Saturday, November 8, 2008


From the Desk of Joe Rollins

Winter is just around the corner, as evidenced by the chill in the air when I went outside to get my newspaper this Friday morning. I am not a fan of freezing cold weather, so I get a little melancholy when I see the trees turning bare and the plants and flowers going dormant for winter. But, there is something to look forward to…

One of the great joys of living in Atlanta is witnessing our spectacular spring begin. I look forward to the transitional period from winter in early March to the glory of our colorful spring in early April; I’m ever-amazed to see the 250 rose bushes planted at my home change from brown sticks to beautiful blooms and the many azaleas turn from ugly twigs to beautiful flowering hedges. The incredible metamorphosis from winter to spring is nothing short of spectacular.

It may be a stretch to analogize the change in seasons to the economy, but I truly believe we will see some spectacular changes in the financial world over the coming months. As brutal, complex and depressing as the news on the economy is today, a financial metamorphosis will occur in the spring of 2009. I know that skeptics cannot see how we will get from the current state of despair to a stabilization of the economy in only six short months, but I believe that the extraordinary efforts of our government and the coordinated efforts of the governments around the world to solve the economic issues will cause our markets to bloom again.

This past Thursday, there were coordinated worldwide rate cuts, as evidenced first by the Bank of England’s lowering of its key lending rate by 1.5% to a 54-year low of 3%. To understand the magnitude of this rate cut, the last time the rate was this low in England was in 1954. The last time the Bank of England cut rates this drastically was in 1992, but that was from a much higher level. A 33% cut in the key rate in one day was inconceivable before the unimaginable events that have occurred in 2008.

Moreover, the European Central Bank, which controls much of the European economies, cut their key lending rate by one-half of a percentage point to a two-year low of 3.25%. Even though Switzerland is not part of the European Central Bank, it likewise immediately cut its rate in a similar fashion. The 3.25% European Central Bank rate is still too high, but at least they’re moving in the right direction.

Similarly, the Bank of Korea in Seoul cut its interest rates a quarter point this Friday. As extraordinary as it seems, this marks the third rate cut they’ve made within a month, lowering its key lending rate to 4%. All of these cuts were made in an effort to reenergize South Korea’s economy.

The U.S. banking industry now has a Federal funds interest rate of 1%. It will not be long before the Bank of England and the European Central Bank are forced to lower their rates again. There is a worldwide, coordinated effort to stimulate the global economy by lowering interest rates and instituting other economic stimuli.

Unless the lessons being taught in economic textbooks no longer apply, I truly believe a turnaround in the economy will happen. Since the beginning of time, economies have been stimulated by the lowering of interest rates and other economic incentives. I have absolutely no concerns that these global efforts will fail this time. However, we need to realize that a turnaround will not happen in one day, in one week or even in one month; it will more than likely take five or six months. My suggestion is that we all take a deep breath and watch it all unfurl.

One week ago, my blog post centered on the progress being made in the economy, but since that time we have been on the equivalent of a financial rollercoaster ride. Last week, I pointed out that on October 10, 2008, the three-month London InterBank Offered Rate (LIBOR) was at an astonishing 4.82%. While I was writing my post, the rate had fallen to 3.05%, and the rate now stands at 2.23%. This means that in less than 30 days, the rate has fallen in excess of 50%. The credit markets are quickly thawing, and with this rate coming back inline with normal percentages, interbank lending will increase, expand and help to resolve the credit crisis we have been fighting for the last several months.

As I have mentioned on several occasions, I am absolutely stunned at the naïveté of journalists who cover the economy. It is absolutely amazing that they quote history so inaccurately and without basis on such a frequent basis. For instance, I have read many times in the last week that we are facing a recession similar to the 1980 and 1981 U.S. recession. It is astonishing to me that journalists would make those types of comparisons without checking the facts.

Some of you may not recall the recession of 1980 and 1981, but when President Reagan began his term in 1981, he was on a mission to destroy inflation. Annual inflation was running at an unbelievable 14.8% in early 1980 and, at that time, it was possible to buy a risk-free, 100% guaranteed Federal Treasury bond with a rate of 15.9%. There wasn’t much need to risk investing in the stock market when you could get risk-free rates in the double-digits. As an example, on January 1, 1979, the First National Bank of Atlanta (later acquired by Wachovia), offered a one-year CD rate of 19.79%. This was, of course, a gimmick to offer a rate of return that was the same as the year, but it still reflects the type of interest rates being paid at that time.

In the early 1980’s, under then Federal Reserve Chairman Paul Volcker, the Federal Funds Rate was moved up to a staggering 20%. First mortgages on homes were routinely at 17% or higher, and the stock market suffered through three terrible years adjusting to these higher interest rates and high inflation. However, when the stock market broke in 1983, it led to unparalleled U.S. prosperity that lasted all the way up to this year.

Journalists who try to compare the economy of the early 1980’s to our economy today are not comparing apples to apples. We currently have zero inflation in the U.S. compared to the 14% inflation of 28 years ago. Our prime rate of interest is 4% compared to the 20% rate at that time. Home mortgages today have an interest rate of 6% compared to 17% back then. Unemployment today is in the mid 6% range as compared to the 9% range in the early 1980’s. Do journalists even check their facts better before writing such alarming articles? Shouldn’t readership be gained by accurate reporting rather than by sensationalism?

