TIPS FROM THE GURU-THE GREAT PANIC OF 2008: OCTOBER 10, 2008

First, let’s start with the obvious: This is unlike any market meltdown I’ve seen in my career. That includes the 1987 crash, the 1990 invasion of Kuwait by Iraq, the 1993-94 utility deregulation scare, the 1997-98 Asian Crisis and the 2000-02 Great Bear Market and utility sector collapse.

There is one thing, however, that this collapse has in common with every one previous to it: crushing fear, which has now yielded to unbridled panic.
Up until about 3 pm on Thursday, it seemed as if the selling wave of the past few weeks had run its course. Bargain hunters were starting to venture into a growing number of stocks, and a lot of green was showing up on investors’ screens.

Then came the selloff of the last hour, which wound up carrying the Dow Jones Industrials down nearly 700 points. The selling wave then picked up steam in Asia, swept over Europe and began pounding the US again today.

In short, what had begun as a selling wave has now become a wholesale liquidation. Stocks, bonds, commodities, preferred stocks and mutual funds are being dumped en masse. Business fundamentals, solid earnings--such as Chevron’s preview yesterday--and even dividend increases are being ignored. And anything stock that’s not losing at least 10 percent everyday is considered an outperformer.

To be sure, there are plenty of reasons for concern today. The global banking system has been shaken to its roots, and lending largely remains frozen as the US contagion has now spread well
beyond our borders and well beyond anything to do with mortgage-backed securities.

This week, Iceland announced the government takeover of its banks. That effort was, ironically, aided by Russia, a country whose own banks have had to rely on government assistance and which actually closed its stock market this week.

As for the US economy, the hard economic news is still nowhere close to Great Depression-esque. Initial claims for unemployment insurance actually declined in the latest week, for example.  But the decline in consumer credit is a pretty clear sign that Americans are at last pulling in their horns a bit after years and years of unparalleled spending. If that trend continues, it will mean a contraction in all those industries that feed the consumer appetite, which could be quite severe.

The plunge in oil prices since mid-year, ironically, has also become a cause for concern. When black gold was pushing $150 a barrel, few envisioned a near halving of the price would be possible in such a short time. Now that it’s occurred, however, it’s becoming a real threat to the transition to a “green economy” and getting the nation off its dependency on imported oil. And every drop in oil’s price is another reminder to market participants that the global economy faces tremendous uncertainty in the coming year.

The best thing we have going for us now, of course, is that virtually all of humanity is on the same page on this crisis. And although there’s considerable variation as to tactics from country to country, there’s also a nearly unanimous consensus that the immediate solution is money.

Private sector credit markets remain frozen, as evidenced by still historically high spreads between the London Interbank Lending Rate (LIBOR) and the rate that the US Federal Reserve is currently offering banks. With so many bad assets out there and the economy slowing, banks are still terrified of lending to other banks. The Treasury bill/Eurodollar spread now sits at 452 basis points, near all-time highs.

Even companies in recession-proof businesses are having problems borrowing at decent rates of interest. This week, for example, Southern Company--the very model of stability in the electricity industry--reported that the interest rates it must pay to sell short-term commercial paper rates basically have doubled from earlier in the year. Duke Energy and others, meanwhile, have taken the extraordinary step of actually drawing down credit lines to ensure the money is there when they need it.

Central banks globally, however, have basically thrown open their coffers to all comers. In the US, Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke now have unprecedented powers to buy assets and push cash where it’s needed. Elsewhere, Britain this week provided a massive cash infusion to its banks, and other countries have been quick and decisive about doing the same.

Their actions certainly haven’t done much to calm these panic-stricken markets yet. But they do represent actions that are 180 degrees different from those taken by monetary authorities in 1929-30 as the financial panic of that era unfolded.

Authorities, in short, have recognized that the problem is money, and they’re increasingly willing to put all their resources to that end. Ultimately, that means the debasement of paper money globally and a major boon for raw materials, other hard assets and gold worldwide. For now, however, money is exactly what a credit-short economy needs--and it’s coming in increasing amounts.

Another big difference between the Great Depression and the current crisis is that there are still regulations and safeguards in place that were enacted in the 1930s to prevent bank panics.  Many of these have been dismantled over the past two decades by deregulation. But we still have the Federal Deposit Insurance Corporation (FDIC), which now ensures all deposits up to $250,000. And it may be extended to cover all deposits in the coming days.

