by Ron Muhlenkamp   

 

Quarterly Letter

Over the past two years in our newsletters and seminars, we’ve discussed three major topics: the recession, bailouts and the credit markets, and changes in the regulations and structure of the financial markets. 

Our first topic was the recession. By the economist’s definition, the current recession is probably over.  By the media’s implied definition (GDP is still well below its prior peak and unemployment is well above its prior trough), the current recession will last a while, as it always does.  By the investor’s definition (a chance to buy good companies cheap), the current recession has been fulfilled.  The 50% rebound in the stock market since March is a sizable move by any definition.  (You can access our presentation by clicking this link: Recessions: What Do They Look Like?)

Our second topic was Bailouts, Your Dollars & the Whole Credit Mess.  In most respects the credit markets are back to functioning rather well.  Some of the money the federal government put into the banking system has been returned – with interest.  Other programs will take a while to work out, but we knew that going in.  The “Cash for Clunkers” program has ended, but some subsidies for housing remain.  Inexplicably, some congressmen are back to pushing for subsidies to help more low-income people buy too much house.

Our third topic was The Sign Posts of Change, showing how we monitor the recession, regulations, and markets. To that topic, in the fourth quarter of 2008 consumer spending as a percentage of GDP fell about 5% (and consumer savings rose by about 5 percent).  The first question was whether this was a step function – like stepping off a curb, or a new trend – like the first step down a flight of stairs. 

Since the beginning of 2009, consumer spending has been basically flat.  So now the question is to what extent consumer spending resumes growth or stays subdued.  If spending resumes, then providers of discretionary goods should do well, as they did following the 2001 recession.  If consumer spending stays subdued, (and consumer savings grow), then providers of financial services should do well, as they did following the 1990 recession. 

Frankly, I think people should rebuild their savings.  Savings are necessary to weather the normal swings of economic life and the unplanned emergencies which are part of that life.  As a group of people, we’ve dissipated our savings habits over the last twenty years.

In our public presentations, we have begun to ask two questions:

• “Over the past two years, how many of you have cut back on your spending?” (Nearly everyone says they have.)
• “How much has it hurt?”  (Not so much.)  This implies to us it may continue.

In the area of rules and regulations, I don’t believe anyone can state what the tax rules will be a year from now or what the regulations will be on companies providing health insurance or carbon dioxide emissions.  I do suspect that people will be reluctant to start or expand a business, at least until the rules are known – and not just business people.  As a result of proposed rules, we know doctors who are considering retiring and others who are discouraging their kids from becoming doctors. 

Our list of items being monitored remains:

• Consumer Spending;
• Business Investments;
• Taxes;
• Regulation;
• Velocity of Money;
• Federal Reserve and Treasury; and
• Credit Deflation / Bank Health.

We’re looking for clues to the direction of some of these trends to help our conviction going forward.  Much has been written lately about the coming defaults in commercial real estate.  We agree that this will be a problem, but it should be on the scale of prior real estate recessions and may be less than it was in 1989-90.  Prior to the 1990 recession, the expansion got overdone in commercial real estate.  This time, it was most overdone in residential real estate. 

-- Ron Muhlenkamp

The comments made by Ron Muhlenkamp in this article are his opinion and are not intended to be investment advice or a forecast of future events. Copies of past newsletters are available at www.muhlenkamp.com.