Sunday, July 11, 2010

Get ready for the second leg of the recession?


I subscribe to Morningstar Research and, yesterday, Morningstar released a video where Dr. John Hussman, President of Hussman Investment Trust, was interviewed by Ryan Leggio, and Investment Analyst with Morningstar. After I watched that video, I visited the Hussman Funds web-site ( and found (and read) two different articles, both authored by Dr. Hussman.

On November 12, 2007, Dr. Hussman wrote an article, one that appeared on his company’s web-site, in which he predicted that a recession would soon begin. As we later learned, the current recession (although some would say we are now in a period of recovery although it does feel like we are to me) began in December 2007. In other words, Dr. Hussman’s prediction was “spot on.” I went back in time to read Dr. Hussman’s article from November 2007 before I read the article he published on July 6, 2010, simply because I wanted to see what he said back then before I read what he’s now saying. I am glad I read both articles. Both are a mixture of economics, investment, finance and public policy lessons.

The first article I read, Expecting A Recession, by 

John P. Hussman, Ph.D., November 12, 2007, can be found at this internet address:
In this article, Dr. Hussman basically says that a recession will soon begin, and he goes on to share the factors why he came to that conclusion. (As I earlier said, his prediction proved to be “spot on.”)

The second article I read, Implications of a Likely Economic Downturn, by 

John P. Hussman, Ph.D., July 6, 2010, can be found at this internet address:
In this article, Dr. Hussman basically says that we will soon be in another recession, or, if you want to call it this, a double-dip recession
. Like in his earlier article, he goes on to share the factors why he’s come to this conclusion. (As to whether this prediction will prove to be accurate, who the hell knows.)


As most people, who do any amount of reading about the economy, finance, investments, blah, blah, know, when leading experts are asked this question, “will the economy continue its recovery?”), 50% of the experts say “yes” and 50% of the experts say “no.” (Well, maybe it’s never quite 50-50, but I’m sure you get the point.)

I was not an Economics major in college, and, quite frankly, I struggled with Econ 1, 2 and with Econ 101. I did take accounting and finance courses (lots of them), not that I learned anything useful (I’m kidding, of course.) In spite of my lack of “economics background,” I’m going to now attempt to put a “reprographics industry – reprographics business” SPIN on Dr. Hussman’s articles. That’s because this blog is titled “Reprographics 101”.

As I pointed out in one of my earliest blog posts, I was involved in a reprographics business that was sold in December 2007. Our company had experienced a significant boom in business, for several years running, up until late 2007. Our “first-half 2007” sales were up over our “first-half 2006” sales, but, by the end of the third quarter, we were flat, comparatively speaking, 2007 vs. 2006. Because we sold the company in mid December 2007, I do not know how the company’s sales compared, Q4 2007 vs. Q4 2006 (quite frankly, having sold the company it was “not our problem” at that point), but, if I were to venture a guess, our Q4 2007 sales were less than our Q4 2006 sales, and, with that, it is quite possible that our full-year 2007 sales came in less than what our full-year 2006 sales had been. So, 2007 was an “up, then down” year. During the early to mid part of 2007, we had already begun to notice a drop-off in sales to customers who were involved in “civil, site, survey and land planning”; these are the engineering and planning firms that do work for new “residential” developments. The point of this paragraph being that, when Dr. Hussman, in November 2007, predicted that the economy would soon be in recession, we were (meaning, our company was) a “poster child” for that prediction.

When the residential design/development/construction industry went south, many were saying, “no problem for the reprographics industry, that’s only (residential is only) 15% or so of their business; commercial design/development/construction is fine and will carry the reprographics industry through the downturn in the housing sector.” As everyone in the reprographics industry *learned, “that’s not so.” A downturn in the housing sector leads to a downturn in the commercial (non-res) sector. The crisis in the finance industry certainly accelerated the downturn in the non-res sector, but, even if that acceleration had not happened, there still would have been a downturn in the non-res sector. It is the “natural trickle-down” effect, as I think I’ve talked about in past posts on this blog. (*Stock analysts and investors, who really had no clue about the reprographics industry, finally learned this lesson, I think.)

In light of Dr. Hussman’s most recent “recession” prediction, let’s take a look at “present indicators”:

• the design/development/construction industry is a huge part of the U.S. economy. Residential development is still weak, commercial development is still weak, and, unless the government puts additional money to work to stimulate public works projects, that sector is going to decline in activity, simply because states, counties and cities are suffering severe budget problems, brought on by lower tax revenues. Thesis: without a recovery in the design / development / construction industry, the chance of a double-dip recession remains high.