In contrast, during the Depression, the only recourse for deposit holders when a bank went bust was to physically try to pull their money out. Not surprising, that resulted in bank runs, which are well portrayed in movies depicting that era. You can only imagine the state of the global economy if we had seen full-blown bank runs after Washington Mutual and Wachovia went bust a few weeks ago, as deposit holders rushed to pull cash out of every bank in America. Happily, thanks to President Roosevelt and the FDIC, that won’t happen this time.

The FDIC isn’t the only Depression-era creation that’s proving its worth. The Federal Housing Administration (FHA) suffered years of neglect under deregulation-minded White House administrations. But it’s now making a major comeback. And despite the demise of AIG, investors can be confident in the safety of their annuities, insurance and brokerage accounts, thanks to regulations that segregate their assets from those of holding companies like AIG.

Sooner or later, all the money being pumped into the global economy is going to have its desired effect. In a sense, the action now is like a group on a camping trip trying to light a fire when all the wood has been soaked by a storm. The campers are ready, willing and able to dump all the paper, cardboard and lighter fluid to get the fire going. For a long time, it seems no matter what they do can spark things up. Eventually, however, it does light. And when it does, it quickly becomes a conflagration.

This weekend, I’m in New Orleans with my parents on their 60th wedding anniversary. That gave me the opportunity to talk with my Dad, who--along with my Mom--actually did live through the last Great Depression. That experience stuck with both of them through the years since. Dad has always been an avid investor in stocks, but his retirement is constructed on a basic principle learned by all who lived through the Depression: have a lot of different sources of revenue tied to many different things, some of which aren’t tied to the stock market.

With the Dow Industrials down triple digits for seven consecutive days--and well on its way to its eighth--I fully expected him to offer up some comparison to the Depression and why it made sense to be very cautious. In contrast, he’s pretty sanguine. He’s certainly not happy about the losses but convinced that “quitters” who liquidate and sell out now are going to regret their actions--and probably a lot sooner than they think.

Of course, when your underlying house is solid, it’s a lot easier to stay in the market as its crashing than it would be if all of your assets were in stocks, as is the case with so many investors. But here’s something else to keep in mind if you’re thinking about bailing today: Big declines are bullish.

In the early 1990s, I assisted an old friend of mine, Stephen Leeb, with his book “Market Timing for the 1990s.” One of the chapters addressed major, sudden declines in the stock market, their causes as well as their aftermath.

That the action in the market since early September 2008 has been sudden and extremely devastating is beyond dispute. And as I’ve pointed out above, the root causes and circumstances surrounding it are different from those of any other before it, at least for the data covered in the book.

The same thing, however, was true of every other market crisis we reviewed that hit Wall Street. One big thing they did have in common was a consensus conviction among investors that it was the end of the world and that things would never be as good again. Another thing: They were followed by mighty recoveries as the market psychology shifted dramatically.

I certainly didn’t foresee how bad things would get in this crisis. No doubt, many will come to the fore in coming days and proclaim that they did, just as was the case following the Great Depression. But the point isn’t what we should have done several months ago. It’s what we’re going to do now at this critical time.

Do we join the panic and liquidate our holdings, trying to avoid an even worse catastrophe ahead? Do we back up the truck and buy our favorites among the good businesses? Or do we just sit back with our current positions, shepherd the cash from big dividend payers and wait to see how this shakes out?

One of the reasons that big declines tend to be so bullish is they shake out all the excesses of the prior boom very quickly and dramatically. Like a skilled swimmer suddenly thrown into cold water, there’s a shock to the system followed by an adjustment. In a market panic, sellers are quickly shaken out, and what you’re left with is those who are focused on value--who won’t be shaken out.

Big declines also create slack in the overall economy. That basically means more room to grow without igniting inflation, which is the fuel for any bull market in stocks. Before this crisis, inflation had hit a 17-year high in the US. Now raw materials’ prices have come off sharply, and labor costs are certain to moderate as jobs become more difficult to find. Obviously, most of us would rather see more people working. But again, the point for the market is more slack and more room to grow.

When will this big decline end and the big recovery begin? That’s a question best suited for social psychologists. When I see the likes of Southern Company down 10 percent in half a day’s trading, it says to me that market emotion--in this case extreme fear--is in full control, and investors have thrown any semblance of rationality out the window.

