Welcome to the Oracle of Omaha’s “Long, Deep Recession”

Warren Buffett Investing: Welcome to the Oracle of Omaha’s “Long, Deep Recession”

by Alexander Green, Chairman, Investment U

Investment Director, The Oxford Club

Friday, May 30, 2008: Issue #801

Warren Buffett opined that the United States is already in recession, even if it’s not in the sense that economists would define it: two consecutive quarters of negative growth, in an interview with the German magazine Der Spiegel on Saturday. Furthermore, Buffett argues the recession “will be deep and last longer than many think.”

Sounds pretty ominous. After all, Buffett is now the world’s richest man - he recently surpassed Microsoft chairman Bill Gates - and is easily one of the planet’s most successful investors. If Buffett himself thinks the economic outlook is lousy, the average punter thinks, maybe I should get out of the market.

If you have money in the stock market that you will need in the next few months ahead, you should. (Not because the market is about to go down - although it may - but because money earmarked for short-term expenditures shouldn’t be in the market in the first place.) (Comment: The largest market losses, as you would expect, are in the beginning of any recession.)

However, if you own stocks to meet your long-term financial objectives, stay put. And look for fresh opportunities, too. After all, that’s what Buffett himself is doing… (Comment: The largest gains come from staying invested through the entire period. The numbers show market timing would have given you an 8% gain at best and a -3% loss at worst. )

Warren Buffett’s Global Investment Opportunities

One of the reasons Warren Buffett was in Germany is that he shares our view that you should search worldwide for the best investment opportunities. Right now Buffett would like to put Berkshire Hathaway’s cash war chest to work in a few well-managed German family-owned businesses.

But why would Buffett buy companies if the economic downturn is likely to be deeper and last longer than generally expected? (Ooops. Same comment: The largest market losses, as you would expect, are in the beginning of any recession. The largest gains come from staying invested through the entire period. The numbers show market timing would have given you an 8% gain at best and a -3% loss at worst. )

Because he knows that nobody can accurately or consistently predict something as big, diverse, and dynamic as the global economy. (Work like this is better left to the experts: you know, palm readers and Ouija boarders.)

Warren Buffett knows that even if you somehow knew what was going to happen in the economy, you still wouldn’t necessarily know what was going to happen in the stock market. Stocks fall during good times. They often rally during bad times. Money manager Ken Fisher doesn’t call the stock market “The Great Humiliator” for nothing. (Same comment again: The largest market losses, as you would expect, are in the beginning of any recession. The largest gains come from staying invested through the entire period. The numbers show market timing would have given you an 8% gain at best and a -3% loss at worst. )

Buffett knows that the stock market is a discounting mechanism. It takes the news and reflects it into stock prices immediately. Who in their right mind would sell their stocks today because he realizes the economy is slowing down. We’ve known that for months already. (And again: The largest market losses, as you would expect, are in the beginning of any recession. The largest gains come from staying invested through the entire period. The numbers show market timing would have given you an 8% gain at best and a -3% loss at worst. )

And, finally, Buffett knows that nothing beats the long-term returns available in equities. Where else can you put your money to work today? In real estate that is in a death spiral? In bonds that pay less than 5%? In money markets yielding 2%?

Warren Buffett’s Investment Strategy

In the same interview with Der Spiegel, talking about his investment strategy, Warren Buffett said “If the world were falling apart I’d still invest in companies.” In other words, he gets it. There is no superior alternative to common stocks. The long-term returns of every other asset class pale by comparison.

In an interview in the April 28, 2008 issue of Fortune, Buffett said “I think we’ve got fabulous capital markets in this country, and they get screwed up often enough to make them even more fabulous. I mean, you don’t want capital markets that function perfectly if you’re in my business. People continue to do foolish things… and they always will.”

Realize that when other investors sell too cheap or buy too dear, it creates opportunities for those of us on the other side of their trades.

Buffett ends his Fortune interview by saying, “Stocks are a better buy today then they were a year ago. Or three years ago… The American economy is going to do fine. But it won’t do fine every year and every week and every month… The only way an investor can get killed is by high fees or by trying to outsmart the market.” (And again the same comment: The largest market losses, as you would expect, are in the beginning of any recession. The largest gains come from staying invested through the entire period. The numbers show market timing would have given you an 8% gain at best and a -3% loss at worst. )

Amen. They don’t call him the Oracle of Omaha for nothing.

Good investing,
Alex

Alexander Green’s recommendations have beaten the Wilshire 5000 Total Market Index by more than 3 to 1 over the past five years. To get access to a steady stream of the companies he expects to outperform this year, consider joining The Oxford Club, our premium service. You’ll have access to all of Alex’s growth-stock recommendations in a matter of minutes. Learn more.

http://www.investmentu.com/IUEL/2008/May/warren-buffett-investing.html

Rules for Investing in the Next Bull Market

Rules for Investing in the Next Bull Market

Sponsored by by Brett Arends
Wednesday, May 6, 2009
provided by

How to be smarter when the market comes back – and it will.

Is this a new bull market? Nobody really knows for certain. But one will -- presumably -- come along in due course. Will investors make the same mistakes they made last time, or will they be wiser? Here are 12 rules for the next bull market -- whenever it turns up.

1. Go global.

Most investors prefer to stick to their "home" market. It's a mistake. America accounts for only a fifth of the world economy but a third of its share values. No one knows where the best or worst returns will be, so spread your bets across the board. And you already have an oversized bet on the U.S. economy:, because you likely live, work and own a home here.

2. Avoid big moves.

If you buy or sell heavily in one shot you're taking a needless risk. And waiting for the right moment to make your move is futile. You probably won't catch the bottom or the peak anyway. If a market trend has much further to run, then what's the rush? And if it doesn't … what's the rush?

3. Remember the market is just "us."

No wonder shares rose when everyone was buying, and fell when they were selling. That was the reason. And when everyone is trying to predict "the market," they are effectively chasing themselves through a hall of mirrors.

4. Don't get fooled, don't get tense… and don't get fooled by the wrong tense.

Wall Street is riddled with people who mistake the past perfect ("these shares have risen") with the present ("these shares are rising") or the future ("these shares will rise."). Don't get suckered.

5. Pay no attention to TINA.

Sooner or later someone will urge you to buy shares, even at very high prices, because There Is No Alternative. It is a popular hustle at the peak of the market. There are always alternatives -- like holding more cash until valuations are more attractive.

6. Be truly diversified.

That means investing across a spread of different asset classes and strategies. As investors discovered last year, "large cap value" and "mid cap blend" funds don't offer diversification. They're just marketing gimmicks.

7. Treat forecasts with a grain of salt.

Most economists missed the recession, most strategists missed the crash, and most analysts are bullish just before a stock falls. Even the good experts are prone to group think, office politics, career risk - and hall of mirror syndrome (see point 3, above).

