QUARTERLY LETTER

Published Second Quarter 2002
Muhlenkamp Memorandum 62

The economy has turned and is beginning to expand rather than contract. As is normal in transitions, the crosscurrents are many. Some data have turned plus; others remain minus, so forecasters can argue either side. As a friend of mine observed a similar transition nearly thirty years ago, "If you look for remaining signs of winter, you can find them long after spring has begun. If you look for signs of spring, you can find them long before winter is over."

We’ve been expecting economic spring; but frankly, it seems to be coming quicker than even we expected. Stock price moves in early March indicate that many investors are even more surprised than we are. The increase in prices for many cyclical stocks from homebuilders to auto parts to hand tools farm equipment has been truly dramatic. Suddenly, investors believe that the recession is over.

We believe that the recession is over. But we also know that the data will remain mixed for some time, giving ample fuel to fears of a double-dip and/or of rising inflation and interest rates. As a result stock prices will remain quite volatile. But the bottom line is – Economic Spring is here. Enjoy it.

There are also fears of a spread of "Enron-itis" – an epidemic of disclosures of corporate theft and accounting dishonesty. These fears are fed by some people who believe that all businessmen are dishonest. We’re about to relearn the lesson that most businesses and businesspeople are accurately portrayed in their financial statements. Granted you may have read the footnotes to get a good picture, but knowledge seldom comes without some effort.

As the Enron saga demonstrates, some managers do lie to us. (I figure about 3-5% – much like the general population.) And we have no recourse against management lying – except to limit the amount we invest in any one company. That is the purpose of diversification: to limit our risks in areas where we have no other protection. It is interesting to me that businesspeople comprise the only profession whose results are audited and widely disseminated. What would happen if we audited the professional results of doctors, lawyers, economists, professors, congressmen, etc.?

A couple of observations: all the recrimination about the events of 9/11/01 and the demands for greater airport security, little has been said about the key issue of allowing the hijackings to occur in the first place. The hijackers complied with airport security, only carrying weapons that were allowed. The hijackers succeeded because they exploited a dumb policy. The policy of the Federal Aviation Administration (FAA) was not to resist hijackings.

The policy has since been reversed, but I’ve seen no statement from the FAA changing the policy. Airline passengers and crews have reversed the policy. The passengers of UAL Flight 93, which crashed in Southwest Pennsylvania, first reversed it. It took these passengers but a few minutes to reverse the policy, and airline crews but a few hours. Folks, we airline passengers are safer today than we were on 9/10/01, but it’s mostly due to this change in a dumb policy, a change brought about by passengers and crews.

A recent Wall Street Journal article stated that the government and the American Medical Association (AMA) are moving closer to allowing payment for organs used in transplants. The whole idea of economic incentive (money) as an inducement to donate organs has been anathema for much of the medical profession, but particularly to the United Network for Organ Sharing (UNOS), the non-profit group that coordinates transplants for the federal government. The article states that 79,000 people are awaiting organs for transplants. But there are a limited number of organs available, and over 5,000 people die each year while waiting for organs.

The AMA could solve the shortage with the stroke of a pen (i.e., a change in policy). If they stated that henceforth priority for donated organs would go to those who had volunteered to donate their own organs (and signed a donor card) and that priority would then be given to whoever signed their card at the earliest date, they would have a surplus of available organs in less than three years. The ideal organ donors are healthy people who die unexpectedly. We kill over 40,000 of these people on our highways every year. Yet, healthy people have no personal incentive to sign a donor card. So they don’t.

The only downside to my suggestion is that some doctors at UNOS would no longer get to play God, deciding who lives and who dies. My suspicion is they won’t want to relinquish their role.

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