So Far, So Good . . . If You Did What I Said

by Gary North
by Gary North

But did you?

In 2005, I warned that real estate would fall. Such a decline had not taken place since the Great Depression. This was considered an off-the-wall prediction then. Not now.

I have been writing for months that we were moving into a recession, that stocks would fall, that foreign currencies would rise, that the Federal Reserve System was not inflating, and that consumer prices in America would rise in 2008 at a rate less than 2%.

If you acted on these warnings, you have done very well. If you just sat there, you have not done well.

We are in the early stages of a great unraveling. The visible breakdown today is residential real estate. The other breakdown is in the financial sector, which used short-term money to fund subprime mortgages. The unraveling has spread to Alt-A mortgages, the next tier up.

Bear Stearns stock fell from $160 a year ago to $2 on Sunday morning, to $4.81 yesterday. This was the fifth largest investment bank in the United States as recently as a week ago.

A week ago, its CEO assured investors that everything was just fine. The headline on CNN/Money (March 12) blared the official line:

Bear Stearns CEO: We'll meet estimates
Investors cheer after Alan Schwartz says the bank has a $17 billion safety net and its liquidity remains intact.

The report indicated that lemmings were still alive and well on Wall Street.

Shares of Bear Stearns Cos. leaped Wednesday after the investment bank's chief executive said he is "comfortable" that the company's profit will fall within the range of analysts' estimates for the first quarter.
In an interview with CNBC, Alan Schwartz said he expects Bear Stearns fell within the range of estimates that analysts on Wall Street forecast for the fiscal first quarter, which ended last month.
Analysts' expectations for profit range from 46 cents per share to $1.61 per share.

The analysts were blind as bats. So was Alan Schwartz. By Friday, March 14, the company was nearing bankruptcy.

Its stock price chart tells all. On Monday, the 11th, the shares opened at $68. They fell to $60. Mid-morning, Schwartz gave his happy-face prediction. The shares moved back to $67. On the 13th, they fell to $50, but rose to $57 by the end of the day. They fell to $30 on Friday, the 14th. By Monday morning, the 17th, after a weekend takeover by J. P. Morgan that was backed up by a Federal Reserve guarantee of $30 billion credit line, its shares had fallen to $2.

The investors are no longer cheering.

Flashback to the 11th.

Schwartz also denied rumors that the company's liquidity is under threat. Bear Stearns still has a $17 billion cushion against losses, he said.
"Our balance sheet has not weakened at all," he said. "We don't see any pressure on our liquidity."

I think the New York Stock Exchange should institute an annual "Kenneth Lay Award for Misleading Forecasts by an American CEO." Alan Schwartz gets my vote . . . this week.

Mr. Schwartz did not have a clue as to how bad it was in the capital markets. He has now made himself legendary with his forecast. It will be quoted for years. It took months for Enron to go belly-up. It took Bear Stearns one business week.

How bad is it? A lot worse than the CEO's think.

SHOOT THE MESSENGER

As the markets keep confirming my forecasts, and as my website's subscribers make more money, a few of them cancel. It's the oddest thing. I am reminded of the old statement, "nothing fails like success."

I have a theory about this. When my subscribers see my predictions come true, those who failed to act get upset with themselves. A few of them cancel. They do not want to be reminded of the investment opportunities they have lost. They would rather not read my forecasts any more. Instead of finally taking action, they prefer to cancel.

I suspect it is the same with some Reality Check subscribers.

I know that 80% of my newsletter subscribers do not open the daily letter.

Of those who do open it, my guess is that fewer than 20% actually read each issue.

Of those who read it, about 20% actually act in terms of it. That's about 4%. It may be less.

People do not like to be reminded of lost opportunities that were in their hand.

To those of you who have read my letter and who have seen all this unfold, I ask: "How much confirmation can you afford?"

The best and the brightest, or at least the richest, did not see this coming. The standard forecast as late as December, 2007, was that there would be no recession in 2008.

Most of the forecasters who predicted this are lying low today. A few have switched. The editor of the "Bank Credit Analyst" abandoned pages and pages of data that supposedly justified his "no recession" call in early January. By late January, he was forecasting a recession. He alerted his subscribers of his changed views in a special issue. Most forecasters are not this open. Here is an account of this reversal by someone who promoted the BCA's bullish forecast to his clients in early January and was still unwilling to accept the new message on January 24.

