"He that tries to control the economy though irrational intervention, will eventually destroy it"
These days I am spending a lot of time doing macro-economic analysis running various scenarios, trying to determine where we may end up in the next 1, 5 and 10 years. The following is a table of the 30 year mortgage interest rates from 1964-2010.
From carefully examining the table above, you will notice that in 2010 we hit a historic 46 year low on the 30 year, so the odds are that we may be going higher from here on out. The historical pattern also clearly shows that once you start going higher in rates, that they continue going up for the many years that follow. For example in 1964 rates generally went up for the next 17 years and finally peaked at 16.63% in 1981. Interest rates skyrocketed during those years and the results for the Dow Jones Industrial Average were as follows:
Dow Jones Industrial Average
December 31, 1964 = 874.12
December 31, 1981 = 875.00
But as soon as interest rates peaked they started going lower for the next 17 years and as a result the Dow Jones Industrial Average performed as follows:
December 31, 1982 = 1,046.54
December 31, 1999 = 11,497.12
The Dow Jones Industrial Average went up 998.58% during those years.
December 31, 1999 = 11,497.12
December 31, 2010 = 11,577.51
As we entered the new millennium we went from irrational exuberance to irrational intervention and it all began on January 3, 2001, when we had this happen.
Historians will probably look at that day as the official start of irrational intervention, which compounded into a nightmare scenario that continues to haunt us to this day. Irrational intervention has overtaken the economies of the world and has brought them to their breaking point. The majority of nations have gotten to the point where they will someday soon owe more interest on their debt then their economies can produce. When that happens, the monster of Inflation will show its ugly head and interest rates will skyrocket. Irrational intervention will stop cold in its tracks and countries will start monetizing their debt as they will not have the money through tax revenue to pay it down. This will devalue the currency of any nation that goes down that path and inflation will rise steadily as it did from 1964 to 1981.
As we continue to have such destructive irrational intervention, even to this day, what is an investor to do?
Well the answer is that you buy stocks that are extremely undervalued from a free cash flow point of view just like Warren Buffett did from 1964-1981,as he performed extremely well during those years as the table below demonstrates:
(Click to enlarge)
Warren Buffett bought stocks like Blue Chip Stamps, the Washington Post (WPO) and ABC Corporation during those years, because they had tremendous price-to-owner earnings numbers. Today stocks like Nokia (NYSE:NOK), GenCorp (NYSE:GY) or Computer Sciences (NYSE:CSC) are pumping out tremendous amounts of free cash flow relative to their price and are extremely beaten down to the point where they have reached what Sir John Templeton used to call "the point of maximum pessimism." Over time as interest rates start to go up and inflation becomes more of a problem, stocks similar to these will start showing up in large numbers as they did in early 2009, so it is very important to have a large position in cash to take advantage of this situation when it shows up.
I, on the other hand, am only concentrating my future purchases on stocks selling at ridiculously low levels relative to their owner earnings, as I have a strong feeling that this decade coming up is going to be a tough one, as governments all over the world both on the federal, state and local levels will start to have problems, especially when interest rates start going up as they will need to refinance at much higher rates in order to meet their debt obligations.
Until the governments of the world stop operating through irrational intervention and stop rewarding failure, they may find out that they in turn will need help and then reality will hit, as there will be no takers. Eventually a Volcker-type central banker will come in and give everyone the harsh medicine of reality and hopefully save us from ourselves.