After a late dinner in the Summer of 1982, a friend and I walked past a night club in New York City. Red Fox was on stage and there was no cover charge. The price of a drink took half of the per diem I was receiving from my company but there was no cover charge. My friend got smart and tried to go one on one against Fox. Needless to say, Red verbally abused us both. I will not mention the names he called us, the language he used to describe our wives or mothers or the relationships he decided my friend and I must enjoy.
Red was a funny man. His running gag about "the big one" is a classic. On the show Sanford and Son, in want of sympathy, he would sometimes clutch his heart, look into the sky and say, "This is the big one. I'm coming, Elizabeth". His TV son, Lamont was able to hold his own against Fred. For example Fred once said that he still wanted to sow some wild oats and Lamont retorted, "At your age, you don't have no wild oats, you got shredded wheat."
THE BIG TURN AGAIN?
In several posts, I have said that after the big decline in commodities is well under way that the price of treasury bonds will soar, that financial stocks will make a V bottom just after the big rally in bonds and that consumer stocks will soar next. Last week, with gasoline at levels not seen in 4 years, the 30-year treasury bond soared to prices not seen since the 1950's. Across the big pond, English 5-year guilts jumped as hard and as fast as ever recall a bond market move. Is this "the big one"?
The momentum of the commodity bust has certainly slowed. The Baltic dry shipping index fell harder and faster than ever before but it can hardly fall anymore. We are in a period of deflation, so bond prices could go lower still, but current low long rates are consistent with high PE ratios.
I must run because I am headed to the beach for the holidays. Having said that, the calendar is normally very kind to the market during the Thanksgiving stub week. The huge rally of the past two days could be nothing more than a holiday bounce. On the other hand, the best historical season for stocks is all the way from November through May.
REZ, a home real estate reit, sure looked like it made the big turn this week. On November 20, it sold for 18.50 and for 21.07 yesterday. This 14% gain was out done by the bounce in beaten down bank stocks but both are feeding off the extra low bond rates.
Another extremely powerful indicator from two days ago was when a regular reader gave up. He held on to his stocks all the way to the bottom and then let'm fly. When a determined fellow lets go, it is common to see an immediate rally. I wish you all Peace, Grace and a Happy Thanksgiving.
Tuesday, November 25, 2008
After a late dinner in the Summer of 1982, a friend and I walked past a night club in New York City. Red Fox was on stage and there was no cover charge. The price of a drink took half of the per diem I was receiving from my company but there was no cover charge. My friend got smart and tried to go one on one against Fox. Needless to say, Red verbally abused us both. I will not mention the names he called us, the language he used to describe our wives or mothers or the relationships he decided my friend and I must enjoy.
Posted by Courtney at 11/25/2008 08:15:00 AM
Monday, November 24, 2008
According to stats from PAIX, Internet traffic around the world is growing 65% per year! Wireless traffic is growing 400% per year!
After the holidays, a long list of stores will close, Linen and Things, J. and Jill, numerous video rental stores and book stores, etc. A regular reader notes that one should be careful when giving gift cards. Even chains that are not closing will close many stores. Card holders may lose their gift or have a difficult time in using it.
An old friend, who is Internet challenged, recently bought a wedding gift online. Like many men, this fellow does not enjoy shopping. He was tickled to be able to see pictures of register items, to easily pick one on line and to have it delivered. This is old hat for so many of you but it shows how the Internet is gradually spreading. In the short run, the Internet is contributing to the problem of too many goods chasing too few dollars but in the long run to a higher standard of living for all.
400% annual growth in wireless traffic! As in all economic rotations, just as one business flounders another one takes off. Larry Kudlow would call the wireless traffic growth a mustard seed. It is that and more. It represents a paradigm shift, a game changer, a new way of living. It represents much more than checking ones email on the road. Talking computers that accompany us where ever we go will prove to be invaluable, a necessity for living a "normal life". My Dad passed away 4 years ago without ever owning a cell phone, Mom goes nowhere without hers. She is 86 and still getting accustomed to searching the web. She will want a web connected phone before too long. This product has broken through the early adopter's stage and has entered the rapid growth phase during which half the people will buy.
All components of this business are very competitive. Winners could range from AT&T to SamSung but I believe Google will be the biggest big winner. The small software firm that creates the best new application will soar but the day to day search is going to give Google steady but dramatic compounded growth.
Posted by Courtney at 11/24/2008 12:04:00 PM
Some Netbook computers are breaking the $300 price barrier. Dell has announced that it will produce a computer that uses "TV white space". Google is elated.
Google makes its money from advertising. It does not make telephones or computers. According to one of Google's founders, the advent of "white space Internet" will increase Google's advertising revenues by 30%!
The lowest priced Netbook computers do not have hard drives or Windows software. They are designed to be Internet appliances. For those who use Gmail and other Google hosted products, who needs a hard drive? Who needs windows?
In a year or two, the $100 price barrier might be broken and white space transmissions might be available free of charge. When price falls, growth occurs. In a few years, school kids will carry a 2 pound $100 compact Netbook computer instead of a 50 pound sack of text books. They will have access to the whole world of knowledge.
This Christmas Season, a lot of $500 to $1,500 laptops will be purchased. Many of the buyers will never do more than what they could do with a $300 Netbooks. The public is not very aware of Netbooks yet. Business people who have them tend to use them as a second, ultra portable computer. The day is approaching when people have extra computers sitting around, like they now have extra calculators.
I can see a Netbook based on Google Android Software in the making. These machine will have the ability to use cell telephone connections if necessary but they will default to white space or WiFi connections. Because the cell phone providers will share in the advertising revenues, carriers will offer machines that assist the customer in reducing his cell phone minutes.
The promise of having the Internet everywhere has been made by WiMax and other "long distance" proponents for years. In numerous markets, the promise is becoming reality. Mobil TV service is sweeping the country.
New 3G Storm phones can be bought for $199 provided one is willing to sign up for a two year data contract at $49 per month. This data plan is unlimited Internet but it includes no regular sell phone service. In other words a working phone will cost a minimum of $69 per month. Add on TV networks for another $15 to $30. A steep price, but a cheap price for those who need mobile access to the Internet. If a service worker saves one trip a month, he is way ahead. The business that learns to substitute Internet for physical movement will be at a competitive advantage.
The $69 price will fall, especially when white space services start cranking up. The key point is that mobile access to the Internet will generate so many advertising dollars that the service can be made available free of charge. One of the hooks that will speed the adoption is access to entire libraries of books. Consumers will pay for the purchase of books but much less than the total cost of the same book in hard copy.
Google shares are available at less than 10 times earnings. The price today is $262. You had better get these while you can, limited supplies are available at that price. I am not a financial analyst, investment advisor or broker, but, as an amateur investor, I see a bargain here.
Posted by Courtney at 11/24/2008 09:27:00 AM
The following is my response to a buyer of the I-Shares TIP Fund. The buyer bought as protection against inflation, but he has been getting creamed by deflation. He sees the flood of reserves from the FOMC as the grounds for coming hyper inflation.
I understand your concern about the new fed reserves, because a good definition of inflation is too much money chasing too few goods, however, I think the world economy is in a state of deflation and it will be several years before we see high inflation rates again. Inflation is determined by both the supply and demand for goods and by the supply and demand for money.
1) Goods: The excess supply of goods is not going to be easily worked off. Oil is only one of many examples available; as a result of many prior years of exploratory drilling, production went from around 60 million barrels per day to 87 million barrels per day in just 6 years. In addition to this dramatic growth in actual production, by the end of the huge price run-up, the pace of effective drilling surged to record levels and producers around the world made massive commitments to long-term projects. Two examples tell the story.
While prices were soaring, Brazil executed very expensive exploration in deed water, through difficult salt layers. They hit back to back to back home runs. The estimates of the reserves discovered just keep going up. It appears that at least 150 Billion Barrels of oil will be recovered. After the discoveries, Brazil ordered 30 Billion Dollars worth of off-shore drilling ships to develop these finds. These ships will be not be allowed to sit idle, regardless of how low the price of oil goes. In the mean time, Shell has started developing a 485 Billion Barrel field in Canada. Canada holds substantially more oil than Saudi Arabia. In the past, the 485 Billion Barrels of gooey oil was not worth processing. Today it is, largely because of new technology. Shell has learned how to refine the oil by cooking it in place for about a year. New nuclear technology allows Shell to heat this goo for 70% less than it would have cost with natural gas. All 485 Billion Barrels will not be recovered with this technology but a couple of million barrels per day should be easy. Technologies still being developed (most likely the digestion of goo by tiny microbes that produce natural gas) will ultimately allow the use of most of this oil.)
