With all the talk of the current economic situation now being officially classified as a recession and quickly heading toward the official classification of a depression, I got to thinking that maybe it isn't a recession or a depression, rather a correction. When I explained this theory to Schlitz over lunch last week, he raised an eyebrow, but heard me out on my reasons for making that assertion.
If you've made it this far into this post, hang in there, I'll explain my line of thinking on this to you too.
First, I became a bit skeptical of calling this a recession when I noticed that the dollar has actually increased in value against competing currencies over the past few months. The 'experts' say, "well, this is a global recession and the U.S. is still an economic powerhouse." Okay, so if we're all in a global race to the bottom and the U.S. economy is actually falling slower than most of the rest of the world, wouldn't that support my idea that this is simply a correction?
Second, I started looking at the DJIA's historical graph from '70-present and noticed that the period from 1995-2007 just didn't fit with the rest of the graph. That period was a giant bubble in comparison. To put it simply, the DJIA was about 750 in 1970 and only climbed to 3,750 at the end of 1994. That's a change of 3,000 points in the span of 25yrs. Now, looking at the span of time from 1995-2007, the DJIA went from 3,750 to about 14,100 at its peak in October 2007. That's a change of over 10,000 points in 13yrs. What's that all mean? Well, from 1995-2007, the DJIA climbed at a rate that was over 6.4x as drastic as the preceding 25yrs!
So what happened from 1995-2007? The short answer is the dot com boom from '95-'01, followed by a housing boom that started with sub-prime mortgages in the early 2000s and finally spiked in 2005 and began to burst in 2006. Basically, it was a bubble that formed on top of another bubble, and when it finally burst, the market went down like few imagined was possible.
Getting back to my assertion that this is a correction rather than a recession or depression, I looked at history again and used it as the basis to form projections about where the market should really have been if the dot com boom and sub-prime mortgage that spanned from '95-'07. I chose the span of time from '86-'94 as my data group from which to project forward. Why '86-'94? Well, in 1986, the Tax Reform Act of 1986 was passed and it removed many tax shelters, especially in real estate, and put an end to the real estate boom that occurred in the early '80s. Basically, the span of time from '86-'94 fell between the early '80s real estate boom and the dot com boom of '95-'01.
Using a single arbitrary data point from each year (I chose a date in mid-January for each year), I formed a pool of data representative of the span of time from '86-'94 and projected it forward to eliminate the double bubble of '95-'01. What did I find? Well, using those projections, I found that the DJIA should probably be at 7,687 for January 2009. That's a pretty accurate projection considering the DJIA actually fell to 7,949 in January 2009. Since that point, the DJIA has found a new low of 6,594 last week. Well, doesn't that mean that my projections are off then? No, it doesn't... I'm not projecting the bottom, I'm projecting the normal level. Negative market sentiment could easily drive the DJIA even lower than 6,500. Until consumer confidence returns to normal, the market will continue to be a bear market and will be driven to levels below its norm.
While I won't get into it in this post, I've also created a theory on individual stock price projections using the same data points that also appears to be pretty accurate so far. Stay tuned for that as it may change your thinking on perceived values.
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21 comments:
Well this is clearly a recession (which is based upon GDP) AND a correction in the stock market. I'm not exactly sure the value of our currency has anything to do with it either.
That said, I agree with you that the Dow was completely out of whack with where it should have been. And I'm definitely interested in seeing your correlation between individual stock prices and the market indices.
I agree that this fits the definition of a recession as you accurately state due to the decline in GDP, but my contention is that it is different than in the past because this isn't unique to one country or region of the world, rather it is as the talking heads like to say, "a global recession" which has no definition.
If the rest of the world is falling right along with America's economy, but in most cases the other countries' economies are falling faster and farther, this should raise a red flag for all of us. Maybe the U.S. isn't as screwed as we might think or fear it is. In a race to the bottom, the first one there is the loser. This is where the correlation between competing currencies comes into play.
At its peak in July '08, the Euro was worth $1.58. Now, it sits at $1.26, a 25% drop against the dollar. Since December '09, the dollar has jumped from 87.44 Yen to 99.13 Yen, a 13% rise against the Yen. As recently as June 2008, the British Pound sat right at $2.00. Now, the British Pound sits at $1.38, a 45% drop against the dollar. As recently as July '08, the Canadian dollar was at a 1:1 ratio with the U.S. dollar. Now, the Canadian dollar is worth $0.77 USD, a 23% decline.
Why is any of that important? Well, because it gives a pretty clear picture that the rest of the world is hurting worse than the U.S. and is falling at far faster rates.
Paul, it seems like you use the word "correction" to describe a fundamanetal shift in how we value companies and are pointing out just how out of whack P/E multiples became under Greenspan's watch (or lack thereof). Therefore you intended the word "correction" to be distinct from an ordinary recessional correction. No?
Correct. I think the flaw in calling this a recession is two fold...