8. Never invest in what you don't understand.

Be happy to underperform a bull market. During the last boom, many investors were advised to go all-in on shares to get the biggest long-term gains. But the stock market has infinite risk tolerance and an infinite time horizon. Real people can't compete with market indices, and shouldn't try.

9. Ignore what everyone else is doing.

It's natural to want to "join the crowd" and avoid being "left behind." Leave those instincts in eighth grade. When it comes to investing, do what's right for you and your family.

10. Be patient.

Investment opportunities are like buses. If you missed one, you don't have to chase it. Relax. If history is any guide, others will be along shortly.

11. Don't sit on the sidelines completely until it's too late.

You'll probably end up splurging at the last moment. If you are afraid to invest, do it early, little, and often.

12. And above all: Price matters.

After all, an investment is just a claim check on future cash flows, whether it be a company's profits, a bond's coupons or an annuity's income stream. By definition, shares in a solvent company are twice as good at half the price… and vice versa. It's amazing how many people get suckered into thinking it's the other way around.

I'd like to hear from readers: If you have any suggested rules of your own, let me know.

Write to Brett Arends at brett.arends@wsj.com

Copyrighted, Dow Jones & Company, Inc. All rights reserved.

http://finance.yahoo.com/focus-retirement/article/107035/Rules-for-Investing-in-the-Next-Bull-Market?mod=fidelity-buildingwealth

Financial markets are racing well ahead of the real world

Financial markets are racing well ahead of the real world


Positive thinking is a powerful force, even when it doesn’t make much sense. That is one explanation for the mounting exuberance in financial markets.

By Edward Hadas, breakingviews.com

Last Updated: 8:50AM BST 06 May 2009

It’s not exactly 1996, when Alan Greenspan, the then chairman of the US Federal Reserve, warned of “irrational exuberance”. But there is an uncanny similarity in investors' willingness to look on the bright side.


Not all of today’s exuberance is irrational. The narrowing of credit spreads, to levels before the collapse of Lehman Brothers, can be linked to effectively unlimited government support. The reversal of stock market losses in the first few months of 2009 may be a justifiable response to green shoots of economic recovery – even if economists, corporate bosses and politicians are doubtful of the turn.

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But overall, markets and indicators are diverging. The price of oil has risen from $40 to $53 a barrel since February, but inventories are up and demand is down. US bank shares have risen sharply in spite of leaks that 10 out of 19 of them would fail the government’s not terribly exigent stress tests. Meanwhile, government bond yields are barely moved by deficits that would have been considered tragic a few years ago.


Bulls argue that the markets are thinking ahead: oil demand will turn soon and banks will shortly generate decent earnings to offset their losses. As for the deficits, the government can always shut down the money presses before inflation takes hold.


These may be true, but they do not justify the market euphoria. They are reminiscent of the dubious explanations provided by suspects in murder mysteries. Readers are well advised to ignore them, and look for the love interest. In market mysteries, the answer can be found in the money.


In the 1990s, too much money flowed into markets, thanks in large part to Greenspan’s low official interest rates. Now generous central banks and profligate governments are trying to keep the economy afloat with vast amounts of funding. Investors get first dibs on much of the cash. That kick starts markets. And that can help the economy. But right now, the markets are well ahead of the real world.


For more agenda-setting financial insight, visit www.breakingviews.com



http://www.telegraph.co.uk/finance/breakingviewscom/5278103/Financial-markets-are-racing-well-ahead-of-the-real-world.html

The dangers of failing to write your will

The dangers of failing to write your will

Not writing a will, or not updating it, can be disastrous for those left behind.

By Emma Wall
Last Updated: 10:13AM BST 05 May 2009

Actress Natascha McElhone with her late husband Martin Kelly Photo: GETTY

The actress Natascha McElhone feared she might lose her home after her husband died without leaving a will, she has revealed.

Although in the end McElhone managed to keep her property with the help of a lawyer, her fears illustrate the dangers to a family's finances if one of its members dies intestate.

A survey by Standard Life, the insurer, revealed that only a third of people aged 35 to 44 had a will and, perhaps more surprisingly, one in five people aged 65 or more did not. But only with a valid will can you be certain that your estate will go to the right people.

If you do not draw up a proper will, you risk depriving your spouse or partner of their home, increasing the inheritance tax (IHT) burden and leaving parts of your estate in the wrong hands.

On a brighter note for people who fail to make a will, the rules governing an intestate death have been changed to their benefit. People who die without making a will shall now have more of their estate given to their spouse or civil partner.

Previously, if you did not have children, £200,000 of your estate was awarded to your spouse should you die without a will. This figure has now been increased to £450,000. The remainder of an estate is then halved between your parents and your spouse.

Should the parents be dead, it is divided between siblings and the spouse. If you do have children, £250,000 (previously £125,000) of your estate will be awarded to your spouse, before being divided between your children.

The changes mean that inheritance tax liabilities are reduced because the spouse (who is tax exempt) will inherit more, and so the amount going to non-exempt beneficiaries is reduced.

Experts worry, however, that these changes will create a false sense of security and people will feel they do not need to make a will. People may consider their estate to be covered under the law change, when it is still just as important to draw up a will. Failure to do so can cause acrimony and complications.

Look no further than famous stars such as Barry White, Bob Marley and Jimi Hendrix whose families squabbled for years because they all died intestate.

Paul Bricknell, private client associate for Mace & Jones, warned that the increased limits did not mean that a will was now unnecessary. "There are so many reasons to try and avoid the intestacy rules. Failing to make provision for a partner will almost certainly lead to unnecessary legal costs in trying to rearrange an estate after death," he said.

There are many eventualities that are not covered under intestate law. For example, if you die without making a will the rules of intestacy award none of the estate to stepchildren and live-in partners, regardless of the longevity of the relationship.

Unless you have a joint mortgage, the house that you share with your live-in partner, even if they have lived there for 20 years or more, could potentially be passed onto your children, parents, siblings or the state, leaving your partner homeless.

Leaving no will can also mean extensive legal costs for your beneficiaries; failing to provide for a partner or dependent will mean they will have to hire legal help to contest the state's decisions, with no guaranteed result. Complex cases can require the hire of a genealogy expert, at great cost, to clarify relatives' rights to your estate.

Julie Hutchison of Standard Life said making a will and keeping it up to date could save family and friends a great deal of distress and, potentially, money, so it should be regarded as a priority.

Aside from the legal implications, there may be personal wishes that cannot be fulfilled without a will. You may not want your children to inherit at 18 – the set inheritance age in intestate law – considering it too young, or you may not want parents or siblings to benefit at the detriment to your spouse.

If you draw up a will, you can specify how long funds must be held in trust for children, to any age you deem appropriate. You may also exclude family members who you don't want to benefit from your estate in a will.

