Dessauer Investors World Blog

Expanding Credit -- the Silver Lining

2008-11-07T19:31:11Z

The headlines remain mostly gloomy. The economy keeps losing jobs - losing 240,000 jobs in October. Unemployment is up to 6.5% and is probably going higher. Manufacturing is down. Consumer confidence has plunged to the lowest reading in years. Corporate earnings reports tell a tale of a slowing global economy. Surprisingly, most media commentators still have not recognized the most important positive story. The LIBOR rate has come down. The interest rate on 30-year mortgages is coming down. The commercial paper market is functioning again. Total commercial bank credit in the United States is over $10 trillion, a new record high and growing fast. And they don't know why the dollar has been going up instead of down as the media pundits predicted. The dollar is up and very close to my estimate of 1.30 versus the euro.

The turbulence in financial markets is testimony that the U.S. dollar is the biggest financial pillar of the global economy. There is an overlay of speculation but on the fundamentals the U.S. currency is still #1 in international trade. For example, on the Shanghai docks there are containers full of goods ready to be shipped. They sit there because the shipper has not been able to get a letter of credit in U.S. dollars to finance the goods and shipping costs. Dollars are needed because the dollar market is the biggest, most trusted and the most flexible. The Russian central bank has lots of dollars, thanks to oil sales, but Russian commercial banks do not have the dollars they need for financing trade. They have to borrow dollars. It has become difficult to borrow dollars, so the Russian commercial banks have been forced to buy dollars to pay off loans coming due.

I could provide many more examples. But the point is that the shutdown of the U.S. credit market has had the effect of paralyzing much of the world's trade. Banks and businesses all around the globe need to be able to borrow dollars for short term financing. That is why it is so important to get the U.S. credit market functioning in a normal way as fast as possible. And that is why central banks all around the world are working alongside the United States to make sure there is plenty of liquidity. They are making progress. But it is not easy to stop a self-intensifying circle of fear. It takes time for investors and business managers to realize that their worst case fears are not going to happen. We are now in the aftermath of the credit crisis. We are seeing the damage done when credit markets froze - and that is indeed scary.

Here at the DC Money Show, a lot of people are saying that this is the worst financial market they have ever seen. I can't say that. I believe the 1970s and early 1980s were much worse. The Dow Jones Industrial Average hit bottom in 1974 and eight years later we had the worst recession since the Great Depression, lurching from 18% inflation to 11% unemployment and a 21.5% Prime Rate. Today's economic slowdown and financial market convulsion feels bad because it has exposed just how fragile financial markets really are. Markets depend on confidence. We used to think the global financial were so large and so complicated that they were invulnerable. Now we know otherwise. But this is a financial crisis and it will be fixed by making sure there is plenty of money in the system to satisfy legitimate business needs. The billions in China and India are not going to retreat. They are going to march forward working hard to improve their standards of living. They are a major source of global growth. Business managers know that and will continue to pursue opportunities in emerging markets. Be patient and stay fully invested.

For instance, Disney (NYSE: DIS, $24.00) reported fourth quarter earnings from operations at $0.43 a share up slightly from $0.42 a year ago. But Disney is feeling the pinch from gloomy consumers. Attendance at the theme parks is down about 1%. Earnings for the fiscal year that just ended were $2.28 a share. Earnings this year may be flat or even slightly down. Still, at just 10 times earnings, Disney is very attractive. The long-term average P/E is 18. Disney will come through the slowdown in better shape than many other companies. Disney is a Buy.

Focus on Economics, Not Politics

2008-11-02T00:30:42Z

In just a few days we will know the results of the presidential election. No matter what the outcome may be my strong advice is to stay focused on economics rather than politics. The new president and the Congress will have very little wiggle room because of the credit crisis and weak economy. Tax collections are plunging at both federal and state levels. Taxes from capital gains are evaporating. Dividends have been cut. Corporate profits are down. And personal income is down. Based on tax collections in September the federal government is expected to run a deficit of $750 billion this fiscal year. And that may be an optimistic view. Next you add on the $250 billion that is being invested in the banks. That will be treated as an expense this fiscal year. Put the two together and the total federal deficit will most likely be a trillion dollars or 7% of GDP this year. Just the words trillion dollar deficit are likely to be a shocker. I expect there will be public outrage when this news hits the media. Of course there will be demands that the government reduce the deficit. What can the new president and Congress do to reduce this huge deficit; very little. Spending will not go down. It will go up by the amount of any additional fiscal stimulus the Congress and president decide to enact. Raising tax rates in a soft economy makes no sense. First that could do more harm than good. And higher rates do not always mean more taxes collected. The federal government is going to have to hope the Federal Reserve, working with other central banks, will be able to get financial markets functioning again. Fixing the markets and restoring economic growth will take time. And by the time the economic outlook has improved the political landscape may have changed.