1. It includes the assumption that any down turn in GDP over two straight quarters equals a recession.
I'll use a simple example to explain my position on that. This can be paralleled to the level of a company, industry, country or so on...
Suppose you're working at a job for a time making a decent salary and small but steady pay increases. You've put in a few years and were able to buy a small house and a newer car with your salary.
Suddenly, business takes off to the point that you start receiving large bonuses, working lots of overtime and making a huge salary. Nothing has really changed with your performance, but this continues for years, and you're suddenly making a salary that's 3.5x your base salary. Like most people in your position would, you've adjusted your lifestyle to your earnings and you've got nice new cars and a big house in a wonderful neighborhood.
Then, out of nowhere, the work dries up. The boom has stopped and the workload drops to levels not seen in years. You find yourself saying, "This is the worst I've seen it since right around the time I started here. I'm really hurting, I took a huge pay cut and can't afford anything anymore, and I'll be lucky to stay in my house."
Some might call this a recession, and it very well could fit that broad definition based on the symptoms, but I contend that this is nothing more than a correction to where things should naturally be.
2. It doesn't consider that in the boom times, many adjusted their lifestyle beyond what their skill and salary potential levels would permit in normal times.
This helps to explain the reduction in consumer spending, the huge numbers of foreclosures, the devaluation of real estate, and so on.
We've all seen it around here in metro Detroit. The typical example of the longtime auto worker who drives a $50K truck, has a wife that doesn't work but drives a $40K luxury car, has a huge new house, a cabin up north with lots of toys, and two kids in college. Many of these guys are high school graduates who got into the company 25 years ago or more and now sit at the top of the pay structure, have the seniority to keep them employed and to get them first crack at overtime.
Logic should tell us that having only a high school diploma and no specialized skill set, this person would be living FAR beyond their means in normal times, however, recent history disputes that stance. Many of the unskilled workforce in these companies have historically outearned the skilled workers (e.g., engineers and designers) in addition to having greater job security.
This begs the question, should we really be using the last 10-15yrs as a measure of normalcy?
Should we base the criteria of a recession from the previous couple quarters?
What about the time period of '91-'00 in the U.S. where had 37 straight quarters of economic expansion, doesn't that skew the basis for calculating these numbers?
Well, based upon your defintion, I still don't think I would have a problem using the term correction in regards to the stock market, but I would still consider this a recession. It seems you're trying to put a positive spin on things, which is rare these days. But regardless of the terminology you use, I think individuals are going to frame this around their individual situation. Do people really care if Europe is in the tank worse than the US, if they are unemployed? Probably not.
Your example of an auto worker is interesting. I completely agree that union workers in general are overpaid for the job that they do compared to their skills. But looking at my own working career, I would consider this a recession personally, not a correction, based upon my skills. And there a whole bunch of industries out there where pay was not inflated. Good teachers have been underpaid for years because pay for performance was not around until recently.
All this being said, I don't know how valuable it is arguing over semantics, unless you can frame it in a way that benefits us when we start investing again. If you can use your definition with the statistical model you are working on to create a new (buzzword alert) PARADIGM, then this becomes a more important discussion.
Leave the semantics to the overpaid and overhyped TV financial personalities and economics professors. In the end, we are in a world of shit right now, no matter how you put it. The 20 minutes you spend trying to properly word your argument for the financial crisis we are in could be better spent researching stocks or learning about the markets. Unfortunately, our society cares too much about appearance and political correctness, and certain words frighten them. This is why so many people sell when the price drops (other people are selling) or buy when the price is high (other people are buying).
Trust me, I've been researching the market, individual stocks, other investments, as well as my own personal situation. My point is that comparing current stock pricing to 52-week highs or any other measure of history based upon the last 15yrs or so of the economy is pointless. I could care less about trying to put a positive spin on anything, I only want to put money in my pocket and secure my future financial positions.
I've already projected out the share prices on roughly 30 different companies, many of which fell right in line with current pricing, some were far above or below pricing points currently found in the market. This has, in part, helped to change my outlook on the perception of value, but it has also helped me wrap my head around why I've watched many stocks fall so hard in comparison to the market without having any real explanation why it was happening.
Maybe we can take the discussion away from semantics then, and take a look at your findings for what stock values should be at the Monday meeting. And then post the findings and discussion on the blog.
I definitely think you are on to something with trying to determine a correct value for the market based upon 100 years of history rather than 15 years. That has much more value than the arguing of definitions that we have been doing, which I will take responsibility for instigating.
Schlitz, any thoughts? I know you have looked into this as well.
I still feel that you are missing the main point of this theory and my reasons for this post. It isn't to spread cheer, to argue semantics or to be a ground breaking economist.
The reason for this post is to caution anyone who reads this that using the previous 15yrs of economic data as the basis for determining value may be a grave mistake. This goes for the individual as well as our investment club.
