The Interesting Thing About The Economy

What is kind of bizarre is how the US economy has been holding up over the last year. Yes, economic numbers may be revised down in the future; yes, things are not exactly rosy; yes, corporate profits have been declining. But has anyone looked at the economy in aggregate? Except for the troubled areas (housing, retail, financials,) things are not as bleak as they seem. Don't forget that the housing collapse has been unfolding for almost 3 years now (peak in 2005 depending on what measure you look at) and almost an year of the credit crisis has passed. The relatively mild weakness in the economy is one reason I am not as bearish as I otherwise would be.

Thanks to Contrarian Investing Blog, I ran across a Boston Globe interview with Ken Heebner where he is far more optimistic than most. I don't know much about Heebner but my impression is that his investing style is sector rotation with heavy trading (his portfolio turnover is very high.) He has a good track record of late and is generally bullish on commodities (I'm bearish on commodities though). Here are some interesting points from him:

Q: There's a lot of pessimism about the economy. What's your take?

My view of the world is quite different. I think people are very concerned about our economy, they're starting to realize there could be higher inflation to come. The consensus is that we'll bring the rest of the world into our recession. But my view is we've probably seen the weakest period of economic activity. The economy may not be robust in the next year, but it's seen its low point and at some point will move higher.

Q: That's reassuring, but how can this be?

I understand how serious the housing problem is. But it's not as broad a problem as widely perceived. It's reduced everyone's sense of financial well-being, but a third of homeowners don't have a mortgage, and the vast majority of people made down payments and have fixed-rate mortgages, so there's no financial strain. For them, the only impact is the psychological impact of declining housing prices. So therefore I don't think this is as big a deal as everyone else does. We've passed the point of maximum distress.

Like most commodities bulls, he expects high inflation going forward. If we end up with high inflation (Heeber thinks inflation will hit 10% in 3 years), financial assets (stock and bonds) will be severely re-priced downwards, as was the case in the 70's. P/E ratios around 10 for the market (meaning around P/E of 5 or 6 for the contrarian stocks) could be the norm. I don't expect to see that so it remains to be seen who is right...

Whatever the economy does, do keep in mind that the economy and the stock market are not correlated as closely as many think. The stock market can fell sharply in 2000 to 2003 but the economic recession is considered mild (as long as you were nowhere near the technology sector.) One of the reasons value investors do well through any condition is because of this fact. That is, you try to pick companies that are undervalued and will do well regardless of the environment. Warren Buffett is the absolute best but if you look at his record, he has done well through many different conditions, including high inflation, wars, panics, and crashes.