Yesterday the Bureau of Economic Analysis or BEA told us that in the third quarter the economy shrank 0.3% in real terms. When I looked at the details I was astounded. In current-dollar terms the economy grew at a 3.8% annual rate in the third quarter. That is down slightly from the 4.1% rate in the second quarter but still much better than the 2.3% rate in the final quarter of last year. What astounded me is that this small change in nominal or current-dollar growth resulted in a huge change in real growth. The BEA said the economy grew 2.8% in the second quarter. How did real growth plunge 3.1% when current dollar growth was down only 0.3%? The implication is that inflation used in the calculation for real growth shot up from 1.3% in the second quarter to 4.1% in the third. Yes oil prices pushed inflation up when they were rising. But oil and many commodity prices peaked in July and are now down. Inflation is moderating. The answer to all this confusion is that the BEA now uses a chained dollar method to determine real growth. This is producing wide swings in real growth. In my opinion watching current dollar growth will be much more useful in determining the best investment strategy. The economy has been in a slow growth condition since the last quarter of 2007. The details from the third quarter say the economy is likely to stay in a slow growth condition with some ups and downs for the next several quarters. Stock markets are priced to anticipate something much worse. This makes stocks the best choice.

Federal Reserve Cut key Rates

2008-10-29T21:05:24Z

The Federal Reserve cut key short-term interest rates by one half of one percent today. This is another step in the direction of turning markets around and restoring confidence. There still is some downside risk to the economy. But we have confirmation that the Fed will do whatever it takes to restore confidence in the financial markets.

While doing research for the November issue of my newsletter, I found a chart showing total commercial bank credit in the United States. I was intrigued and dug deeper to look at the underlying data base. Credit is the basic fuel for every economy. Total commercial bank credit grew even during the deep recession of 1982. Keeping total bank credit growing is the #1 objective of all the actions being taken by the Treasury and the Federal Reserve. When I looked at the data for this year, I saw why there has been so much intense and aggressive action taken by Washington. In March, total bank credit declined and then stopped growing for six months. The decline was small, not a disastrous plunge. However it doesn't take a plunge in credit to stop economic growth in its tracks all it takes is for credit to stop growing. That is precisely what happened last March and that is why Treasury Secretary Paulson asked Congress for the rescue package and why the Federal Reserve stepped up its efforts and began buying commercial paper.

It has taken time to get credit growing again, but the data says that is exactly what has happened. In the five weeks ending October 15, total bank credit surged $520.8 billion to a new record high near the $10 trillion level. This is more than a simple resumption of the growth trend. This looks like a catch-up move. Total bank credit is back where it would have been if the growth had not stopped last March. This is a sure sign that the healing process has begun in the credit markets. Ironically, stocks around the world kept falling as bank credit began to surge. I have seen this before. In 1987, stocks plunged as a new strong growth trend in corporate profits began. Stocks don't keep falling when economic fundamentals are improving. They do what we saw yesterday - they move higher, sometimes sharply higher in a hurry.

There are also signs of recovery in housing. Sales of new homes rose 2.7% in September. Sales of existing homes were up 5.5%. Here in Florida, one of the troubled real estate markets, sales of existing homes rose 24% in September. Slowly but surely the housing challenge and the credit market crisis are being resolved. Our best strategy is to stay fully invested in good stocks.

Good News....Can't Stop Panics

2008-10-24T19:56:10Z

Just a few months ago, this morning's news would have sent stocks soaring. Sales of existing homes rose 5.5% in September, the biggest monthly gain in five years, reaching an annul rate of 5.18 million. The inventory of unsold homes fell in September, the first decline in more than a year. The evidence of a change for the better in housing is growing. Gasoline prices are back at or below $3 a gallon. That is good news for consumers. But in today's dismal market, good news is being ignored. On Friday, Japan's stock market fell 9.6%, Hong Kong was down 8.3% and South Korean stocks fell 10.6%. European stocks followed the trend, falling up to 6%. And our stock market was down sharply at the opening this morning. It can be hard to tell which part of the world is leading and which part is following the decline in stock prices. Yesterday, the U.S. Dow Jones Industrial Average finished up 172 points. But other U.S. indices were flat or down. And it was a roller coaster ride all day. Did U.S. uncertainty yesterday trigger the drop in Asia that in turn triggered a drop in the United States? Having been through several global stock sell-offs, my opinion is that the world looks to the United States for market leadership. My conclusion is confirmed by the strong dollar, up 20% from its low to the euro just three months ago. Capital flowing into the dollar shows that foreign investors see the United States as a safe haven.

Unfortunately, when it comes to the stock market, American investors are in a full-blown panic. Morningstar's Market Intelligence data says that a record net $49 billion went out of U.S. mutual funds in September and that early October data shows that the situation is even worse this month. When fund holders ask for their cash, the fund manager has no choice but to sell some assets (usually stocks) to raise cash to meet the redemptions. The selling drives prices lower, terrifying more fund holders, who then want their cash. This is a vicious cycle that is terrifying investors all around the world. It also is a lose/lose situation. Long-term investors who hold on to their fund shares see their net worth plummet. Those who sold have cash with a very low yield, and no hope for growth. They are also highly unlikely to go back into the market for a long time.

Morningstar studies mutual fund investor returns. They found that investors buy high and sell low to their disadvantage all the time. This history says that today's panicky selling is a contrary indicator. We should be buying when the crowd is panicked and selling. However this is hard to do, even for the most patient investors. No sooner do we buy a depressed stock than it becomes more depressed. There is no way of knowing in advance exactly when and where stocks will bottom out and start climbing. What we do know is that this is a financial crisis, not an economic crisis. There will be economic damage done by the financial crisis, but that kind of damage can be repaired fairly quickly. Stocks, as we have seen, can go back up as fast as they came down.