Stepchildren or live-in partners can only inherit part of the deceased's estate if specified in a will, as is the case for friends or charities. You may also want to outline personal wishes, such as funeral arrangements or who should inherit particular property or items of worth.

Drawing up a will also prevents assets being claimed by the state at the cost of loved ones. Ms Hutchison urged people to make sure they had an up to date will. "A will should be part of bread-and-butter financial housekeeping," she said.

"Once you've bought your first property you should draw one up, regardless of your age."

Even if you have made a will, you need to ensure it is updated. Family make-up can change after the birth of a child or the breakdown of a marriage, but if a will is not updated to include or remove beneficiaries, they will have little or no claim to the estate should you die. The late Heath Ledger's daughter Matilda was left out of a will completed before her birth.

Neither, in the event that both you and your spouse dies, will you have any say in who becomes your children's guardian. If your child or children are under the age of 18 it is essential you have a will for this reason. This also applies to a family member or dependant with special needs.

Nearly half of all marriages end in divorce, meaning that not updating your will can have devastating effects for your spouse and any new children or stepchildren. It is also vitally important that family members know where your will is kept and that a duplicate is stored with a solicitor or financial adviser.

Mr Bricknell cautioned: "Many people's estates are administered as if they are intestate, even if they have a will, simply because no one knows where the will is kept."

http://www.telegraph.co.uk/finance/personalfinance/consumertips/5277201/The-dangers-of-failing-to-write-your-will.html

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When investing in stocks control your greed and fear

Wednesday May 6, 2009
When investing in stocks control your greed and fear

Personal Investing - A column by Ooi Kok Hwa

We need to know who we are in order to do well in stock market investing

THE recent strong market rally caught many investors by surprise again.

Most investors, including some analysts, predicted earlier that it was just a bear market rally. They have been hoping the market will turn down again. Unfortunately, it has been moving up strong without looking back.

For investors who have not invested during the recent low in March 2009, they are getting very worried as they are not benefitting from the recent rally. They may even wonder whether they should jump in now in order not to miss the boat.

Another group of investors, who have managed to catch some stocks at cheap prices during the previous market low, are also facing the dilemma of whether to lock in their gains now or continue to hold on to their gains. Some even regretted selling their stocks too early last month.

We all know that it is very difficult, in fact impossible, to predict stock market movement. Most investment gurus will refuse to time the market.

Howard Kahn and Cary Cooper published a book titled “Stress in the Dealing Room” in 1993. According to their surveys done on 225 dealers, 73.8% of them suffered from fear of “misreading the market.” Most dealers have the same problem of acquiring and handling information.

We believe that in order to do well in stock investing, we need to know ourselves, especially in controlling our emotion on greed and fear.

Due to information overloading, our emotion is highly influenced by the news that we read. Each time we feel that the market is getting bullish and time to buy stock, the overall market will collapse the moment we enter.

On the other hand, the moment we fear that it will drop further and we have decided to cut losses, we will notice the market will recover after that. Most of the time, the prices of stocks that we sold were at the lowest of the recent fall.

In order to control our greed and fear, we need to ask ourselves whether the market has discounted the news that we have received.

For example, many analysts have been bullish lately, having the opinion that the worst may be over for the market based on the recent economic indicators which showed that the overall economy may have stopped contracting or is on its way to recovery.

Nevertheless, the recent strong market rally would have discounted this bullish news. In fact, we need to ask ourselves whether the current stock prices can be supported by the fundamentals for certain listed companies.

In our experience, in most cases, the moment we feel like buying stocks is the best time to sell them while the moment that we feel like selling them is in fact the best time to buy. We can apply this contrarian theory quite successfully in most periods.

Sometimes, if we are taking in too much contradicting information and, as a result, get confused over the market direction, we feel that the best strategy is to stay away from the market until we have a better and clearer picture of the overall market or the economic situation.

We should not be influenced by other opinions.

There are times that we need to follow our heart. Sometimes, our hearts try to warn us from taking hasty investment decisions. However, we refuse to follow our intuition but instead, choosing to get influenced by others or the information that we read and ending up making mistakes.

In conclusion, we need to maintain our concentration.

We should not be led by the market sentiments regardless whether it is on the way up or crashing down fast. We need to go back to the fundamental of economic situation and the companies’ performance and future prospects.

One way to minimise the feeling of regret is to stagger our purchase and selling. We will only know the peak when the market starts turning downwards and vice versa. Therefore, by staggering, we will have an averaging effect rather than taking a one-time hit, especially if it is at the wrong timing.


Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting

http://biz.thestar.com.my/news/story.asp?file=/2009/5/6/business/3838362&sec=business

Economist cautions on equities market

Economist cautions on equities market
Wed May 6, 2009 6:47am

SINGAPORE (Reuters) - Rallying global stock markets will likely reverse trend later this year when weak earnings and economic news surprise investors, Nouriel Roubini, a well-known economist who predicted the credit crisis, said on Wednesday.

"This is still a bear market rally," Roubini told a financial seminar. Roubini is chairman of independent economic research firm RGE Monitor and professor of economics at the Stern School of Business at New York University.

He gave three reasons why investors ought to be cautious about the rally that has seen the Dow Jones Industrial Average .DJI rise 27 percent in two months and taken Asian stocks 42 percent higher over the same period.

Roubini expects macroeconomic news to be worse than expected, lower than expected earnings, and more bad news from the banking sector or an emerging market crisis.

"We will discover soon enough there are a lot of financial shocks.

"While financial markets are mending, we are going to see negative surprises in the next few quarters," he said.

"Markets are getting ahead of themselves."

(Reporting by Vidya Ranganathan and Kevin Lim; Editing by Tomasz Janowski)

http://uk.reuters.com/article/businessNews/idUKTRE54514W20090506?feedType=nl&feedName=ukdailyinvestor

Now It's Time for Short-Sellers to Panic

Now It's Time for Short-Sellers to Panic
By Dan Caplinger

May 5, 2009 Comments (0)


For more than a year, investors who own stocks have heard over and over again that they shouldn't panic. Now, their patience has finally earned a reward, and it's time for another group of market participants to have their turn at dealing with a challenging market.

Short-sellers have turned bets against the market into huge profits ever since the market peaked in late 2007. With so many stocks losing huge portions of their value, finding a profitable short-selling candidate has been like shooting fish in a barrel.

