The news media is full of stories blaming the latest wild market swings on Wall Street acquiring "recession fears" and fretting about "weak earnings." The New York Times, for example, published a story entitled "Stocks Dive as Crisis Erodes Earnings" and cited weak earnings from Wachovia, Boeing and Merck as "major businesses across a range of industries."*
Few if any are the voices which point out that we have reached a state of irrational pessimism, in which nothing can possibly be good news and everything is interpreted from the viewpoint of certain Armageddon.
It is important to view the current state of the economy accurately. The current credit crisis did not arise because the economy was slowing down. The fall of companies like Bear Stearns and Lehman Brothers did not result from spreading economic malaise in the country which caused home foreclosures to rise and thus drive Bear and Lehman out of business.* Bear and Lehman were brought down by their inability to get lending, due to problematic balance sheets and a death spiral exacerbated by mark-to-market accounting regulations and the removal of the short-selling uptick rule, among other reasons which we have noted in the blog.
This is important. If the chaos caused by the problems in the financial sector actually does eventually receive the "recession" label from the National Bureau of Economic Research (NBER), then you should realize that the direction of the disease was from Wall Street to the broader economy, rather than from the broader economy onto Wall Street. Thus, we believe that the continued dire predictions of "the worst recession since the Great Depression" just around the corner are overblown. In fact, there are hints in the earnings reports coming out this week which bear out this analysis.
Certainly, financial companies in deep distress, such as Wachovia, are going to have bad earnings results. But Boeing's earnings woes stem directly from a machinists' strike and are not symptomatic of the overall economy, the way the New York Times would have you believe.
On the other hand, Apple yesterday released earnings that beat analysts' estimates by three cents a share, and which included Apple iPhone sales numbers that one analyst described as "jaw-dropping."* Apple's Peter Oppenheimer said that they sold nearly 6.9 million iPhones in the September quarter, exceeding the 6.1 million units shipped over the entire lifetime of the first generation iPhone. That was in one quarter. If we are in the Great Depression, it isn't stopping too many people from needing to get their new 3G iPhone.
Elsewhere in the third quarter, Amazon* reported that sales were up 31%! Major League Baseball had record revenues in the just-completed season -- an all-time high of $6.5 billion, and attendance just 1% off from the previous record set the season before, according to this Bloomberg News story.
But of course, the spin on all these stories is how negative things are about to be. Many companies (including Apple and Amazon) issued very gloomy outlooks in their forecasts for the upcoming quarter. Can you blame them, with a regulatory environment in which CEOs are frightened by what might happen to them if optimistic guidance turns out to be wrong? In the Apple story linked above, an astute analyst notes that Apple's low-key sales forecast for the upcoming quarter calls for results that are flat from a year ago and ignores the obvious demand for the latest iPhone. He calls the forecast "comical" and says "It's almost mathematically impossible."
Our advice to investors is, first and foremost, to avoid investment strategies that try to predict economic cycles, as we have explained in previous posts. We advise ownership of good companies through economic cycles -- the same way most of the great fortunes in America have always been made.
Secondly, while we don't try to predict economic cycles, we would advise a healthy dose of skepticism about the current calls for the worst recession since the Great Depression. If we do dip into recession, we believe it will be brief and that recovery will be rapid, mainly because we believe it is clear that the current problems came from the financial sector and not from an economy-wide disease, an important distinction.
When everyone is ignoring any good news and are convinced that all news is bad, it is irrational, just as it is irrational when everyone was ignoring any bad news and convinced that the market would go up forever (a situation that seems like a distant memory, but it really did happen once). We are in such an irrationally negative situation now.
* The principals of Taylor Frigon Capital Management do not own securities issued by Wachovia (WB), Boeing (BA), Merck (MRK), Bear Stearns (BS), Lehman Brothers (LEH), Apple (AAPL), or Amazon (AMZN).
For later posts dealing with this same issue, see also:
- "It's a panic, not a Great Depression" 01/21/2009.
- "Managing Investments in the New Era" 02/18/2009.
- "Repeal what remains of the misguided stimulus" 09/01/2009.
- "The Consumer" 10/19/2009.
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