Significant quantities of oil will begin to flow from these discoveries and from many others around the globe just when CAFE standards cut demand. CAFE standards go into effect in 2011 and they ratchet up for many more years. This round will produce the same results as those in the past. By the time the standards are fully implemented the amount of fuel being used will have gone down, even while available supplies have gone up. The marginal cost of the last barrel produced is likely to fall to around $35.
This story is about many commodities other than oil. The average car includes 40 pounds of copper and the average home 400 pounds. Before the 1990 recession, copper stockpiles reached the very low levels of about 500,000 tonnes. By the end of the 2001 recession stockpiles reached 11,500,000 tonnes. Three months ago we were back down to 500,000 tonnes.
Even though the demand cycle has been broken, producers will continue to run their very capital intensive mining operations. New mines will not be started but the existing ones will just keep on producing. Some years from now, stock piles will once again exceed 10 Million Tonnes. The price of copper has fallen from around $4.20 per pound in July to around $1.60 per pound today, a close parallel to the price of gasoline. Before this cycle hits bottom, copper is likely to be back under 50 cents per pound. Indeed, because nano technology is allowing the much cheaper production of graphite based materials, some that conduct electricity much more efficiently than copper, a large number of uses for copper will be eliminated before the next demand cycle heats up. In like manner, graphite is replacing millions of tonnes of aluminum and steel. So far, most of it is going into airplanes but as production capacity increases, it will replace much of the heavy metals used in autos.
Furthermore, China is hurting. More than 100,000 factories have been closed. The government is afraid of revolution. It is using massive dollar reserves to buy its own excess production of goods when those goods can be stored to meet future demand. Government factories have lowered wholesale prices of finished goods to zero profit margins. China was exporting disinflation of goods prices to the US until the shortages that developed the last couple of years. We are back at the other end of the cycle now. The Chinese are flooding the world with low cost goods. Inflation is too much money chasing too few goods but, because of productivity, innovation and excess supplies of labor in China and elsewhere, excess goods are flooding the world.
As you well know, hand held wireless phones and Netbook computers are rapidly replacing large desktop machines and millions of servers are being replaced by "cloud" data centers. This is another area where the demand for materials is falling rapidly. A related action is that as the price of liquid paper technology readers fall, thousands of newspapers and magazines are going out of business. Hundreds of thousands of video rental stores and book stores are being closed. Billions of trees are being saved. The cost of producing one more digital copy of a book is almost zero. The resources used to send a digital book by wire is a very tiny fraction of the resources needed to transport it from tree to store to home. This rapidly growing trend represents a massive increase in the supply of goods, every book in the library will soon be available by wire.
2) Money: Most of the money printed is a result of the multiplier that happens when banks lend the same dollars over again and again. The multiplier or velocity of money has fallen off a cliff. The Fed is enabling banks to lend by making reserves available but the public is no longer in the borrowing mood. The reason the FOMC is having to increase reserves so quickly is to prevent a dramatic drop in the money supply. When a consumer saves-up and pays cash to buy something, there is no printing of money involved.
Last year, the person who had a 7% car loan was a happy camper. Inflation was pushing 5% and his total compensation was going up even faster than inflation. Buying on credit, worked fine. His net income was rising even after the hit of 7% interest. Today, the 7% car loan has become a very expensive loan. The car has tanked in value; the price of a new one is certainly not going up by 5% annually. Instead of 5% inflation, lets say the guy is looking at 2% deflation. Instead of paying 2% real interest (7% -5% inflation) he is paying 9% real interest (7% plus 2% deflation). He also doubts if he will see a 5% raise. This guy does not understand what is going on with the economy but he is pretty sure he heard Hank Paulson yell fire. As a result, he and millions of others are eager to pay off loans. To the extent that loans are repaid, the money supply is shrinking. Instead of too much money chasing too few goods, we actually have too many goods chasing too little money. Too many houses are chasing too few customers.
Politicians and the media keep harping about how government debt is going to cause higher interest rates or higher inflation, but the fact is that government debt does not cause higher interest rates or inflation. It is the monetization of debt that ultimately causes inflation. Most of the funding done by the FOMC has been sterilized lending. The shifting of paper from the banks to the FOMC books has been offset by open market transactions. FOMC reserves have recently shot out the roof but so far there is little evidence of new excessive lending.
In boom times the multiplier causes about 5 times as much printing of money as is done by FOMC actions. Today, the velocity of money has slowed by even more than the FOMC has increased reserves. Once the recovery starts, it will be important for the FOMC to pull the reserves back-in, but that is easier to deal with than is deflation.
You are correct to be concerned about the possibility of future inflation, however, even if the democrats go wild, the timing is tricky. The Great Society programs of Johnson went into place from 1964 to 1968 or so. The hyper inflation did not occur until late in the 1970's. When Volcker and Reagan brought the hammer down, inflation responded promptly but it still took years to get to the low levels seen in the 2000's. It remains to be seen how much printing of money the congress will allow Obama to do. The blue dogs will have a lot to say. In any event, high inflation rates should be years away.
Finally, even if you want the protection of TIPS against inflation, you should consider buying the individual bonds. By buying at par value, you can eliminate the downside risk of the fund. The fund holds bonds that have appreciated above par to as much as 1.3 times par. By buying above par value, you have accepted the risk that deflation will cost you 30% of your principle.
To add insult to injury, the fund has a .2% fee. .2% is substantially lower than the fees and hidden fees in managed mutual funds but it is a significant amount on a low yield fund. I have never purchased a TIPS, but I believe the issuing costs are paid by the government. Your cost to acquire and to hold the bonds in your account should be zero.
Posted by Courtney at 11/24/2008 08:46:00 AM
Friday, November 21, 2008
It is painful not to have made a fortune off the decline in oil prices. For months on end, I wrote that conventional wisdom was wrong. I repeatedly said that the price of oil was not going to keep going up but that it would ultimately come back down to the marginal cost of production, which is less than $35 per barrel for most of the oil produced. I wrote thousands of words but I blindly continued to invest in other areas. As far as I know, not a single reader, including myself, bought inverse oil funds or shorted the price of crude.
Now we are in a treasury bond bubble. In this case, I wrote hundreds of times that bonds would rise to a peak after commodities begin to fall sharply. Unfortunately, I kept wanting to believe the optimistic story that the decline in gasoline prices would show up quickly in lower home mortgage rates and an increase in consumer spending. I invested with emotion while ignoring my own words about the natural order of progression. I said that stocks will go up after the bond market rally. I skipped ahead and bought stocks when I should have bought bonds.
Obviously, I was very wrong about the economic downturn. Forty years ago, I understood that once the Fed tightens short term interest rates to the point of inverting the yield curve that a recession is likely to follow about a year later. The yield curve was flat to negative from June of 2006 to July of 2007 and I failed to pay attention.
Now there is talk about deflation. Once again, the talk is late to catch up with reality. The fact is that there has already been a tremendous deflation in asset values. Three of the big four asset classes have deflated substantially, real estate, commodities and stocks. The forth asset class, bonds, has set long term record highs and lows at the same time.
Yesterday, the price of treasury bonds soared to new highs, highs not seen since the 1950's. The yield on the 10-year note dropped to under 3% yesterday. The drop in the value of corporate bonds has roughly parallel to the drop in the stock market. Baa and lower quality bonds are at prices I have never seen. Yesterday, the markets were clearly in a capitulation mode. There was a true "flight to quality". Investors decided that it does not matter how cheap a security has gotten, they want the "safety" of short term treasury bills paying as little as .03%.
WHERE IS THE TOP?
How high can the price of treasury bonds go? The thirty-year bond is trading at 3.5% while the effective rate on Fed Funds has traded for around .4% for the past several weeks. The 3.5% to .4% makes for a nicely positive yield curve, suggesting economic recovery ahead, but the hidden story is in the inflation adjusted curve.
The inflation adjusted curve is inverted. It indicates that there will be "negative inflation" in the short run and even a negative average rate for 5 years. Over the next 10 years, the inflation adjust yield curve is forecasting average compounded inflation of just 1% or so.