But over the past two months, the market's extraordinary rebound has put short-sellers in the squeeze of a lifetime. As you can see, some of short-sellers' most popular targets have performed extremely well since the market's lows in early March:

Stock
% of Shares Sold Short
Return Since March 9
1-Year Return

Barnes & Noble (NYSE: BKS)
34%
67.7%
(11.4%)
MGM Mirage (NYSE: MGM)
30.9%
305.2%
(80.6%)
Goodrich Petroleum (NYSE: GDP)
24.5%
75.8%
(22%)
Citigroup (NYSE: C)
23.8%
204.8%
(87.2%)
Hovnanian (NYSE: HOV)
23.5%
400%
(74.7%)
Green Mountain Coffee Roasters (Nasdaq: GMCR)
44.4%
97.1%
96.7%
Bankrate (Nasdaq: RATE)
36.1%
47.2%
(46.5%)
Sources: Yahoo! Finance and WSJ.com. Short interest as of April 15.

Those rebounds have been extremely painful for anyone who sold those stocks short. No matter how bad things get, investors who buy stocks can never lose more than what they paid for their shares. But as these examples show, short-sellers can do much worse. If you sold Hovnanian short in early March, for instance, you've now lost four times as much money as you initially received when you sold your borrowed shares.

Why do they do it? In some ways, short-sellers have much in common with any other investor. They do their research and try to find promising candidates for their investing strategy. It's just that the "promising" stocks that shorts look for are those that are least likely to do well -- companies whose businesses are failing or whose prospects have gotten so pumped up that there's no way the reality can ever meet shareholders' expectations.
Under ordinary market conditions, you'll usually find a few companies that fit the bill. In the past, stocks like Krispy Kreme and Crocs acted almost perfectly for short-sellers; hopeful investors bid up shares to the stratosphere, and then all it took was having the patience and financial resources to wait for the company's fundamentals to fall apart.

An embarrassment of riches

Now, though, short-sellers are in the same position that most investors enjoy at the top of a bull market. Shorts have had many chances to make huge amounts of money in the past year, but now, many of their best candidates have already fallen substantially. With many stocks having fallen 80% or more, the risk for short-sellers who continue to bet against the market has risen exponentially.

Perhaps the most dangerous part of short-selling is that if you keep upping your bet on a particular stock, you can end up being right about the stock dropping but still lose money. For instance, say you shorted 100 shares of General Motors last year at $22 per share. If you closed out the short now, you would realize a little over $2,000 in profit.

But now say you upped your short position to 1,000 shares. If GM stock rose to just $4 -- still an 80% loss from last year's levels -- you would have lost all your profits and then some.

Yet that's the dilemma short-sellers face now. Do you increase your exposure on existing positions, hoping shares will fall back but taking on a lot more risk -- or do you give up and cover your shorts in the face of the current rally?

Be panic-proof

There's no one-size-fits-all answer to that question. But by the time the situation comes up, you should already know what you're going to do. If you're going to sell stocks short successfully, you need several things:

An exit strategy.

Even more than with owning shares, you can't afford to panic when the market moves against you. Know your risk tolerance, and know in advance when you'll get out to limit your losses.

Discipline.

It's tough to watch a company's stock rise when you know its business stinks. Irrational markets can last a long time, though, so being patient is essential.

Hedges.

Sometimes, a safer way to short is to buy shares of another stock in the same industry. That way, you can make money overall even if your short does badly, as long as the stock you own does (relatively) better.

Short-selling is not for the meek, so don't do it if you're not comfortable with the consequences. And right now, with the market already having declined so much, short-sellers could find themselves even worse off than investors who've owned shares throughout the bear market.

Fool contributor Dan Caplinger hasn't sold anything short for a long while, though he does have a bunch of thumbs-down positions in CAPS. He doesn't own shares of the companies mentioned.

http://www.fool.com/investing/high-growth/2009/05/05/now-its-time-for-short-sellers-to-panic.aspx

****Investing Lessons From Benjamin Graham

Investing Lessons From Benjamin Graham
By Motley Fool Staff May 5, 2009 Comments (1)

A dictionary will tell you that investing involves putting money into assets with the intent of making a profit. But that's not the whole story. Speculating, for example, involves the very same process.

The legendary Dean of Wall Street, Benjamin Graham, differentiates the two approaches in his seminal work, Security Analysis, and in the process offers one of the best definitions of investing. Ever.

Graham says an investment is something that "upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative." [Emphasis added.]

Given that definition, a lot of us who think we are investing may come to discover that we're engaging in what I would call intelligent speculation.

So let's briefly review Graham's three criteria for an investment.

1. Thorough analysis : Do your homework
Warren Buffett used to write down why he was making an investment. If what he wrote wasn't crystal clear, he either did more research, or he'd decide that he simply could not understand the business well enough to make an investment.

Imagine you're buying a house. You'll make sure it's in a nice, safe neighborhood with a good school system before you put down your money. Buffett puts that kind of prudent diligence into his stock research, and so should you.

Really good investments are really hard to find. So when you find one that looks interesting, do your homework. Study the industry. Examine the competition. Find out everything that could possibly go wrong through boom and bust cycles.

2. Safety of principal : Never lose money
Buffett says he has two goals when making an investment.

Rule No. 1: Never lose money.
Rule No. 2: Never forget Rule No. 1.

There are three types of stocks:

• the overvalued type,
• the fairly valued type, and
• the undervalued type.

Your goal is to avoid the first, ignore the second, and buy the third.

One way to keep attuned to that goal is to focus on value over price.
Apple (Nasdaq: AAPL), for example, is a great business that has done all the right things to ensure its long-term success. Yet when it traded early last year at more than $200 a share, Apple had an extremely rich earnings multiple. As the ensuing year proved, even as Apple continued to exceed analyst expectations on earnings, you didn't have much safety of principal at $200.

But after the stock suddenly shot down to below $100, if you believed the economic characteristics of the business remained intact, then your investment thesis was entirely different.

The one variable is the price. As Buffett once said, "Price is what you pay. Value is what you get."

3. Satisfactory return : Risk versus reward
Any time you commit capital to one business, you are forgoing the opportunity to commit that capital to any other business. But that's OK, because if you are rational, the investment you choose will be better than all other alternatives.

So what should you be looking for? Well, you can always invest in the market through index funds and earn, on average, about 10% a year without exerting any effort.

Whatever you do, you should at least expect a higher rate of return than 30-year U.S. Treasuries, commonly referred to as the risk-free rate, which currently stands at around 4%.

A reasonable goal is to make investments that you think can exceed the market rate of return by 3 percentage points over the long run.

John Bogle once stated that more than 85% of active money managers fail to beat the stock market by 3 percentage points, so making investments that can yield you 13%-15% a year is a great return, given your alternatives.

Meeting the Graham threshold
So how do you find good prospects for stocks Graham might approve of? Using Motley Fool CAPS, the Fool's free online investing community, you can run a simple screen to find some reasonably valued stocks that have earned the attention of Foolish investors.