And that’s far from the only example. Yesterday, Dan Duncan’s Enterprise Products Partners and TEPPCO Partners both increased distributions by a significant amount. That same day, however, both limited partnerships posted significant market losses, adding to their massive declines of previous days. Both are now less than half their highs of earlier this year.

They weren’t the only pipeline owning limited partnerships (LP) to boost distributions this week, either, as business after business continues to hike cash flows by adding fee-generating assets. Some LPs have faltered in recent months. But many more  a re having no trouble accessing credit, and revenues remain solid. They’re now paying their highest distributions ever with an average in the low teens, an historic spread relative to Treasury paper. And this is in the pipeline business, where cash flow is basically of utility quality and surety.

I’ve mentioned several times in recent weeks that energy was vulnerable both to a slowdown as well as a revival of the market panic. That’s certainly proven to be the case recently, as a drop in oil prices has triggered a full scale panic out of any and all energy-producing stocks, LPs and Canadian income trusts.

Chevron’s announcement yesterday that its third quarter earnings would match expectations didn’t stop its stock from being pounded today. In fact, Super Oils across the board have been falling 10 percent or more a day. That’s despite having more cash that most governments and the fact that lower energy prices present a welcome opportunity for them to buy assets and further boost dominance over the industry.

With Super Oils in free-fall, others in the industry surprisingly haven’t been pounded even more. One group I follow closely is Canadian income trusts. This week, I compared their current share prices to where they traded at the low prices for oil and natural gas this decade. That was a little more than $18 a barrel for oil and $2 per million British thermal units (MMBtu) for natural gas.

What I found surprised me. Basically, even the strongest trusts such as ARC Energy Trust and Enerplus Resources are trading where they did when oil was at $25 per barrel and are fast headed back to levels held at $18-a-barrel oil and $2-per-MMBtu gas. Buying them, in other words, is like buying oil again for $25 a barrel.

In addition, income trusts have basically been stress tested for nearly two years, since the Canadian government ruled they would be taxed as corporations beginning in 2011. That ruling included strict limits on the number of shares trusts could issue, basically forcing trusts to rely on their own resources. Some failed, but the survivors have basically been stress tested.

That’s definitely what I take from Advantage Energy’s announcement on Monday that it’s increasing its capital budget for the rest of 2008 by 25 percent--hardly the action of a player in a credit stressed business. Trusts on the whole also treated the surge in energy prices earlier this year as a one-time windfall rather than a new pricing floor. As a result, they used the cash to cut debt and expand drilling projects and held down dividend increases. We may yet get to energy prices that threaten current dividend levels. But again, prices of trusts aren’t reflected $70-a-barrel oil or $50- or even $30-a-barrel oil; they’re right back to where things were in 2001.

There are so many other examples of massive values like these throughout the markets. Clearly, this isn’t because someone is taking out a calculator and deciding what this business is worth at this price for energy or some other asset or trend. It’s sheer panic. In fact, no one is looking at any of this stuff, which is why everything had dropped so far and so fast.

In the utility industry, for several years I’ve rated most stocks as holds at best. That was largely because the market had already rewarded them for their recovery from the 2001-02 debacle. Now I’m looking very closely at financially strong, highly-regulated companies such as Allete, which is now back to very reasonable valuations--and I intend to focus on such companies
in the next issue of Utility Forecaster.

In the Oct. 22 issue of Personal Finance, I’ve authored an article on the largest and most dominant utilities, which now trade collectively at just 11 times the lowest Wall Street estimate for 2009. Those are projections that include some pretty dour assumptions for the coming year. These companies now yield nearly 5 percent and are on track for upper-single-digit growth in earnings and dividends for years to come, as they build out their infrastructure with regulators’ support. That’s business growth that’s assured even in a weak economy.

And the carnage and panic hasn’t been confined to stocks by any means. Take, for example, the extreme volatility in the prices of preferred stocks and bonds on an intraday basis. Yesterday’s graph of Cincinnati Bell Preferred B--which is backed by a company with a very steady telecom business--is positively penny stock-like. The shares opened in the low 30s, already a significant decline since early September when the overall market panic began. They then proceeded to drop to under $20 before rebounding to the mid-20s. Today, they’re off on another rollercoaster ride.

