QUARTERLY LETTER

Published Fourth Quarter 2002
Muhlenkamp Memorandum 64

October 2002

The economy continues to expand and the markets remain volatile. Several interesting things are going on. Six percent unemployment means that 94% of the people who want to work are working. These people are earning an income. They have only two choices. If they spend their income, the economy comes back fairly strongly. If they don’t spend their income, the economy remains slow and interest rates decline and they get the chance to refinance their mortgage once again. People are doing some of each, so the expansion is about half-speed and mortgage rates are declining. You may recall that the expansion coming out of the ’90 recession was half-speed, and that didn’t work out too badly.

Also, as sometimes happens in a recession, consumers are shifting their spending patterns. In this case, they are shifting towards spending on their homes and on autos. So we have the fascinating circumstance of economists lamenting the fact that consumers are spending too little at retail stores and too much on housing, as if consumers should allocate their spending patterns to conform to economists models. Folks, this is backwards. Economists models are useful only to the extent that they conform to the actions of consumers/workers/taxpayers. Over the years, I’ve learned that when economists say one thing and consumers do something else, watch the consumer.

From January through May of 2002, stock prices reflected the relative values and economic strengths of various industries and companies. In June and July, none of this mattered. Segments of the investing public wanted out of their stocks and out of equity mutual funds and they sold – regardless of price. This emotional sell-off appears to have climaxed in late July. Since then the stocks of good companies at cheap prices have begun to outperform their competitors and overpriced stocks. We expect this to continue. While we cannot say for sure that we won’t get another emotional sell-off (we can never say that), the odds decline dramatically after each one.

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