Tuesday, October 21, 2008


Stock prices turn up just as the great majority of people come to know that there is a recession. For more than a year, some have argued that the US is in a recession. The housing business was in a recession way back when the total economy was growing by better than 3%. The auto business was in recession way back when US exports were soaring. The last quarter of 2007 contracted by a tiny amount but the next quarter saw rapid growth. By the classical definition, the US is in recession only if it experiences two negative quarters in a row. After the swoon in September, it is highly likely that the current quarter will be a negative quarter, however, recessions tend to be over by the time most people believe we are in one. The public believes.

Looking back, we see that the real estate recessions of 1973-74 and 1990-91 ended just when housing starts hit rock bottom, just when real retail sales fell rapidly and just as industrial production hit the skids. Over lay the numbers and this recession is just where the 73-74 and the 90-91 recessions were when the markets began to soar.

Stocks were up big in November and December of 1974, but they were down for the full year. In 1975 the average small stock appreciated 52.8% in value, the average large cap value stock appreciated 43.4% in value, the average conglomerate appreciated 37.2% in value, the average growth stock appreciated 31.7% in value and the average non US stock appreciated 26.9% in value. In November of 1974, at the jump off point, new housing starts hit a low not seen in many prior years. The words being used by the news media were about how bad the recession would be and was another great depression upon us?

Google the headlines in early 1975 and you would come to the conclusion that the consumer was unemployed and broke. Many Americans were very confused. Why were stocks going up during the worst of times? Most people decided to wait before "jumping back in". Many waited for a "pull back" buying opportunity. In 1976, the respective gains for the classes of stocks mentioned above were 57.4%, 34.9%, 23.8%, 13.8% and -.6%. (Notice that international stocks do not do nearly as well as US stocks in the years just after a real estate recession). Those who bought a non levered $1,000 worth of small stock shares on January 2, 1975 saw the value climb to $1,520 in a year and to $2,392 in two years. Those who used maximum leverage turned $1,000 into more than $10,000 ($10,000 into $100,000) in two years.

The story of the next and only other real estate recession since 1973-74 is the same. The market "released" around February of 1991, right when everyone was well aware that a recession had hit. The returns on small US stocks (large companies but small relative to S&P 500 companies) over the next several years were: 1991, 44.6%; 1992, 23.4%; 1993, 21%; 1994, 3.1%; 1995, 34.5%; 1996, 17.6%; 1997, 22.8%; 1998, -7.3%; 1999, 29.8%. It was easy to miss the 44.6% return in 1991 because "the wheels were falling off the economic wagon". Even the 23.4% returns of 1992 were not easy to grab because the world looked to be in such great trouble, after all Hillary was about to force the takeover of the private health care system. The average person found the way to start adding money to the markets by the mid to late 1990's. Today, they still wonder what hit them when stocks went down from 2000 to October 2002. The returns of -3.6%, 2.5% and -15.3% of 2000 through 2002 hurt badly if one did not catch the 44.6% return of 1991.

Yesterday, the story went around that OPEC will slash production this week. How silly the concern! At $70 per barrel, windmills and other expensive alternative energy projects make economic sense. OPEC can encourage the building of windmills if it likes. Once the huge capital per kilowatt is spent to build a windmill, it will not be shut down even if oil drops to $5 per barrel. The windmill that does not make economic sense to build makes economic sense to operate. Each member of OPEC certainly wants to keep their oil revenues high. Total revenues are a function of both price and quantity. The current price is well above the cost of exploration and development of new supplies.

Cuba just discovered 20 Billion Barrels; it will make huge profits at $30 per barrel, any oil not sold by OPEC today for $70 will be competing against Cuban oil in a few years. Within 10 years, the USA will be extracting oil from fields adjacent to the Cuban fields.

A few months ago, resources were the King of the Hill. Resources were in tight supply. China, for one, was seeking supply deals from all around the world. Today, resource after resource is being stock piled. Aluminum, steel, copper, zinc, silver and other industrial metals are being stock piled; the amount being consumed is lower than the amount being produced. Gold is being horded because people fear that the wheels are falling off the economic wagon, but, the fact that home sales in England are down 53% from a year ago shows just how much the demand for zinc plumbing facets has collapsed. Palladium has never (as far back as I can find) been so cheap relative to gold! The CRB Index divided by spot Gold prices has not been so low since the fall of 1982, the jumping off point for one of the greatest bull markets of all time. Most of 1982 was a recession year but stocks took off by September. Small stocks gained 28% on the year and were up another 39.7% in 1983.

A few months ago, resources were the King of the Hill, but the King has taken a fall. Many want to help this King back up the hill. Yesterday, energy and materials stocks lead the charge. All the while, the new King is gaining strength. Last night, during a meeting on other matters, I learned that our church pumpkin sale is $4,000 ahead of last year. I noted that people have money to spend and I mentioned that the average family will spend about $4,800 less on fuel over the next 12 months versus the last 12 months. The chorus of gloom and doom from the other committee members was amazing. One believed the drop in the price of gasoline was temporary, another said that those who still have jobs have money and the third said 401-K accounts had been devastated. All points made were true but they all were looking backward. Markets do well during times of falling inflation rates. Inflation rates cannot fall unless they are high in the first place. Getting to the high inflation rate was fun for the owners of resources; the fall will be fun for the consumers of resources.

In a couple of weeks, when retail gasoline hits $2.30 per gallon, these attitudes of gloom and doom will begin to fade. The new king of the hill is not resources but consumers. While Ben Bernanke talks about another economic stimulus package, Americans are starting to receive their first "energy rebate checks". The total value of the energy rebate checks is at least three times the size of the prior government rebate program and the energy rebate checks will just keep on giving. Just like Alan Greenspan, Ben is talking gloom just when boom is approaching.

Perhaps one more set of numbers is worth posting. From November 23, 1990 (during the middle of the real estate recession) to October 1993, Rex Stores (RSC) went up 643% in value. Over the same time frame, Best Buy (BBY) went up 1,472%!

Yesterday, the word on the street was that Circuit City will close hundreds of stores to avoid bankruptcy. CC cannot afford to stock and man these stores during the Thanksgiving through New Years selling season! The consumer appears to be totally tapped out. On the other hand, we know that millions of people will sign up for cable and buy new TV's between now and the analog signal cut off in February. Can you believe that the second generation of the Android mobile computer is close to production? before the first generation has gone on sale! The mad rush is on! Consumers are about to be flush with cash. Retailers will have a surprisingly good season. King Oil is dead, long live King Consumer!