Welcome to Murphy's Market
If you sold out of the stock market last year – or even back in June or early July 2008 – you probably feel pretty good right now. And if you took the cash and spread it around to a group of well-run banks, so as to take advantage of the FDIC insurance, then you must be feeling fine. Read no further. Take the rest of the day off. But if you still have some skin in the game, you’ll want to hear what Byron King has to say…
"Markets Routed in Global Sell-off," was the banner headline of the Financial Times this week. It seems like anything that can go wrong will go wrong. It’s Mr. Murphy’s market, right?
How bad can it get? It’s already bad, but can it get worse? Markets go up and they go down. That’s what markets are all about. Still, it’s one thing to live through a market pullback or correction. It’s another thing entirely to experience a total rout. It’s like what happened during Napoleon’s retreat from Moscow. There’s no relief from the suffering.
Evidently, the world wants its money back. It’s selling. In fact, a lot of people want out of the market right now. Are you one of them? I don’t blame you if you are looking for a way to bail out. But before you pull the "Eject" handle, let’s think this through.
Sure, it’s easy to wish that you sold your stocks six months ago. But you didn’t. Neither did I – at least not all of them. Why didn’t we sell? Were we focusing too much on the long term? Did we miss some sell signal? Where’s that bell that they’re supposed to ring at the top of the market? What the hell were we thinking, that we’re bulletproof or something? Well, before we get too far ahead, let’s look back and see how we got here.
From the end of 2006 to July 2008, oil steadily increased in price:
Also, between late 2006 and July 2008, the U.S. dollar declined in value, particularly against the euro.
Both run-ups – in the price of oil and the value of the euro against the dollar – were too much, too fast. The apparent strength in both oil and the euro (and the weakness of the dollar) masked the fact that the trading numbers were outrunning the pure economic fundamentals.
Here’s the key set of points. The eurozone economy was not that good last year. The dollar and the U.S. economy were just not that bad. Oil was just not worth that much. Despite the Peak Oil thesis – in which I believe strongly – the world really wasn’t coming to an end last summer. (And it didn’t.)
So by this past July, oil was too expensive and the dollar was too cheap. I said so both in writing and on Fox Business News and other media. As you can see from the charts, by the second week of last July, oil was selling at $147 per barrel and the euro was over 1.6 relative to the dollar. Too much.
What happened, then? In mid-July, the dollar began to strengthen, due to central bank intervention. And the price of oil fell. Both changes were rapid, even abrupt. A surprise? No, not really.
I expected the dollar to strengthen, and I said so. And I expected the price of oil to decline from the $140s to about $100-110 per barrel, with a possible excursion down into the $90s per barrel. I actually thought that a stronger dollar and declining oil prices would be "good" for the overall world economy, because this would leave more money in the pockets of consumers – especially energy users.
But now in hindsight, it appears that the run-up in oil prices from 2007-mid-2008 sapped household and consumer income across the world. The oil run-up and simultaneous dollar devaluation were enough to trigger the mortgage crash. Of course, the mortgage crash was coming, and it was always just going to be a question of causation. Now it’s up to history to assign naming rights to the meltdown.
Let me use a different analogy. The dollar decline and energy run-up did not give just a chest cold to the world’s credit-driven economy. The yearlong decline of the dollar and rising oil price gave the world economy a case of tuberculosis. And it’s a strain of TB that is resistant to all the usual antibiotics.
So here we are. The world economy is sick. And I mean really sick. The markets are coughing up blood. None of the usual remedies will work. There’s no magic pill. From here on out, it’s trial and error. It’s hit or miss. And the prognosis is grim.
Let’s get back to whether or not to sell your stocks.
First, I’m certain that it’s painful for you to watch your investments decline. You worked hard for the money with which you bought stocks over the years. And now the value of those stocks is falling. It just stinks.
This market meltdown is not like Goldilocks sneaking into your kitchen and eating your porridge. No, this is like Goldilocks breaking into your house and burning the place down using magnesium flares as accelerants. Years of hard work are just turning into smoke and ashes right before your eyes.