The company has a low credit rating, so it’s no secret why investors are fearful. But it also generates a mountain of predictable cash flow from what are largely essential services, and there’s been absolutely no significant news coming out of the company this week. Again, it’s simple unadulterated panic driving the market for this company’s preferred shares, just as it’s driving the market for virtually everything else.

One of the very halfhearted jokes making the rounds in our office--and elsewhere--is we’re “only” 16 days of 500-point declines on the Dow Jones Industrial Average from an absolutely sure bottom. That’s what it would take to send the value of the stocks of the largest US companies down to zero.

Possible? Well, that would entail the complete and total collapse of not only the US economy but of capitalism itself. It’s what Karl Marx and the early Communists envisioned when they were writing in the mid-19th century.

Much, much, much more likely, however, is that the fire that everyone’s now throwing gasoline on will suddenly ignite. What we’re really waiting on is some catalyst that starts to convince people that the system will recover. That, in turn, will build on itself and quell the panic, just as it has during every era of panic since investment markets have been in existence.

For the past several weeks, I’ve posited the idea that banks are going to follow the example of utilities over the past several years. Basically, that industry--like the financials--was deregulated and went to excesses of greed, leverage and risk taking. The result was a titanic crash, and a lot of very smart people got buried in the process.

The utility industry has recovered since by cutting debt and operating risk and getting back to running core, regulated businesses effectively. It’s no longer the “great” business for its players like it was in deregulation’s heyday in the late 1990s. But it is a “good” business and infinitely more stable, as evidenced by the fact that utility businesses are still weathering the crisis as businesses.

The catalyst that started the utility recovery in 2003 was a little heralded event brought to my attention by my friend and industry attorney Jonathan Gottlieb. Basically, an Asian company had made a bid for one of the gas-fired power plants that were then in receivership. It was only one plant. But it established there was a market for these assets, which many had written off as worthless and no one up to that point had wanted to touch. In the weeks that followed, we saw more moves, at first halting but later more aggressive, to snap up these assets. That, in turn,
freed up lending to the industry, and the recovery was underway.

Only time will tell what the great catalyst will be for this recovery, i.e., what will ultimately quell this panic. But it will happen. The pragmatists now in charge of the financial system are going to keep dumping gasoline, kerosene, bottle rockets and everything else they can find until they reignite global lending.

Markets have always been impatient, and they’re more so now than ever with so many global linkages. One reason this panic has lasted so long and has been so devastating is that there are so many global linkages. And, although I hate to say it, it could very well last much longer.

If you’ve resolved to stay with companies backed by solid businesses, however, the question is not really how low can it go but what kind of world we’ll be looking at when it does. As I’ve pointed out above, if you assume this is the end capitalism itself, you probably want to take these losses. Anything short of that, however, and the only possible conclusion you can reach is that this is a time of unprecedented values.

For those with cash to spend, I don’t see any great rush to buy. But it’s a great time for a strategy of incremental, disciplined investing in great companies for which you’ve always wanted to name your own price. It’s always a bad idea to “average down” a position, solely for the sake of getting a lower cost basis. But buying oil at $25 a barrel again, Fort Knox-solid utilities at early decade prices or big telecoms such as Verizon Communications and AT&T at near decade lows or cash-generating businesses paying 12 percent and up after increasing dividends is always a good idea.

In short, it really boils down to all of us asking ourselves one question: Do we believe in tomorrow? If “yes” is your honest answer, the best thing you’re going to do now is hang in there.
Even during the Great Depression, the best course was to do just that. The worst case was to liquidate into panics. Staying steady, in contrast, was the strategy that actually made money, even with the economy in ruins and the world in growing political chaos.

If you answered “no” to the question above, I also have an answer for you. Buy gold, the only asset that’s not simultaneously someone else’s liability. If the authorities can’t revive the system in the coming weeks, it will hold its value as it has for millennia. And if they do get the fire going, it’s going to burn very hot, scorching paper currencies across the board.

Again, gold will be the beneficiary and my view is $900 an ounce is going to look pretty reasonable in a few years. And you don’t have to hold physical metal to get the benefit. Buy the SPDR Gold Trust (NYSE: GLD), an exchange traded fund that essentially holds gold bullion.  Susan Vance Wilson - Crowell, Weedon & Co. 624 S. Grand Ave, Suite #2600 Los Angeles, CA   90017

NON-TRADITIONAL NEEDLING  AS EFFECTIVE AS THERAPEUTIC ACUPUNCTURE IN THE NEWS II