On September 30, 2006, the Net Asset Value
of the Muhlenkamp Fund was $80.72, down $3.72 year-to-date. Click
here to see the current Net Asset Value of the Muhlenkamp Fund. From 2002 through 2005, the economy was in a recovery mode. The recovery was strong enough that many people, including members of the U. S. Federal Reserve Board, became worried about inflation. In response to their fears, the Fed followed a policy of steadily raising short-term interest rates; first back to normal levels and then to a level designed to slow the economy to a sustainable non-inflationary pace. As short-term rates approached 5%, inflationary fears boosted long-term rates above 5%, causing the prices of long-term bonds to decline. Meanwhile, the price of many raw materials, especially oil and gas, were bid up on the strength of the world economy. Last year’s hurricanes in the Gulf of Mexico decreased available supplies of energy, resulting in further price increases and fears of inflation. The stock market reflected these fears. For the past couple years, strength in the stock market was concentrated in a mix of industries including commodities, energy, and real estate. The interesting thing about inflation is that it is calculated by adding up price changes, but it is caused (we believe) by the Fed printing money at a rate greater than the rate of real GDP growth. Since the various measures of money growth have been well-contained in the past few years, we did not share the market’s fear of inflation. All of the above has changed in the last six months, which is why we believe that “transition period” is coming to an end. Specifically:
In response, since May, stock market fear has shifted to a fear of recession. Stock price leadership has shifted to groups such as telephones, electric utilities, foods, soft drinks and healthcare. Leadership has also shifted from small-cap companies to large-cap companies. These shifts make sense if the economy were entering a recession. The dramatic slowdown in orders for new houses has fueled this fear. We admit that the fear of recession due to Fed tightening may be well-founded. Since WWII, the Fed has engineered a “soft landing” (a growth slowdown that doesn’t become a recession) once, in 1994-95, and has triggered recessions ten times so the odds of a successful soft-landing may appear to be slim. Nevertheless, we believe that the odds this time favor a soft landing. Recent data from the economy and the markets reinforce that belief. As this data is absorbed, we believe the fears of inflation, and of recession, will dissipate. We believe this will allow the prices of many stocks to begin to reflect the values we see. In short, we think it’s a good time to be investing in the companies we own. A Caution: We do believe the markets will remain
quite volatile on a day-to-day basis. The number of people and the amount
of money attempting to beat the market on a short-term basis makes daily
volatility almost certain. And there will be more examples similar to
the hedge fund Amaranth. Amaranth lost half of its value in a week due
to leveraged positions in energy. Emotional
vs. Intelligent Economics BACK In Muhlenkamp Memorandum
#74, I wrote an essay entitled, “Optimizing Investment Performance.”
In that Intelligent – Reflecting good judgment or sound thought. Too often, investors get caught up in the hype of the current investment trend. They buy when a stock is climbing because it’s doing so well, and they sell when it is falling because they are afraid of losing more money. However, this emotional approach is costly; it is a formula for buying high and selling low. As a result, the average investor sees only a 3% annual return, while the average equity mutual fund returns 10%1. With this in mind, I believe I showed the reader how to become a more “intelligent” investor and improve his or her portfolio’s performance. Just as investors often react emotionally to markets, so too can investors react emotionally to economics. That’s right; economics can be either emotional or intelligent. In this essay, I’d like to apply these concepts to the field of economics. Webster defines economics as follows: Economics - a social science concerned chiefly with the description and analysis of the production, distribution and consumption of goods and services. Sometimes Webster is too exact for his own good. What economics really boils down to is people and their choices. By understanding economics (people and their choices), we can promote policies that lead to stronger economic growth. So let’s take a moment and see if looking at economics in terms of “emotional” and “intelligent” can help us better understand economics. “Emotional economics” is very prevalent. All you need to do is turn on the nightly news or open the daily paper and you will see it. Emotional economics looks at an issue, considers the immediate impact on the group of people most directly (adversely) affected, and draws a conclusion. This sort of economics has several advantages: it is easy to understand, easy to sensationalize (so it gets lots of media coverage), and there is usually a special interest group eager to tell you what we, as a nation, must do about it. However, it has a serious disadvantage. It often leads to poor public policy because it ignores the long-term effects of the policy on those outside of the special interest group. In Economics in One Lesson, Henry Hazlitt alludes to this when he says, “economics is haunted by more fallacies than any other study known to man.” He states the two main causes of these fallacies are “endless pleading of self-interest” and “overlooking secondary consequences.” Additionally, he says, “The bad economists... see only what immediately strikes the eye.” Don’t “endless pleading,” “overlooking secondary consequences,” and “seeing only what immediately strikes the eye” sound emotional to you? The alternative is “intelligent economics.” Intelligent economics looks at an issue, sees the immediate impact on the group of people most directly affected, and then asks “who else does it impact?” Intelligent economics digs deeper into the issue to find the secondary effects, the long-term effects, and the effects of a policy on all groups. So when you hear an economic debate, the first thing to do is to determine if the argument presented is emotional or intelligent. Emotional economics Intelligent economics Let’s look at an example. In the recent debates