This past week, one of my clients wondered why the banks are hoarding money. My banking sources tell me that almost every bank is covered-up in money, which is due to a combination of the Federal Reserve’s injection of capital in the banks along with the bank’s failure to make new loans. The byproduct of this hoarding of cash will be that interest rates will continue to fall on savings accounts. Therefore, CD’s and money market accounts are doomed to get even lower rates in the coming months than they are fetching today.

I know it feels like it’s been a lifetime, but it has literally been one week and two days since the banks were funded under the Troubled Asset Relief Program (TARP). It is unreasonable to assume that any coordinated effort to loan this money could have occurred in just this one-week period.

I continue to be frustrated by the so-called “experts” regarding their perceived failure of the TARP plan. As of this writing, only $180 billion of the $700 billion appropriated has been expended and that’s happened in only the last 10 days. I do not understand the belief that the injection of capital into the economy isn’t working when the injection has yet to occur. By government standards, this injection of capital is moving at warp speed. However, it just doesn’t seem to be moving fast enough for those on Wall Street.

There is a general consensus developing among Wall Street-types that investors should trade on a daily or even hourly basis. This phenomenon is best illustrated by the hosts of the CNBC show, Fast Money. On it, traders are not concerning themselves with stock market evaluation or traditional methods of valuing stocks. Rather, they are only paying attention to the ups and downs in the market. Every single day, they recommend buys, sells and shorts and, oftentimes, they trade the same stocks within the same 24-hours. This type of trading should only be left to Wall Street professionals. It is irresponsible and not conducive to the average investor, and can be financially catastrophic.

I received a number of phone calls this week regarding the two-day decrease in the market on Wednesday and Thursday after the big run-up on Monday and Tuesday. I got the sense that the investing public felt there was no reason that the market moved up so rapidly over the last several weeks only for it to fall so hard during the two-day 10% downturn that occurred. It goes without saying that I was tremendously disappointed in this downturn; but in all honesty, it was fully explainable and should not create alarm.

Since the market bottom in mid-October of 2008, the market moved up almost 18.5% in only a two-week period (by measuring the S&P 500). That is an extraordinary move by any definition. While the move did occur from a lower base, any move of this magnitude over a short period of time will bring out major sellers.

One of the favorite quotes on Fast Money is that you must, “Sell the Rips.” An 18.5% move in two weeks is clearly a “rip.” The market momentum traders came out in force after the major run-up on Tuesday and sold down the markets 10% in only two days. It’s most important to understand that the net positive move was 8%.

Before the market reaches a bottom, there is a period where bottom-seeking occurs. This is when momentum traders continue to challenge the market to find the bottom, and each time there is a lower low and higher high, that is a positive. It did not surprise me to see the market sell-off; it just surprised me that it happened so quickly. Hopefully, as we move forward towards the end of the year, we will see more of these cycles of lower lows and higher highs until we get back to normal higher ranges.

Jeremy Siegel, Ph.D.’s article, “Why Stocks are Dirt Cheap,” is particularly interesting, and I urge you to read it (click on the article title to read it). Dr. Siegel is a well-known professor of finance at the Wharton School of the University of Pennsylvania, and he is a well-regarded expert on the economy and financial markets. Dr. Siegel was one of the first to forecast the economic disaster of the dot-com era. We now have accreditation by two of the most famous all-time investors – Warren Buffett and Jeremy Siegel – that the relatively low valuations in stock prices today bode well for stock market investors in the future.

As Dr. Siegel points out in his article, “The total losses in the world stock markets have been over $30 trillion over the past year. That is about ten times the entire size of subprime mortgages issued over the past five years, the purported cause of the current crisis. I believe a year from now we will be looking back on this October, kicking ourselves for not having the courage to buy stocks.”

I am not trying to diminish the fact that the current economy is frightful. It is certainly not as bad as it was three weeks ago, but it’s rocky, for sure. However, you invest looking at the future, not the past. Stocks are a forecasting vehicle, and so what happened over the last 12 months is irrelevant history to valuations in the future.

Had it not been for the extraordinary actions of the U.S. government in concert with other governments around the world, I, too, would be concerned about the prospects for our economy. However, governments around the world have taken extraordinary actions and those actions will work. It’s important that we give it time to allow these economic fixes to occur. It is unreasonable to persecute the plan when it hasn’t been fully put in place.

It was announced that the unemployment rate for the month of October moved up to 6.5%. Given the extraordinary volatility and disruption that occurred during October, this is a fairly low rate. Frankly, I am somewhat surprised it wasn’t higher. Furthermore, while it’s insensitive to disregard the devastating effects of unemployment, from a stock market investing standpoint, there are actually benefits.

When companies recognize that their profits are not holding up and prospects are diminished, lay-offs are necessary. Unlike the American automobile industry which cannot lay-off employees due to restrictions put in place by the unions, private businesses can (and do) cut their costs. While this certainly isn’t helpful to the employee that loses his or her job, it materially helps the companies. This is always a positive for stock market investing.

The world is not ending, the economy will improve, and stock prices will be higher. My suggestion is that you give yourself a break from the talking heads and start enjoying the beautiful fall season. When the ground starts to thaw at the end of winter, a beautiful metamorphosis will occur.

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