Stock
Current P/E
Estimated Future Earnings Growth

Accenture (NYSE: ACN)
10.9
13.3%
Cameron (NYSE: CAM)
10.3
12.0%
Enbridge (NYSE: ENB)
10.6
11.2%
GameStop (NYSE: GME)
12.2
17.0%
Nokia (NYSE: NOK)
12.7
13.8%
Raytheon (NYSE: RTN)
11.5
11.7%
Source: Yahoo! Finance, Motley Fool CAPS. P/E = price-to-earnings ratio.

Of course, screen results alone aren't enough to conclude that these are truly Graham-quality stocks. Rather, these give you a place to start your own research.


For more on value investing:
This Rally Is Ridiculous
The Best Opportunity This Decade
How Low Can Stocks Go?


This article, written by Sham Gad, was originally published on June 12, 2007. It has been updated by Dan Caplinger, who doesn't own shares of the companies mentioned. Apple and GameStop are Motley Fool Stock Advisor selections.

Stop Worrying About the Rally

Stop Worrying About the Rally
By Dan Caplinger May 5, 2009 Comments (0)


Everyone seems convinced that the recent rally in stocks has absolutely no chance of holding up. Yet a few years from now, what's happened since March -- and what's yet to come over the next few months -- will be just a bump in the road compared to the overall fortunes of the stock market.

Guts and glory
During times like these, it's tough not to think like a short-term trader. After the market was cut in half in just 15 months, stocks have now jumped by over a third from their March lows. In just two short months, the S&P 500 has erased all of its losses for 2009.

Moreover, those traders who picked the exact bottom have seen some of the worst-hit stocks during the bear market shoot back up with amazing gains. Take a look at some of the top-gaining stocks since

March 9:

Stock
Gain Since March 9
1-Year Return
5-Year Avg. Annual Return

Las Vegas Sands (NYSE: LVS)
569%
(87%)
(28.1%)*
Office Depot (NYSE: ODP)
374.6%
(79.1%)
(30.6%)
USG (NYSE: USG)
295%
(55.4%)
3.9%
International Paper (NYSE: IP)
221.6%
(40.8%)
(15.6%)
Bare Escentuals (Nasdaq: BARE)
218.5%
(50.9%)
N/A
Citigroup (NYSE: C)
204.8%
(87.2%)
(39.6%)
Dow Chemical (NYSE: DOW)
163.1%
(57.3%)
(12.9%)
Source: Yahoo! Finance.*4-year average return.

Profits like those we've seen from these stocks in the past two months often take years for long-term investors to earn. So it's no wonder that the rally has taken many unprepared investors by surprise -- and left them wondering whether they've made the wrong decision with their long-term investing strategy.

Irrational in two directions
Of course, as the table above shows, there's nothing particularly extraordinary about how these companies have performed when you look at them on a longer-term basis. They've all done worse than the S&P over the past year, and all but USG have underperformed the index since 2004.

The real question, though, is which is more irrational: the plunge in these companies' stock prices, or the ensuing recovery. Clearly, during times of panic like we saw in early March, investors believed that many of these companies were in danger of falling apart. Now, shareholders seem convinced that their failure isn't imminent -- yet they certainly haven't bid shares back up anywhere close to where they traded last May.

In that light, a small rally like this doesn't seem all that ridiculous -- especially in light of the bigger picture.

A little perspective
In late 2007, investors still believed the future would stay bright forever. When that scenario proved grossly incorrect, stock prices took a 57% haircut, most of which has happened just since last September. Now, after a seemingly huge rally, the S&P 500 is down "only" 42% from its record highs.

That 42% drop doesn't come as a shock to anyone. With unprecedented government intervention and uncertainty about whether the economic cycle is broken for good, lower share prices only make sense.

But the way we got there -- with an even bigger plunge and a subsequent bounce -- is what people are focusing on. And that's the wrong focus.

The right thing to do
Long-term investors know better. They realize that over the long haul, it makes absolutely no difference whether stocks take a straight-line path down or take investors on a roller-coaster ride. The important thing is figuring out which stocks have solid business foundations and taking advantage of attractive valuations when they come to buy.

You might be tempted to wait until this silly-looking rally ends and share prices on your favorite companies fall back toward their lows. That may even turn out to be the right call. But if you play that timing game, you're doing exactly the same thing as the speculators you've criticized -- and if your stocks don't cooperate, you may miss out entirely on a huge opportunity. Just as Warren Buffett missed out on Wal-Mart because of a fraction of a point, you could miss the next big growth stock.

As we know well by now, markets will plunge and soar from time to time. But you don't have to get caught up in the hype. Stick with the investing strategy you've developed for your long-term goals -- it'll serve you better in the end.
Fool contributor Dan Caplinger bought a little in March, bought a little in April, and plans to buy a little in May. He doesn't own shares of the companies mentioned.

http://www.fool.com/investing/general/2009/05/05/stop-worrying-about-the-rally.aspx

When you should not sell.

When you should not sell.

The Stock has Dropped

By themselves, share price movements convey no useful information, especially because prices can move in ALL sorts of directions in a SHORT TERM for completely unfathomable reasons.

The long-run performance of stocks is largely based on the expected future cash flows of the companies attached to them - it has very little to do with what the stock did over the past week or month.

Always keep in mind that it doesn't matter what a stock has done since you bought it. There's nothing you can do to change the past, and the market cares not one whit whether you've made or lost money on the stock.

Other market participants - the folks setting the price of the stock - are looking to the future, and that's exactly what you should do when you're deciding whether to sell a stock.

The Stock Has Skyrocketed

Again, it matters little how those stocks have done in the past - what's important is how you expect the company to do in the future.

There's not a PRIORY reason for stocks that are up substantially to drop, just as there's no reason for stocks that have tanked to "have to come back eventually."

Most of us would be better investors if we could just block out all those graphs of past stock performance because they convey no useful information about the FUTURE.


So When Should You Sell?

Run through these 5 questions whenever you think about selling a stock, and you'll be in good shape.

1. Did you make a mistake?
2. Have the fundamentals deteriorated?
3. Has the stock risen too far above its intrinsic value?
4. Is there something better you can do with the money?
5. Do you have too much money in one stock?

For every Wal-Mart, there's a Woolworth's

For every Wal-Mart, there's a Woolworth's

Sticking to a valuation discipline is tough for many people because they're worried that if they don't buy today, they might miss the boat forever on the stock.

That's certainly a possibility - but it's also a possibility that the company will hit a financial speed bump and send the shares tumbling.

The future is an uncertain place, after all, and if you wait long enough, most stocks will sell at a decent discount to their fair value at one time or another.

As for the few that just keep going straight up year after year - well, let's just say that NOT MAKING is a lot painful than LOSING money you already have.

For every Wal-Mart, there's a Woolworth's.

Finding companies that can be held long-term

The challenge: Finding companies that can be held long-term

Despite the volatility in the market, Tan says he is still a long-term investor.