On the other hand, the most recent CPI numbers showed the biggest drop in inflation in 60 years! One number does not make a trend, but big drops in wholesale prices are feeding into the CPI. The wholesale price of gasoline indicates a retail price of $1.65 within 10 days. The long term, inflation adjusted average price of gasoline in 2008 dollars is somewhere in the $2.25 range. Gasoline is already selling well below its average inflation adjusted price and very near the its all time low price (think in terms of how many hours work it takes to buy one gallon, people who remember .19 cents per gallon for gas fail to mention in the same breath that they made two dollars per day for their labor).
The see-saws are making big moves. The market is discounting the probability that a democratic president with large democratic majorities in the house and senate will make the same mistakes made in the past. However, government bureaucrats on the left and the right have generally learned from past mistakes; the odds that another Smoot-Hawley type trade bill will pass is remote. Democrats in congress are holding up the free trade bill with Columbia, but the economic team being assembled by Obama is not stupid. They understand that raising taxes or restricting trade during an economic downturn would be counter productive. It is also clear that the public has no stomach for more massive bail out bills. A deal to release the previously passed $25 Billion to the auto companies is likely, but even that is likely to come with strings attached.
One of the really big see-saws is the increase in real income that is being poured on the typical worker. About 95% of the people in America who want jobs have them and another several percent are drawing benefits while they look for work. The sharp drop in commodity prices, including the cost of money is flooding the world with purchasing power. In the short run, this flood is being used to pay down debt.
The price of a 7% auto loan has gone from very cheap to very expensive! When the inflation rate was 5.5% last summer, a 7% car loan had a real cost of 1.5%, much less than the average annual wage increase. Do the loan as a tax deductible home equity loan and consumers were being paid to buy cars now instead of later. Today, with the inflation rate negative by perhaps 2%, the real price of that old auto loan is 9% and the worker is not confident that he will get any raise and it makes good sense to wait to buy one of the new energy efficient designs that are on the way. The swing from 1.5% to 9% is a 600% increase in the cost of the loan. While people often say irrational things about financial matters, as a group, they tend to behave rationally; they follow the crowd to big mistakes but also to big corrections of mistakes. An individual may not have a clue that his real cost of credit has gone up but he is instinctively paying down debt.
In the short run, we are caught by the "Paradox of Saving". The more we save, the worse the economy gets. However, the probability that a family will travel to the beach this spring goes up each time the price of gasoline comes down a penny. On the way up, only the number and volume of complaints went up as gasoline went up, until we got close to the $4 range. Now on the way down, people are talking about the declines but they are not ready to spend their savings just yet. I suspect that gasoline at $1.65 per gallon will encourage more travel. The invisible hand of Adam Smith is hard at work. The economy will recover.
Today, one can buy high yield bond pools that offer unprecedented yields. The symbols for some of the funds are PHF, COY, MSY, HYF, HYI, HYP, and PHB. As an amateur private investor, I cannot recommend these funds but I can suggest that they are worth investigating. Where is the bottom? I don't know but, by a number of measures, we have never been this low before!
Posted by Courtney at 11/21/2008 09:51:00 AM
Monday, November 17, 2008
When the TIP price is below one hundred, the inflation adjusted yield curve is negative.
Posted by Jack Miller at 11/17/2008 04:35:00 PM
Hind sight is always easy. This big bear market started in 2000 when the technology bubble broke and when the average PE ratio was at 42. The charts show that we are living through rare times; in 1938 and in late 2008, the 10-year cumulative return on the stock market was negative! A once in a life time event that has been seen twice by a few percent of the worlds population.
The crash started in 2000 but did it end in 2008? The "old pig farmer" will not try to guess if 2008 is a bottom, he will simply note that prices are cheap and thus he will buy low in order to sell high. He may not have much to invest but he will put in all he can while prices are low.
Those who had money and the fortitude to invest in 1938 enjoyed fantastic 10-year cumulative returns again and again all the way to 1959. Indeed, from 1949 to 1959 the average stock went up by 600%, on top of the 170% average return from 1939 to 1949.
In the current situation, what evidence do we have that the market is ready to turn up? Actually there is much evidence but it is not what the media is talking about.
In 1938 a major economic recovery was brewing but the outlook did not look so good. Indeed in 1938, Hitler was actively engaged in preparations for war. He had formed an Axis with Italy in 1936 and in 1938 he expanded the Axis to include Japan, he forced the annexation of Austria and he made preparations to invade Poland. The US response was a weak comment or two. The public was so fed up with stocks that dividend yields on major companies paid more than bond yields (yes history repeats or at least rhymes). Today, scores of well capitalized companies pay dividends that exceed the returns people are scrambling to get in money and bond markets.
After 1929, unemployment rates soared to the 25% area and remained there for years. The "wipe out" of 1929 still makes the tech bubble pop of 2000 look tame. Ironically, the bubble that popped in 1929 was largely an auto bubble. Car sales had gone from mild in 1914 to wild by 1929. Of course, the car industry came back and a significant part of the run-up to 1959 was the auto industry run-up. The death of industry after 1929 was mostly the "old stuff" that was no longer needed, things like buggy whip makers and wagon works.
After the 2000 crash, it was mostly Internet.com companies that went busted, the Internet did not wipe out newspapers or telephone companies but forced them to gradually adopt the digital model. Today, we are on the verge of the next big wave in the Internet story and there is capitulation occurring. My favorite example is the decision by the owners of US News and World Report, a major magazine, to stop publishing a hard copy. In 2009, there will be billions fewer hard copy pages sold in the USA than in 2008. The momentum toward digital media is surging.
Ford owned the auto market by 1919, GM took a big lead by 1929 and both companies suffered while the Great Depression played out. Saddle companies that stayed in business, despite declining sales throughout the 1920's were forced to quit when the down turn hit. The most parallel comparison today is that Yahoo owned the search market got slammed when the bubble popped in 2000 and has since watched Google take over the market. Google shares have been slammed right along with Yahoo shares just before the great surge of mobile computing starts the next big wave. Google and Yahoo (perhaps as a subsidiary of MSFT) will see dramatic growth over the next 20 years, like the auto companies did from after the great depression. It is the "other stuff" that will go out of business.
WHAT A DIFFERENCE 5 WEEKS CAN MAKE!
Five weeks ago, banks were hurting. They were in such a scramble to attract deposits that one month and three month CD rates reached 5.1%. Six month CD's only paid 4.75%. Last week, the 1one month CD fell to 1.6%, the 3 month to 2.3% and the 6 month to 2.9%. The markets are quickly returning to "normal". The yields on hundreds of corporate bonds peaked on the 27th day of October. Commercial paper is once again being bought and sold.
Pendulums always swing to the other side of "normal". The UK is now on the "other side" by several measures. The weakness of the UK economy has caused the pound to fall from $2 in mid July 2007 to below $1.50 yesterday. This decline may not be over but the UK government is going all out with fiscal and monetary stimuli. The last UK Funds rate cut from 4.5% to 3% was the action of a chef with a meat clever. It was accompanied by several tax cuts. The US has provided the stimulus of soaring money reserves and bail outs to banks but there have been no tax cuts, except the acknowledgment by Obama that planned tax increases will have to wait.
The UK 5 year rate has fallen from 4.4% in August to 3.24% Friday. The 5-10 year spread has jumped to levels not seen in many years, only exceeded by the spreads reached in June of 2003. Yield curves are now forecasting economic rebounds in the UK, the EU, the US and elsewhere.
We live in exciting times. This week it will become clear that there are not enough votes in congress to use TARP money to bail out GM and Chrysler. The auto companies will likely win a speed up in the distribution of the $25 Billion loan but even that assistance is likely to come with stipulations. The drawing of a line in the sand, in regard to government spending, will be great news to the market place. The best way to bring growth back to the US is to realign our pay rates and tax rates to global realities. We are competitive in many markets but It makes no sense to pay GM auto workers $70 plus per hour. No company can enjoy long term success against Toyota or Hyundai while paying so much.
A line in the sand will cause home mortgage rates to fall. The prospective returns on real estate and invested capital will soar. The attitude shift will take time to spread but investors who add money to the market now will enjoy year after year of financial blessings.
The Bear has swung a might second blow, but each decline in commodity costs, including the cost of money, feeds the Bull and makes him stronger. The Bear is old and worn out. Long live the Bull.
