SAPPHIRE CAPITAL STRATEGIES INC.

The End of The World As We Know It

B. Scruggs 
July, 2008

As I browsed the business section of the Los Angeles Times dated July 1, 2008, I realized one days’ financial news couldn’t get much worse.  One article discussed the stock market’s 19.9% drop since October, as being “just short” of the 20% decline that defines a bear market.  Another article said the price of oil had again closed at an all-time high, and the average price of a gallon of gas had also set a record.  The main “human interest” story told a tale of woe for many investors who had lent construction money for speculative Malibu lot development, only to wonder where their investment money had gone when the lots were foreclosed on.

Not to be outdone, the housing market had a couple of entries.  One story told of the farewell speech of Angelo Mozillo, and the decline of the company he founded, Countrywide mortgage.  The article said in retirement, he planned to spend time with his grandchildren and defend himself against numerous lawsuits filed against him while at Countrywide.  And the final front page article discussed how Indy Mac bank was fighting for its life, as their CEO explained how they were trying to raise new capital to stay afloat.

Wow. With news like this, the Middle East seems like a relative sea of tranquility.  Is this “the beginning of the end” as we stare into the abyss of economic disaster? While there is economic pain out there in the real world, we must remember what preceded this economic downturn.  Housing values had been on an upward trend for 7 years, reaching all time highs in 2005.  Interest rates were the lowest they had been in 45 years.  Underwriting guidelines on home loans had loosened to the point where people were being approved for loans they didn’t understand, nor had the long-term ability to pay for.  Consumers were keeping the economy going with home equity loans and record use of credit cards.  In other words, the “good times” were being fueled by unsustainable forces that at some point had to return to sustainable levels.

While we acknowledge the current challenging economic picture, the more important issue is “where we go from here?”  Are we on some slow decline toward the disappearance of the American Dream?  With inflation, bear markets, the war in Iraq, the price of oil, and declining house values, have we ever had so many economic challenges thrown at us at one time?

I am reminded of the story of George Merck, the chairman of Merck Pharmaceuticals.   Founded in 1891 as a chemical manufacturer, he had a vision to transform his company into one of the preeminent drug-making companies in the world.  In 1933, during the depths of the Great Depression, he had a vision for his company that he articulated at the opening of their first research facility.  He proclaimed “We believe that research work carried on with patience and persistence will bring to industry and commerce new life; and we have faith that in this new laboratory, with the tools we have supplied, science will be advanced, knowledge increased, and human life win ever a greater freedom from suffering and disease…We pledge our every aid that this enterprise shall merit the faith we have in it.  Let your light so shine – that those who seek the Truth, that those who toil that this world may be a better place to live in, that those who hold aloft that torch of science and knowledge throughout these social and economic dark ages, shall take new courage and feel their hands supported.”

As we know, Merck grew into one of the world’s premier and most profitable pharmaceutical companies, with 2007 annual sales exceeding $24 billion worldwide.  Yet it was born during a time of economic despair when the unemployment rate was 25%, almost one half of the nation’s banks had failed, war was brewing in Europe, and the stock market had lost almost 75% of its value in the previous 4 years.  The vision George Merck spoke about, captured the true potential and promise of the American spirit, and looking back, it is inspiring to see how his dream came to life, despite the dire economic environment it was born in.

I predict there will be a time in the future when we will again see double digit returns in the stock market, housing prices appreciate, banks being profitable, investors happy with their returns, and the price of gas under $2 a gallon…..(well, four out of five isn’t bad).

When I start seeing people rent one-way Ryder trucks, with destinations to China, India, and Singapore, then I will get worried.  Until then, I will lay my bets with the ingenuity, resiliency, and entrepreneurial spirit of the American citizen.  We have been here before, and just as sure as good economic times cannot last forever, challenging economic times always lay the foundation for the next recovery.