“We bought into Parkson in 2002 when it was around 40 sen. It went to a peak of around RM10. If we had sold at 80 sen, we would have made 100% gains. The question is, if you sell, what are you going to reinvest in? The advantages of buying and holding is that if you have the right company, you don’t have to worry about reinvesting. Of course, at RM20, we would have sold because it would have been so overvalued. But a good company, managed well, has tremendous potential. If you buy and sell once in 10 years, you only have to be right twice. If I buy and sell every month, I have to be right 24 times a year. "

The dramatic drop in stock markets last year has led to the long-term approach of buy and hold being questioned. In an article in late April, The Wall Street Journal ran said that advisers are ditching the ‘buy and hold’ dogma in the face of massive losses.

For Capital Dynamic Asset Management Sdn Bhd’s managing director Tan Teng Boo, the question is not whether to invest long-term but in finding companies that can be held long-term. The value investor seeks companies selling at an attractive discount from the intrinsic value. And in this market, he is rubbing his hands in glee. Tan says he has been steadily accumulating stocks over the past year. The iCapital Global Fund, a fund for high net worth investors that was launched in July 2007, now only holds 6% in cash, says Tan.

“We see a lot of prices which have bombed out although the company has not,” he says. “I have never seen so much pessimism in so many places at so many levels of society in my life. The negative sentiment is a divergence from the economic numbers, which isn’t as bad as those seen in the Depression. This is a springboard for a major rally.”

The Retail Game

The Retail Game

Great companies in attractive industries generate returns on invested capital that far exceed the cost of capital.

1. However, retail is generally a very low-return business with low or no barriers to entry.

Retail bellwethers Wal-Mart and Walgreen earn little ore than 3 cents profit for every dollar of sales, so store management is critical. The problem is that many retailers don't execute as flawlessly as these two and flame out as soon as trouble hits.

2. The sector is rampant with competition.

Think of all the specialty apparel shops that try to imitate Abercrombie & Fitch and Gap. A few succeed; most fail, but the point is that nothing exists to prevent new concepts and stores from being launched. There are few, if any, barriers to entry. Customers may be swayed to buy a cool $50 sweater, but they'll quickly go to the store next door if the same sweater can be had for $40.


3. The primary way a firm can build an economic moat in the sector is to be a low-cost leader.

Wal-Mart sells items that can be purchased just about anywhere, but it sells it all for less than the competition, and consumers keep coming back for the bargains. Others may try to imitate Wal-Mart's strategy in the short run but lack the economies of scale to remain profitable employing the strategy in the long run.

How Healthy Is the Balance Sheet with All Those Leases?

Common Investing Pitfall: How Healthy Is the Balance Sheet with All Those Leases?

Many retailers use operating leases to "rent" space for their stores. Because these leases aren't capitalized and are kept off the balance sheet, they understate a firm's total financial obligations and can artificially inflate financial health. The leases aren't inherently bad or sneaky; in fact, their existence is core to most retailer's expansion plans. Lease obligations can be found in the footnotes of a firm's 10-K under the heading "commitment and contingencies."

Be sure to give a retailer a thorough checkup before declaring it to be in tip-top financial shape.

For example, Tommy Hilfiger appeared to have pretty good financial health going into 2002. The firm had $387 million in cash and $638 million in total debt. However, the specialty apparel firm also had $273 million of future financial obligations in the form of operting leases. If we add off-balance sheet leases to the debt on the balance sheet, the toal comes to $911 million, and the coverage ratios don't look as robust. Tommy Hilfiger entered 2002 with declining sales and stagnating profits and cash flow. When Hilfiger announced that it neede to close many of its retail stores in October 2002 and pay to break the leases, the stock price was hammered.

Are Those Same-Store Sales (SSS) Growth Numbers Accurate?

Common Investing Pitfall: Are Those Same-Store Sales (SSS) Growth Numbers Accurate?

Every quarter and, for most restaurants and retailers, every month, same-store sales (SSS) numbers are released. SSS growth measures sales at locations open for at least a year and excludes sales increases attributed to current openings (also known as new store sales growth). For purposes of reporting, SSS are also know as comparable-store sales or comps.

But, what if a new store doesn't fully mature in 12 months? The process of that new store reaching maturity in year two or year three helps boost the SSS figure, while sales at older stores may not be growing at all or are declining.

This is a very important consideration for companies that are transitioning from aggressive growth into slower or steadier growth. As long as they can open a greater number of stores year after year, the SSS or comps will look impressive. But every company's expansion plan reaches an inflection point - they're still growing, just not as fast. This has two effects.

• First, opening fewer stores obviously translates into smaller new store sales growth.
• Second, having fewer stores entering those productive years two and three also lowers SSS or comps.

The combination of slower new store growth and lower SSS or comps can send overall growh and the stock price plunging quickly.

From 1995 to 2000, Office Depot averaged 14 percent per year in new store growth. However, the office supply store business quickly became saturated when competitors Staples and Office Max also engaged in aggressive expansion plans. In 1999 and 2000, the last two years of its rapid expansion, Office Depot's total SSS increased 6 percent and 7.5 percent. In 2001, new store growth stopped and SSS declined 2 percent; the stock price sank below $10 from a high in the mid $20's in 1999.

Investing in Retail: Understanding the Cash Conversion Cycle

Investing in Retail: Understanding the Cash Conversion Cycle

One of the best ways to distinguish excellent retailers from average or below average ones is to look at their cash conversion cycles. The cash cycle tells us how quickly a firm sells its goods (inventory), how fast it collects payments from customers for the goods (receivables), and how long it can hold on to the goods itself before it has to pay suppliers (payables).

Figure: The cash conversion cycle

= Days in Inventory + Days in Receivables - Days Payable Outstanding

= 365/Inventory turnover + 365/Receivables turnover - 365/Payables turnover

Where,
Inventory turnover = Cost of goods sold/Inventory
Receivables turnover = Sales/Accounts receivable
Payables turnover = Cost of goods sold/Accounts payable

Naturally, a retailer wants to sell its products as fast as possible (high inventory turns), collect payments from customers as fast as possible (high receivables turns), but pay suppliers as slowly as possible (low payables turns).

The best-case scenario for a retailer is to sell its goods and collect from customers before it even has to pay the supplier. Wal-Mart is one of the best in the business at this: 70 percent of its sales are rung up and paid for before the firm even pays its suppliers.

Looking at the components of a retailer's cash cycle tells us a great deal. A retailer with increasing days in inventory (and decreasing inventory turns) is likely stocking its shelves with merchandise that is out of favor. This leads to excess inventory, clearance sales, and, eventually, declining sales and stock prices.

Days in receivables is the least important part of the cash conversion cycle for retailers because most stores either collect cah directly from customers at the time of the sale or sell off their credit card receivables to banks and other finance companies for a price. Retailers don't really control this part of the cycle too much.

