Double Dip Recession? The Emperor’s Naked

On Wall Street, as in all places, the truth will set you free. The opposite may be occurring. The un-truth may be trapping us. I’m hearing almost universal consensus on two theories that strike me as possibly fallacious:

1. The economy is hitting a soft patch.

2. If economic data continue to weaken, the Federal Reserve will have to act.

White House Economic Advisor Austan Goolsbee, on weekend news/talk shows, was less than charming in his strident assertion that the economy was merely experiencing a “few bumps.” (We reckon that “soft patch” may have been a little too strong for Mr. Goolsbee.) His performance reminded me of the scene in “Animal House” when the officious ROTC student shrieked to the stampeding mob, “Remain Calm! All is well!” Indeed talking heads across the universe of cable channels are insisting that the current economic weakness is JUST a “soft patch.” As I found out yesterday during my CNBC appearance, woe betide he who suggests otherwise.

Here’s the point: in my over twenty years as a professional investor, whenever the herd becomes insistent on any isolated possibility, it is urgent that one consider other possibilities.

I am not saying that we will have a second recession but that in order to be responsible stewards of clients’ funds, we are honor-bound to consider all outcomes: both more and less dire. Yet, Wall Street seemingly will have none of it. This is worrisome.

As to point number 2, this is a recent phenomenon. It is stunning how investor’s and consumer’s expectations have become so embedded in the theory that the Federal Reserve’s role is to prevent economic weakness. Periods of economic expansion and contraction are almost tidal with wax regularly giving over to wane.

Alan Greenspan memorably kept interest rates at or below 2% for three years following the dot-com bubble of the late 1990s. While a more severe decline was likely avoided, additional bubbles in real estate and credit were born. Of late, in addition to near zero percent interest rates, the Bernanke Fed has been providing huge amounts of stimulus in various forms to stem the hemorrhaging caused by the collapse of Greenspan’s real estate and credit bubbles. One should rightly question what sorts of consequences may be anticipated from the current trillions of stimulus. But those questions are scorned by policy makers who are desperate to focus on the positives. Mr. Roarke on the tv show “Fantasy Island” instructed, “Smiles, everyone. Smiles.” And that was perfect for “FANTASY Island.”

If you believe as I do in Kudlow’s Creed that ‘Free market Capitalism is the best path to prosperity,’ then you must be stricken to your core that markets have not been allowed to clear. As investors we need to wonder that if prices have not been allowed to be determined by unfettered free markets, are they accurate, too high or too low?

Housing prices have resumed their downtrend. Our experience tells us that trends ALWAYS last longer than anyone thinks they will. There is no reason to expect that things will be different this time.

So, rather than hang on the final arrangement of tea-leaves at the bottom of the cup, Have a clear, articulate investment discipline, apply it consistently, and change it almost never. Investing for the next 100 points is like betting on red or black. Investing in companies with strong balance sheets, limited debt, increasing earnings, and strong returns on equity makes sense to us. At the fish market it’s wise to ignore the yelling and screaming and pay attention to the price of fish.

Hang in there.