Investing or Gambling?

Years ago, when buying stocks, the pattern of many people was to carefully pick a target industry in which to invest, and then equally carefully pick companies within that industry that were growing or seemed poised to grow at rates faster than the general market. With this system, through the years, people made a few killings, and had a few losses, but overall created a steady and good return on their investments. Later, in managing a small 401k investment sthe process was the same, this time picking funds that were in target industries and that performed better than other funds in those industries. SGenerally the returns were better than double stock market indices growth rates. Buying in, and selling out of stocks, or more succinctly, TIMING was the key.

Some people pto them that this was not investing, it was gambling. Short selling seemed to be about the same thing; making a bet that a stock would go down, and making money when it did. It was also gambling. Sure, careful study preceded these investments, but because of the limited time period for them, it required selling on a schedule, not like longer term investments. Sometimes the timing was not favorable.

Day trading requires almost constant attention to the market, a luxury not available to most people.

Fortunately, most people did not become involved in the real estate bubble, although many did. In Phoenix, for example, there were plenty of opportunities. Property values in some areas increased 50%, or doubled, or in some cases even tripled in a year. The question was, “had the properties risen in value by the same amount as the increase in price?” It did not seem so. The great bulk of properties could earn only slightly greater rent because of higher property prices. It was apparent that properties were overvalued. (Some of this is 20/20 foresight, and some is 20/20 hindsight.)

For example, an investment group bought a nearby apartment complex with 270 units, and announced they would convert the units to condominiums. Tenants could buy their apartments at favorable prices, and a few did. After refurbishing the complex the new owners sold, in a little over two weeks, the remaining 200 or so units. Investors, not prospective tenants, bought the bulk of the condominiums. They gambled, and for the most part, they lost when the real estate bubble burst.

The same is so with most of the gamblers who expected great gains when they bought asset backed securities (derivatives), hedge funds, and other such paper instruments about which most people know nothing, or sold short, or bet on commodities, etc. In other words, they did not invest into value; they invested in paper assets. Underlying assumptions and the tacit assumptions behind them were either not investigated or ignored. Many of those paper assets disappeared, in many respects causing the mess our financial system, and our economy are in.

Here are some questions to consider. Readers say they appreciate your comments….

First, is there more benefit to the economy by investing in productive assets, such as operating companies, rather than investing into paper assets? Second, do the high-risk instruments and investments benefit our economy? Third, should we consider limiting or banning investments in paper assets and other high-risk methods of investing in the financial system?

Revision and more thoughts on the economy

It was only eight days ago that I posted a comment about the economy. In those eight days, worldwide financial and economic news was so bad, with massive employee layoffs, terrible earnings reports and steep stock market declines that, in my opinion, the comments in that post proved wrong. If there was an ethical way to remove those comments from the Internet, I would.

The better action, though, is to acknowledge an overreaction to the short-term developments that led to the opinion expressed. Following is a revised opinion.

Credit will slowly loosen making borrowing at all levels somewhat easier. The change will not be as fast as the Treasury and the Federal Reserve would like, but credit will slowly loosen. The Federal Reserve has started lending against commercial paper from banks and corporations, and some of the $250 billion used to capitalize banks by buying stock is deployed. Banks are slowly beginning to trust other banks – interbank loans are slowly rising. Yesterday’s news showed a rise in the rate of new home purchases, probably because cash rich buyers (there are some out there) see housing prices near the bottom of their decline. New home construction will not pick up for some time though because the inventory of unsold new homes is still high.

The Conference Board's index of consumer confidence index was just published. At 38.0, down from last month's 61.4, it is dismal. Consumer spending already is down. As consumer confidence declines, so does consumer spending. The present level of the index points to an extremely weak retail season. If gains in the stock market - up some 400 points today - continue, and gasoline prices stay down, confidence and spending will slowly return

Small business owners – hunker down. Reduce expenses as much as possible, and increase revenue if possible. Depending on the business, most of you can survive unless you are heavily in debt. If heavily in debt, have a contingency plan in mind or on paper so that if your line of credit is reduced or canceled you have a plan of action ready to go. Many options exist – take off the blinders and look at all.