over free trade, what is immediately visible and emphasized in media coverage is the plight of textile workers who have lost their jobs as production has moved to China. The displaced workers and representatives of their interests lobbied the government for intervention and the result was quotas between the American and Chinese governments on imported clothing. The outcome would appear to be that the textile workers found partial victory and remain employed. But in trying to help the textile worker, have we created secondary consequences? The reason that textile production moved to China is that the textile companies could make clothes cheaper in China than in the United States. Therefore, the clothes made in China cost the American consumer 30% to 50% less than clothes made in the United States. With quotas on imported clothing, American consumers will need to spend more on clothes, which means they will have less to spend on other things. This will hurt the workers in the industries that supply those “other things.” Taking a moment to look at long-term effects of free trade, we notice the jobs being exported are in industries that are experiencing declining profits and have become less competitive. In free markets, capital flows away from declining, low-profit industries to growing, high-profit industries. Economic convention tells us the jobs in these declining, low-profit industries will slowly disappear even if they are not exported because new capital will be invested into higher-profit industries and labor saving machines. By imposing quotas and tariffs, we are helping ailing industries to limp along and keeping resources from stronger industries that are trying to grow. Now, let’s look at a secondary consequence on labor allocation. Textile jobs have been moving overseas for years, creating a surplus of labor in the Southeast. Foreign car companies subsequently opened new assembly plants in the Southeast, in large part because labor was available. The lost textile jobs paid $10-$15 an hour. The new automobile assembly jobs pay around $25 an hour. Given the choice, which job would you prefer? I would suggest that our protectionist energies are better spent helping the workers in their transition from an ailing industry to a thriving one. Undeniably, the transition is painful, but if we keep our resources in industries that are faltering, we hinder the industries that are growing. The United States has a long history of special
interest groups lobbying to protect jobs. However, if we fail to consider
the secondary consequences and blindly protect the declining industries
from foreign competition the results could be devastating to our economy.
As consumers, each of us would feel the impact by having our standard
of living reduced in the form of more costly goods and services. Additionally,
we risk having a stagnant economy based on declining industries. Unemployment
would rise as industries continue to decline and growth industries
would unnecessarily slow as they are robbed of available labor. Prime
examples of such protectionist economies are France and Germany, which
both suffer from low growth and high unemployment rates (see following
table). I believe that their protectionist policies are a significant
factor in their poor growth and rampant unemployment. Unless we want
to emulate these economies, we need to consider long-term, secondary
effects of economic policy on our whole economy, not just on special
interest groups
There is one more argument that the special interest groups present that we should address here. Very simply, the special interest groups argue that if we keep exporting American jobs, one day there will be no American jobs remaining. But in fact, the United States has been exporting jobs for decades. In the 1980s, they were exported to Japan; in the 1990s they were exported to Mexico, Taiwan and Korea; today they are being exported to China and India. In each case, our economy continued to adjust, higher value-added jobs were created and consumers prospered. Data from the past 25 years shows unemployment declining from 7.1% in 1980 to 5.1% in 2005. Real incomes have risen 13% for lower incomes and 24% for higher income workers, while the number of workers has grown 28%2. This is because our economy is still essentially a free market economy, which allows businesses to allocate capital and labor efficiently, delivering goods and services to consumers better, faster and cheaper. Using “intelligent economics” is certainly not easy.
It requires asking hard questions and doggedly looking for answers.
There’s no anchorman to tell you what to believe. There’s no lobby
group to tell you what to do. You need to question what you hear and
read in the media. You need to ask who else is affected, and how.
You need to consider secondary consequences. You need to look to the
long-term effects. Certainly, we need to address the immediate issues
of economic decisions, but not without considering all the implications
that are not immediately apparent. Fortunately, our economy has shown
great resilience in the past. If we endeavor to practice “intelligent
economics,” I believe we will better understand the implications of
economic policy, and this understanding will lead to better policy
and a stronger economy. The results for American consumers will be
a continued rise in real incomes with higher paying, value-added jobs,
low unemployment, and available goods and services that are better,
faster and cheaper — all of which leads to a higher standard of living
for all Americans. 1 Based on a study done by
Dalbar Inc., using data from 1984 to 2002 Announcements
Back *Forbes magazine’s rating criteria for earning a place on the Forbes Mutual Fund Honor Roll include: 1. Strong relative performance in up and down markets; Please click here to see important performance-related information. 2006 Distributions
IRA Account Maintenance Fee Muhlenkamp Fund Minimum Balance Maintenance To avoid having this fee deducted from your account, you may choose to either submit a check to raise your balance above $1500, enroll in the Automatic Investment Plan (AIP) or close your account. If you choose one of these options, your request must be processed by November 15th to avoid having the fee deducted from your account. Automatic Investment Plans do not assure a profit and do not protect against a loss in declining markets.
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