energy stocks showed strong relative performance from 1999 until 2008. For the past 3 months, in the middle of great noise about a financial crisis, bank stocks have out performed energy stocks. This new trend will gradually gather steam and it will last several years. There will be consolidation of banks and the relative number of physical visits to banks will decline, but bank stocks will do well. The Secretary of the Treasury is the "king of the day" in America, but most of his work is done. A system is in place to re-capitalize the banks that are in trouble. The decline in energy costs, including the pending drop in the price of gasoline to $2.50 per gallon, will give consumers the money they need to pay mortgage payments. The unfreezing of capital will release pent up demand for home purchases. The troubles caused by the housing bubble, the one that reached its zenith in 2005, are mostly behind us.

The FASB has softened its crazy mark to market accounting rules. The SEC refused to act to suspend these rules but the Accounting Board has fuzzied them up enough to give banks wiggle room. Under the new rules banks will be able to price their holdings based on a cash flow model. Last week, banks were holding tight to securities that last traded at fifty cents on the dollar. The bid for the securities was at 20 cents while the banks argued that they were worth 70 cents. Should any bank sell at 20 cents, the other banks would have to recognize the "loss" on their holdings of 30 cents, from 50 cents to 20 cents. The bid of 20 cents was based on the vulture price. Again, the situation was similar to the beach home purchased for $100,000. With gasoline at $4 the home produced cash flow to support only $50,000. The vultures were willing to buy for $20,000 the owner knows that a small drop in the price of gasoline would push the price back to $70,000. Having a government rule that says the homeowner must sell at $20,000 would be a dis-service. Under the new rule, banks can value the "beach condo" at the $50,000 and it can increase its holding value to $70,000 if the "rents" come in strong.

The market is not going to go straight up but investors should remember that 40% of the recovery occurs in only 10 days of market moves. Today was one of those days.