Posted by Courtney at 11/17/2008 10:04:00 AM
Hind sight is always easy. This big bear market started in 2000 when the technology bubble broke and when the average PE ratio was at 42. The charts show that we are living through rare times; in 1938 and in late 2008, the 10-year cumulative return on the stock market was negative! A once in a life time event that has been seen twice by a few percent of the worlds population.
Cast all your anxiety on him because he cares for you. I Peter 5:7
1825 Curraghmore Road
Clemmons, NC 27012
Posted by Jack Miller at 11/17/2008 10:04:00 AM
Saturday, November 15, 2008
We are living during through a time of deflation -- something that has rarely occurred in America. The five-year inflation protected note yields about 1% more than the standard five-year treasury note. The bond market is projecting that prices will decline an average of 1% per year over the next five years.
We all know how the excess supply of houses has created a down draft in home prices, a decline that is all but over, however, I don't believe the public is as fully aware of the magnitude of the Moore's Law Deflation that is in progress. The housing "problem" will be gradually fixed as the unsold supply is gradually absorbed by new household formation, however, the computer story is different. Moore's Law says roughly that computers will do double the work at half the cost every 18 months. Because we now have billions of computers doing huge quantities of work, the doubling of work capacity has gotten to be a number of gargantuan proportions. Lower costs are circling the globe at fiber optic speeds. The computer story is becoming one of why buy an expensive and massive server -desktop computer for work and a desk top for home when a $200 mobile phone in proximity to a monitor will do much more?
In 1968 good quality pocket calculators sold for $1,200 dollars, more or less. In just a few years, the price dropped to $7, more or less. Billions more have been sold at $7 but the business of selling $7 calculators has not been much fun. Of course, there are fancy calculators that cost more than $7 but most of us buy the $7 ones and make do. We generally use computer software to replace the extra functions available in the most expensive calculators.
The "free with two years of service" mobile phones are becoming very powerful. As multiple desk top computers are replaced by mobile phones, it is understandable why Intel is selling for $13 per share and why the prices of commodities are dropping so much. Ten ounce telephones are replacing multiple 50 pound desktops and whole racks of servers.
Last week, Microsoft bragged about spending $3 Billion to beef up it cloud computing services. A day or two latter, Google announced that a large company signed-on to replace its Microsoft Exchange Server network with Goggle hosted Gmail. There are many cloud computer services battling for leadership. It does not matter which ones grow the most, consumers of computer services will be the big winners.
The company that switched to Google will pay $50 per year per user to have its own Google hosted domain and the extra conveniences that offers, while it's net annual savings will be $750,000. Millions of individuals and small businesses are gradually replacing tons of hardware and multiple copies of expensive software with low cost NetBook computers or with Mobile Phones, all very powerfully connected to efficient, well utilized cloud computers.
Verizon and AT&T are each rapidly expanding their Mobile Services, including mobile TV service. In scores of cities across the US, one can pay from $13 to $30 per month for ten or more Mobile TV Channels. Two major TV Networks recently expanded their Internet and Mobile availability. Is broadband wired service about to go the way of the land line telephone? Who needs a separate land line if you can set your phone next to your big screen TV and watch what you want, when you want?
PAYING BY THE WHEELBARROW LOAD
Newspapers, magazines, bloggers, radio stations, YouTube and many others have struggled to find a profitable Internet business model. The struggle is about over. The big Internet Service change underway is the conversion of unlimited access plans to wheelbarrow load access plans, somewhat similar to the way we pay for cell telephone with text messaging access. The person who routinely downloads HD movies will pay for wheelbarrow loads whereas the person with limited needs will pay much less. One irony is that AOL once revolutionized the industry by switching from the per minute model to the unlimited time model. Now there are scores of people with unlimited Internet access to lots of junk. Much great content has been kept off the Internet due to the abundance of cheap stuff. People are funny about free stuff. They will waste a lot of time and energy to collect free stuff when the great stuff is cheap but not free. In the past, those who wanted to read a recently published best selling book or hot movie, had to go off line. Today, the low cost way to buy a book is through Kindle and similar eBook services.
We now have more than enough "junk" available. The public is not interested in adding another 500 cable TV channels filled with advertising or another 10,000 bloggers writing about not much. Some people want to read their local newspaper, watch prime time shows and read the latest books but some do not. Some want to read US News and World Report, but delivered newsprint, even if it were blank, is expensive stuff relative to digital print. US News is a rare example of an information provider which has made the unforced decision to stop selling hard copies, many more will follow. While the subscription model and unlimited access do not go hand in hand, the wheelbarrow model and the subscription model fit.
If the New York Times asks for a fee to read a story, under the unlimited plan, it is too easy for readers to Google the idea and find others sources. When thousands of premium items are subscribed to for a fee, the service provider can offer standard, limited access at a very low price. All the routine stuff, such as email and web surfing can be included at one low price. When users select a fee for service item, such as an i-Tunes .99 cent song download or a $5 per month subscription to the Stars Movie Network, the provider can revenue share with i-Tunes and with the Stars Network. Some folk will choose a high minimum per month plan that includes unlimited HBO but others will choose to only occasionally pay to watch a certain HBO series or special.
Pay per view has been around for ages but it has been very limited and relatively expensive. High price has been a function of limited supply. AT&T advertises the availability of 8,500 movies, not as many as available through NetFlix but they are catching up quickly. The new system will bring new revenues to countless older films, TV shows and books. The new system will dramatically reduce delivery costs. Hand delivered newspapers and DVD's will go the way of the horse and buggy; rather quickly when the momentum gathers.
Please understand that the current deflation is not a sign of another Great Depression, but rather a sign of great productivity gains. In a few years, we will include stories of the mail man when we tell our children of the days of the Pony Express. We will wonder why it took so long to do away with newsprint, postage stamps, DVD's and trips to the rental and book stores and the libraries. The savings of trees, copper, glue and gasoline will be just part of the total savings. The number of garbage trucks needed is going to decline substantially. The foolishness of spending time to separate cans from newsprint will be more obvious and these wasteful programs will cease.
The directions the majority of Americans and Obama want to go are generally the wrong directions, but most of Obama's programs are in relative terms the size of a gnat on the backside of an elephant. Obama plans to spend $150 Billion to develop alternative energy. The money being spent by industry to provide new high speed mobile connections to cloud computers is many times $150 Billion and both the earnings of the industry and the savings of the public will be 100's of times larger than $150 Billion. Most of Obama's $150 Billion will be wasted, while nuclear power plants are built around the world. No matter how much money Obama pays researchers to grow elephant grass, the stuff is not likely to be relatively productive for many years. Together, India and China will spend more than $150 Billion on nuclear power while Obama "invests" primarily in other alternatives. The difference is that we are 99.9% certain that India and China will produce large amounts of low cost electricity while most of Obama's money will go to inefficient systems.
The probability that Mobile-Phone-TV service will be available to you in a year or two is much higher than the probability that congress will go along with Obama's spending plans. With billions of barrels of oil new oil coming online and the price of gasoline falling rapidly, does it really make sense to spend billions to build windmills that will sit idle 75 to 85% of the time? The math has changed dramatically over the past several months but Obama's rhetoric has not changed.
This coming February, the old analog TV bands will be taken over by AT&T, Verizon and others. The availability of high speed wireless broadband is going to soar. The relative cost of broadband service is shrinking. A new age is is upon us.
My words are not written to diminish the current economic "crisis". Banks are still paying stiff premiums for 6 month CD money but the premiums are coming down rapidly. The incredible influx of reserves from the FOMC is having the desired effect. The market inflation forecast is likely to jump when consumers start spending their gasoline savings elsewhere. Many will buy a $200 computer-tv-phone.
Posted by Courtney at 11/15/2008 05:11:00 PM
Friday, November 14, 2008
A friend recently demonstrated i-phone's ability to find the song hummed to it; a neat trick but not a "Killer Application". Killer APPS are "game changers". They are the things, that when your neighbor gets one, you have to have one. Today, Google voice search goes live on the i-phone. Ask where is Shell Gasoline? and the i-phone provides a Google map of your current location with Shell stations marked with teardrops.
Sophisticated voice systems, such as those sold by Nuance, are exceptional tools, but they require practice time for the computer to learn the nuances of each voice. Google's recognition ability has a long way to go to reach the accuracy of the Nuance systems, but many questions will be correctly answered in the early days and most will be answered correctly in future days. As this technology is widely adopted, productivity will take another giant leap forward. Trillions of questions will be asked. The answers will ultimately save consumers Trillions of Trillions of time and dollars.
