Market Cycles Never Cease

The market is always writing a new story. It’s hard to know sometimes where we are in the grand cycle of creation and destruction. But Chris Mayer thinks there are still some opportunities out there. Read on…

It’s 3 a.m. Aymer Vinoy Laughner, son of an oil baron and savvy businessman, entertains various well-to-do friends and celebrities at his St. Petersburg, Fla., home. Among them is Walter Hagan, the celebrated golf pro of the 1920s, and Gene Elliott, a big-time real estate developer.

Laughner makes a wager with Elliott that will change the face of St. Petersburg forever…

The bet is this: If Walter Hagan can drive three golf balls off the face of Laughner’s pocket watch without damaging it, Laughner will buy the 12-acre site across the street and build a resort there.

I still have a hard time imagining it, but they place the pocket watch out on the lawn somewhere.

Hagan succeeds, bouncing golf balls off the face of the watch, but never breaking it. Moments later, the men draw up a contract on a brown paper bag for the purchase of a 12-acre site that would open two years later as the Vinoy Park Hotel.

The story that follows is historical, but it illustrates how the ebb and flow of markets never cease. It truly speaks to President Truman’s old line: "The only thing new in the world is the history you don’t know."

The Vinoy opened in the sun-drenched opulence of the Roaring ’20s. Optimism and opportunity abounded. Think we had a real estate bubble? They knew how to put on a good show back then too.

Board writes of a lot selling for $500 on Monday and $1,300 on Tuesday… only to flip yet again for $2,000 on Friday. I looked over black-and-white photos in Prudy Taylor Board’s book on the history of the Vinoy. I saw some happy chaps in straw hats walking along a street near Tampa Bay. The caption actually read, "Smiling realtors." In the background, I could make out a placard that read: "Our flowers never die."

Bullish optimism at its best.

Signs of prosperity were everywhere. Building permits nearly tripled from 1920-1923. Bank deposits nearly tripled, too. All those real estate commissions, you see.

It wouldn’t always be smiles and easy money. The hotel itself passed through many ups and downs throughout its history. In fact, within 20 years of its grand opening, the Vinoy was in trouble. The property actually held up well during the Great Depression. War was what finally did it in.

In 1942, the number of guests dropped by more than 50%. Profits were insufficient to cover maintenance expenses and the interest on the mortgage. By 1943, the Vinoy ceased operating as a resort. Instead, it became the local headquarters for the U.S. Army Air Corps. Laughner wrote to his shareholders in his annual report that the lease with the War Department "was made against the better judgment of the officers and directors of the company, and was done mainly as a contribution to the war effort."

Hard to imagine how different St. Pete must’ve looked in that dark year of 1943. Today, the palm trees still sway in the salty breezes off the bay. The sunshine beams as brightly as ever. But instead of chunky Americans with fanny packs wobbling around, there were GIs in combat fatigues marching in the parks.

By the end of 1944, the War Department canceled the lease. The good news was that the cash flow from the lease paid off all the debt on the property. The bad news was that the hotel took quite a beating and needed a major renovation.

Laughner sold the Vinoy in 1945 for $700,000. The saga continues, but I will stop here. I’ll add only that the hotel had years of ups and downs (and another closure) left in its future. In a nutshell, the Vinoy story is part of the ebb and flow of markets. Few investments are good for all seasons. What worked for a while later stops working. And what seems cheap today becomes dear tomorrow. And back again.

It takes time to work these things out. The Vinoy was profitable for years, but trouble encountered in ’42 essentially put it out of business by ’43. It’s always easier to destroy than to create. I stayed at the Vinoy recently for an investment conference in which I was a speaker. It’s a grand old hotel, looking like a pink wedding cake, with its distinctive observation tower on top dominating the view on the waterfront.

The market is itself always writing a new story. It’s hard to know sometimes where we are in the grand cycle of creation and destruction. But I think there are opportunities out there. It helps to have the kind of perspective that sees these long patterns. You come to appreciate that things take time. The recent credit crisis, for instance, will take some years to cycle through, just as it took years to wash out the effects of the 1920s speculative fervor. The banks and financials had a long run, both in the ’20s and in the two decades before 2007.

Now comes the long period of convalescence. As the Vinoy history illustrates in a nutshell, prosperity comes and goes…and comes back again.


Chris Mayer
The Daily Reckoning
July 29, 2008

The above was taken from the latest issue of Mayer’s Special Situations. 

Chris is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer’s essays have appeared in a wide variety of publications, from the Daily Article series to here in The Daily Reckoning. He is the editor of Mayer’s Special Situations and Capital & Crisis – formerly the Fleet Street Letter.

Chris also recently wrote a book: Invest Like a Dealmaker: Secrets from a Former Banking Insider.