I do not believe the US will suffer either the depth or the length of the worldwide recession that is at hand. However, it will be at least a year, and perhaps two years, before an upturn in the economy show up. Worldwide it will be deeper and longer.

In this country, we will have dodged a bullet. Barely.

Positive Signs 10/20/2008

Barring unforeseen surprises, of which there have been many, there seems to be light at the end of the tunnel of economic crisis. There are several signs of (the overused term) “cautious optimism” showing their heads long before Groundhog’s Day.

First, interbank lending rates are down today to the lowest level since September 30. That does not mean the credit crunch is over; in fact, it is long from ending. However, the lower rate does mean a larger number of banks are willing to lend to other banks – a statement of rising confidence in the viability of the banking industry. Confidence needs to increase even more before the credit crisis ends, but a glimmer of hope is showing.

Second, and quite a surprise, the Conference Board reported today a slight increase in leading indicators. Caution: this does not mean business will be booming soon. Nor, with a one-month increase, does it mean the economy is turning around. Having expected a decrease in the indicators, though, the very slight increase is welcome news. There is little question that the economy will continue to fall for some time; perhaps the slight rise means the fall will not be as severe as some expect. If there is continued rise in the indicators, a turn in the economy could be expected in less than a year.

Third, there is less and less doubt that the government will create another economic stimulus package. The style of the package will depend on the creators: either the current administration or a newly elected one (of either party.) Certainly, the infrastructure needs investment, and along with encouragement to the housing industry, a stimulus package can in short order return thousands of unemployed workers to newly created jobs.

Before dancing in the streets in celebration of an economic recovery, temper all the above with the size of the deficits that will follow, and the enormity of the national debt. The United States will be financially weakened for many years to come. We have put ourselves into a large hole and now face the perhaps impossible task of digging out.

Musings on the Economy

In the spring of this year, it seemed certain the economy was entering a recession. Oddly enough, based on the definition of a recession as two consecutive calendar quarters with shrinking GNP, we still are not in a recession.

Another definition sees a recession as a reduction in the amount of business activity in the economy, based on measures like employment, industrial production, real income and wholesale-retail sales. A recession starts as business activity reaches a peak and starts to fall and ends when business activity bottoms out and begins to rise. Using this definition, recessions last on average about a year.

Now, in the current economic drama, recession seems sure – using either definition. Employment is down; unemployment is up. Industrial production is down; wholesale and retail sales are down. Food and fuel prices have risen sharply, driving down real income.

There are some interesting good signs, though, even during the drama. The dollar is stronger. It has risen some 17% over the last two and a half months. Looking at the economy, that is a surprise. It seems it should have fallen further during that time. Apparently, compared to national economies around the world though, ours is better than most, giving strength to the dollar. If other economies are worse than ours are, they must be very bad. With the weak dollar, exports rose. As the dollar strengthens, they will fall. With a stronger dollar, the real cost of a barrel of petroleum is lower. Fuel costs are lower and may go down even more.

The critical issue in the current economic drama is credit. No one wants to lend money, especially banks to other banks. Without bank-to-bank short-term loans, credit availability dries up. The Fed yesterday intervened by buying commercial paper, never before done. Then the Fed, joined by the larger industrialized nations in the world, reduced interest rates. In the US, the federal funds rate dropped half a point. Mr. Bernake and friends are creative geniuses – he seems to have something new every day. The result, along with interest rate cuts worldwide, may stem the tide of the drama. If only (and how many times have you heard,”if only”) we get a few days of calming, these and other measures will begin to defuse the drama. I personally believe that the many measures and rescues of the Federal Reserve and the US Treasury will keep the economy from falling into a depression - defined as a severe economic downturn lasting several years.

Speaking of depressions, the Great Depression of 1929 lasted ten years, ending only when the outbreak in Europe of World War II began demanding greater output from our mines and factories. We certainly do not want that. Overburdened with a national debt far into the trillions, surviving a depression would become problematic.