The skeptical will retort that the world is going to be "cold" when people talk to machines instead of to other people. Successful people will use the computer conversations to raise human conversations to a new level of quality. The system will benefit us is by helping us avoid annoying unnecessary interruptions. I will not need to call my wife to find out things that I "should know". I have found that women just love to have their man call to ask what time the ball game starts.
Over time, the answers will "go deep". Instead of just mapping Shell stations locations, the maps will display prices. Instead of only asking generic questions, one will be able to ask specific questions, such as, What is on my calendar for the afternoon? or What is on my wife's birthday wish list? That is about as deep as I get but others of you will think of deeper questions.
The process will be like that of two young children having a conversation. At first, the computer will have a hard time understanding what its connected children are asking and the connected children will only know to ask for the basics. Later, the computer will know to provide certain information at certain times without being asked; the computer might happen to mention that the traffic has stopped moving on I-40 and the next exit offers the fastest time to work. Later still, new information will be input by voice. Such as, Computer please add an item to my calendar: meeting with the boss at 3:15 -- over-ride the automatic 15 minute meeting reminder with a 30 minute alarm.
A new "Killer App" is here. The time will come when everyone must have a "talking computer phone". Social networks, such as FaceBook, are reaching the level of killer apps. These systems are part of the same need for easy access to information. Closer connections between members of all sorts of groups, social and work related, make for better relationships and better communication.
There will always be other Killer Apps, but the dream of voice computer communication has been around for a long time, well before the early days of Star Trek. The early adoption phase will see rapid growth from a zero base. We should enter the dramatic growth stage, when the base is already 10% of the population and growing rapidly, within two or three years. Computer chips will notify our computer phones of many worthwhile details. There will be "big brother" concerns when the computer knows who is late from lunch and is currently located at Joe's Bar and Grill etc., but we will work through the proper and improper uses of the technology. We will keep the benefits and throw out most of the down side. A new age has dawned.
Posted by Courtney at 11/14/2008 11:18:00 AM
In 1982, when company earnings were falling rapidly, it was time to buy stocks. In 1991, when ... In 2002, when ... You get the drill.
It was not time to buy MEI stocks (Materials, Energy or Industrials) but the insuing strength of the other stuff was so strong that the market averages soared.
The S&P 500 total earnings is falling like a rock. Just like it did before the market took off in 82, 91, 02 and at other times in the past.
Posted by Courtney at 11/14/2008 10:10:00 AM
Brian Wesbury, one of my favorite economists, has nailed our current political situation. Politics and economics are like Siamese Twins who somehow temporary get unhitched, they must reconnect or they die. Here is a link to his article.
What Brian did not mention is the irony of the "union election win". Obama, Pelosi, Reid and others received millions of dollars from auto workers and other union members. It is only common sense for auto workers, whose total compensation is about $73 per hour, to protect their gravy train. Factory work is hard and the average factory worker in the USA makes $58,000 annually, all-in. Auto workers have a sweet deal at an average all-in pay of $151,000 per year. Obama was careful to make his attack the rich taxes neutral for his highly paid union friends. The socialist-democrat ideal would be for all citizens to make $151,000 per year. Yeah, right!
The irony is that the auto workers won the election too late to save their collective skins. The American people are simply no longer willing to buy a car with $1,500 worth of worker health care benefits added-on when they can buy an American made Honda, Nissan or Toyota with only $110 of auto worker heath care benefits added-on. The auto health worker accessory is one that many had just as soon leave off, since it is not as efficient as simply paying a fair wage. Those who think they want government mandated health care are (unconsciously?) at least partially rebelling against the unfairness created by our unwillingness to let the free market be free.
A coalition of west coast and east coast liberals, environmental extremist, union members, trial lawyers and minorities have taken the great majority of white voters out to the wood shed. According to George Will, 90% of voters in the Jimmy Carter election were white. The percentage of white voters has fallen in each election since. Bush won the support of more blacks than the average republican and he did very well with Hispanic voters. In the most recent election, something like 76% of voters were white and, if I recall correctly, McCain won a majority of them. It has been estimated that as early as 2042 whites will be in the minority. The next coalition of politically successful conservatives will have to adhere to principle, for example it must not spend money like drunken sailors on leave, and it must include conservative members of minority groups.
My point is not a racist point. I, like Brian, voted for Jimmy Carter. I, like Brian, was quickly disillusioned by the ineffectiveness of Carter. Reagan was such a relief because he attacked problems with force. Reagan opened the flood gates to let the free market do what it does best.
The bail out bill passed by congress does not give Hank Paulson a mandate to bail out the auto sector. Hank and Bush have properly thrown the auto mess back into the lap of congress. If there is to be a government bail out of private manufacturing businesses, there must be a vote to do so. Congress does not have the votes. The previously authorized $25 Billion Dollar loan might be reallocated but a new bail out bill is not likely.
Again, the unions won the election but the people are tired of paying aircraft pilot wages to assembly line workers. In the old days, many people bought American name plates out of loyalty. Today much of the content of all brands is foreign made. Few Americans are willing to discriminate against Honda, Nissan and Toyota because most of these "foreign cars" are made in America. Today, when an American buys an imported car, there is no stigma, very few people know the difference. This is as it should be. American consumers should get the benefit of buying from low cost producers and American producers should get the benefit of large world markets.
The logical way to "fix" GM and Ford is to allow them, if necessary, to file bankruptcy. Thousands of outdated rules and restrictions, yes laws, can be legally nullified through bankruptcy. GM and Ford have already negotiated dramatic reductions in employee count. It is totally false that the bankruptcy of these companies will reduce employment in America. Just as an artificially high minimum wage reduces jobs, an artificially high auto worker wage reduces jobs. The total number of Americans working will increase when American businesses are allowed to pay fair wages.
A couple of years ago, Ford built the most highly automated auto plant in the history of the world. It built the plant in Brazil. Like agricultural jobs, manufacturing jobs have been on the decline and they will continue to decline as a percentage of total jobs. The real inflation adjusted price of an auto is at its all time record low price because competition has crept back into this market. The people of the world benefit when there is productivity growth. Union rules hampered US auto company productivity growth for too long, now the piper has to be paid. To survive, US companies must be freed.
THE CALVARY IS ON THE WAY
The sound of the bugle blows from across the big pond. The yield on 5-year British Guilts are as low as they have been since the great depression --- and still not low enough! The British Pound has fallen 29% against the US dollar in just a few months and, even now, 5-year rates in England have not been reduced below 5-year rates in America.
The whole of Europe does not appear to be falling into as deep a recession as is the UK but Euro Bund rates are following UK rates down. Average rates today are close to where they were at the stock market jump off in late 2002.
The number one indicator of future growth, the yield curve, is as steep in the UK for as far back as my records go! While my foreign yield curve charts do not go as far back as my American charts, the current curve is very steep and probably at a new post depression high.
DON'T FIGHT INTEREST RATES (THE YIELD CURVE)!
Back in 2007, I was "too busy" to keep my eye on the yield curve. The world came though a mild 2001 recession, one in which three of the big four English speaking countries, Canada, UK and Australia, stayed strong. I was lulled to sleep and my focus wandered. In hind sight, it is very easy to see that month after month, from June of 2006 until July of 2007, the yield curve was forecasting a recession. The longer the curve stayed tight, the bigger the recession forecasted.
Starting in July of 2007 and moving with pace by August of 2007, the yield curve began to reverse itself. By January of 2008, the US had reached a very positive curve. The longer the curve stays so positive, the greater the rebound will be.
The US yield curve said a year ago; US growth is going to pick up. Sure enough, it did, largely because of dramatic export growth. The US GDP was weak the first quarter this year but it bounced up by the second quarter. The US has been dealing with two big problems: 1) US growth had to drag a dramatically over built housing market along for the ride and 2) yield curves in Australia, India, China, the UK, the EU and many other nations were holding back demand for US goods.
Of course, the prospects for faster growth in the US caused the US dollar to do a 180. The US dollar has soared. The Japanese, who rely even more heavily on imported oil than does the US, has seen the Yen soar even faster than the dollar. As a result, US markets and Japanese markets are showing great strength relative to emerging markets; markets that depend on the sale of commodities or on the conversion of commodities into low priced goods for their incomes. In other words, be thankful that you have not been invested heavily in the BRICs, Brazil, Russia, India or China.