Yesterday, the Dow dropped 239 points.  Oil rose $1.46.  Gold remains at $927.  And the yield on a 10-year Treasury note is barely above 4%.

It’s that last item that puzzles us.

People are buying Treasuries for safety.  Money markets, which hold short-term Treasury bills, are at record levels.  We understand why you might want to have money in a money market fund…but where’s the margin of safety in a 10-year note paying less than the rate of consumer price inflation?  Even in the money market funds, you’ll lose money when the dollar goes down – whether it goes down against other currencies or against consumer items.  And what do you get in exchange for the risk?  Not much.   The 91-day T-bill rate is only 1.66%.

Currently the inflation rate – according to official statistics – is near 5%.  Buying a 10-year note at a full percentage point lower is not a safe investment – it is a speculation, a bet on the direction of rates in the future.  If they go…the value of the T-notes goes down.

Lately, that’s begun to look like a reasonable bet.

"Falling prices ease worries about stagflation," says a headline in the International Herald Tribune.  Oil is down about 15% from its peak.  Food has fallen a similar amount.  Could it be that inflation has topped out?  Could it be that the "civil war" between inflation and deflation is finally reaching a conclusion…with deflation the clear winner?

Could be.  Then again, it could not be.

"The question for investors is whether the slump in oil and commodity prices will last or is simply a temporary retreat brought on by overstretched increases," continues the IHT.    If the increase in prices won’t last, we can all forget about girding our loins for the fight against inflation.  We can simply buy Treasury notes and wait for the current downturn to pass, right?

Maybe.  Maybe not.

Inflation is at about two and half times the Fed’s key lending rate.  Overseas, many countries are facing much higher rates.  Russia has an inflation rate of 14%.  China’s rate is over 7%.  Inflation in India is running about 12%.  And Dubai has inflation at 22%.  Dubai, by the way, is a bubble.  It has only .02% of the globe’s population.  But it is home to 10% of the world’s construction cranes and seems hell-bent to prove to the world that there are bigger fools than Americans – as if that needed proving.  It now has the world’s only 7-star hotel…and the world’s tallest building too.  In the harbor, it’s building a series of artificial islands in the shape of a map of the world.

The gods must be watching…and getting ready to teach Dubai a lesson.  What would it take to kick Dubai in the pants?  A lower oil price…

For the last few weeks, oil has been going down…and the news has been overwhelmingly deflationary.  The S&P is down 14% for the year.    The credit crunch continues to pinch businesses and investors.  This morning, we got news that Merrill Lynch announced $5.7 billion in write-downs.  Wall Street will hand out an estimated $10 billion less in bonuses this year.    Mortgage-backed securities are selling at only one-fifth the rate of a year ago.  And the IMF says there is "no end in sight for the credit crisis."

Now, it’s beginning to hit the wealthy, too, says the Financial Times.  Prime mortgage delinquency rates are increasing.  So are late payments among the best credit card customers.  AMEX, which targets good-quality borrowers, saw its earnings fall 37% in the second quarter.

Meanwhile, investors are selling stocks short at record levels.   The pros think stocks are a bad bet.  This puts the stock market under a lot of tension.  A rally to the upside can be explosive, as the shorts need to buy in order to cover their positions.  On the other hand, the pros may be right; deflation is a big threat to stocks.  The amateurs may be right too – they’re moving to cash and bonds.

Cash is probably a good move.  You’re protected against defaults and write-downs.  And you can take cover if inflation gets worse.  Moving to bonds is another matter.  They are a leveraged bet against inflation.  And yes, for all we know inflation is dead forever.  But we wouldn’t want to bet on it.

*** One of the biggest humbugs in capitalism is private equity.

We have chuckled about it before, but we come back to it today because the granddaddy of private equity – Kohlberg Kravis Roberts – is preparing to sell shares to the public on the NYSE.

The idea of private equity is that a group of smart, well-financed, slick operators can get the better of the chumps in the public markets.  The idea is probably right, but it makes nonsense of the whole premise of modern market theory – that the markets always know more than any individual or group of players.  If the markets put a price of $100 on a stock – that’s what it is worth, no more, no less; at least, that’s the theory.

But the private equity hustlers nevertheless go into the public market, buy a company at a price set by the market, clean it up, cut it up, and then sell it back to the market at a higher price.

Supposedly, the private equity boys have "added value" by nipping and tucking on the corporate body before selling it back to the yahoos.  But what do the financiers know about running a company?  How is it possible that they are able to take a company out of the control of the people who know it best – founders, CEOs, managers – and improve it?  And even if they were to get lucky with one, what makes these dilettantes think they can do it 160 times – which is the number of buyouts completed by KKR?  We don’t recall the details, but we remember a study showing that private equity surgeons had added no net value to the companies they sliced up…and that share prices tended to sink after the initial return to the market.