However, some stores, such as Sears and Target, have brought attention to the receivables line because they've opted to offer customers credit and manage the receivables themselves. The credit card business is a profitable way to make a buck, but it's also very complicated, and it's a completely different business from retail. We're wary of retailers that try to boost profits by taking on risk in their credit card business because it's generally not something they're very good at.

If days in inventory and days in receivables illusrate how well a retailer interacts with customers, days payable outstanding shows how well a retailer negotiates with suppliers. It's also a great gauge for the strength of a retailer.

Wide-moat retailers such as Wal-Mart, Home Depot, and Walgreen optimize credit terms with suppliers because they're one of the few (if not the only) games in town. For example, 17 percent of P&G's 2002 sales came from Wal-Mart. The fortunes of many consumer product firms depend on sales to Wal-Mart, so the king of retai has a huge advantage when ordering inventory: It can push for low prices and extended payment terms.

Home Depot finally started taking advantage of its competitive position by squeezing suppliers in 2001 and 2002. Days payable outsanding for the home improvement titan has historicaly been around 25. In 2001, the figure hit 33 days, and by 2002, it exceeded 40 days. By holding on to its cash longer and reducing short-term borrowing needs, Home Depot increased its operating cash flow from an average of $2.4 billion from 1998 to 2000 to $5.6 billion from 2002 to 2003.

Warren Buffett interview on how to read stocks (Petrochina)

http://www.youtube.com/watch?v=Lc791is6X0o

Warren Buffett: Why Buying Constellation Energy Group Is A Sweet Deal

Warren Buffett: Why Buying Constellation Energy Group Is A Sweet Deal

by Floyd G. Brown, Advisory Panelist, Investment U
October 01, 2008: Issue # 863

Last week, I suggested you ignore Washington and “the bailout plan,” and do what great investors such as Warren Buffett do in times of crisis - buy stocks.

Based on reader response, you would have thought I recommended investing in the Titanic, and doubling down on the Hindenburg. My email inbox was full of remarks from people who thought I had lost my mind, such as, “There are idiots out there saying [the credit crisis is] ‘no problem’…you know who they are!!!”

I think he means me…

But this kind of reaction isn’t out of the ordinary. In times of intense fear - such as this week - contrarian investors often have opposing views from the crowd. And while many investors are running scared, legendary investor Warren Buffett is betting big. Let’s see what Buffett just bought on the cheap and how we can profitably do the same…

Warren Buffett’s $10 Billion Spending Spree
Berkshire Hathaway, Warren Buffett’s holding company, spent nearly $10 billion in the last week. Not only did he spend $5 billion to acquire preferred stock in Goldman Sachs (NYSE: GS), but he also is backing MidAmerican Energy’s $4.7 billion buyout of Constellation Energy Group (NYSE: CEG) based in Baltimore.

Frankly, I find Warren Buffett’s investment strategy with this bid much more interesting than the Goldman Sachs deal, even though it is slightly smaller. In early January, shares of Constellation were trading at over $100, and yet its management accepted Buffett’s $26.50 a share offer earlier this month.

Constellation is a diversified energy company that owns an energy-trading unit. Its portfolio of energy generation plants covers the spectrum and includes the old-fashioned utility Baltimore Gas and Electric Company. Like many of the financial traders on Wall Street, the firm is a big user of borrowed capital. And because of this Constellation was slammed by the credit crisis.

Constellation’s CEO, Mayo Shattuck III, told The Wall Street Journal last week that he was forced to sell to Buffett after a “classic run on the bank.” Investors dumped shares, fearing CEG wouldn’t be able to get a $2 billion bank loan necessary to fund its energy-trading operation.

The additional cash was needed so the investment ratings agency wouldn’t downgrade the firm from investment grade. If that had happened, it would have increased Constellation’s collateral requirements by $3 billion - thereby putting it into bankruptcy.

“We engaged in discussions,” Mr. Shattuck said, “as we perceived we might not be in commercial operations for long.” According to Shattuck, Warren Buffett moved quickly and injected $1 billion in capital the day after the deal was inked.

Let me explain why this deal is so amazing…
Warren Buffett & The Constellation Energy Deal
The Constellation Energy deal will give MidAmerican control of five nuclear reactors, two in Maryland and three in New York. Plus they get:

• A large portfolio of coal and gas plants stretching from coast to coast.
• Baltimore Gas & Electric.
• And a profitable energy trading operation

all for less than it would cost to build one nuclear plant.

Currently Constellation controls 9,000 MW of power generating capacity. To build or replace these assets would cost billions more than Buffett is paying.

Warren Buffett Starts A Bidding War
In fact, Warren Buffett is getting such a great deal on Constellation Energy that a bidding war is erupting.

Électricité de France International, the French power giant and Constellation Energy Group’s largest shareholder, is making its own offer to buy the firm for much more than the $4.7 billion accepted by management from MidAmerican. EDFI said it is offering $35 per share to buy Constellation. The only problem is Constellation’s board has already agreed to go ahead with MidAmerican, and they’ve already cashed Buffett’s billion-dollar check.

In addition, there are tough regulations prohibiting foreign companies from owning nuclear assets in the United States… Good luck to the French and Constellation’s other shareholders intent on breaking up this deal. (This morning, Constellation traded at $23.75, a 11.58% discount to Buffett’s buyout price. Which could open the door to some short-term arbitrage gains - as the market still hasn’t made up its mind about the buyout.)

Bottom line, there are lots of extraordinary deals right now, but it can take an iron constitution to be a buyer in this environment. If investment greats like Warren Buffett are investing without fear, then we should be doing the same. So I encourage you to look for companies trading for far less than they are worth.

They are out there for the bargain minded investor.

Good investing,
Floyd

PS. Why is CEG trading at a discount? Stay tuned. Next week, I’ll look at arbitrage situations… And how to profit from them.

Today’s Investment U Crib Sheet
Warren Buffett once said, “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” And that is exactly how he has approached his recent railroad purchases.

In Investment U Issue #846 Floyd showed us that there are still vast fortunes to be made in the transportation sector, and why Buffett has been loading up on them.

Buffett is infamous for buying companies trading at a discount to their value. And for the average investor, it can be hard to tell whether a company is under- or over-valued by looking at the stock price. But, by understanding a few sections on a company’s annual report, you can understand the financial picture of any company, just like he does.

The current market downturn has created an environment where thousands of stocks are trading at multiyear lows. But finding the good ones can be difficult. To find these diamonds in the rough, learn how to screen stocks like a professional.

Earlier this month, Alex Green showed us why Buffett has been the single greatest investor of our lifetimes. Alex also walked us through Warren Buffett’s investment strategy, what kind of questions he asks, and the three reasons he’s buying right now.