It is going to take great skill for Obama to succeed. He must walk a narrow path. I wish him the best.
To succeed, he must be pragmatic. He was elected by ideologues, but he must govern as a centrist (to the left of center perhaps, but a long way to the right of congressional leaders). He needs a strong economy to support his desired spending programs. Most of his big programs will require the support of Mitch McConnell and friends.
In 2001, US markets were rapidly healing themselves when we were attacked on 9/11. It took a year for US markets to absorb the hit. Yield curves were forecasting strong growth when the attack was made. Today, yield curves are forecasting strong growth and clearly public sentiment is at market bottom levels. Consumers who are holding off on the purchase of new cars are seeing rapid improvements to their balance sheets. Those who were living beyond their means by using expanding home equity lines to occasionally pay down credit card debt are caught in a squeeze; they are, per force, living a more frugal life while paying down old debts. When that old five year old car is paid off, that money can go to pay off other debts.
This process has been going on for about three years. Stocks will go up before the process is over. Millions of people, those who were highly levered and those who were not, are enjoying the lowest real prices in years. The affordability of almost any good has changed dramatically over the past couple of years. The price of the average home has fallen, the interest cost to buy a house has fallen and the average income has risen. Homes are the most affordable they have been in many years.
The great majority of Americans believe Obama's planned economic policies will hurt rich US businesses. Our economy has prepared for the worst. The reality is that Obama has the option to pull another Roosevelt and prolong the tough times for over a decade, to pull a Jimmy Carter and do little to help cure what ails us or he can do a Clinton 180 and support sound economic policies. Obama cannot do a 180 the first week in office but he does not have to kill the US to save it.
Conditions are ripe for a dramatic move into early cycle stocks. Companies which provide services to or that make or sell goods to consumers (including home town banks that make loans to consumers) will do very well. If the Obama $1,000 checks from the sky program materializes, it will add a little to the consumer boom while taking away a little due to slightly higher interest rates. It will not hold a candle to stimulus provided by declining real prices of goods.
Everyone is convinced that it will take at least another year before the economy recovers and thus it is too early to buy stocks. A TV pundit yesterday suggested that all seniors should sell all stocks. He was pushing the sale of high fee insurance annuities. Yes, the market move will catch us by surprise. Yesterday, just as it looked like the bottom of the water bucket had been breached, there was a dramatic recovery. Was it because Paulson has given credit card debtors hope of relief? Maybe. Was it part of the bottoming process? Yes. Because energy stocks jumped 11% in one day, those hoping for a return to $147 per barrel of oil have found temporary reason for optimism.
Finally, the last irony I will throw out this morning is that the 30-year inflation protected yields spiked last week and they have since fallen rapidly. This means that instead of heading to zero inflation, the bond market is now projecting a little inflation. This is the best dose of medicine we have had in some time. The world is returning to normal!
Posted by Courtney at 11/14/2008 10:02:00 AM
Thursday, November 13, 2008
It seems that all is lost, but the healing process is having success after success. The economic patient is sick but recovering.
For weeks on end, US companies were not able to issue commercial paper; no one would buy it. The money that would have been used to buy commercial paper was dumped into short term treasuries, causing those to yield as little as .09%! Thus we have had a spike in investment grade bonds to almost 10% over the 90 day t-bill rate. This spread is higher than the one reached in 1982, when 30 year treasury bonds yielded 15%! As noted yesterday, when the spread spiked to 9% in August of 1982, before the month ended, the spread collapsed and stocks soared in value, virtually uninterrupted for the next 9 months. Many a stock jumped 100% or more in value.
TWO WEEKS OF GOOD NEWS
For two weeks in a row, borrowing at the Fed Discount window has declined and for two weeks in a row the dollar amount of commercial paper being issued has climbed. Companies that can issue commercial paper at today's very low short term rates will save a bundle over other financing methods. The profit margins at these companies will increase due to the lower cost of funds. The markets are rapidly healing. Bond markets in the EU and in the US are forecasting a strong economic recovery. Remember, the cycle is lower commodity prices (including the cost of money) leads to higher bond yields and then to rising stock prices.
Yes, consumer sentiment is about as bad as it has ever been. People who own shares are being pounded day after day and people at many businesses are concerned about the health of their company and the safety of their jobs. As a result, consumers are saving all they can, indeed, they are saving too much! The more they save the less they spend and the less they spend the lower the sales of the next guy and the more compelled he is to save. In the short run, this is a positive feedback loop that seems to have no end; but it does.
Take a look at what is happening at Wal-Mart; the same thing that is happening at your local gasoline station. The wholesale price of gasoline is down to $1.25, implying that $1.85 is a fair price. The gasoline stations are enjoying, for as long as they can, an extra spread. Eventually the market will force the retail price down, but the gasoline stations that were hammered last year are witnessing the miraculous healing of their balance sheets. In like manner, Wal-Mart can hardly keep up with the falling price of its imports. The old saw is that when the US sneezes the rest of the developed world gets sick and a third world country goes into intensive care. Third world economies that rely on manufacturing are hurting for certain. There are too many --- you name it, in the world, too many cars, too many toys, too many houses. To make and sell a car or a toy or a house, you must be the lowest cost producer. The high cost producers must go out of business while the survivors battle to be competitive. Sooner or latter there is "Joy in Mudville". Consumers realize how many bargains are available to be scooped up and a year or two latter the successful competitors hire the laid off workers of the failed companies.
The banks, which have little incentive to lend, have cut available credit lines on everything from credit cards to home equity loans. However, in the long run, banks make their money by lending. In the short run, why would a bank make a prime plus 1 loan to a solid customer when the bank can buy an investment grade bond and lock in a 9% margin? In the short run, banks are not lending because they have capital requirements to meet and because there are more profitable alternatives. However, now that companies are once again able to issue commercial paper (back-stopped by the Fed and evidenced by solid growth the past two weeks), the rates on corporate bonds will soon fall dramatically. Money that is currently flowing out of stocks and into corporate bonds will soon start to flow the other way and stocks will do very well.
The opposing argument is that more companies will experience weak sales and corporate rates will even go higher, but this argument cannot possibly be a long term argument. The failure of the weakest of players will grant higher sales to the remaining competitors. The argument is being made by those who see a great depression on the horizon. Lest we forget, the foolish policies that caused and fed the great depression included, sharp restrictions on international trade, government restriction of money supply growth, higher taxes, and more higher taxes used to support many wasteful government programs. Even though Obama's platform included restrictions to imports, higher taxes and more higher taxes to support government programs, the fear may be greater than the reality.
So far, our government and the governments around the globe, have not certainly not made the mistake of tightening the money supply or raising taxes. Mitch McConnell has 43 votes in his pocket to stop the most silly of left wing proposals. To make the major reforms, such as the reform of health care, that Obama wants to make, he will need to meet McConnell more than half way between the left and the center. George Will is correct that democrats will be able to peal away a few republican votes now and then (of course these votes will include bipartisan shares of pork) but no one is in the mood to raise taxes out the roof during these tough times.
History shows that, with the exception of the great depression, sharp spikes in corporate bond rates have been short lived events. Stocks have historically moved up just when most people believed the worst. I have been wrong consistently wrong about the extremes of this cycle. For two years, I said that oil prices were on the verge of a major collapse. Once the prices started falling, I believed the worst of the real estate recession was over. I am just as confident in the coming economic boom as I was of the ultimate decline in oil prices. Most people were on the other side of the oil question and now most people are on the other side of the coming boom. One of the economic truths is that in economic matters the majority is always wrong. At some point, the auto pilot takes over. When people believe that their jobs are at risk, they work harder. When people believe in economic collapse they save more (short term dramatic increases in savings are bad but in the long run we must have savings).
The average Baa to T-Bill spread since 1970 has been 3.65%, the current spread of 10% is enough to make professional money managers, not sure of which stocks to own, to sell stocks to buy bonds. Other professional money managers are still convinced that high inflation is just around the corner. These managers have fallen lock stock and barrel for the belief that the world is over heated and running out of resources. Everyone seems to know we are in a deep real estate recession, but few are willing or able to buy real estate at these low prices. Most of those who know that small cap stocks, retailers, banks and consumers goods stocks will lead the way out of the recession are not willing to buy. The majority will pay down debt when they should be aggressive and they will resume their borrowing some years from now when they should be saving.
