blog12oct2008

Hot Off the Web

The headlines are scary. Not only because of the 40% drop from peak of U.S. and Canadian markets, but also due to the swiftness of the drop. Some suggest that stocks are heading to still more losses, while others appeal to our sense of history that we are close to the bottom and there are tremendous values out there…unless we are going into a depression. Most discount a depression since governments are taking coordinated action to do what’s necessary in their wisdom to prevent a meltdown and to keep the economy moving without significant or prolonged contraction. The reality is that nobody knows where we’ll be in one year or three years; but unless it’s the end of the world or at least the end of the capitalist system as we know it, historically the market has recovered as liquidity returns, the economy and earnings start growing again and investors’ confidence returns. We just don’t know when. Most, though not all, of the following articles try to anchor an understanding of what’s happening based on historical perspective.

WSJ’s Mark Gongloff in “Crisis goes from bad to worse” writes that considering that S&P500 is  already down 40% and given that historically even the 2000-2003 and 1973-1975 peak-to-through drops were “only” about 50%, there many think that that it may be time to buy stocks. However since nobody knows the depth and the duration of recession. The author here suggests that “When the credit crunch begins to ease, high-grade corporate bonds could be attractive. Investors have fled from any credit-related risk and, as a result, the bonds’ prices are very low and their yields very high”. However while many assets are very cheap, they “but could get cheaper”.

In Barron’s “Closer to the bottom”  Jacqueline Doherty’s subtitle is “There’s reason to believe that the stock-market averages will hit bottom sometime in the next few months, even if the economy is still in the middle of a recession. The buy-and-hold approach still applies”. Anchoring on historical data she writes that “today’s 40% drop also far surpasses the average bear-market slide of 30% since 1940. Markets that decline for more than a year average a loss of 42%, says Paul Desmond, President of Lowry Research Corp. The Dow has fallen by more than 40% 10 other times, with all but one such drop occurring between 1900 and 1930. It slid by more than 50% only once, between 1929 and 1932, when it shed 89%. That bear was bracketed by the Great Depression, which lasted for 44 months. A recession is labelled a depression when economic activity shrinks by 10% or more. From August 1929 to March 1933 U.S. economic output contracted by more than 30%. That’s what made it “Great.””  But today’s stock prices are not unreasonable with trailing P/E of about 17 (but of course earning will likely fall further), though not as cheap as during mid 70s and early 80s recessions when it dropped to about 7. Some suggest that it could still get worse, but then since it is impossible to time the market, you may be unable to participate in a rapid market recovery.

In the NYT’s “Those with a sense of history may find it’s a time to invest”  Alex Berenson quotes Marty Whitman a well known value investor of 50 years that “as long as economies worldwide could avoid an outright depression, stocks were amazingly cheap” and “this is the opportunity of a lifetime, the most important securities are being given away.”

Jason Zweig in WSJ’s “What history tells us about the markets”  looks at the great depression when Benjamin Graham said that many stocks were selling “at less than the cash and marketable securities on their balance sheets”. Resorting to historical (Graham) P/E ratios he suggests that the worst-case scenario could take us much lower (another 50% down from here), but Zweig feels that this is a very low probability and quotes an economics professor that now “market is moving on fear, not facts”. Now the investors are incapacitated by stupor, which will then move to the final stage, and difficult to discern point, of “capitulation” which takes place when some investors will just dump their stocks. That’s when markets a ready to rise.

Globe and Mail’s Derek DeCloet tables “The depression’s history lessons”  His list of lessons are action oriented dos and don’ts: (1) “move quickly, be decisive” and reassuringly suggests that today’s leaders are well on the way of executing on this, (2) don’t be dogmatic about government deficits, they are OK during recession (as they act as a shock-absorber), (3) bailouts will likely continue, (4) prevent protectionism which, while politically it may emerge its ugly head, if implemented, will only make matters worse, (5) protect biggest banks, and asks if letting Lehman go was a mistake and (6) don’t believe the rosy story from leaders. He concludes with the current similarities to (property bubble, excessive debt, financial “innovation”, lame-duck president), and differences from (social programs, inflation, unemployment/economy, flexibility in economic policy) the Great Depression

And for those who want to read more about potential parallels with (and differences from) the Great Depression, there is John Authers’ piece in the Financial Times entitled “Heed the harsh lessons of history to find value” . He argues that this is not like 1929 (2000 was a more like that), but “our position is more similar to that of the late 1930s. That is not so encouraging: in the decade after October 10 1938, the S&P gained 5 per cent.” He also invokes Graham and Dodd approaches to security analysis where in security selection emphasis is placed on stocks of companies which have strong balance sheets and can generate lots of cash, giving investor a margin of safety.

Ron Lieber in NYT’s “Switching to cash may feel safe, but risks remain” empathizes with readers who just want to sell all stocks and go into cash, however if they plan to get back into stocks, he questions if they’ll be able to do that without missing a lot of the upside. “From 1963 to 2004, the index of American stocks he tested gained 10.84 percent annually in a geometric average, which avoided overstating the true performance. For people who missed the 90 biggest-gaining days in that period, however, the annual return fell to just 3.2 percent. Less than 1 percent of the trading days accounted for 96 percent of the market gains. “

And it takes a cool and calculating accountant to find the good news in this carnage. Tim Cestnick in Globe and Mail’s “Five ways to turn capital losses to your advantage” identifies five ways to profit from your capital losses. Among these are: (1) transfer losses to spouse (trigger cap loss, but have spouse buy same within 30 days-thus disallowing loss, then sell 30 days after cap loss was triggered-now spouse has cap loss), (2) debt swap (sell off losers without cap gain tax, pay down debt with non-deductible interest payment, buy original stocks with borrowed money), donate to charity, gift to kids and trigger cap gains to be offset by cap losses.

And finally, to further add anxiety to Canadian about their retirement, all the papers report that Canadian defined benefit pension plans took a major hit in the third quarter (e.g. “Canadian pensions the worst hit in 10 years”  ) Pension consulting firm Mercer estimates that funded ratio (not clear if though I suspect it is solvency rather than going concern ratio) in their model pension plan is 72% at end of the last quarter (Wow! That’s scary if your pension plan sponsor also happens to be in significantly weakened financial position.) Of course since the end of the quarter the damage continued unabated, so no doubt the ratio is even lower today. If you have a private sector defined-benefit pension plan you may want to read my just posted in-depth look at their deep problems and possible solutions in What’s wrong with private sector defined benefit pension plans? Everything? …Problems and Solutions.

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