Ten Questions For Yamamoto

During last month's vacation in Maui, I had the pleasure of spending time with Irwin Yamamoto, the Maui Contrarian.

Irwin is an interesting person who shares his market perspectives with thousands of subscribers worldwide through his monthly newsletter. Because many of you have asked me for an update, I sent him 10 questions by email last week. While our perspectives and views are different, you'd be hard pressed to find someone more bearish about the market's longer-term prospects. Enjoy!

Kirk:  Hard for to me to believe that it has been over two years since our monthly Q&A! A lot has happened in the market since and I'd like to obtain your current big picture view (fundamentals, technicals, sentiment, economic) for the economy and market as we head into the second quarter. Any perspectives you can share would be appreciated.

Yamamoto:  Investors are spoiled - big time. They are accustomed to multiple years of bullish cycles with only minor corrections along the way. People forget how bear markets are part of the investing landscape. Therefore, the false perception leads me to believe a long bearish period awaits us. The same can be said for bad economic times. Based on a study by the Federal Reserve Bank of Dallas, the average recession from 1959 - 1983 lasted 12 months. It usually occurred every 47 months, or roughly 4 years apart. And the gross domestic product (GDP) declined about 2.7 percent. More recently, the typical recession has a new profile. The length of the 1990 business downturn - only 8 months. And it followed a 7 1/2 year growth period. The decrease in GDP, a mere 1.26 percent. Likewise, the 2001 recession was also 8 months in duration. The gross domestic product fell a scant 0.35 percent. And this short occurrence developed after an extended 10 years of expansion - a record. Some economists even dismiss the 2001 recession on a technical basis. GDP slid into negative territory in the third quarter of 2000, and in the first quarter of 2001. However, it did not go down for 2 straight quarters. Recall the definition of a recession - a contraction in GDP for two consecutive quarters. In summary, the United States went through extended expansions and relatively short periods of negative growth. Hence, chances are the country will regress to the mean when up cycles were briefer in length and downturns were longer in duration. I don't want to sound like a party pooper, but the length of this recession will surprise many. In fact, yours truly wouldn't be surprised to see the domestic economy suffer a double-dip recession. We're presently in the first phase. The second one should develop when Fed must raise interest rates next year and in 2010. That scenario could translate to the extended bear cycle and recessions I was referring to.

Kirk:  When visiting your island last month, I couldn't help but to think that many of the major issues that Hawaiians now face daily are a good example of long-term trends we're likely to see across the mainland. Namely, very high energy costs ($4 gas), high prices for food and housing, and increasing unemployment. In addition, it is clear to me from reading and watching the media reports there that there is a huge battle underway between the island's resources from the need for clean drinking water to land preservation. In your opinion, do you think any investment ideas can come from these trends?

Yamamoto:  There will always be a battle between the business community and the environmentalists. The business sector desires growth to create jobs and profits. While the environmentalists want to protect Mother Nature. The differences between the two group are going to be even more pronounced as the economy turns south. An investor who understands this situation can take advantage when the political trend either favors business or the environmentalists. The investor may benefit financially if he or she realizes if a shift is forthcoming, either a growth cycle or a non-favorable business landscape. That realization affects the investment choices. If not, the landscape dictates whether the investor is successful or fails.

Kirk:  My wife and I have been watching the Hawaiian real estate market for some time and the prices to us still are very high for what you get. At what point, if any, do you think that will change and what are some trends we should be watching in the real estate cycle both there and here at the mainland?

Yamamoto:  Generally speaking, in most area of the United States, a real estate bubble occurred. The housing market was not merely strong, but it was a bubble of major proportions. As we know, all bubbles eventually burst. And the current cycle is no exception. In the past, after the real estate bubble exploded, it normally took 5 to 7 years before the market recovered. I don't see why this trend will be any different this time around. If history's the guide, then we're only in the early stages of the downward cycle. When housing prices find a bottom, only then can the overall economy rebound here in Hawaii and on the mainland.

Kirk:  One of the things you've said in the Q&A is that you look at everything like a true businessman. In other words you like to purchase wholesale and sell retail in your investments and acquire them below their values. What, if anything, do you see that represents good value today?

Yamamoto:  Yes, I am endlessly searching for values. I study the financials of companies. However, I go beyond the numbers. In other words, I not only look at tangibles - I dig for the intangibles. For example, a corporation might possess a valuable "brand name." Yet it is nowhere to be seen on the record books. Or an enterprise may have a huge investment portfolio of stocks and real estate which is separate from its main line of business. There are values out there. Still, in a bear phase, most stocks fall in price. These bargains could very well become better bargains later on simply because of the soft equity market. I am being patient.

Kirk:  I know you review balance sheets in order to determine intrinsic value. Have any balance sheets drawn a sparkle in your eye recently?

