Thriving in the New Economy, Part 1

The following is an excerpt from Lori Ann LaRocco's new book, Thriving in the New Economy: Lessons from Today's Top Business Minds. Benzinga will post the complete Chapter 8 of her book over the next week in several installments.

Ron Baron, The Economy

Whether the stock market is rising or falling, Baron Funds founder Ron Baron never loses sight of his long-term objective. With a time horizon of five years or often longer, Ron and his firm invest on behalf of their shareholders primarily in small and mid-sized growth companies, and the managements who run those businesses. The companies that attract Ron are financially strong, are well managed, and have prospects to become significantly larger. Ron and his firm use a bottom-up, intense company research strategy and try to invest in companies at what they believe are attractive prices.

When investing in growth companies, Ron uses a value-oriented purchase discipline. Short-term market fluctuations usually don't disturb him. If Baron Funds believes the fundamentals that justified an investment haven't changed, they will hold that investment and may even buy more. This flies in the face of the response usually made by rule-based investors who sell when stock prices fall, assuming they must have made a mistake. Ron's long-term approach and focus require him to study the big picture: Just because a business is earning less money or even losing money for a short period does not mean that business's viability or long-term growth prospects are threatened. In most cases, Ron expects Baron Funds’ current investments to recover the value they have lost between the fall of 2007 and the spring of 2009 during the next several years.

Ron Baron was smitten with stocks at age 13, when he invested his $1, 000 bar mitzvah gifts and, in a rising market, immediately began to make money. Adding to his investments with earnings from shoveling snow, waiting tables, serving as a lifeguard, and selling ice cream—like so many students today—he helped pay his college tuition. Ron officially began his career in finance in 1970. He has witnessed numerous recessions and stock market “panics”: the extended bear market of 1973 to 1974, the crash in 1987, the free fall after 9/11, and countless other market dysfunctions both in the United States and abroad. Ever the optimist, Ron says that no matter how bleak our economy's prospects may seem, our country and its economy have always recovered from distressing circumstances since its founding. He subscribes to Warren Buffett's philosophy that “pessimism is the friend of the investor” and to Ronald Reagan's motto that “America's best days lie ahead”; accordingly, he believes that “2009 offers investors the best opportunities of my lifetime.” Although he began working in finance years ago, Ron's passion and excitement about investing still keep him up at night, especially now, with so many stocks at levels he finds unusually attractive.

Looking back, I think this crisis had many similarities to what happened following the Crash of 1929. I thought our government had learned the lessons of the 1930s and that tragic periods like that would be confined to history books. I didn't think we would see such things again: a financial chain reaction with continuing negative feedback that could cause an extraordinarily weak economy for an extended period. However, Lehman Brothers’ bankruptcy on September 15, 2008, was the catalyst for just such a financial chain reaction. This is because Lehman Brothers’ balance sheet was so large—just like AIG's—that virtually all the other large financial firms with whom it had done business were adversely affected when it failed.

When the stock market began to plunge day after day after September 15, real-time news coverage on television, the Internet, and newspapers brought these events into everyone's living room on a daily basis and in terrifying detail. It was like watching a catastrophe; it seemed surreal. The resulting fear in America and worldwide and the loss of confidence in our capacity to deal with crises caused stock markets here and globally to continue to fall. Investors, consumers, and businesspeople reacted, economies everywhere fell into a deep recession, and stocks fell further. It couldn't have been clearer to us what was happening when one corporation after another in which we had invested began to tell us they were cutting expenses, reducing employment, and cutting capital expenditures. That would clearly reduce consumer confidence and purchases, which would lead to even more business cost reductions, which would lead to even lower consumer confidence, and so on. It reminded me of the reported meeting early in the twentieth century between Henry Ford, the founder of Ford Motor Company, and Walter Reuther, the head of the United Auto Workers union, in one of Ford's new plants. “Do you see all those workers, Mr. Reuther? Some day all their jobs will be done by machines, ” Ford told Reuther. “Just who do you expect to buy your cars then, Mr. Ford?” Reuther replied. When businesses cut jobs, there are obviously fewer customers for their products. This is an immutable rule.

The situation with Lehman Brothers brought to mind Warren Buffett's comments regarding the propensity for one to rely upon someone else's promise: that the promise is no better than the ability and desire of the person making it to fulfill it. Lehman Brothers had made commercial promises to many upon which they relied to establish other commercial and contractual commitments. Many of those to whom Lehman Brothers had made these promises—promises it would now be unable to fulfill—and those counterparties could be greatly affected. But by how much? No one seemed to know. Lehman Brothers was so large. It was difficult to understand how the government could allow it to fail. But, for some reason, it did.

After Lehman Brothers’ failure, it became clear how dangerously leveraged our economy had become, and how leveraging had been an important driver of our growth over the past 30 years. Borrowing allowed people to buy things they could not have bought otherwise; it made assets more valuable than they ever might have been. This trend could have ended at any time, even 5 or 10 years ago. Indebtedness in our economy increased from about 170 percent of the gross domestic product (GDP) in 1982 to 350 percent of the GDP in 2009. We simply could not support that indebtedness if either interest rates increased or the economy faltered.

Excerpted with permission from the publisher, John Wiley & Sons, from Thriving in the New Economy by Lori Ann LaRocco. Copyright (c) 2010 by Lori Ann LaRocco.