QUARTERLY LETTER

Published First Quarter 1992
Muhlenkamp Memorandum 21

1991 has been a good year. For our clientele, it has been a superb year financially. Not all problems have been solved, but they never will be. We are now seeing the payoffs of the slowdown that our federal government engineered nearly 4 years ago. For a number of reasons the slowdown became a recession and it persisted longer than desired. The payoffs resulting from the recession are lower inflation and interest rates. These are driving forces that have strengthened the bond and stock markets and will reinvigorate the economy. "How can the market be up when the economy is down?" is the question of those who fail to understand that this is normal. The market almost always leads the economy because it is much quicker to react to changes in the underlying conditions that drive both.

The fourth quarter of 1991 had a number of crosscurrents that served to feed the hopes and fears of bulls and bears alike. Though we witnessed the final dissolution of the U.S.S.R., Yeltsin and his advisors seem to have taken poor monetary advice (from mainstream international experts) and subjected their people to unnecessary pain and suffering. But that's a topic that will have to wait for another time. If you want a brief argument for the alternative see Jude Wanninski's editorial column in the Wall Street Journal on 12/20/91, page A14.

As we said above, the recession drags on well past our expectations and those of the experts. We seem to have reached the point where the public is giving up and the politicians are panicking. Today, it's not unusual to hear people lament the state of the economy, comparing it to the hard times of the depression, only to have the conversation shift to a discussion of a newly discovered restaurant or the price of plane tickets to Florida. In mid-November, President Bush suggested that banks lower rates on credit cards. Within 24 hours this was followed by a senate vote to force banks to do so, which precipitated a 4 percent drop in the stock market. In turn, President Bush promised that he would look at all available options but would not (again) do anything "dumb."

While it is discouraging and a bit frustrating to observe such ignorance of basic economics among our leaders (and our populace), it has ample precedent. I recently read, A Financial History of The United States, and learned that each and every thing we have seen in the past twenty-five years has occurred at least four times in our short two hundred years as a nation. I found this both heartening and disheartening. Nevertheless, recessions are fundamentally self-correcting and this one will end sometime. Recent history suggests it will end at just about the time that the public gives up and the politicians panic, or right about now.

Meanwhile, on December 29, Alan Greenspan told Congress that economic recovery was stalled by the unanticipated decisions of businesses and households to pay down their debt. We believe that this fact and his statement on it go a long way toward explaining what is happening in the economy and the markets. On the following day, the Fed lowered the discount rate by a full point, and touched off a sharp rally in the bond and stock markets. In the 23 years since I have been paying attention, economic predictions have been most wrong when the public changed its "anticipated" actions. More than in the past, the current change in action by the public is visible and possibly measurable.

Read our quarterly newsletter, Muhlenkamp Memorandum, for more by Ron Muhlenkamp.