Ron is in world of hurt and so prompted his feelings...The TSC Streetside Chat: Fund Manager Ron Muhlenkamp
By Dagen McDowell
06/22/2002 08:10
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The fate of this economy hinges on consumer spending -- whether people will continue to buy appliances, cars and giant packages of paper towels. Corporations haven't opened their wallets to start buying things like computers again. But individuals continue to whip out those charge cards.
Can this trend hold up until businesses begin spending again?
That's a question every investor wants answered. About a week ago, the University of Michigan's consumer sentiment index made the sharpest one-month drop since the September terrorist attacks. People started crying double-dip recession -- the dreaded outcome if consumer confidence falls off a cliff and people stop buying.
But Ron Muhlenkamp isn't pulling a Chicken Little. Muhlenkamp, who runs the aptly named Muhlenkamp MUHLX fund, believes the consumer will hang in there just fine. And business spending will follow shortly. Muhlenkamp is the right man to ask about the topic. Studying consumer spending habits are part of his investment approach, and he's been investing for about three decades.
He's seen his share of recessions. Here's what he thinks about this one.
TheStreet.com: Consumers have kept right on spending through the economic downturn. Is this unusual during a recession?
Ron Muhlenkamp: To some extent it is. But also, this time around there are a couple of things going for the consumer that weren't there before. First of all, we don't think the consumer is as "borrowed out," if you will, as a lot of people do. What is viewed as consumer savings is really a combination of a couple of different numbers that the government keeps. One is consumer discretionary income, income after taxes. And the other part is consumer spending. Then they net those two out and say the difference is savings.
When we put money into stocks 10 or 20 years ago that was viewed as savings because that was money that wasn't spent. But if those stocks quadrupled in the interim, that's not booked any place. So the numbers we've received from the economists about consumer saving haven't been quite accurate. And when bank credit analysts adjusted for those, they found savings isn't nearly down as much as people think. In fact, it's down very little.
Coming into or out of recession, the consumer can either spend less, in which case they save more, or they can spend. This time around interest rates came down, which allowed them to refinance their mortgages. That wasn't true, for instance, in 1980 or prior periods when interest rates were going up.
And this time around, we lowered taxes over a period of time. The bulk of those cuts haven't even kicked in.
The point is, those two things have helped the consumer. Much of the spending has been related to their homes. The fact that they could refinance their mortgages has brought home that their houses are doing well for them. To a large extent much of the continuity of spending has been home related.
If you look at all the recessions -- we've now had 10 since World War II -- it's always kind of hard to find it in consumer spending. Recessions tend to be inventory recessions -- that is businessmen and manufacturers cut back on inventory.
What you usually get by the consumer, and you've got less of it this time, is postponing of discretionary spending on things like houses and automobiles. That's been the big surprise this time around, and a good bit of that is because of lower interest rates.
TheStreet.com: People are worried that if consumer confidence doesn't stay strong that we could end up back in a recession. Do you think that can happen?
Ron Muhlenkamp: Obviously it can. But we've been through the worst of it. My observation over the years, and I can't really prove this, is that when people become fearful of something they can hold that fear from something for six months. Then it either happens, in which case they go on with their lives, or it doesn't happen, in which case they go on with their lives.
Most people who'll lose their jobs in this slowdown have already lost them. After six months or so if you feared losing your job and you don't, that fear tends to go away.
We had a great excuse last fall on 9/11 for people to lose confidence and they didn't. Could something kill consumer confidence? Obviously it could. But when you have a shock like we had on 9/11 and people respond the way they did it, it makes it pretty hard to imagine what could kill it in the future.
We always find it interesting to see what the consumer does when they get hit with something like that. The response was superb.
TheStreet.com: Do you think people will continue to spend?
Ron Muhlenkamp: That was the point the bank credit analysts were making. Consumers do have the money. What's interesting is that in 1999, discretionary money was going into tech stocks. Nobody worried about the public running out of money. Now it's going into housing and everyone's worrying: Gee, what if they run out of money?
