More pain?

Ron Muhlenkamp's review of events that impacted the markets during the past quarter.
QUARTERLY LETTER
Published Third Quarter 2008
by Ron Muhlenkamp

The pain continues. The focus has shifted somewhat from financial concerns to the price of commodities, particularly energy and food.
One reason this is important is that increasing prices for food and energy affect nearly everyone worldwide, including people in the emerging countries including (and maybe especially) China and India which have provided strong economic growth over the past number of years. This increases the odds for a worldwide slowdown/recession which could be longer and deeper than one in the United States, if the U.S. was going through this recession alone.
Parts of this picture we have seen before. In 1973-1974, the price of crude oil tripled as did the prices of wheat, corn, soybeans and a number of other commodities. The increased grain prices resulted in an increase in production which caused their subsequent prices to fall by a third within three years, their prices then stayed in that range for 30 years. The increased price of crude oil drove efforts to improve energy efficiency. In the U.S. and other countries, we now use half the energy per dollar of GDP that was used in 1970! We expect much of this pattern to occur again – but it takes time.
Meanwhile, another factor has helped to complicate the process. Because commodity prices have gone up, a number of investors have concluded they can benefit from buying commodities as an investment. And they’ve allocated a portion of their assets to that end. This is similar to buying Internet stocks in 1999 because they’d gone up; in 2005 it was houses; and in 2006 it was Chinese and Indian stocks. Such actions are self-fulfilling, for a while. We believe these actions are currently driving the price of crude oil. The difficulty is in knowing when and at what level it will rollover.
This uncertainty, in the marketplace, is putting downward pressure on nearly all stocks, even some that should benefit from the increased prices in commodities (e.g., both Deere and Exxon are down over the past six months). While this pressure is presenting us with the best investment values we’ve seen in a decade, the pressure is likely to continue until we see a crack in the price of crude oil.