I have to say that declining markets are plenty painful for me. It hurts twice as much because I edit Outstanding Investments. That is, I have both money AND a reputation at stake in this process. Agora Financial does not give out personal investment advice. But the last thing I want to do is offer up a bum steer when it comes to helping you make your financial decisions.
Outstanding Investments has a straightforward investment thesis. We invest in energy and resource plays because over time – we believe – energy and resource investments will become more valuable. There are a number of reasons for this, including geological scarcity, past underinvestment and increasing future demand. But it’s a basic idea, and we think it works. At least, it has worked for the past six years or so.
For the past few years, OI has been selecting investment ideas in companies that appear to have bright futures in a looming era of rising energy and resource demand. And many – most, really – of the investment ideas did well. Some did very well. A lot of readers made a lot of money. Whether it was oil, gold, refineries, cement or energy infrastructure, it seemed like we were investing in places where the world was going. Right?
But now it seems like the investment locomotive – energy, resources and related infrastructure – has derailed. Energy prices are declining. Energy-related stock plays are down. Commodities are down. Mining and infrastructure stocks are in the dumps. The falling tide is leaving us high and dry.
But does that mean that the whole OI investment thesis is unraveling? Not so fast, pilgrim. Let’s keep on thinking this through.
Before you do anything precipitous – like sell your last stocks and stuff the cash into your mattress – let’s ask a few more questions.
If you sell out now, what price will you get? A low price, right? So if you sell now, you will leave a lot of value on the table. That is, most things in the world of energy and resources are underpriced compared with their intrinsic value. I don’t care how bad the market looks just now (and it looks awful). Go out and try to find an oil field somewhere, or build an oil refinery, or find an ore deposit and build a mine. Can’t do it, can you?
So if you sell out now, just be aware that you will be getting a relatively low value. You will be leaving long-term value behind. If that’s what you want, then that’s what you ought to do. Just understand the point.
Which brings up the next set of issues. How badly do you need the money? How soon do you need it? How scared are you of further declines? How much risk can you handle, especially going forward? What kinds of reassurance do you need?
The markets are down. A lot of Elvises have left the building. And who is left to do the selling? Just you? Nope. Whatever you think, you are not alone. There are still a lot of people holding their shares. What do they know? And what is their reasoning to hang on?
From what I have seen, the biggest sellers – the market drivers who are taking the express elevator down to the subbasement – are people who have lost control of their money, if not their investment destiny.
People are selling to meet margin calls. The wildest sellers are traders who are just plain behind the eight ball. It’s more than being scared by what is happening. Heck, we’re all scared in some way or another. I wasn’t around in the 1930s, so I have no firsthand experience with the Great Depression. I know only what my parents and other relatives and friends told me. It was pretty bad for a lot of people.
But right now the serious sellers are people who cannot afford to be patient. A lot of the sellers in the energy and resource field are hedge funds. These firms are meeting redemption calls from investors who want out. The hedge funds just plain need cash. They have to sell. And a lot of those funds are throwing everything over the side, even the life rafts and the emergency rations.
When you look in the mirror, is that you? Are you like a hedge fund in panic mode, selling everything just to raise cash? Do you fit into this "sell-sell-sell" model? Don’t feel bad if this is what you have to do. Just be honest with yourself.
Meanwhile, the U.S. – and the world, really – has been dealing with a credit crisis for over a year. Which makes me wonder if there is a turnaround coming sooner, rather than later. I don’t know that. I don’t have a copy of the Financial Times from next March. So I just cannot say if we are closer to the bottom than to the top.
How soon do you need your funds? If you need cash within the next 12-24 months to pay bills like those for college tuition or a nursing home for a relative, then maybe you ought to just take the hit and get out of the market now. There’s no shame in being safe. Look after your needs.
But do you have a longer horizon? Are your "down" stocks in your IRA or 401(k)? You can’t take it out without penalty until you are 59½ years old. Then consider riding it out. And maybe with these low valuations on most stocks, it’s even time to go shopping – but certainly not blindfolded. Nibble away.