The problem for forecasters of recession is that if they are correct, their readers won't believe them and will not take defensive action soon enough, but if they're wrong, people remember. It's safer to go with the crowd. The forecasting crowd remains optimistic as the collapse is in already progress. The Bear Stearns fiasco is a classic example.

WHAT ABOUT YOU?

We survive major threats to our lives and lifestyles by thinking that nothing really bad will happen to us. This is a phenomenon on the battlefield: every participant thinks he will survive the war. He won't get killed. He won't wind up crippled for life from an injury. Yet people do get killed and do get maimed.

I don't know if you have sat down and thought through your degree of vulnerability to a serious recession. The last major one was in 1991. You probably were not in your present job in 1991. If you are in high tech, your industry may not have been in existence in 1991. Here are some questions to get answered now.

How safe is your retirement portfolio from a major recession and stock market decline?
How much of your retirement portfolio is in dollars?
How much equity do you still have in your home after normal discounting and the sales commission? After recession discounting?
How much money do you owe on things other than your mortgage?
How safe is your employer's bank?
What would happen to your employer if the bank were to cut off your employer's normal credit line?
How secure is your job in a recession?
What are your employment opportunities locally?
What is your fall-back position if you get fired?
How long would it take you to get a job in a recession at your present salary?
What is the cut in salary that you could afford to take, given your present monthly budget?
How much could you cut your budget if you had to? How?
Is your wife employed?
How do these questions apply to her?

Recessions are fearful times for people on commission and for companies that sell products and services that are not high on the consumers' lists of non-discretionary spending.

Think of your own household budget. If you lost your job, what items would you cut from your budget in the first month? The second month? The sixth month?

Consumers around the country will be thinking about this in three months, six months, and a year. They are going to go through the gut-wrenching experience of cutting back on spending. Their homes' equity is falling. Lenders will be less likely to extend credit based on home equity.

If your job is vulnerable to a budget-cutting exercise, you had better get used to the fact that your employment opportunities will be shrinking in 2008 and 2009. This may extend through 2010.

This is not yet visible in the unemployment figures, because hundreds of thousands of Americans have ceased looking for jobs. Because the unemployment rate is based on a comparison of jobs lost vs. job-seekers, the figure does not reveal rising unemployment.

THE LIMITS OF INVESTMENT ADVICE

Investment advice can help you increase your savings, including your retirement savings. But if you lose your job and are forced to tap into your savings in order to keep food on the table and the bills paid, investment advice cannot help you.

Most of your income is from your job, not your retirement portfolio. You would therefore be wise to pay close attention to your local job market. But most people assume that they will not get fired. So, they are more apt to pay attention to their retirement portfolio or their savings plan, assuming that they can direct the assets. If they are dependent on third parties to do their investing, they are facing a major problem. The Bear Stearns experience is indicative of the problem. Remember these words:

Analysts' expectations for [Bear Stearns] profit range from 46 cents per share to $1.61 per share.

I have tried to show my subscribers what to do with their investments. But, ultimately, what matters most for most people is their career plan. What about yours?

Is it consistent with recent events?
Is it positioned for future events?
Does it maximize your lifetime opportunities?
Does it allow you career flexibility (new career)?
Does it lead toward a retirement career?
Does it offer you enough time to build a side business?
Have you identified your fall-back job?
Have you developed a system of networking?
Do any potential employers know how profitable you are?
Does your boss know how profitable you are?
Does his boss know how profitable you are?
Are you well known within a niche segment of your industry?
Do you have your own website?
Do you have your own blog site?

These are the kinds of questions that most people refuse to ask. They know the answers: "no." They prefer to live with this answer to these questions. They hope for the best.

Always hope for the best. Your career plan should be the basis of this hope. Hope should be an extension of a well-developed career plan, not a substitute for one.

I have written a report on "Ten Factors in Your Career Plans to Consider Before the Recession Forces You to Do This."

CONCLUSION

In times of economic recession, a few people learn this lesson: "I'll never allow myself to be caught flat-footed again." For them, a recession is like a diet or an exercise program: painful but necessary.

Most people weather the storm. Even in the Great Depression, most Americans had a job. It just wasn't a good job. It was filled with uncertainty unless it was a Federal government job.

I strongly suggest that you look at this as an incentive to think through your career plan. You probably will not get fired. You may not suffer a loss of income. But you will get a renewed sense of the vulnerability of being at the mercy of just one employer. You are dependent on third parties to make investment decisions for you, namely, the investment decisions that keep the company's doors open.

When you think of corporate wisdom, think "Alan Schwartz."

March 19, 2008

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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