Leonid Sorokin
Tools to Separate
When confronted with a mass of unknowns, we often use brief labels to separate subjects into smaller packages. It is useful for focusing our attention, but it is a gross selection device. For instance, night and day. Each of us has had good nights and bad days. Yes, it helps us divide a 24-hour period, but it does not lend itself to finely useful distinctions.
Unfortunately, popular pundit labels may be useless, or even misleading, in the art of investing. If one did a word count in the financial media, the three words most used would be “growth, value, and recession”. Some recognize how misleading these terms can be. This weekend, I received an electronic transmission from Seeking Alpha entitled “Amazon: No Longer A Growth Stock”. The New York Times business section had an article titled ”Value Stocks? Growth Stocks? It’s All Topsy-Turvy”.
These brought to mind my college discussion with Professor David Dodd of Graham & Dodd fame, about the wisdom of buying a particular stock that was selling substantially below its adjusted net worth. The great professor shut me up when I mentioned how much money his fund had made. I suggested growth investing made more sense.
He was right, of course, if he had reminded me that successful investing relies on losing little first and winning on the rest. I eventually learned this from his great disciple, Warren Buffett. His Berkshire Hathaway (BRK.A, BRK.B) stock is a prominent holding in my portfolio as well as my family’s holdings.
In examining the terms growth and value, I now recognize that the two labels should not be given to stocks, but to periods of time when a company is experiencing growth or value. The genius of Buffett and Charlie Munger is that they try to buy stocks that are priced as value but are expected to grow. They have done this recently with two integrated energy stocks, Chevron (CVX) and Occidental (OXY). Years before, they did the same thing with two financial services stocks, American Express (AXP) and Moody’s (MCO). Time will tell whether Berkshire’s newer positions in Apple (AAPL) and BYD (OTCPK:BYDDF) will produce similar returns. (I own all the stocks mentioned based on my own analysis, and I am therefore happy that Berkshire owns them too.)
Recessions
In today’s financial media, there is no single term that is more frequently used than recession. Like the terms value and growth, the term recession is not fully identified. Recession refers to a decline in economic activity. Economic history is full of intervals of decline, some brief and others lasting ten years or more.
For those of us emotionally connected with stock market prices, there is a tendency to label a “bear market” a recession. Most often, bear markets precede an economic recession, but not always. To me, a bear market is a price decline of more than 20% for the bulk of stocks. (This decline is normally more than twice the normal price gains of each of the previous two years.)
Bear Market
Since bear equity markets sometimes precede economic recessions, I have included bear markets as part of the discussion on recessions.
Investors enjoying rising stock prices want it to continue. They often rotate out of some or all their holdings that have slowed down from their previous substantial gains. Recognizing that past gains took time to achieve their above-average growth, the owners feel they need an accelerator to continue these gains. Accelerators can be any of the following or a combination: leverage through margin loans, derivatives, or newer, more marginal companies. Owning a lot of accelerators often makes them nervous, particularly when they are working. They are often more conscious of market risks and more susceptible to selling during minor price declines. If the declines reverse, they double up on the accelerators.
Cyclical Recessions
The same enthusiasm that drives bear markets also triggers excessive expansions of the larger economy. People and businesses believe the good times will continue and rush to increase their participation. The accelerator in this case is debt and other ways to take unprotected risk. These can be through loans or accepting future obligations to cover other expenses. A recent development is that over the last two Presidential terms, the deficit increased materially. (Some states have also increased debt, but many are limited by balanced budget requirements.)
Any review of history shows people, businesses, and governments being surprised by sudden negative conditions like wars, plagues, unfavorable weather, or a radical change in people’s behavior. Whether it’s the Biblical seven lean years or the assassination of the Archduke (or shooting down a “weather balloon”), bad things happen and people cut spending, which causes an economic downturn.
A cyclical recession is the most frequent type of recession and is usually relatively short in duration. They leave scares but not long-lasting pains.
Stagflation
This is a relatively rare condition that can last for ten years or more. Consumers and businesses feel squeezed by rising expenses, including taxes, and the declining value of income. These periods are usually caused by policy mistakes. One example was raising the Smoot-Hawley tariff to protect heavily indebted farmers. It reduced world trade combined with attempts to restructure the economy and government.
Depression
From today’s vantage point, the things that could impact us are:
- The term depression is usually attributed to a psychological disorder of unreasonable fears.
- The Depression started as a cyclical recession with too much farm and margin debt. It was made worse by government action, the Smoot-Hawley tariff to protect farmers and FDR’s attempt to restructure the Supreme Court and federal government.
These had both short-term and long-term impacts. Raising the tariff reduced world trade in an overly indebted global economy. This induced decline made it easier for authoritarian parties to get control of many governments.
Longer term, the relatively few remaining in the financial industry became very risk-averse and reduced the number of new employees. When my brother and I entered the financial community in the mid- to late ’50s, our bosses were much older and very risk-averse. They were not prepared for the good times of the ’60s, which gave us an early chance to grow.
This Week’s Comments
- “Apocalypse postponed” (An earlier comment before Friday’s jobs announcement)
- “Between 2019 and 2022 there was a decrease of 33 hours worked per person.” (15 hours from a drop in the labor force and 18 hours from younger, high paid, workers leaving)
- Vanguard’s ten-year per Anum projections:
Global Equities 7.4%
Ex US Global 7.2%
US Small Caps 5.0%
- A surge in bond buying will eventually lead to equity market declines hurting the retired.
- Capacity utilization in December was 78.8% vs. 79.4% in November.
- 7 of the 11 equal-weighted S&P sectors beat the weighted sectors.
- Jeremy Grantham says stocks are much too high historically.
My thoughts
Amazing how many investment professionals are exhibiting less fear of markets and inflation. (I think inflation is much greater than interest rates.) Inflation will be cured by an increase in sales.
The Friday jobs jump looks like an error, perhaps in the seasonal adjustment. This is just one of many errors in the numbers and actions of people suggesting everything is good or getting better.
What do you think?
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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