In a lot of respects, the world is on sale right now. Heck, a lot of stocks in the OI portfolio have turned into dividend plays. Can they maintain their dividends? That’s a good question. Can they sustain earnings? At the same time, if you were management at these companies, would you risk further tanking the stock by cutting the dividend?
And let’s look ahead a year or two. Commodities in general have been plunging in price since early July. The dollar has been strengthening. Will that continue? Can it continue? Why should the dollar stay strong? Does the number $700 billion mean anything to you? So sure, the strong dollar can continue and commodity prices will stay weak. But at some point, the dollar will start to decline in value. And commodity producers will have to cut back on operations by closing mines and mills and smelters. Then they regain pricing power.
And if the world has the vast recession that many people are forecasting? Then global demand should decline in the near and further future.
But there are 6.5 billion mouths to feed on this planet. The world will still have to produce a lot of materials to satisfy basic demand. That is just built into the equation of human survival. And what will happen to pricing power as some layers of high-cost output go away?
For example, the world petroleum industry will lift over 31 billion barrels of oil this year. Even if world demand dropped by, say, 5% – as if the world airline industry simply vanished – the world would still lift nearly 30 billion barrels. And as the current economic woes cause new projects to slow, annual depletion will overwhelm annual new output from new fields. There will be less oil.
That is, looking ahead, the world may never again exceed the oil output levels that we will have in 2008. Indeed, it will require heroic efforts just to keep global oil output flat in the future.
So this brings us back to that OI investment thesis. Energy and resources are getting scarcer and ought to become more valuable going forward. Hey, too bad the world financial system is busted. But that just means that there’s an opportunity to buy good stuff really cheap.
No, I’m not saying that you ought to go out and buy stock with both arms or back up the pickup truck and start shoveling. You need to be very cautious right now. But don’t panic, either.
Sell if you need to sell. Buy if you want to take on the risk. We’re in for some rough economic times. But unless world population starts to die off fast or people develop a taste for living low and being cold a lot, the energy and resource plays are still going to work over the long haul.
Until we meet again…
Byron W. King
for The Daily Reckoning
October 09, 2008
Byron King currently serves as an attorney in Pittsburgh, Pennsylvania. He received his Juris Doctor from the University of Pittsburgh School of Law in 1981 and is a cum laude graduate of Harvard University. Byron is also co-editor of Outstanding Investments, and editor of Energy & Scarcity Investor.
"The boom years are over…"
Speaking was a spokesperson for Vienna tourism board…20% fewer Americans are visiting the city. But almost anyone might have said the same thing.
The boom in construction has been over for nearly two years…
The boom in the financial sector ended about 12 months ago…
The boom in the aviation industry died when oil went over $100…
The boom in commodities was killed when oil went under $100…
The boom is retail seems to have come to a halt more recently. This will be the first quarter in many years with declining consumer spending…
The boom in consumer borrowing seems to have come to an end too…
Yes, dear reader, what MUST happen, DOES happen. But it usually happens when you don’t expect it…or in a way that surprises you. The big surprise has been the violence of the correction when it finally got going.
"Day of Reckoning," the Telegraph called it.
But we should be happy. Not only is the mainstream media picking up our themes, now both sides of our Trade of the Decade are working. Yesterday, the Dow went down another 189 points. Gold went up $29.
But instead of joy and satisfaction, we feel a sense of dread. It’s all very well to have a few Krugerrands and gold louies stashed somewhere…but you can never have enough of them to brighten up a darkened world. As an insurance policy against a financial catastrophe, gold still works – perhaps better than anything. But who wants his house to burn down so he can collect the fire insurance?
Guess how much Americans have lost so far from the stock market decline? Almost $5 trillion. Stocks are down about 33% from their ’07 peak – resulting in the destruction of wealth on an unprecedented scale.
Add to that the loss of wealth in the domestic property market, and you can’t help but wonder…how do people keep going? The Wall Street Journal reports that one in six homeowners is "under water" – with more mortgage than house.
"About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth, according to Moody’s Economy.com."