The healing process is underway but most people will not feel comfortable about the patients health until he is out running laps.
Posted by Courtney at 11/13/2008 11:29:00 AM
Wednesday, November 12, 2008
Back in 2002, before the real estate boom, a table in the Economist Magazine reported that the developed world had assets as follows:
Residential Real Estate $48 Trillion
Commercial Real Estate $14 Trillion
Equities $20 Trillion
Government Bonds $20 Trillion
Corporate Bonds $13 Trillion
Total $115 Trillion
We know that 2002 was the year of a major market bottom, just before a tremendous boom in real estate asset values. The Big Picture Blog reports that just financial assets had grown to $140 Trillion by 2005 and using the same ratio of financial to real we can guess that total assets were $260 Trillion in 2005, probably much more. It would take time to find current numbers but the above numbers show a number of things, including the relative size of the housing market. When the US Treasury proposed a $700 Billion Bail Out, the number sounded huge. It is; however, when compared to the size of the assets involved it is not big. It is less than 1% of the sum of US households assets and just slightly more than 1% of US households net worth. The bail out is a misuse of our treasury because it was done in a way to allow the powerful to pick winners and losers but not big relative to the problem. It is small relative to the size of the flood of dollars pouring in from the private sector. Much is made of the fact that a lot of homes are being sold through foreclosure but no one seems to consider who is buying all these foreclosed homes.
The Dow Jones Global REIT Index is currently trading 54% below its 52 week peak and 68% below its all time peak. The numbers above show that real estate was 54% of the developed worlds assets in 2002. Ouch! Double Ouch! Fifty four percent of the worlds assets fell 54% in 52 weeks.
The average individual owns more real estate than anything else. In 2002, the average guy held 54% of his assets in real estate. A family with assets of $115,000 averaged holding $48,000 in residential real estate and $20,000 in equities.
Of course, there is no average guy. The worlds assets have never been and never will be equally distributed. While much was made during the election of the fact that the US consumes 25% of the worlds oil consumption, the reality is much "worse" than what was implied. In terms of assets, the top 2% of the people of the world own half of everything! The bottom 50% own less than 1%! This is the 80/20 rule on steroids. The median family has assets of about $2,000. If the middle is $2,000, how would you like to be on the end?
Over the past 30 years the poor have benefited from the opening of trade by Richard Nixon and by policies encouraged by Ronald Reagan and Margaret Thatcher. Nixon was a democrat in republican clothes but he did get an important ball rolling. Sine the Reagan/Thatcher reforms, the rich have paid an increasing share of taxes and as can be seen at gapminder.org, the poor have made huge gains. The distribution curve of income and wealth is still lopsided but free and open markets have been a huge blessing for the poor. Free trade is the best way to help the poor. In one of the great ironies of ethical living, we help the poor when we help ourselves to their low cost products.
By blocking free trade agreements, democrats help rich union members, rich lobbyist and rich politicians. The workers at GM could not "earn" an average compensation of $73 per hour without the crushing of the poor done through trade restrictions. The average US car includes about $1,500 in health care expenses compared to the average Toyota car which includes $110 of health care expenses. By blocking the free market, the congress permits union workers to make 260% of the average American compensation while allowing poor people to go hungry. Because union workers are so dramatically overpaid, US car companies have spent more heavily than necessary on industrial robots. We have substituted too much capital for too much labor instead of accomplishing the same work while feeding the working poor. I object to democratic strategies to help the "middle class" because their policies are specifically designed to help the rich; it is hypocritical to throw poor man out of work by spending money to "help the middle class".
Just a few months ago, the public had been brain washed into believing oil supplies were running out. A couple of years ago, the public was brainwashed into believing man is over heating the earth (the earths temperature has fallen from a sun induced peak 10 years ago). During this election cycle, the public was brainwashed into believing that 95% of the people will receive tax cuts with the attached implication that they will not pay a portion of the planned tax increases on the most profitable of employees and businesses. Who said that the most insidious tax increase of all is the inflation tax?
The average real estate investment cycle is 18.3 years long. At the bottom of the real estate cycle, the world is always in pain. The world is currently in a lot of pain. In the last year, the results have been the same as if a world wide fire burned down half the houses. Over three years, the fire burned three out of four! The Dow Jones World REIT index was down around 75% at the bottom. It is still down 68%.
The good news is that the fire department is and has been on the scene, putting out the fires. These fires are being put out by a flood of money. My only complaint about the governments portion of the flood of money is that winners and losers are being selected by those in power. On the other hand, the biggest flood of government money has been more fairly distributed by the FOMC which has increased its balance sheet by about 1 Trillion Dollars over the past few months! The UK and EU fire departments were late to arrive but the fire chiefs are catching up quickly. There should be several more interest rate cuts in the days and weeks ahead. Australia has only sent a couple of fire trucks so far but more should be coming soon.
The remaining areas of tight money are fading fast. The US Treasury bond rate has bounced back above 2007 levels in terms of the Australian Dollar but in terms of the average world currency the rate has fallen from 3.52% in June of 2007 to 2.87 as of November 7, 2008. The reduction in money costs is far more powerful than all the other floods of money. The rents available from real estate are being discounted at lower and lower rates, the values ready to start a 15 year climb.
The Baa to T-Bill spread has jumped well above the levels reached in August of 1982. August of 1982 was the jumping off point after the worst manufacturing recessions the world has seen. The Baa to T-Bill spread is currently above 9%. Such as spread is a measure of extreme fear in the market place (buy on fear). After 9/11, on October 10, 2002, and during the great depression years of 1934 and 1936 this measure hit 6.5%. Only in 1982 and in 2008 has this indicator gone higher. It spiked to 8% in August of 1982 and it spiked to 9% last week.
When the poor old stock broker asked the wealthy pig farmer his secret to success, he answer, "Buy low and sell high". A broad index of the worlds real estate fell 54% in the past 52 weeks, the maximum draw down was about 75% and the index is currently 68% off its peak. The index has made a bottom and bounced.
At today's prices, the world's accounted for real estate is priced about 70 Trillion Dollars below its peak value. Seventy Trillion Dollars sounds like a lot of money but it is not. It is only $10,700 per person. But how many of the 6.5 Billion people will buy while prices are low? Probably less than one half of one percent. The few who buy will net 99.95% of the gains on the way back up. One half of one percent of the people will share in 70 Trillion Dollars of gains. Will you get your share?
I suspect the wealthy pig farmer is buying. Ouch! Double ouch!
Posted by Courtney at 11/12/2008 10:21:00 AM
Tuesday, November 11, 2008
Republican's and Democrats are issuing government checks right and left. When will they ever learn? The following is another good letter from Professor Donald J. Boudreaux.
Andrew Wilson is right: the New Deal did not end the Great Depression ("Five Myths About the Great Depression," November 4). No less an authority than FDR's Treasury secretary and close friend, Henry Morganthau, conceded this fact to Congressional Democrats in May 1939: "We have tried spending money. We are spending more than we have ever spent before and it does not work. And I have just one interest, and if I am wrong ... somebody else can have my job. I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises ... I say after eight years of this Administration we have just as much unemployment as when we started ... And an enormous debt to boot!"*
Indeed, FDR's market-suffocating policies are almost surely what put the "Great" in "Great Depression."
Donald J. Boudreaux
Posted by Courtney at 11/11/2008 04:03:00 PM
It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.
Charles Dickens, A Tale of Two Cities
English novelist (1812 - 1870)
Dickens noted the hype in his day; it is equally present today. I have been justifiably accused of hype and of wearing rose colored glasses. I often see the glass as being half full and I am excited about the wonderful innovations coming that will make life easier and longer.
Besides, the current economic conditions are absolutely great for a very large number of people. Those who have steady incomes through pension and social security checks and those with job security. Under the current circumstances these folk are enjoying the best of times. If these same folk have a lot of assets, such as real estate and stocks, they have suffered severe financial hits to their net worth but on a cash flow basis they are most likely starting to have the time of their life. The cost of most everything is falling fast.
The people of Japan are enjoying the decline the most, because they are seeing an even bigger decline than the people of the US. The people of Europe are seeing a smaller decline in prices. Of course, there are people in Saudi Arabia, Brazil and Russia who are not enjoying the massive price declines in the goods they produce.
