How's the Economy Doing? A Look Under the Hood in August

by: Jeffrey Walkenhorst, CFA

This is an update of our "How's the Economy Doing" post from June. As a reminder, while our our investment strategy focuses on bottom-up analysis of individual companies, we think awareness of overall macroeconomic conditions is helpful since trends that may impact certain companies or sectors. On 8/12/09, we wrote about the many mixed views regarding what happens next in the Market and the economy. Rather than speculate on which view is correct -- we can't say for sure and the market will do what it does, often detached from fundamentals in the short-run.

On our blog here, we look at some hard data in railroads, trucking, air transit, and other areas. The hard data is decidedly negative on a Y/Y basis and jibes with anecdotal information we've collected:

  • The job market for white and blue collar workers is extremely difficult around the country.
  • Like commercial real estate (see our June post), residential real estate activity is very slow with plenty of "for sale" signs in most suburban neighborhoods (in particular, we can vouch for the Greater NYC area) -- we think prices will continue to fall well into 2010, especially since real estate typically runs in very long cycles (i.e. seven years up, seven years down, seven years up, etc.) and the last up-cycle lasted approximately ten years (ending in mid-2006).
  • All kinds of services are being impacted by the downturn, including barbers (our NYC barber: "business is slow and we're losing customers because they're moving out of the city").
  • The hatches remain mostly battened up in the venture capital community and poor returns over the past decade leave many investors scratching their heads over future capital allocations.

Of course, the market is forward looking, and, what we call "the hope rally" since March is based on the hope that things will surely soon get better on the back of government stimulus packages in the U.S. and elsewhere. We're natural optimists and also hope so, however, we're inclined to remain in the cautious camp. Now and always, we need to pick our spots with a preference for very low multiples of current earnings and growth.

Fortunately, we do see some reasons for hope: inventories are being worked downward to adjust for slack aggregate demand and, as noted in June, once we reach 4Q09 and 2010, Y/Y comparisons for all sectors of the economy will be against very weak 4Q08 and 2009 figures, which could at least bring stability and set the stage for inventory restocking (growth) at some point. We should no longer see negative 10 to 20% Y/Y declines in 2010 and could even see areas of growth (which largely explains the hope rally).

Unfortunately, we've missed a number of incredible stock moves -- four to five times March lows -- by being in the cautious camp and avoiding most cyclical companies with still horrendous fundamentals. Yet, we've done well with select cyclical plays where we saw a margin of safety, such as Harry Winston Diamond Corporation (HWD), Brandywine Realty (NYSE:BDN), Sun Communities (NYSE:SUI), and Wiengarten Realty Investors (NYSE:WRI). In addition, we continue to sleep well owning franchise type businesses that are currently generating significant excess cash flow and have limited to no debt. As before, examples in this category include eBay (NASDAQ:EBAY), Yahoo! (YHOO), j2 Global Communications (NASDAQ:JCOM), PetMed Express (NASDAQ:PETS), and (UBET). Finally, given our quick post on Y/Y retail sales declines, people may think we're crazy for owning Bidz (NASDAQ:BIDZ), yet we see reasons to own the bombed out online retailer. At the more speculative end, we include another idea on our blog that has a leading market position and current year growth.


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