November 12, 2007 Edition > Section: Business > Printer-Friendly Version Talk of Worst Recession Since the 1930s BY DAN DORFMAN November 12, 2007 URL: http://www.nysun.com/article/66268 <table align="left" border="0" cellpadding="1" cellspacing="10" width="160"> <tbody><tr><td> <iframe src="http://oasis.nysun.com/oasis/oasisi-i.php?s=9&w=160&h=600&t=_blank" marginwidth="0" marginheight="0" hspace="0" vspace="0" frameborder="0" height="600" scrolling="no" width="160">is.nysun.com/oasis/oasisc.php?s=9&w=160&h=600&t=_blank" TARGET=_blank><IMG SRC="http://oasis.nysun.com/oasis/oasisi.php?s=9&w=160&h=600&t=_blank" WIDTH=160 HEIGHT=600 BORDER=0></A> </iframe> </td></tr></tbody></table> <table style="width: 313px; height: 142px;" align="right" border="0" cellpadding="1" cellspacing="10"> <tbody><tr><td> <center>ADVERTISEMENT </center></td></tr> <tr><td> <iframe src="http://oasis.nysun.com/oasis/oasisi-i.php?s=7&w=300&h=250&t=_blank" marginwidth="0" marginheight="0" hspace="0" vspace="0" frameborder="0" height="250" scrolling="no" width="300"> <A HREF="http://oasis.nysun.com/oasis/oasisc.php?s=7&w=300&h=250&t=_blank" TARGET=_blank><IMG SRC="http://oasis.nysun.com/oasis/oasisi.php?s=7&w=300&h=250&t=_blank" WIDTH=300 HEIGHT=250 BORDER=0></A> </iframe> </td></tr> <tr><td></td></tr> </tbody></table> After what Los Angeles money manager Arnold Silver called "a brutal three days," the question is: What now for the market? A Wall Street superstar this year who runs Balestra Capital Partners, Jim Melcher, says he's "worried about a recession. Not a normal one, but a very bad one. The worst since the 1930s. I expect we'll see clear signs of it in six months with a dramatic slowdown in the gross domestic product." Balestra Capital, a $350 million New York hedge fund, was up 3% for the past three market sessions, when the Dow Jones Industrials, spearheaded by widespread declines in financial stocks and fears of more billion-dollar-plus asset write-downs, tumbled more than 677 points, or about 4.5%. The Nasdaq fared worse, skidding about 7%, triggered by across-the-board declines in those fast-stepping technology stocks. Balestra has increased in value by 175% so far this year, Mr. Melcher tells me. A 9-year-old fund, it has posted compounded annual growth of about 30% since its inception. Mr. Melcher, a market bear, had some pretty discouraging words. "What I think is not good for the country, but good for me." he says. His basic advice to the country's roughly 80 million stock players: Run for the hills — the worst is far from over. An investor's stock portfolio now, he believes, should be only about half of what it might normally be. With the housing market in a state of collapse — and he says he believes it is far from over — Mr. Melcher argues that average homeowners will not be able to withstand the kind of recession he sees, given the added burdens of rising energy and food costs, and continued deterioration in the credit markets. Noting that consumption is already slowing, Mr. Melcher figures sharply rising unemployment is inevitable. Our bear figures the next six to 12 months will be awful for investors as the market goes down "pretty substantially." His frightening outlook calls for an additional 20% to 30% decline from current levels. A drop of that magnitude would put the Dow down in a range of roughly 9,100 to 10,400. Asked how he could conceivably give credibility to such an ominous forecast, Mr. Melcher observes: "I've never seen a market with more risk and what's significant is that risk is not yet priced in." Given his grim expectations, he says there is no equity market in the world he would play right now. "When the American market goes down, other equity markets around the world should follow," he says. As of now, his portfolio is pretty much devoid of stocks, save for an exchange-traded fund focused on leading companies in oil services, which he regards as an ongoing growth industry. The ETF, the Oil Services Holders Trust, trades on the American Stock Exchange under the symbol OIH. Although enthusiastic about the industry's growth prospects, Mr. Melcher says he would be reluctant to recommend oil services stock because he believes the price of oil could easily drop 50% in the recession he envisions. Another danger he sees for the market is the prospect of huge withdrawals of funds from America by foreign investors due to the falling dollar, the credit crisis, and a slowing economy. At the moment, Mr. Melcher's chief investment strategy is shorting stocks and certain bonds, notably mortgage-backed and junk bonds, through the use of derivatives, put options, and credit default swaps. He is also short ABEX, an index of residential mortgage-backed securities. His short strategy is largely responsible for his super performance this year, as are his holdings in gold. The fact he's sticking to this strategy is evidence that he firmly believes the chaos in the financial markets is far from over. Mr. Melcher is also gung-ho on several currencies, particularly the Swiss franc and the Japanese yen. The average investor, he believes, should seek to protect his assets by raising cash, putting money to work in short-term treasuries, and buying some gold (notably through StreetTRACKS Gold Trust, an ETF that tracks the price of the precious metal and trades on the Big Board under the symbol GLD). Is the world coming to an end? I asked our bear. "I don't think so," he replied, "but as I mentioned, the ingredients are in place for the worst kind of a recession, which means it's the wrong time to own stocks."
I think Mr. Melcher's opinion is overly optimistic but otherwise correct. Remember, in the Great Depression we had deflation, in the upcoming depression we'll have (thanks to the Federal Reserve) inflation. If anyone knows an older person who remembers the Great Depression, now's the time to sit down with them and pick their brains for ideas.
One problem Mr. Melcher doesn't mention: Before the depression, owning a home generally meant actually OWNING it. Today, what most people own is the exclusive right to rent that home, until they miss a payment or two. And if those mortgages go into default after the value drops below the remaining principal, those "owners," will find that they're in even worse shape than renters. If I can't pay my rent, I get kicked out. I currently have several friends who, if they can't pay their mortgages, will get kicked out, AND owe tens of thousands for the privilege of having payed all that interest.
One thing that he also forgets is that during the first depression most people in this country were only one generation off the farm and knew how to garden and raise livestock. So people in cities raised rabbits and planted gardens. People today have no clue what it takes to get food from seed to their table, or how to raise and butcher small animals. OGM
Interesting that he expects oil to drop in price. That doesn't fit the curve. Notice, he said price, not value. To my feeble mind, that sorta indicates that the dollar will go up vs. other things. I guess that could happen, especially if there are fewer FRNs floating around because of debt collapse. Hm.
Recession = Slowing of Economy = Drop in Demand = and according to supply/demand curves that means a lowering in prices. He assumes there will be a drop in demand that will pull down usage which will lower prices. What we have been experiencing in the current economic market is both Demand-Pull and Cost-Push inflation. Increased demand + increased cost to produce = $3.50 gas (plus a little market speculation).
I would question that assumption. From what I remember and observed over the last couple decades is that fuel demands (think heating oil, for example) are rather inelastic; if it is available, it gets consumed no matter the price. Translation; necessity, not choice. For a drop in demand of that magnitude, lots of folks will have to choose walking, less lighting, and chilly houses. The former two are possible, the latter apt to be untrue. How the mix will fall out is unclear to me.
