Sunday, November 30, 2008

We're not doomed! We're not doomed!

You may have noticed, lately, some commotion in the stock markets.

The end of the world as we know it? The beginning of the next Great Depression? Hmmm, perhaps not. How about some perspective?

In 1930, nominal GDP fell by 12.0%. In 1931, it fell by another 16.1% In 1932, it plunged another 23.3%! And in 1933 it finally stabilized with a “modest” 3.9% decline. (source: Zeal Investing).

Depressions are extended periods of intense economic shrinkage. The Great Depression cut the US economy in half in less than 5 years in nominal terms. Adjusted for inflation, the shrinkage was a compound 7.4% per annum. And the current forecasts for the US economy? Shrinkage of less than 0.5% p.a. Far from the end of the world.

Internationally, China has been singled out as becoming a basket case as the US economy retracts and China's export market dries up. How much of the Chinese economy is export driven? 7%. A slow down in China might be overdue, might even be welcome. But it won't be the end of the world.

In Canada oil sands projects are being shelved, to the dismay of the Alberta government which has been forced to cut its forecast budgetary surplus from $8 Billion to a mere $2 Billion. That's the annual surplus, folks. In a province without a provincial debt.

So who is doomed? Well, maybe GM and Chrysler. It's not about your vehicles, guys. It's about your ability to negotiate contracts with your unions. Buy peace by making yourselves uncompetitive? And the various Auto Workers unions must shoulder half the blame for demanding the golden eggs that their employers have granted. Shame on both of you. For this reason and this reason alone, let the corporations and their obligations fail, and let the facilities be brought back into production by people who take their long term responsibilities more seriously.

Who else could be doomed? Pretty much every fancy pants financial institution that lost its ability to judge creditworthiness. But, for reasons that seem plausible, most of them have been bailed out by governments (=taxpayers!) concerned with the very real threat of total failure of the world's financial system. Shielding financiers from the consequences of their own actions is a lot like developing an AIDS vaccine at taxpayer expense and giving it free to the most promiscuous.

Don't get me wrong. We need a financial system so that commerce can occur, be it paying for a meal in a foreign country with your credit card, or having Irrevocable Letters of Credit to enable international shipments. That is the heart, literally and figuratively, of the global economy. But I would tell every recipient of bailout money that there will be no bonus program for their staff until the bailout money has been repaid to whatever government provided it in the first place.

What will you and I experience? Homeowners will find their houses worth less than they were worth last year. Toughest on those who bought at the top. Not the end of the world for others. Good news for those who want to buy a house. Bad news for builders. Good news for people looking to hire a renovator.

Shareholders and pensioners are finding their investment portfolios in ruins this quarter. Many will sell at a loss into the first hints of share price recovery. This behavior is normal but will prolong the slump. Others will recognize the opportunity for what it is - an extended bargain basement sale on high quality stocks. Oh, and on low quality stocks as well. Just because it's cheap doesn't mean it is a good business. Companies without cash flow, with high debt, with customers who can't pay, with facilities in politically unstable areas, will have their weaknesses amplified. Don't buy because the price is low, buy because the stock price of a good business got sucked down with the massive liquidation of leveraged positions as the financial system went through its spasms.

Deflation? Inflation? Who knows. If there is deflation coming, cash is your friend. If there is inflation, low interest debt is like free money. But remember it was low interest debt that got us into this just-burst bubble in the first place, so living within your means and setting real wealth aside for a rainy day are good things, regardless. My guess is that prices continue to fall for a while, which some call deflation, and then all the new money that is being poured into the system begins to exert its inevitable devaluation of the currency and inflation becomes the risk. Watch and see whether central banks raise interest rates to curb this inflation or whether politicians decide that inflation gets them off the debt hook that they are currently busy hanging themselves on.

A couple of countries will emerge from this with strong and respected currencies. Many will not. Real wealth (property, some precious metals, good commodity companies) will always be worth something. Paper wealth (derivatives of unknowable provenance, anyone?) may turn out to be just paper.

Evaluate, then don't be afraid to buy. It's a pre-Christmas sale on stocks, and there are some real gems in the bargain bin. Choose well.


PKD said...

You know I'd love to believe your advice going to be too bad.

But I also worry that your economic wisdom is based on the same wisdom you apply to AGW, so I'm afraid I'll take it with a large pinch of salt before I commit any cash on the wisdom of your advice...

PKD said...

Sorry, my typo - I meant your advice that its *not* going to be too bad - lol!

Halfwise said...

Hi PKD. It is probably wise to do the very opposite of whatever investment advice you read here. But even a blind squirrel will find the occasional nut.