Information, not Advice #20

Continued . . . The Energy Crisis Recession of 1980 – Duration: 6 mos.  GDP Decline: 2.2%. Peak Unemployment: 7.8%.    10 yr T-Note Beg 10.80% / End 10.25%.

Inflation reached a bit over 11% and the Federal Reserve, not unsurprisingly, raised interest rates to slow money supply growth. When money supply slows so does the economy and – since employment numbers rise and fall with money supply (as reflected in interest rates) – reduced money supply causes unemployment to rise. It’s another teeter-totter: money supply down, unemployment up. Vice versa works as well.

One of the causes of the high inflation was the Iranian Revolution of 1979-1980, which sparked a second round of oil price increases, following the increases of 1973-75. 

Note: The National Bureau of Economic Research considers the 1980-82 recessions as two separate events due to a pseudo-recovery between July, 1981, and November, 1982. That is the perspective taken here. The reader should know, however, that some reputable economists see the two recessions linked by both time and agency, and call it a single event separated by a breather.

The Iran Crisis Recession of 1981-82 – Duration: 16 months.  GDP Decline: 2.9%.  Peak Unemployment: 10.8%.  10 yr T-Note Beg 14.28% / End 10.55%.

The 1978-79 regime change in Iran overthrew its US backed government in favor of a theocracy. Prior to the revolution Iran was the world’s fourth largest oil producer.  The new regime, however, exported oil at inconsistent intervals and at lower volumes, creating a shortage in the marketplace and forcing prices higher. Domestically, this caused high unemployment (“impact”) for a long time (the “extent”). Again, the US was facing stagflation (a recession with simultaneously high unemployment) and the Fed responded in the manner of 1973-75: with a tighter monetary policy (tighter monetary policy: interest rates increase). The prime rate had to reach an unfathomable 20.5% (1981) before inflation imploded.

Takeaway: Twice now, in 1973-75 and 1981-82 the economy has experienced the black swan of high inflation and simultaneously high unemployment. In each case the issue was resolved by first addressing inflation. And both times it worked. Granted that N=2, but it does appear that when (if) stagflation reoccurs it is likely inflation will again be addressed before unemployment.

The Gulf War Recession of 1990 – Duration: 8 months.  GDP Decline: 1.5% Peak Unemployment: 6.8%.  10 yr T-Note Beg 8.47% / End 8.11%.

Iraq’s invasion of Kuwait resulted, again, in yet another dreadful oil shortage. The (i) spike in the price of oil caused (ii) manufacturing sales to decline, (iii) the North American Free Trade Agreement (NAFTA) to be finalized, and (iv) a significant number of manufacturing companies to move outside the United States to better access cheap labor.

Takeaway: The combination of the increased costs of irregular or uncertain oil supplies threw the US into an oil related recession for the fourth time (1973, 1980, 1982, and now 1990). Contemporaneously, NAFTA was displacing domestic manufacturing jobs and generating high unemployment: a double whammy. 

The DotCom Recession of 2001 – Duration: 8 mos.  GDP Decline: 0.3%.  Peak Unemployment: 5.5%.  10 yr T-Note Beg 4.89% / End 4.65%.

The DotCom recession began in March 2001 and concluded in November 2001. It only lasted eight months, but there was an awful lot packed into that brief period. The primary cause was the implosion of the DotCom bubble. Secondary causes were the 9/11 attacks and accounting scandals at major US corporations.

Although in the end it did not turn out well, the DotCom bubble was in some ways an entirely rational response to the stimuli of enormous growth and cascading opportunities.

Growth: An Englishman, Tim Berners-Lee, invented the internet in 1989 as a wonkish communications tool amongst the scientists at the European Organization for Nuclear Research (CERN). A year after the world’s first website and server went live at CERN, researchers MacGyver’d a live shot of their coffee pot (becoming possibly the first screen saver) so they could tell from a glance at their computer screens when a fresh pot of coffee was ready. That screen shot was the birth of the internet.

