With my background in corporate finance and analysis, I try to find historical parallels to current ...
With my background in corporate finance and analysis, I try to find historical parallels to current economic events in an effort to find roadmaps for the future. Seeing great opportunities last year at this time, I structured portfolios for a possible resurgence of consistent growth stocks (very much value stocks at the time) in beverages and food, defence and healthcare as the Federal Reserve tightened credit. Uncharacteristically, I even thought investors should buy bonds. As many recall, this was a major shift from the view I first adopted in the fall of 1998 when portfolios were positioned to take advantage of the turnaround of the Asian economic crisis through cyclical recovery beneficiaries in oil, semiconductors and basic industry shares.
So now, with many classically trained economists throwing out 1995, 1991, 1984, 1975, 1968, 1957 and even 1930 as economic roadmaps for investors to follow in 2001, I find myself culling bottom-up company information and trying to find modality in an effort to parallel history. Despite the new crowd of historians, and, perhaps fittingly, my belief is that, due to a turn of events, there is no period that most likely mirrors the path for 2001.
When investors think about 1990, their first thought is probably the stock market downdraft brought about by the Iraqi invasion of Kuwait in August. As an Army Reserve Captain at the time who needed to post my whereabouts weekly to the Reserve Control Centre, I have vivid memories of 'what if' conversations about how my life and career might be disrupted by possible war. Looking back now as a portfolio manager trying to assess current opportunities, my interest is in examining what might have happened if Saddam Hussein's tanks did not roll into Kuwait on 2 August and the events surrounding it had not occurred.
At the end of 1989, increased volatility had emerged on Wall Street and the economy. The collapse of the buyout for United Airlines in October was the signal for many that the era of highly leveraged transactions financed by abundant, cheap capital was over. The losses incurred by the major risk arbitrage firms parallel the recent drubbing of venture capitalists.
Moreover, industrial firms and banks were struggling with profits and the overall economy, starting to feel a hangover from the excesses of the 1980s, was puttering along because of a change in risk tolerance driving up the cost and making capital scarcer. Ironically, unusually harsh winter weather gripped most of America during December and sent food and home heating fuel prices higher, making the situation seem even worse.
With criticism about foot-dragging starting to mount against Alan Greenspan, the Federal Reserve reversed posture towards easing of credit beginning in November 1989. That said, after initial rate cuts in November and December, the Federal Reserve held back in lowering interest rates further until July 1990. The ever-elusive soft-landing and 'target zero' seemed at hand.
Impact of war
Then, in July of 1990, President Bush, the father, did an about turn on taxes. In addition, squabbling between the President and Alan Greenspan over the necessity for further interest rate reductions threatened an already weak economy. But before the achievement of an actual soft landing and a fine-tuning approach to interest rate policy could be real-world tested, Iraq invaded Kuwait and set off a severe curtailment in consumer demand, capital spending and confidence globally, leading to a (short) bear market and a deep recession.
Although it is always easy to craft historical parallels that seem remarkably similar, the 1986 to 1990 string of events matches quite closely with the events of 1998 to 2000, even if things happen at double-time this time around. In this case, the commodity price trough and developing world crises of summer 1986 and fall 1998 were followed by massive central bank liquidity flows.
These were then followed by economic recoveries (1987-88 and 1999), which were followed by tightening credit and a sharp rise in the cost and cut back in the availability of capital (1988-89 and 2000), and then a bell-ringing event, usually lagging, ushering out an era (UAL buyout collapse in 1989 and internet stocks collapse in 2000). Notably, this is where the roadmap ends because we never know how 1990-91 would have ended up if the Gulf War did not occur. So just when there is a return by many former 'new paradigm' economists and portfolio managers to business cycle parallelling, I am for the first time in quite a while seeing less thematic inference from bottom-up stock selection research and analysis.
As I said before, it is always easy to see mirror events in history and perhaps get a false sense of one's forecasting ability. There are many parallels to draw from the LBO experience and the technology spending boom in terms of cheap and abundant capital. However, the one issue that warrants a high degree of examination is something as mundane as useful lives in order to assess whether or not, and for how long, a recession might occur.
As any accountant can tell you, the limiting factors of an asset's useful life are physical deterioration, maintenance and obsolescence. The one stark contrast to the late 1980s LBO frenzy and the late 1990s spending boom on technology is not the cost and source of capital, but the use of that capital and the useful lives of the assets that literally had capital thrown at them.
Just like dot.com IPO mania with its connotation of free equity capital replaced the 'unfair' cost of capital advantage from junk bonds and Japanese funds, servers, routers, software and data storage units replaced office towers, paper mills and television properties. Obviously, a new office tower or a n
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