More on this topic (What's this?)
How Buffett Has Failed the True Test of Leadership (The Enlightened American, 1/27/09)
Constellation Energy (CEG) Merger Arbitrage Opportunity (Dividend Growth Investor, 10/28/08)
Buffett Bargain Hunting Despite 2008 Losses (Money Morning, 2/12/09)
Read more on Warren Buffett, Constellation Energy Group at Wikinvest



http://www.investmentu.com/IUEL/2008/October/warren-buffett-why-buying-constellation-energy-group-is-a-sweet-deal.html

World Stock Markets, Now vs Then

World Stock Markets, Now vs Then

Source: Global Financial Database.

(The above graph tracks behaviour after the peaks in world industrial production, which occurred in June 1929 and April 2008.)

While the fall in US stock market has tracked 1929, global stock markets are falling even faster now than in the Great Depression (Figure). Again this is contrary to the impression left by those who, basing their comparison on the US market alone, suggest that the current crash is no more serious than that of 1929-30.

Also read:

Market Performance Around Recessions

World industrial production, trade and stock markets are diving faster now than during 1929-30.

World industrial production, trade and stock markets are diving faster now than during 1929-30.

Tuesday, April 7, 2009

World Economy Falling Faster Than in 1929-1930


Barry Eichengreen, an expert on the Great Depression, and Kevin O'Rourke, take issue with the notion that the current downturn is less severe than the Great Depression. While the slump in the US is not as bad, that mis-states the global picture.

Note that many economists expect the US to suffer less than the big exporters, namely China, Germany, Japan. The reason is that the economic adjustment required of surplus nations is greater than that of debtors. Similarly, in the Great Depression, the US, then a major exporter, was harder hit than the overconsuming importers such as Britain, who defaulted on their debts.

The one bit of cheer is that this time around, government action is more aggressive, but it remains to be seen whether it is sufficient.

From VoxEU:

Often cited comparisons – which look only at the US – find that today’s crisis is milder than the Great Depression. In this column, two leading economic historians show that the world economy is now plummeting as it did in the Great Depression; indeed, world industrial production, trade and stock markets are diving faster now than during 1929-30. Fortunately, the policy response to date is much better.

The parallels between the Great Depression of the 1930s and our current Great Recession have been widely remarked upon. Paul Krugman has compared the fall in US industrial production from its mid-1929 and late-2007 peaks, showing that it has been milder this time. On this basis he refers to the current situation, with characteristic black humour, as only “half a Great Depression.” The “Four Bad Bears” graph comparing the Dow in 1929-30 and S&P 500 in 2008-9 has similarly had wide circulation (Short 2009). It shows the US stock market since late 2007 falling just about as fast as in 1929-30.

Comparing the Great Depression to now for the world, not just the US

This and most other commentary contrasting the two episodes compares America then and now. This, however, is a misleading picture. The Great Depression was a global phenomenon. Even if it originated, in some sense, in the US, it was transmitted internationally by trade flows, capital flows and commodity prices. That said, different countries were affected differently. The US is not representative of their experiences.

Our Great Recession is every bit as global, earlier hopes for decoupling in Asia and Europe notwithstanding. Increasingly there is awareness that events have taken an even uglier turn outside the US, with even larger falls in manufacturing production, exports and equity prices.

In fact, when we look globally, as in Figure 1, the decline in industrial production in the last nine months has been at least as severe as in the nine months following the 1929 peak. (All graphs in this column track behaviour after the peaks in world industrial production, which occurred in June 1929 and April 2008.) Here, then, is a first illustration of how the global picture provides a very different and, indeed, more disturbing perspective than the US case considered by Krugman, which as noted earlier shows a smaller decline in manufacturing production now than then.

Figure 1. World Industrial Output, Now vs Then
Source: Eichengreen and O’Rourke (2009).

Similarly, while the fall in US stock market has tracked 1929, global stock markets are falling even faster now than in the Great Depression (Figure 2). Again this is contrary to the impression left by those who, basing their comparison on the US market alone, suggest that the current crash is no more serious than that of 1929-30.

Figure 2. World Stock Markets, Now vs Then
Source: Global Financial Database.

Another area where we are “surpassing” our forbearers is in destroying trade. World trade is falling much faster now than in 1929-30 (Figure 3). This is highly alarming given the prominence attached in the historical literature to trade destruction as a factor compounding the Great Depression.

Figure 3. The Volume of World Trade, Now vs Then
Sources: League of Nations Monthly Bulletin of Statistics, http://www.cpb.nl/eng/research/sector2/data/trademonitor.html

It’s a Depression alright

To sum up, globally we are tracking or doing even worse than the Great Depression, whether the metric is industrial production, exports or equity valuations. Focusing on the US causes one to minimize this alarming fact. The “Great Recession” label may turn out to be too optimistic. This is a Depression-sized event.

That said, we are only one year into the current crisis, whereas after 1929 the world economy continued to shrink for three successive years. What matters now is that policy makers arrest the decline. We therefore turn to the policy response.

Policy responses: Then and now

Figure 4 shows a GDP-weighted average of central bank discount rates for 7 countries. As can be seen, in both crises there was a lag of five or six months before discount rates responded to the passing of the peak, although in the present crisis rates have been cut more rapidly and from a lower level. There is more at work here than simply the difference between George Harrison and Ben Bernanke. The central bank response has differed globally.

Figure 4. Central Bank Discount Rates, Now vs Then (7 country average)
Source: Bernanke and Mihov (2000); Bank of England, ECB, Bank of Japan, St. Louis Fed, National Bank of Poland, Sveriges Riksbank.

Figure 5 shows money supply for a GDP-weighted average of 19 countries accounting for more than half of world GDP in 2004. Clearly, monetary expansion was more rapid in the run-up to the 2008 crisis than during 1925-29, which is a reminder that the stage-setting events were not the same in the two cases. Moreover, the global money supply continued to grow rapidly in 2008, unlike in 1929 when it levelled off and then underwent a catastrophic decline.

Figure 5. Money Supplies, 19 Countries, Now vs Then
Source: Bordo et al. (2001), IMF International Financial Statistics, OECD Monthly Economic Indicators.

Figure 6 is the analogous picture for fiscal policy, in this case for 24 countries. The interwar measure is the fiscal surplus as a percentage of GDP. The current data include the IMF’s World Economic Outlook Update forecasts for 2009 and 2010. As can be seen, fiscal deficits expanded after 1929 but only modestly. Clearly, willingness to run deficits today is considerably greater.

Figure 6. Government Budget Surpluses, Now vs Then
Source: Bordo et al. (2001), IMF World Economic Outlook, January 2009.


Conclusion

To summarize: the world is currently undergoing an economic shock every bit as big as the Great Depression shock of 1929-30. Looking just at the US leads one to overlook how alarming the current situation is even in comparison with 1929-30.


Topics: Economic fundamentals, Globalization, Macroeconomic policy
Posted by Yves Smith at 1:26 AM



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