Just Wait ’til Your Father Gets Home
Many things have changed since I was a little boy. Back when the post-war generation was raising children, my dad worked a full day downtown but my mom taught school and arrived home about the same time my sister and I did. You may be surprised to learn that I was not a perfect child and I sometimes needed to be reminded of that fact. The title of today’s article is something I heard from time to time – a warning from my mother that something really bad was going to happen and it wouldn’t be long in coming.
Thinking back, I don’t remember punishment being vastly different between Mom and Dad but I do remember the dread I felt while awaiting his return. I didn’t know what was coming but I was pretty sure I wasn’t going to like it.
If you recall similar emotions from your childhood, that might make the current market situation a little easier to understand. Market valuations have a tendency to swing too far in both directions, driven too high by our collective greed and too low by our fear. This time, an unsustainable market in home purchases, enabled by relaxed lending standards, created a “bubble” which has been popping in slow motion for the past year or so. At some point, even seasoned investors’ fear of “what’ll happen when dad gets home” overtakes their reason and they join the rush to sell securities, driving prices further down. They don’t know what’s coming but expect it to be bad.
According to the National Bureau of Economic Research, our country has had to endure 14 previous recessions with an average duration of about a year (10.5 months excluding the Great Depression, 12.9 months including it). These have proven to be great times to invest in stocks, bonds and real estate, a concept which makes perfect sense during the good times but is very hard to execute during the event. The other famous Warren in the investment world, Warren Buffett, once said that it makes investing easier to think of stocks as hamburgers. He explains that the investors for whom he works have always been net buyers of hamburgers, so buying them when they are cheap has proved to be a good strategy. He hates selling them when prices are low.
At recent levels, the stock and bond markets are priced in anticipation of a terrible event, something along the lines of the failure of all businesses. As scary as things are (and I am just as afraid as any of you who are reading this article), I don’t think that’s a likely outcome, at least in conjunction with the current recession.
Although Warren Ward Associates has adjusted allocations in those investment accounts we manage, we remain basically fully invested. Many headlines have questioned that strategy, suggesting that joining in the sales and moving to cash would be more appropriate. Since I am unable to predict the future I am forced to look to the past for guidance. The reason we have not sold meaningfully is that recessions always seem to end and market values always seem to return. The first year following the 14 previous recessions, stocks have averaged about a 20% return, bonds about 4% and cash a little less than that.
This time, as in the past, our allocation strategy has allowed our clients to do better (i.e., lose less) than the broad markets. That puts them in a better position heading into a period of recovery. As I look around, little peace of mind is to be found in the headlines or in conversation with friends. If that’s what you find too, let me ask you to consider the “when your father gets home” concept and remember that the sky is not falling, rainbows do follow storms and markets are quite likely to recover once again. As always, please feel free to contact Jalene or me with your specific questions.
Save The Environment: Buy an SUV
Most businesses are operated rationally. Even though we have all heard the joke about a store that “sells at a loss but makes it up on volume”, I bet the proprietors of Lockett’s and Dell Brothers know exactly what price they must sell their garments for to keep the doors open. The same is true for all types of businesses. Professionals like attorneys, doctors and financial planners have little to sell but time & expertise and you may be sure we know what we must charge in order that our practices remain viable. Manufacturers are no different. Each item they make must cost less to produce than it sells for. Unless, of course, a company has a broad enough product line to sell a specific item below cost, using profits earned elsewhere to keep things in balance.
Toyota, one of the best managed companies in the world, does just that. According to the website of Rep. John Campbell (who owned several automobile dealerships before he began representing the citizens of Southern California in Congress), Toyota sells its hybrid Prius model below cost in order to offer something in the “environmentally friendly” corner of the market. Profits from Toyota’s full size Tundra pick-up and Sequoia SUV are about four times what is earned on its smaller cars. That profit allows Toyota to offer a very competitive price on the Prius, a vehicle which includes a second power train, extra batteries and sophisticated computerized controls not found in conventional small cars.
How do other companies manage to compete? Honda is one of the few auto manufacturers in the world to report a profit for 2008. Its business is quite complex, including emergency generators, solar panels and motorcycles. Despite a slump in auto sales, those two-wheeled vehicles continue to sell well, especially throughout Asia and South America. Profits from those sales supported the remainder of the company last year - including its hybrid automobiles. Like grocers who offer specific foods at prices below cost to bring shoppers into the store, manufacturers are sometimes able to support specific “halo” products with the profits of others.
We have a new President in the White House and one of the key elements of his platform was taking a greener approach to managing our economy. Many citizens say they are interested in doing their part to help protect the environment, yet we have seen wind farms opposed by local residents from Maine to California. It also seems that even the most sophisticated manufacturers may have to sell at least a few SUVs to support reasonably-priced hybrid cars.
Now that two of the “Big Three” have borrowed money from the federal government, they must be attentive to its wishes, which may include producing more cars like the Prius and fewer of the very profitable larger vehicles. Our government’s approach to energy has generally been haphazard, consisting of short-term decisions aimed at narrow issues. For example, legislation regarding the use of corn as fuel led to riots in Mexico, as corn was diverted away from use as food. I think Thomas Friedman’s recent book, Hot, Flat and Crowded, spotlights a more sensible approach. Friedman calls the oil we import from the Middle East a “petro tax” and suggests that we are funding (thus arming) the very societies which “have drawn a target on our backs”. He contrasts our item-by-item approach with the more consistent energy policies of western European countries which have taxed gasoline, thus enriching those countries’ own coffers, while encouraging development of alternative energy sources. He calls for a thoughtful, long-term strategy which would lead our country to reduced reliance on imported oil while encouraging our own industries interest in non petroleum-based energy sources.
I have written previously about how various world governments decide whether to subsidize or tax gasoline sales, a choice based strictly on political considerations. As we reconsider our approach to energy, I wonder if a simpler, more market-based solution like Friedman proposes might not be the best strategy.