Case in point, let's take Manitowoc (NYSE: MTW). If you looked at the 52-week high of $45.47 against the current share price of $3.15 you'd probably say that it was a huge value. However, based on the projections from '86-'94, it says MTW should be valued at $3.27/share in early '09. Not such a great value anymore, huh? Keep in mind that MTW's business has changed a bit since the time of the projected data, so the projection may actually be a bit pessimistic (or it could be a bit optimistic), but this begins to help unravel the question of why MTW's share price kept falling, more than the market, even without any bad news. The shares were simply overvalued for the years leading up to the bubble bursting.
While I still like Manitowoc as a company, don't plan to unload my shares, and think they will grow in value over time, it is no longer something that I see as a once in a lifetime deal. Rather, I see it being right in the neighborhood of where it should naturally have been when the bubbles of '95-'07 are removed from the picture.
Does inflation factor at all into any kind of projection?
I didn't include a separate factor for inflation, but I'd say that it should be accounted for since I used real data points spanning '86-'94 where inflation naturally would have occurred.
http://www.esquire.com/blogs/lists/rick-santelli-rant-030909
Talking heads = entertainment, not education
People should be intelligent enough to do their own research rather than blindly following anybody.
I'm curious, do you know what the correlation using this theory looks like for the S&P 500 or the NASDAQ as well? I'm guessing it would be the same, but I don't know.
Yes...
NASDAQ projects to 1522.54 in January '09. It actually started the month at 1577 and ended at 1476, so that number is spot on.
S&P 500 projects to 955.39 in January '09. The actual January '09 high was 934.85 on January 6, so that number is also very good.
Have you looked at P/E ratios as well, possibly by sector? I think you mentioned that in the past. I would imagine that would also help in projecting the share prices of individual companies in a particular sector.
One other question, how specifically did you extrapolate the share price of MTW?
Same way as everything else. I took an arbitrary data point from January 10th of each of the years of '86-'94, then projected those numbers forward.
First off, I'd like to say that I did not mean that you were not doing any work. I was pointing out that many people consider "research" to be watching Jim Cramer scream at them, or just some dramatic baffoon (Santelli) yell about this or that. Too much of the mainstream media's economic analysis seems to be more for entertainment rather than valuable, insightful commentary, which makes sense because they are working for ratings. I think this blog is touching on important information for the new or average investor, but I would like to see more stock specific information. Routinely updated stock analysis for major companies and perhaps a segment in the buy/hold/sell arena could also be very useful.
In any case, I was wondering if you take your extrapolated stock value as the average, then have the peaks and valleys the market been increasing in magnitude in the past 15 years? You made a good point about Citigroup that although it may not be the best run company (for now, that may change in the future) the value of stock was good, and in the end, your goal is to get the biggest return possible. An aspect of the stock analysis is how it compares to its fair value. Your extrapolation could go a long way in determining a company's actual fair value, so that when the price is significantly above that, you sell, or significantly below that, you buy.
Also, do you think you can incorporate this type of analysis into companies in emerging markets, that do not have the history of other companies, perhaps by looking at sector?
The best research that can be done is to take everything in, and to then draw your own conclusions from that. That includes watching guys like Cramer scream at you, because believe it or not, he's actually got some legitimate points. While I might disagree with many of his "buy, buy, buy" or "sell, sell, sell" picks, I can, at a minimum, hear his line of thinking and get stocks on my radar that wouldn't otherwise be. Anyone relying on one voice to guide them is missing out on a wealth of information.
Personally, I do a lot of reading, discussing and my own investigation and theorizing, in addition to watching the typical talking heads. To make the assumption that I watched Cramer (or some other talking head) and made a corresponding blog post is the extent of the research I did is not only uninformed, it is insulting. This economic theory is 100% my own, and largely came about after lengthy discussions with Schlitz.
I feel that I'd be doing a great disservice to anyone that may come across this blog to continue to shell out stock picks at the same time I'm developing the belief that the criteria traditionally used as a gauge is defective.
Albert, I'll answer your questions in order...
1) While I haven't really cared about the magnitude of the peaks and valleys in particular, it is pretty clear by looking at the graphs that the day-to-day and month-to-moth swings have become greater in magnitude of points in the past 15yrs. That said, they may not have changed in actual percentage change... I haven't had a reason to check that though.
2) I can't say that I'd feel too comfortable speculating on companies or industries that didn't exist during the time span of '86-'94. Reason being, I feel that these companies might be naturally overvalued due to their market entry point being overvalued. Also, many of these companies are service and technology oriented companies that don't actually produce a tangible product you can hold in your hands and quantify a value for, so that makes valuation a bit tougher. With technology advancing at an unbelievable pace, 5yrs is an eternity in an industry like computing. What was considered cutting edge and would have cost a premium a year ago, can likely be had for a lot lower price or may even be considered outdated now. Beyond that, it fits in with Buffett's philosophy on value investing; don't speculate on companies or industries you don't fully understand. There are too many other companies out there I feel like I've got a better understand of that I can invest in.
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