And then you have to wonder about the chutzpah of it.  Public shareholders were getting smacked both coming and going – once when they sold a company to KKR for too little…and again when they bought it back for too much.  And now cometh KKR into the public markets to smack the poor lumpeninvestoriat again.  This time, KKR says, in effect: we’re smarter than you are…but we’re going to let you buy our shares anyway.  Of course, if KKR really were smarter, why would they want to cut the little guys in?  If they could reliably add value and produce above-market gains they could raise all the capital they could possibly need.  Of course…they can’t.  And now, with the chumps wising up, it’s getting harder for private equity players to raise money.

Nor is this the first time KKR has sold shares to the public.  The IHT reports:

"KKR Private Equity Investors had its debut on the Amsterdam bourse at $25 on May 3, 2006, when KKR sold 200 million shares of the unit, valuing it at $5 billion.  The shares have fallen more than 57% since then, to close Friday at $10.50."

*** Canada is mostly empty – as you can clearly see from the air.  We must have flown for three hours across the northern part of the country without seeing a single house…and barely a single road.  Finally, the pilot pointed out the town of Churchill on the banks of Hudson Bay.  Looking down, we were barely able to see a town at all.  It looked more like a village – cut off from the rest of the world by thousands of miles of wilderness.  Then, heading out across Hudson Bay, the blue sea was soon dotted by thousands of tiny white spots – an ice flow.  It was like looking at the sky at night, with a vast expanse of stars that seemed to go on forever.  Flying at about 600 mph, it nevertheless too about an hour before we had left the ice flow behind us.  Pity the book mariner who got stuck in one!

*** A note from Addison and Short Fuse:

"Thanks you to everyone that made it to the screening of I.O.U.S.A. last Tuesday in Vancouver. It was great to show the movie to such a responsive audience!

"What makes this particular screening special is that we’ll be simulcasting an incredible discussion afterwards… live with Warren Buffett, Pete Peterson and David Walker. This will be a one-time event that’s not to be missed.

"What’s more, the success of the 21st will largely dictate the film’s future syndication across the county. If it does well, there will be more shows in theaters. If it doesn’t, off to TV and DVD land. So… buy a damn ticket! Buy two. Buy tickets for your family, your friends. Buy ’em as a gift. Buy two hundred and host an I.O.U.S.A. party at your local theater.

*** August is approaching.  The Bonner family has picked up the French habit of taking the month off – gathering at our house in remote Poitou.  Now, the tribe is trickling in.  Gone are the days when the family all drove down from Paris together.  Now, each comes from his own place…bringing his own baggage.

Yesterday, Maria came from London, with her friend, Sophie, a French actress.  Damien, our gardener and "homme a tout faire" went to pick them up at the airport in Limoges.  He was impressed by the two actresses:

"Oh la la…it was a pleasure driving them down.  I only wish my friends had seen me…"

The two girls are used to the fast life of London…with late nights ("I haven’t been to bed before 4am in weeks," says Maria…)…chic parties…and endless chatter.  But this is not London, nor Paris…nor even St. Louis.

Dad had to lay down the law…

"If you are going to sunbathe topless, make sure you do it where no one can see you.  This is not the Cote d’Azur.  This is the countryside.  La France profonde.  People are very conservative.  Damien has high blood pressure already.   And you know how hard it is to find a good gardener….

"And another thing…make sure you get to bed at a reasonable hour.  We have a lot of shutters to paint…"

Tonight, Henry comes home after spending nearly a month working in Ireland…and Edward returns after three weeks at a wilderness camp in Scotland…  Stay tuned…

*** Speaking of shutters.  We described James Kunstler’s critique of the suburbs – "cartoon" houses, he said.  They have porches that only look like porches from a distance.  When you get up close you find that they are only 17 inches wide…so you can’t sit on them.  And the shutters are phony too – they’re nailed to the wall, so you can’t open or close them.

It’s a shame.  Real shutters are a marvelous addition to a house.  Our guess is that are about to make a comeback.  First, real shutters look good.  We’ve seen a normal, American ranch house, in Texas…nothing special, like millions of them built in the ’50s, ’60s and ’70s…onto which the owners had put real shutters, hung at the top, swinging out from the bottom, like shutters in Jamaica.  The effect was dramatic.  The colorful shutters made the whole place look charming, on the outside.  On the inside, the effect was even more delightful.  The shutters blocked the sun and glare, greatly reducing the need for air-conditioning.  Shutters protect windows…and keep curtains from fading.  In winter, they help reduce heat loss from the glass.  In summer, they prevent heat build-up from the sun.  And year-round, they make the house safer; just pull the shutters closed and lock them.

But most important, shutters give your children something to do when they come for a holiday.

Until tomorrow,

Bill Bonner
The Daily Reckoning

The Daily Reckoning