Saturday, January 24, 2015

A comment from Rudi Dornbusch

Rudi Dornbusch was a professor of economics at MIT from 1975 until his untimely death in 2002.  A native of Germany, he spent the majority of his adult life in U.S. academia.  He was a renowned teacher at MIT who focused on international economics and macroeconomic theory.  He was by all accounts an amusing and provocative public speaker who was the highlight of any conference or consulting role that he participated in.  This comment from him was stumbled upon recently, and its truth has been seen repeatedly.

"In economics, things take longer to happen than you think they will, and then happen faster than you think they could."

Think of the 2008 market collapse in the U.S.  Concerns about the state of the U.S. mortgage and credit markets were not uncommon well before the crisis. Here on ENS there were comments beginning in 2006, continuing through 2007 and early 2008 that raised question about various credit practices and the levels of mortgage finance.  It took longer than anticipated for regulators or market participants in general to heed any concerns broadly.  Then when the crisis hit in the second half of 2008, it was for the most part not one that could not be rationally traded.  Everything was happening too fast.  Any attempt to look for value in a crippled stock was just doomed for more losses. Bargains were only possible in the first quarter of 2009 when most market participants were completely scared, exhausted, crippled by margin calls, or lacking liquidity.

In individual stocks the best example of that thought in recent times from a positive point of view is Microsoft.  After its spectacular run in the '90's, from the early 2000's to 2013 the stock languished in the low to mid-20's. The company had great patents, a near monopoly in its personal computer software, a pristine balance sheet, solid earnings, and yet it went nowhere as it was too big to have the high rates of growth that investors wanted.  I gave up at some point except in younger daughter's portfolio as she had the longest time horizon in terms of both life and in terms of not being aware of what I was doing and being able to criticize me.  In mid-2013, with a change in management from the befuddled CEO Ballmer, the stock began to move up steadily and is now at $47.  This was a no risk and obvious situation that was missed for the most part here because it took so long, and when the move began, slow but steady, there were almost no dips that could be traded.

GE would seem to be in the same situation now.  It's a great company but it is not happening.  Before the great recession in 2007 it was trading in the low $40's and back in the bubble it was trading at much higher levels.  It has not recovered and has been stuck in the mid-$20's for five years while at the same time dismantling much of its vulnerable finance division and bolstering its focus on environmental protection and cost efficient technology.  There is no giving up on this one.

On the immediate downside is IBM.  As recently as mid 2013 it was trading at $214.  Under the stewardship of CEO Ginni Rometty, the company has disappointed investors quarter after quarter over the last three years, with its restructuring process that never materializes into anything positive in its financial results.  Now the bottom has dropped out and it trades at $155.  What looks like a bargain may have more downside than upside at the moment, until she is replaced.

On the macroeconomic front, the U.S. financial market is not ringing any alarm bells, no recession in sight and modest economic progress continuing.  The U.S. of course is not an island, and the global economy is a cause for great concern that could shake the U.S. markets substantially if currency wars, deflation, political disruptions, and regional recessions proliferate.  We can see the potential for this but don't expect it now.  Is it possible that one day global economic problems will be upon us in a way that overwhelms the U.S. market's resilience and current role as a safe haven.  If so, how fast would that happen?

Preferring to be optimistic, Dornbusch's quote, which certainly resonates here, is one that leads to stepping back to ponder what's next.  Good alternatives do not come to mind other than keeping reasonable liquidity, taking some long term capital gains in outsized positions, and staying calm. Relatively speaking, the U.S. economic outlook is favorable and there is the potential for ongoing growth.  One could think Europe can only improve from this low point, but China will inevitably stumble at some point.  There is much to think about.  Stay calm I say to myself.


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