Asset bubbles and valuation. (Part II)

Part II will look at recessionary periods that occurred this decade and in the 1990s.

Learning to be good traders means that we should learn from current events and take notes. We should also look at the past as a guide - history, as they say, tends to repeat itself.

Make no mistake...we are in the middle of an asset devaluation period and maybe even a recession. This afternoon comes news that the White House has put together a rescue plan for Fannie Mae and Freddie Mac that will include the funding of stock purchases and the infusion of cash all in the neighborhood of $15 billion.

With that said, there are basically three questions that concern investors at the moment:

1) How long will this last?
2) How bad will it be?
3) What was the cause?

I believe the best way to answer these questions is to explore our economic past for a bit of insight. Specifically, let's revisit our previous recessionary periods and the consequences of them:

(starting with the most recent)

a) Early 2000's recession (2001-2003) - Lasted 2 years
The collapse of dot-coms, the September 11th attacks, and accounting scandals were the primary drivers of this recession. As a consequence, the US saw large layoffs, a great deal of outsourcing, and a jobless recovery, with many high-paid manufacturing employees being force into much lower paid service positions.

DJIA FY2000 return => -6.18%
DJIA FY2001 return => -7.10%
DJIA FY2002 return => -16.76%
DJIA FY2003 return => +25.35%

Notice the market in 2000 began to discount the likelihood of an economic crisis. Then it was confirmed with lower equity returns in 2001 and 2002. Intrinsically, a combination of rapidly increasing stock price, individual speculation in stocks, and freely accessible funds in the VC markets led to extremely dislocated asset valuations.

Also, let us not forget the effect of 9/11 and the impact it had on transportation, energy, consumer cyclicals and other consumer-sensitive sectors. Traveling and consumer-spending came to a virtual halt.

9/11 represented the significant impact that an exogenous event can have on our equity markets.

[primary factors: bubble in US assets and geopolitical events]

b) Early 1990s recession (1990-1991) - Lasted 1 year
Unlike the previous recessions in the US, which were associated with policies to bring inflation down from double-digit levels, the causes of this recession can be traced to a number of issues: pessimistic consumers, national debt accumulations, jump in oil prices during the Gulf War, a credit crunch induced by banking regulators, and poor policy making on part of the Fed.

DJIA FY1990 => -4.34%

[primary factors: energy prices, geopolitical events, and poor Fed policy]