By 1994, 11,000,000 Americans were “equipped to ride the information superhighway” (https://assets.pewresearch.org/wp-content/uploads/sites/5/legacy-pdf/582.pdf).

That is remarkable market penetration over five years. It is not at all as though something was in common use and had puttered along decade after decade and suddenly an improved version got traction in the marketplace. Early in 1989 there was nothing and five years later 11 million people were surfing the net. Remarkable, indeed.

In 1995 – one year after the 11 million number was achieved – 18,000,000 American homes were online. That’s a 63% increase in 12 months. To lend some perspective, that same year Microsoft released Windows 95 and Match.com went live. 

There were 83,000,000 Americans online in 2000. Forty million (48%) had purchased a product online. The internet went from a single computer monitoring the coffee pot in 1989 to 83 million computers in eleven years.  That is a compounded growth rate of 424%. The phrase “internet time” began to be heard. Is it any wonder why early investors leapt aboard? 

The DotCom investors were the early adaptors, with some earlier than others. They foresaw – or they followed somebody else who foresaw – some of the extraordinary benefits that could accrue to a “wired” world and by the late 1990s they very much wanted a piece of the action.

Opportunity:  One can make much money by (a) choosing the right investments or by (b) shunning the poor ones. In many cases poor investment decisions could have been entirely prevented by heeding John Farnam’s Three Rules: (1) Don’t go to stupid places; (2) With stupid people, (3) And do stupid things. These are probably the same rules your mother taught you when you first started dating.

That doesn’t leave many remaining options; thus people crowd into the investments everyone else is clamoring for. As one example of many, if you “own” a piece of the infrastructure, you get paid every time someone gets on the internet. If you “own” a share of AOL, on the other hand, you only get paid when AOL is being used and nothing if the surfer’s choice is Yahoo. Hypothetically, if in the Old Economy an investor had a few (infrastructural) shares of “U.S. Telephone Wire, Inc.” and received even a minimal fee from every telephone conversation carried in the U.S., eventually he would become rich beyond the dreams of avarice. Now consider the reward from being an initial investor in the world-wide equivalent, Global Crossing.

Global Crossing (GLBC) was born in 1997. It never had a profitable year, but by 1999 (two years later . . . internet time!) the market value of the company was $47 billion. In 2002 it filed for bankruptcy. GLBC was a speculation (it was never profitable, so it was never an “investment”) that proposed the interconnecting fiber optic cables (many being undersea) would soon enough give them a footprint in the internet infrastructure. This was conceptually similar to the early days of cross-country utility poles and telephonery. It was horrendously expensive, but the dreams matched the costs. Global Crossing finally died for sure in 2011 when the remains were sold to another company.

The DotCom Recession was not limited to a single stock, nor a single sector. It consumed the entire NASDAQ market. NASDAQ was quoted at under 500 in early 1990, grew to over 5,000 by March, 2000 before collapsing more than 70% by 2002. 

The implosion of the NASDAQ bubble was a direct cause of the 2001 DotCom Recession and, indirectly, of the subsequent 2007-2009 Great Recession.

Not everybody owned internet stocks. If you didn’t own shares in unprofitable companies like Global Crossing the bursting of the internet bubble would not affect you. You would sip your coffee and nibble on your breakfast toast and wonder what all the excitement was about. A reason for the firewall between DotCom investors and the rest of us is that stocks were bought largely with cash rather than credit. If Phred hazards his own money and loses, Phred is the only one hurt. He’ll have a fleeting moment of fame when the girls at the beauty salon talk about him: “Did you hear about Ellen’s husband? He lost everything. The house and everything! Ellen’s taking the kids and leaving. And did you see her nails the other day?”

 

Takeaway: The asset-price runup preceding a market peak presents many opportunities to make a fool of oneself and is to be avoided. If you really like the offered price, you’ll have another chance to buy it on its way back down.

 

This article is for informational purposes only and is not intended as professional advice. Nothing in this article is presented as investment guidance. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker specializing in vanilla as well as difficult-to-place mortgages for any kind of property. If you are thinking of refinancing or purchasing real estate Klarise Yahya can help. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected].