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Author: Scott Pearson Article source: http://www.askfinancing.com/. Used with author's permission.
AS BUILDERS BEGIN WORK ON THE FREEDOM TOWER in New York City, to be the world's tallest building, economist Mark Thornton offers a history-based theory of the relation between super-buildings and the economy. Thornton surveyed economic performance worldwide following the completion of each of the world's tallest skyscrapers, and suggests what these events foretell.
Thornton cites example after example to back up his theory. His conclusions may surprise readers, but are based on historical evidence. Thornton reports, "The announcement and groundbreaking for the world's tallest building takes place at the end of a long boom or sustained bubble in the economy."
Generally, this is followed by a bear market for stocks, and an economy heading into "recession or worse".
Lest we accept his reasoning without analysis, consider history. The Petronas Towers' completion in Malaysia signaled the Asian Crisis, pushing markets worldwide into a tailspin. The World Trade Center, completed in 1973, and the record-breaking Sears Tower in 1974, led into the dismal 1970's. The Great Depression was heralded by the Wall Street building in 1929, the Chrysler Building in 1930, and the Empire State Building in 1931. The 1913 completion of the 792 foot Woolworth Building foretold only a short downturn in that year, possibly cut short by WWI. As far back as the 1907 Panic, we can draw correlations to Singer's building (finished, '08) and Met Life's building (completed, 09).
One could question the validity of such indicators, just as one might question the "Super Bowl indicator" or other spurious forecasts. But, Thornton makes a good case for why these connections make sense: "Long periods of easy credit create economic booms, particularly in investment, speculation becomes pronounced, and entrepreneurs lose their compass of economic rationality and make big mistakes. The biggest mistakes - record-setting skyscrapers - come toward the end of the long boom and signal the bust."
Even Thornton points out that no such indicator can be foolproof, and we point out that some of these buildings were completed after a downturn, not before. One could say that this building may correlate to the recent dismal economy. But it is wise to consider the possibility that the future may also look bleaker than many in the mainstream media want to admit.
Knowing what to expect is core to sound investment strategy. As we've suggested, the present is remarkably difficult to precisely assess. Policies and events represent such a departure from the recent past that normal prediction techniques become largely useless.
The sad thing is that most analysts and forecasters have ignored the uniqueness of today's economy, and continue to base statements and predictions on mismatched methodologies.
We're not suggesting that economic law has changed: what has been true remains.. However many analysts assume that today is a carbon copy of the glorious 80's and 90's. In fact, today more closely resembles the 70's, when fear of international war and terrorism dominated, and inflation was of great concern to those who intended to save and invest (and great skyscrapers were being built).
The mainstream blindness is best illustrated by recalling the belief among members of the investment community and economic policy-makers that we were heading toward a period of deflation. Of course, deflation of any size hasn't been seen in the U.S. since the Great Depression, but their indicators led them to conclude that we were heading there. They advocated a more inflationary policy on the part of the government and proposed a Keynesian spending spree.
We would dispute their analysis. We never saw any real deflation, and now, as we've been saying all along, real concerns about inflation are beginning to become realistic.
Indeed, it is an election year. History demonstrates that incumbent administrations always follow an inflationary policy in the run-up to the election, printing and spending money to create an exaggerated impression of a good economy. This has been shown to boost re-elections, but also carries with it an inflationary punch that is often seen in the following year(s).
Understanding this simple reality steers us toward intelligent investment decisions. There is clear anticipation of inflation, and rising interest rates, which we are already seeing.
Observing these factors should help us to select investments that will perform well in the coming economy.
We have said that the economy looks strong for the remainder of this year, but as inflation and rising interest rates build next year, a potential for the type of "stagflation" we saw way back under Gerald Ford seems possible.
The market may be beginning to take this potential into account, which explains the downtrend over the past month. Possibly, this fall is the result of terrorism fears that have been drastically overplayed in the media. Terrorism is always a threat, but the idea that we're currently facing a dramatically increased threat is pure election year gamesmanship. Yet, people seem to buy into much of this, and the market follows popular sentiment. Most likely, the recent market drop may simply be a result of earnings disappointments. Most recently, earnings reports have been anything but upbeat, with many companies reporting unexciting results.
With bad earnings already beginning to hit, future economic troubles seem even more ominous. We've been saying all along that the current year should produce good results, but the future was uncertain. We now say that the future is beginning to look less exciting, and may hit sooner than anticipated. This suggests a more defensive strategy.
A defensive strategy is a two-part approach. First, it requires us to get our personal finances in order. This is no time to be carrying unnecessary debt. In the same way, it may be wise to delay those new car loans and leases. Make sure expenses are in tune with income levels, and that ample savings are being put aside as part of the mix. If the future economy is weak, income levels may be constrained, and preparing for the worst is vital. Overlooking this component can make all our good investment choices meaningless.
We mustn't focus only on the downside of the weak economy. Wise investors will look in three different directions for investment success. First, anytime an economy faces weakness, we know to consider stocks that are considered "defensive" - those which will not experience serious downturns from a poor economy. These stocks often pay dividends, which helps to stabilize the share price. This includes food, drug, alcohol, tobacco, and utility firms. Such companies may experience modest downturns in a weak economy, but people still need to eat, still need to use electricity, and still take drugs needed to maintain their well-being. Thus, these stocks generally experience less pressure than other types of firms.
We might choose to delay buying a new car in a weak economy, but we won't really delay buying necessities.
A second type of stocks to consider in an economic downturn may be surprising to some - turnarounds. We've found that times like these may create good opportunities to buy troubled companies. One would think that such "bottomfishing" would be risky in a weak economy, but this is the time when stocks tend to get hit hard when they report weaker than expected results. This creates great buys. Already, we are beginning to see select technology companies selling below book value while maintaining profitability. In a weak economy, such opportunities present themselves, and the upside potential is great. We expect more of these opportunities next year, but some are already beginning to become available. This type of equity can't be expected to provide immediate results. Often they take months or years to turn fully around, so a great deal of patience is required. A different level of investing discipline will be required in these times.
Finally, in an inflationary economy, commodity goods can provide good gains. Thus, stocks such as gold and other mining stocks, oil producers, timber producers, and other natural resource developers may hold promise. While we are inclined to like these stocks generally, many of them have already risen to levels that seem pricey. Overpaying for stocks in this kind of market may prove to be a big mistake, so we're forced to be patient and seek out the few good opportunities in this sector.
Investing in the coming period will not be simple. But opportunities will continue to exist. In such times, selecting stocks carefully and maintaining discipline will be the keys to success. To send comments to Scott Pearson or to learn more about his Investment Management Services, visit http://www.valueview.net
Scott Pearson is an investment advisor, writer, editor, instructor, and business leader. As President and Chief Investment Officer of Value View Financial Corp., he offers investment management services to a wide variety of clients. His own newsletter, Investor's Value View, is distributed worldwide and provides general money tips and investment advice to readers both internationally, and in the U.S.
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