DempseyTV

A fitting title as we begin Mar. 2009. Equity markets have been down six straight months. The Dow Jones was down 15 of the last 17 weeks.

There is a very strong tendency for people to exaggerate the importance of recent events and recent performance. It is human nature. You turn on the t.v., read a paper and whatever is on seems more important at the time than in retrospect. Probably the greatest mistake in investing is exaggerating the importance of, and extrapolating, what happened lately. What has happened over the last 3 and six months has substantially changed the psychology of a lot of people in the direction of betting these recent conditions will continue.

Floyd B. Odlum made a fortune in the Great Depression

So, I’d like to introduce you to Floyd B. Odlum, who died in 1976. He was an investor by profession, CEO of Atlas corp. Functionally he was an opportunist. He made a fortune in the Great Depression by buying up the deeply discounted shares of publicly traded investment trusts, the toxic assets of his day. We can have no finer role model in this, our Great Recession.

None of us can know the future, but like Odlum, we can make the best of a sometimes unappetizing present.

Let us travel back in time to 1930, the first time full year of the great slump. Nobody knew there would be a second such year, let alone a third. They were as much in the dark about the future as we are. In August 1933, the New Yorker magazine ran a profile of Odlum. “His cheerful behavior during this period was a recurring source of wonder and irritation to his friends.”

At one of the most painful moments in the country’s financial history, he was saying “I believe there’s a better chance to make money now than ever before.” As investors we are always so conflicted. We seek out bargains at the mall but shun them with our investment dollars. We loved internet stocks in 1999 at sky high prices, then hated them at $2 per share. Long term U.S. bonds are snapped up today at 3% yields but despised at 14% and more in the early 1980’s.

Odlum’s big idea was to buy dollar bills for 50¢.

Buying Dollar Bills for Fifty Cents

Great investors, world class opportunists, adapt to the times. What makes Odlum a guide and beacon for 2009 is that he saw across the valley of despair. Quoting from a Fortune magazine article about him from 1935: “He has no great faith in the immediate future of the market, whereas he was willing to bet his fortune on the market’s eventual future.” Odlum was bullish on America, as many of us are and should be. But he put money at risk only when the odds seemed right – when the investment has a price tag low enough to afford a margin of safety.

The silver lining of the Great Depression was of course, the prevalence of low price tags. Thankfully, to a lesser degree, it is the silver lining of our Great Recession.

The title of this memo, as investors, says it all! It is audacious to be hopeful, these days, for anything. However, this is exactly why we must begin to adjust our thinking.

While we can’t know what will happen we can at least observe. With that in mind, we’ll observe the period from 11/20/1998 to 11/20/2008. The total return for that period matches the period from late 1928 to 1938! An annual compound loss of (2.58) or a cumulative loss of 23%; dividends included. By this calculation and observation, the stock market may have already discounted a 1929 –1933 type depression.

It is hard, even in our media-hyped fear mongering modern world, to envision that future circumstances would produce a depression with a total earnings wipeout and unemployment soaring to 25%.

Compare the current financial crisis to the war years: 1938-1942

Keeping in mind that the stock market deals with the future and what might happen while the news deals with what has happened, let’s look at the war years 1938 to 1942.

From the time global war was visible in 1938 to the blackest days of 1942, when the risk of losing the war was the greatest, the U.S. stock market fell 60%. This compares to a 52% top to bottom decline 10/09/2007 to 11/20/2008.

Some facts:

• 430,000 American lives were lost in that war.
• Between 50 and 72 million civilians/combatants were killed in that war.
• From 1939 through 1942, Germany and Japan were winning the war, perhaps soon to occupy and control the Pacific Rim, Europe and the Americas, including the U.S.
• In Europe, only England and Russia were not occupied and London was being bombed nightly.

From the actual start of the war in the Fall of 1939 thorough the critical turning point in 1942, the U.S. stock market fell 44% compared to the recent 52% decline. Now, some perspective, does this imply the risk of life, fortune, freedom, future prosperity and well being is greater now than it was back then? I think not.

• Is there any real risk of being ruled by foreign despots?
• Is there now the real risk of total confiscation of personal assets and wealth?
• Are our very lives now at risk?

To say today’s stock market risk factors are the greatest since the depression is absurd.

As a model for the current crisis the great depression does not stand up to even a cursory examination.

Catastrophic policy mistakes following the 1929 stock market crash

Two catastrophic policy mistakes transformed a severe economic downturn following the 1929 stock market crash into a deflation depression:

• General adoption of aggressive trade protectionism – There are no significant pressures now
• Federal Reserve allowed both widespread bank failures and a severe contraction in money supply, exacerbated by the gold standard.

It is clear from the speed, scale and radicalism of the Fed’s ongoing response to the “credit crunch” that they intend to not repeat that mistake. Clearly, they have learned something; with a different set of consequences that we’ll cover in 2009.

Other differences between the current financial crisis and that of the 1930s

There are other crucial differences with the 1930’s. Most bank deposits are now federally insured. Government spending forms a much larger part of the economy and significant components of it automatically rise if the economy declines. These “automatic fiscal stabilizers” are much larger than they were then. Furthermore these factors are replicated across the global as fiscal stabilizers exist in every economy now and bank deposits are widely protected.

Looking beyond

So this leaves us, like the stock market, looking forward to 2009 and beyond, looking to the “audacity of hope” and what can surprise us.

• The new president and leadership from Washington
• So far, crisis responses have been monetary. For 2009 they will be fiscal; evidenced by the President elects plan to create 2.5 million jobs. This is been repeated around the world.
• A plan to end the Iraq war
• Much lower interest rates
• Much lower fuel prices

While 2009 will have news headlines almost too unbearable to read, as investors, I am hopeful we have much to be optimistic for.