A Conversation with Jerry Jordan
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"I want to own … businesses that will benefit from an economy reaccelerating—next year—where capacity remains fairly tight, and … as things improve there will be pricing power".
—Jerry Jordan
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An Interview with Jerry Jordan
Q: What are the top three questions you're getting during these extraordinarily turbulent financial times?
Jerry Jordan: The biggest overarching question I hear now is, "How bad is the global economy?" These questions are all tied together: Is it as bad as the stock prices imply? Is it as bad as the bond-spreads widening would imply? Or on the other hand— as I am leaning towards—are we basically facing a few very odd, somewhat random situations that are overly exacerbating a normal recession? For example, in 2001 the stock market was declining, the NASDAQ was down a lot. Out of the blue we got hit on 9/11. It accelerated the existing decline, and the U.S. market was down something like 15% after reopening the next day.
In a similar vein, the recent market had been going down and down, and then all of a sudden we reached a point where in the same week we had the Fannie and Freddie/Lehman Brothers CDS [credit default swaps] settlement auction.1 With a CDS, the buyer receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap. This settlement auction meant that anybody who had written a CDS on Lehman was going to have to make good on the credit worthiness of the product. In Lehman alone, there was rumored to have been approximately $600 billion worth of CDS—almost 2:1 on the actual debt. So, $600 billion of collateral had to be available on the day of the auction.
Fannie and Freddie and Lehman resulted in the largest margin-call in history. So every trading desk, every prop [proprietary trader] desk2, all of Fannie, Freddie and Lehman’s assets were for sale. At the same time you had major margin calls with CEO’s as well. All of these events occurring together resulted in one of the largest, one-week declines in history. And so the question is, "Are the underlying dynamics as bearish as the stock prices' decline?"
I don't know, but I tend to think they aren't. I look at our portfolio, which was hit hard in the third quarter especially into the middle of October. Our fund had stocks that were trading at single digit multiples, and some stocks that traded at prices to net asset value that were as low as at any time in the last 15 to 20 years. These were businesses that were in better financial shape than at any other trough cycle in 25 years; yet many were trading at valuations that were even lower than prior low-periods. Schlumberger, NuCor, these companies were trading at valuations that they've almost never seen, and when they have seen them, it was because there was a legitimate risk of bankruptcy. And there's not even a discussion of whether there’s a likelihood of that happening now, given the strength of their current balance sheets.
So, I don't think things are quite as bad as they appear. I'm not saying they are good, obviously we are in a recession—and we are in a global recession. Central bankers are doing everything they can to create liquidity, and the markets are ignoring them
What is interesting is that there is very little discounting of the future, i.e., “things are bound to get a little better,” or, “the government has stepped in, and they are not going to allow this, that, or the other thing to continue to get bad.” If there is another bad data point, markets will get worse, but there’s no apparent discounting going on the other side, i.e, the world may get better, which I think is emblematic of a bear-market bottom.
Now, if we are bottoming, what does that mean? It means we’ve seen the low in the Dow, but that we’re probably going to have to trade up and down for a while, before we start any reasonable resumption of a bull market, which is typical of a recession-induced bear market. I assume it will take the balance of this year but some areas will start to improve. I think it will be in the areas and industries that we have owned and I think, especially, commodities are going to get better, particularly oil.
The other potential area is in steel. Steel capacity rests predominantly in China where they are not wild about using all of their electricity and all of the capital necessary to produce steel. If China decided never to export again, we wouldn’t have enough steel facilities in the world to cover normal demand. We’re obviously in an abnormal period right now, but even the U.S. imports 20% of its steel use every year.
The other positive is that most commodities have fairly low inventories because there was not that much production in the first place. I read somewhere that copper production in 2008 is actually predicted to be down versus 2007. Oil production will be up, but not much. During the last down cycle we had about 10% of excess capacity; now we have just 3%.
We are in one of the worst demand periods we’ve seen in 25 or 30 years for oil. So, when the world market eventually gets better—which it will because central banks are pumping—we’re going to have a problem with the supply of oil. And the decline in oil prices has gotten a lot of projects canceled. What people don’t realize is that they should actually want oil at $100 because that would at least spur production, or at least spur the attempt at production. At $70, producers say the heck with it, we’re not going to waste the money. If you’re Exxon or Petrobras, and if you want to bring on 5,000 barrels a day, $70 is fine; but 5,000 barrels a day won’t move the global supply needle. What you really need is to bring on 100,000 barrels a day; 100,000 barrels a day requires multiple years of exploration, building out and drilling, setting up pipelines, tying them back into storage facilities, and it requires a whole infrastructure. At $70 per barrel of oil, I don’t think it will happen.
There are also a number of new-built rigs that are supposed to be delivered over the next three or four years that are being canceled because companies that were going to build them don’t have the credit facilities in place anymore to borrow the money. In many situations, the price of steel has gone up enough over the last four years that they can’t afford to build them. There are all these various pieces that have created a real dilemma in terms of the energy infrastructure, at a time where oil is now low enough that you’ll start to spur demand.
If you have any belief that stocks can rally, and we do, it requires a belief that the global economy is going to improve. And, raw material demand—by definition—will have to improve.
Q: What is the best advice for investors right now?
Jerry Jordan: The problem has been that it’s all about panic. If you’ve got long-term horizons and have diversified your portfolio according to your age—you should recognize this sort of thing is going to happen, it does, always has and always will. And the key is not jumping to the wrong conclusions after it happens. Investing in funds that have a good long track record—when things are bad—and taking a little money out of them when things are good. Dollar cost averaging, buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price—it’s one of the mantras that unfortunately many investors don’t do.
Q: What do you see on the horizon?
Jerry Jordan: There is very little that’s crossing my radar screen that makes me say, “Wow, that’s really interesting.” For the most part, the prices of stocks that are most interesting are things I already own. I avoided technology, but am starting to move back into well-capitalized Global Technology brands.
I want to own businesses that will benefit from an economy reaccelerating next year, where capacity remains fairly tight, and therefore as things improve, there will be pricing power.
For me, there are no better areas than oil and gas related companies.
1CDS settlement auction—The Lehman credit default swap auction that produced bid of nine cents on the dollar.
2Prop Desk— A proprietary trader is one who is involved with transactions with a securities firm that affect the firm’s accounts (or his own linked account within the firm) but not affecting the accounts of the firm’s clients. Strictly speaking a prop trading firm is one where you would trade the firm’s capital (and only their money). But today the most common so-called "prop firms" are ones where you put up $5,000, $10,000, or more and then you trade using 10:1 intraday leverage.
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