Well, if the consumer does slow down in their spending then interest rates come down more. We're seeing mortgage rates gradually come down right now. And they get to refinance again. So that part of it is essentially self-correcting.
What I find fascinating is when that money was going into tech stocks, nobody was worried about the consumer running out of money. You have people in the media worried about these things because they have nothing else to worry about. In fact, the economy looks very healthy to us.
TheStreet.com: What makes you say that the economy is healthy?
Ron Muhlenkamp: The slow part is the capital goods part, but that's always slow. That's why economists call them "lagging indicators." Things like employment levels and spending on capital goods always lag. They require decisions by businesses, and businesses right now are reluctant to spend money until they get it from their customers.
In fact, they lagged on the upside. Business spending was strong longer than the rest of the economy was. It will come back in good time.
Most of what people call tech companies are just capital goods companies. They make capital goods. If you remember 1999, everyone was saying sure the Fed is raising interest rates but it's not having an effect. Well guess what? It did. If you look at any recession, capital goods is the last thing to come back. The first thing to come back is finance. Then the consumer. Then capital goods is the last. I am just suggesting that you be patient for a couple of months.
TheStreet.com: Is that how long it's going to take?
Ron Muhlenkamp: It typically takes three to six months after the consumer turns, and we think things are probably on schedule. But that's a normal pattern.
TheStreet.com: Do you think some of these businesses, particularly in hard-hit areas like telecom, will never come back?
Ron Muhlenkamp: Sure, some will but that's because it's a competitive business. They won't all come back. But we're not going to stop making phone calls. I can't tell you that we'll make calls through AT&T T , Sprint FON or somebody else. But people will make phone calls. The fact is it's a competitive business and a large number of companies built infrastructure. What's interesting is all of that benefits the consumer. All of the things that we see as problems for individual businesses are pluses for the consumer.
Pick any industry you want that has ample capacity, for example retail. When the auto companies are competitive as they are, the consumer benefits. But not all auto companies will gain market share. So we're in a very competitive economy in the midst of a very competitive world, and those things will benefit the consumer.
Of course the trick is to figure out which companies are beating their competitors. But to see a company going out of business doesn't mean that the whole industry is going down. It simply means that company is going out of business. We see people continuing to make phone calls and use electricity. They may travel a little less by airplane. But they seem to be traveling by car.
In the final analysis, consumers can either spend their money, in which case the economy is strong. Or they don't spend their money, in which case they save it and interest rates come down and they refinance their mortgages. And at some point they decide to go spend again.
We see no risk that the economy doesn't come back. The only question is the timing. And we think that's measured in weeks and months, not years.
TheStreet.com: You made a very smart bet on housing stocks. When did you first buy them? And do you still like them?
Ron Muhlenkamp: We were buying housing stocks in the spring of 2000. After long-term interest rates rolled over in January, betting on the normal cyclical rotation. We think they have more to go because they're still cheap.
TheStreet.com: What will be the sign that you should sell your housing stocks?
Ron Muhlenkamp: When they hit 20 times earnings or when people start telling us that you should go and buy a house and not worry about the price because the price always goes up. The first sign of a fad or a mania is when people to tell you to buy something and not worry about the price. And they aren't saying that about housing.
We own NVR NVR , Beazer BZH , Centex CTX , Toll Brothers TOL and Meritage MTH , and we haven't sold any yet.
TheStreet.com: Any stocks that you've gotten out of in the past several months?
Ron Muhlenkamp: People have been sending us money, which gives us the luxury of buying more of what we've got.
TheStreet.com Any stocks you've added to the fund?
Ron Muhlenkamp: Tyco TYC . We started buying it too early. We bought a bunch at 20. And have been buying it since. They make products that people use and are willing to pay for. We aren't too concerned about what happens at the corporate level.
We're buying the values of the businesses they're in. If the values are there, someone will realize it. What Enron was ended up being basically a hedge fund. And it can disappear without a wrinkle. The divisions of Tyco make useful products that people are willing to buy. We believe those divisions are worth well over $20 a share. And it was at $20 a share when we started buying it.
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