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INVESTING: Strange time for business: Bad, good news abounds

August 13, 2007

There is an ancient Chinese proverb that says, "May you live in interesting times." The saying possesses a sort of electric connotation, with hopes that one experiences an exciting lifetime. Yet in the historical use of this proverb, the interpretation of "interesting times" hasn't always meant "good times," with some recitals implying "dangerous times."

For investors, our times are certainly interesting. We have a global economy that is booming. Economic growth across the planet has never been in such harmony.

But beneath the surface, all is not well. In the U.S., the housing market and the mortgage industry are in the midst of a significant downturn. The credit markets-until recently the source of the seemingly endless liquidity that provided the grease for private-equity acquisitions, creative loans for home buying and the ability for some hedge funds to borrow $10 per dollar of equity-have seized up. With the liquidity spigot shut off, all sorts of assets are being re-priced for a riskier environment.

The investment banks, the frontline lenders in private-equity acquisitions, have found themselves stuck with bridge loans that may be difficult to refinance. These short-term loans are used to temporarily finance a business purchase, with the anticipation that they will be repaid once more-permanent financing is secured.

The riskiest mortgage loans Wall Street parceled out to investors have been substantially marked down in price. Their new illiquidity has been the source of several recent hedge fund blowups. Even Harvard, one of the first to adopt alternative investing, recently lost $350 million in a hedge fund that closed. American Home Mortgage, a company valued at more than $1 billion a few months ago, abruptly closed this month and filed for bankruptcy, putting 7,000 employees out of work.

It's also interesting to observe the dichotomies that exist across seemingly closely associated industries. For example, in the transportation industry, the aircraftmanufacturing business is firing on all cylinders. Yet the airlines have been in and out of bankruptcy. Trains and shipping are booming, while truckers struggle and autos sink.

The technology revolution has been upstaged by new themes: infrastructure and commodities. Heavy construction is booming, while residential construction plummets and the shine comes off the commercial real estate market. Notably, just four years ago the survival of companies such as Columbus-based Cummins Inc. was being questioned. Now Cummins and other heavyequipment makers are viewed as drivers of global industrial growth. Likewise, steel companies went through bankruptcy and were reorganized and are now thriving as multibillion-dollar businesses.

The financial titans of this period are not people who built things such as the Carnegies, Rockefellers or Fords. Instead, the new moneyed are people who buy companies and rearrange balance sheets, and financial mathematicians who create and trade derivative securities.

There is plenty of debate among investors as to whether we are in the midst of great times or dangerous times in our global economy. Long-term investors are aware of the benefits of having cash available to take advantage of opportunities during periods of market uncertainty. Interesting times, indeed.



Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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