Yamamoto:  You can catch me analyzing balance sheets of corporations on weekends. Irwin, get a life! But seriously, there are solid balance sheets which have caught my eyes. Yet at the same time, let me illustrate the kind of times we're in. For example, I have been known to take significant stakes in the shares of stock brokerages at the end of a bear market/recession. I am a contrarian - people call me The Maui Contrarian. These stocks did provide me with major capital gains in the past. The premise being, acquire them at the bottom. The perfect "buy low-sell high" dream of a contrarian. And then wait for the economic boom. However, the present scene is different. Why? The exposure of the brokers, banks and investment houses cannot be truly measured and calculated. One cannot figure out the potential losses of these firms in regard to the risky mortgages, bad loans and the liquidity problems. If you think the collapse of investment banker Bear Stearns was the beginning of the end for all the calamity, then reconsider. In the next two years, the Federal Deposit Insurance (FDIC) expects over 100 bank failures. Count them. Who's next? Furthermore, in the hedge-fund industry, 75 percent of 2,600 hedge funds lost money back in August 2007. Today, the risks have risen substantially. Another financial fiasco, like the Long-Term Capital Management mess of 1998, looms. The bottom line, additional chaos will be in the news.

Kirk:  A couple of years ago you said that you expected the Dow to test 10,000 again. Do you still think that is going to happen now with the Fed and government throwing everything and the kitchen sink at the market and economy now?

Yamamoto:  At some point in time, we'll see Dow 10,000. On a historical basis, the dividend yield hovered between 3 percent to 4.5 percent. If that's the synopsis, the Dow will eventually trade between 8,000 to 10,000. My double-dip recession scenario would push down the average to those levels.

Kirk:  One of the things that concerned you in the last Q&A was the overall health of the U.S. consumer. Is this still a concern for you, and if so, what are things that would improve your mood about the U.S. consumer?

Yamamoto:  The consumer is not swimming in debt. No, he or she is literally drowning and sinking in debt. American household debt has more doubled in a decade. At the end of 2007, it stood at $13.8 trillion. Back in 1999, the number was at $6.4 trillion. Mr. and Mrs. Joe Public have been borrowing money furiously to stay afloat. But what happens when their work hours are reduced or they lose jobs outright? Jobless claims reached their highest point since 2005. In 2 years, the unemployment rate could be at 7 percent, up from the present rate of 5.1 percent. That level would rank as the highest level in 16 years.

Kirk:  You've said that the performance of stocks depend on corporate profits. How do you see profits faring as earnings season gets underway this month?

Yamamoto:  The projected price/earnings ratio for the Standard & Poor's 500 index for 2008 is 13.2. At first glance, this ratio appears attractive, especially considering the average p/e of 16.5 going back to 1989. However, this premise is deceiving on two counts. First, Wall Street's estimates are much too optimistic. In fact, they have been coming down quickly based on current economic conditions. Second, bear markets do bring price/earnings ratios down. Today's projected p/e ratio might look cheap, but at the end of the 1980-1982 bear cycle, the ratio plunged to 8.7. Plenty of downside action could be in the offing.

Kirk:  I know you find many of your investment opportunities on the new 52-week low list. Have you found anything of interest there recently?

Yamamoto:  Yes, the 52-week low list is expanding. And I do see more possibilities. Still, this bearish period should offer even better opportunities down the road. Patience's a virtue. Due to the bear market, a previously priced $25 stock could be a steal at the current $20 level. Yet the downward pressures of a bear phase may bring it down further to $17 in a few months. I'll take the discount each and every time. Investors believe the Fed has rescued the financial markets. Hey, nothing is free. Consequences exist. The irresponsible policies of the Mr. Bernanke has increased the growth of the M3 money supply from a year go. How much? 5 percent - no. 10 percent - not. But a whopping 15 percent! And don't forget the unprecedented actions by the Federal Reserve of direct loans to investment banks. Basically, the Fed has destroyed the dollar. Make no mistake about it, inflation is returning in no small way.

Kirk:  I know in your newsletter that you've been relatively inactive for some time now. Something I respect quite a bit since I know from personal experience how much subscribers can insist on being more active no matter what the market conditions may be. How do you resist the urge to be more active in the market?

Yamamoto:  When I first started my newsletter 25 years ago, I made a promise to myself - to be true to my investment philosophy. In essence, I am a businessman searching every day for undervalued stocks selling at bargain prices. Marketing-wise, it would be far better for me to be a "trader" with a lot of stock picks. And to be known as a "technician" (although I utilize the charts). I would come across as more mysterious and exotic. However, I must to be true to myself, and to my loyal subscribers. Still, in a poetic way, it has paid off. My portfolio of cash and an inverse fund has handily outperformed the various market averages My portfolio was in the black while the Dow Jones Industrial Average lost 7.55 percent, the Standard & Poor's 500 fell 9.92 percent, the Nasdaq dropped 14.07 percent, China -down 32 percent, India -off 20 percent, Japan, Germany and France descended 16 percent. In 2007, the number of subscribers to my newsletter achieved a record. I haven't altered my investing style for decades. And I don't plan to change it any time soon. To say the least, I have been fortunate.

We'll there you have it. If you would like to subscribe to his monthly newsletter, here's the info: Three-month trial (3 issues) - $50; 1 year (12 issues) - $350; 2 year (24 issues) - $690. The Yamamoto Forecast, P.O. Box 573, Kahului, Hawaii 96733. (808) 877-2690.