• At this point in time, around 800(!) U.S. banks are on the FDIC’s “problem bank” list. That’s because of soured (and, present tense, souring) loans and reduced capital bases. Many of the banks on that list (and the banks that have already failed this year) are on that list because of “problem” loans to the real estate sector (res and non-res.) As I’ve previously pointed out on this blog, developers don’t build unless they have access to (other people’s) money, i.e., loans to fund land acquisition, property acquisition, design/development and construction, and, when you read the Federal Reserve Board “beige book reports” and consider the CMBS (commercial mortgage backed securities) statistics, it is very evident (at least I think it is) that “lending” to the real estate development industry is still well off; money for development is still hard to obtain. This, in spite of the fact that interest rates are at an all time low!!!

• Even though the employment rate is (supposedly) down (recently dropped to “only” 9.5%), some say that the “real unemployment rate” is much higher than the one the government publishes. I’ve read some reports that say the “real unemployment rate” is in excess of 15%, if not higher. And, even though interest rates (for buying residential property) are lower (at an all-time low for that matter), qualifying for loans today is much more difficult than it was several years ago … and, speaking facetiously, it helps to have a job if you are applying for a loan. No job, no income from work, no loan, even if you have been able to maintain a good credit rating.

• The AIA ABI (Architectural Billing Index) has yet to move to 50 or above, and this condition has lasted (if I’m recalling this statistic correctly) for more than 24 months by now. When that index is below 50, “they say” that it is an indication that business (for Architecture firms) is still in a declining mode. Architecture firms are struggling. Firms in the construction industry are struggling. When you look at the monthly editions of construction industry newsletters, you see mostly “government sponsored” projects highlighted instead of private sponsored (res and non-res) projects highlighted.

• American Reprographics Company (NYSE: ARP) is the largest reprographics enterprise in the world, and, even though ARC has operations in India and China, most of ARC’s revenues are generated in the U.S. ARC’s quarterly revenues peaked in Q1 2008 at $187.4 million, and, since then, declined, consecutively, reaching just under $112 million in Q4 2009. ARC quarterly revenues for Q1 2010 were just above $112 million, in other words, not much better than Q4 2009. Those of you who know the reprographics industry well, very well know that Q1 revenues are supposed to be better than Q4 revenues; in most parts of the U.S., Q4 revenues are traditionally the worst of each year’s quarterly revenues. In addition, ARC does generate some revenues from its Chinese and Indian operations, and the economies of China and India are growing. It would be interesting to compare ARC’s quarterly revenues on a domestic vs. off-shore basis. It is possible that ARC’s domestic (U.S.) revenues in Q1 2010 were less than ARC’s domestic revenues in Q4 2009. ARC will soon be reporting its Q2 2010 numbers, so that should shed some light on “trend”. This paragraph is certainly not a “knock” on ARC, it is simply a picture of ARC’s progress, “now vs. then.” In my opinion, ARC has assembled one of the best management teams ever to grace the reprographics industry, but, no matter how good that management team is, the reprographics business will not be in a position to recover or grow until other factors begin to show positive recovery.

To sum things up, there has not yet been evidence of a recovery in the design/development/construction industry. “They say” that, since our economy is primarily driven by “consumer purchases”, that our economy has to see renewed consumer confidence – and consumer purchasing - in order for there to be a sustained recovery. Dr. Hussman’s most recent article points out that “savings” has grown (meaning that consumers – those that have jobs – are saving more and spending less) and that that actually hurts the economy. Several articles I’ve read this year point to the fact that larger corporations are sitting on (hoarding) lots of cash. Sitting on cash means that they are not investing that cash (in re-tooling their businesses, expanding their businesses, creating momentum for forward growth.) While we may be seeing increased profits, year over year, those profits are mostly coming from cost cuts (including job layoffs and consolidation activities), not from top-line (sales) growth. Top-line (sales) growth has to happen in order for the recovery to sustain itself. Without that (top-line sales growth), there is certainly the chance that we will experience a double-dip recession.

Dr. Hussman pointed out in his most recent article that some say that a double-dip recession is unlikely; they say…. "a few naysayers (like Dr. Hussman) are worried about a double dip, but this can be ignored because double dips are rare."

Dr. Hussman, also said in his most recent article …. “From a Bayesian standpoint (folks, that is “econ-speak”), if you always observe a certain combination of information when X occurs, and never observe that same data when X is not present, then even if X is hidden under a hat, you would conclude that X is most likely there. If I see clowns walking around the grocery store buying peanuts, and there's a big top tent with two unicycles in front of it in the middle of what is usually an open field, I'm sorry, I'm going to conclude that the circus is in town.”

Finally, if the economy is already again in recession or if double-dip recession does happen, what will that mean to the A/E/C industry and to the A/E/C reprographics business and industry???

Even though you may not agree with Dr. Hussman’s current prediction, I urge you to read the two articles I mentioned that are on his company’s web-site. If anything, you will learn some lessons in economics and you will see his point of view about government policy.

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