And house prices are still going down. Yes, that is something that MUST happen too – house prices have to go do to the point where people can buy them. The average house must be affordable to the average homeowner. And since incomes haven’t gone up in the last eight years, we can presume that housing prices shouldn’t have gone up either. So, we ask…how much more do houses have to fall before they are back to where they were 8 years ago…or merely to the multiple of income that buyers can afford? The answer…according to the numbers we’ve seen…is about 20%. That suggests that we are only about half way through this housing decline. It further suggests that when it is over one out of every three homeowners could be in serious trouble. He may not be under water, but he will definitely be up to his neck.
And now it gets worse. Because practically every businessman in America is waking up this morning thinking about how he can cut costs. His sales are going down. What choice does he have? He has to cut his payroll. And so, he begins making a list…which employees are essential to his business…which are not. Overtime is cut. Part-time workers are scaled back. Full time workers are let go. He knows the woman in the mailroom is a waste of money, but she’s nice to look at. The fellow running the advertising is an idiot, but he can’t stop advertising, can he? And how ’bout that driver…he seems to disappear for half the day; he’s never where he’s supposed to be…yes, he’ll be fired immediately…
And then, the world’s lights grow dimmer.
*** What to do?
The world’s buffoons and hacks think they have the answers. In France, the leftist newspaper, Liberation asked a dozens of "intellectuals" and "artists" what they thought. None seemed to have any idea how markets work. And naturally, they had the usual claptrap solutions.
In Germany, people are posing "existential questions," says Handelsblatt, wondering about the "crisis of faith" that has overtaken capitalism. "Now we see that capitalism is nasty," says Die Zeit. "We need more government to bring it to heel."
And in America, too, the clowns and opportunists are working around the clock to take advantage of the situation.
Yesterday came word that the Fed will buy commercial paper. This means the Fed is now financing business ventures. What the Fed aims to do is to cut out the middleman – the banks. For their part, the banks are grabbing all the Fed cash they can – and socking it away. They don’t lend it out…because they’re afraid it might not come back. And they need it to remain solvent. But if banks don’t lend, it defeats the whole purpose of giving them money. The government is famously ‘pushing on a string,’ as Keynes once put it – it sends money out, but the money doesn’t end up where it is most needed. So, now the Fed lends directly to business…and now the business community depends on the government too. Not only will homeowners have to thank the government for the roofs over their heads…company executives and shareholders too will be beholden to the great gods of the Potomac. At this rate, soon the feds will be providing the bakers with flour.
Where this leads, we don’t know…but we don’t think we want to go there.
*** Thank God, the SEC is on the case. After sleeping through the biggest bank robbery in the history of mankind, the regulators are waking up and offering to clean up Dodge City.
And just who do you think they’re aimin’ for? ‘Dirty Dick’ Fuld – who drove the 158-year-old Lehman Bros. into the gulch…and made off with $480 million? Jack-eyed ‘Jimmy’ Cayne, who claimed to be playing cards the night they gunned down ol’ Bear Stearns? Or how about that fast-talkin’ Al "Bubbles" Greenspan – who controlled the whole territory until the Bernanke gang moved in?
Nah, the SEC has put out an arrest warrant for a Beverly Hills money manager whom no one ever heard of. He’s public enemy number one, to hear the SEC tell it. His crime? Short selling. Not even naked short selling. He did it with his clothes on; he bought shares. And then he sold short against them. In so doing, he made the glorious sum of $207,000. Short selling is an ancient and hallowed practice in the financial markets. The SEC has made it illegal; though no one knows exactly why.
But now they’ve got their man. The desperado doesn’t even deny it. Now, the SEC can make him do the perp walk and pretend that it is performing a useful function.
John K. Galbraith, in his book on the Great Depression, describes what is going on:
"As the ghosts of numerous tyrants from Julius Caesar to Benito Mussolini will testify, people are very hard on those who, having had power, lose it or are destroyed. Then anger at past arrogance is joined with contempt for the present weakness.
"The victim or his corpse is made to suffer all available indignities. Such were was the fate of the bankers. They were fair game for congressional committees, the courts, the press and comedians."
The Daily Reckoning