From the peak, crude oil has declined 40% in AU Dollars, 49% in Euros, 54% in SDRs, 58.5% in US Dollars and 61% in Japanese Yen. From the peak, the price of copper has fallen 51% in AU Dollars, 57% in Euros, 56% in SDRs, 62% in US Dollars and 63% in Yen. From the peak, 30-year Treasury Bond Yields have fallen 12.5% in AU Dollars, 17.5% in Euros, 19% in SDRs, 22% in US Dollars and 24% in Japanese Yen. All numbers are approximations made by eyeballing charts posted at ShareLynx.
Prices have fallen the most in countries that are most developed and the most resource import dependent. I used Australia as the best proxy available for Saudi Arabia, Russia and Brazil; obviously these countries have "enjoyed" the price declines much less than Australia.
Prices are coming down and the cycle is rolling forward. As expected, commodities show a greater fall than bond yields but the study above was of US 30-year rates. In recent days there have been huge declines in bond rates around the world. The momentum is shifting. Oil prices were in free fall from $147 to $60 but there has been support at $60 and the price has bounced back to the $70's more than once. This does not mean that the decline in oil prices is over but that the cycle is moving forward. The overlapping declines will continue but the bond rates will fall relatively more than commodities as the cycle moves forward and the rise in bond values will be accompanied by a rise in stock prices. The cycle has the look of backing up when oil prices bounce but this is way the big money has to trade. All the worlds commodities cannot trade hands at the very top or the very bottom.
It is the best of times for a young working couple to buy a home, buy a car, or buy a stock. It just does not get a lot better than this. Times are good.
OUR GOVERNMENT DOES NOT KNOW HOW TO RUN A RAILROAD
A few decades ago, the railroads in the USA were generally broke or close to it. They were burdened with ridiculous rules and regulations. Many of the rules had been negotiated by very powerful unions. Coal trains that needed only an engineer to operate were required by union rules to be staffed with four people. In the old days, going 100 miles in a day by train was an accomplishment. Trains stopped at every small station along the way, often dictated by rules imposed by politicians. By the 60's, freight trains were rationally allowed express status. Trains loaded with crops from Florida traveled to New York overnight. The employees made a full days pay for each 100 miles traveled. Similar situations existed up and down the Mississippi river, out of coal mines in Wyoming and to, from and through California. On the route from Florida to New York, the employees made about 12 days pay each way. A three day trip cost the railroad and the consumers of vegetables 24 days pay for several workers.
Anyone could see that the system had gotten out of whack but special interest voted against change until the railroads were all but busted. When a couple of big rails failed, congress was forced to act. Special interest agreed to rules changes, if and only the government would operate a new company called Amtrak. Amtrak was supposed to become self sufficient but last year the budgeted US subsidy was 1.3 Billion Dollars. The total subsidy was more. Cities and states also subsidize Amtrak. Little old ladies surviving off social security are subsidizing the transportation expenses of New York Investment Brokers who earn millions annually.
The good news is that the rest of the railroad industry was released from the prison of goofy regulation. As a result, investors have made billions and consumers have saved trillions. Many Trillions of Dollars worth of goods have moved to markets as a result of deregulation, producers of goods have seen the size of their markets expand and consumers of goods have paid significantly lower prices.
Woe is me! The total compensation for the average auto worker is $73.20 per hour. The average for all goods producing workers $31.59 per hour and the average for all workers is $28.48 (numbers provided by Carpe Diem). The average auto worker is making about the same as the average airline pilot. He is making 257% of the wages of average workers.
Back in the days when railroads were being rationalized, the congress bailed out Chrysler. Dumb! Dumb! Dumb! Instead of forcing Chrysler to "take the cure" in 1982, Americans paid a very steep price. Today, thousands of auto workers receive $73.20 per hour even though their jobs have been eliminated and the "middle class" keeps paying through the nose to own a decent auto. Nancy Pelosi, Harry Reid and Barak Obama have no interest in learning from history, but only want to payoff their union friends; the ones who routinely spend millions to elect their friends every two years.
During a time when consumers across America and around the world are hurting, how does it make you feel for the US government to spend more and more of your dollars so that union workers can keep "earning" $73.20 per hour? Consumers who purchase a $20,000 car are paying $3,000 or so too much. Each time an American buys a car from GM, Ford or Chrysler, he is paying these salaries and sending a significant check to the campaign coffers of various politicians. These are the worst of times, because the people have not learned from the mistakes made in the past.
The important thing for investors to understand is that the negative effects are very long, unintended consequences, effects. The economic cycle is going forward and several great years await. The silly stuff passed during the late 60's under Johnson did not hit us really hard until the Carter years.
During the great depression, FDR raised taxes several times in order to finance all the more government programs. The people loved FDR and re-elected him 3 times because they saw the short term benefits of the government programs, however, the economic downturn was extended again and again by the actions of the government. Ironically, economically, we must be thankful for WWII when billions of dollars worth of goods were produced just so they could be blown to kingdom come.
Obama is not likely to make all the same mistakes as FDR, at least in the next couple of years. Obama has already implied that he will not go through with his massive tax increase package while the economy is hurting. Any fool should know that it is not wise to raise taxes during a recession. Obama has indicated that he wants to go forward with the his Keynesian $1,000 cuts to "the middle class". The key is for the government not to do too much as market rebates will be much, much larger than the governments rebate. The average savings per household will be an almost unbelievable $12,000 in 2009. In other ways the markets are quickly starting to get over the shocks they have received. Houses were over built due to government mandate and subsidy but the excess is being absorbed. Substitutions are being found for overpriced goods. Innovations after innovations are coming to market.
The most recent spike in the unemployment rate is another government creation. By extending unemployment benefits, 13 weeks once and another 13 weeks latter, a large number of retired folk are still "looking for work". Having taught a few classes in recent months, I have been tempted to file for unemployment. I could probably "look for work" for the next 6 months and collect a lot of benefits. It is the worst of times.
It is politically necessary to extend benefits during this recession and it is important to help those in true need. Those given an easy way to take advantage are being taught damaging lessons for themselves and for the rest of us, but we have to weigh the good and the bad and do the best we can.
Is it the best of times or the worst of times? It all depends on your attitude. There is pain in our midst but there are certainly huge opportunities available!
Posted by Courtney at 11/11/2008 09:40:00 AM
Monday, November 10, 2008
THE LARGEST DECLINE ON RECORD!
As a result of falling input costs, including falling fuel costs and falling interest costs, factory output costs fell last month. Factory output prices fell by 1% while factory input costs fell by 5.6%, the largest decline on record. Oh what a surprise! The quarter after oil prices and industrial metals prices fell from 55 to 95%, factory input costs fell by at a record pace.
Gasoline companies are slowly adjusting retail pump prices to input prices, putting consumers in the same boat as factory managers. Seeing the lower wholesale prices, gives us confidence that further price declines are on the way. As prices fall, we know that ultimately we will enjoy higher real incomes.
The formulas are simple: input prices down by more than output prices equals increasing profit margins; lower output prices encourage sales; flat or increasing sales times fatter margins equals increasing profits; higher profits discounted at lower interest rates equals higher stock prices.
This morning, the futures markets have reacted positively to the 500 Billion Dollar stimulus package announced by China. If enough governments pump-in enough money in enough places, there will be "reflation", but that does not mean that commodity prices are going to soar relative to the price of consumers goods. The price of metals and oil bounced this morning but retail prices have not caught up with the previous declines in wholesale prices. Even if the wholesale price of gasoline were to bounce 20 cents, the retail price would still trend down because there is currently an above average spread between the wholesale price and the retail price. Commodity input prices will come down more in the months ahead. This morning UK markets are up 3% with the biggest gains in basic materials but most sectors are rising.
A flood of liquidity, supplied by governments, is not going to convince consumers to go back to buying monster houses or monster cars. Rising incomes will be spent on other things and it is in other things where the opportunities for great profits lie.
New CAFE standards will dramatically limit the available supply of new monster cars. Auto makers are required by law to sell higher mileage fleets. The easiest way to achieve this goal is to reduce the average weight of fleets. The easiest way to reduce weight is to sell smaller cars. The second easiest way is to use lighter materials.
Once auto makers retool to use graphite parts in place of steel, the relative use of steel will forever be lowered. The 500 Billion stimulus package in China will not be spent trying to make the same heavy cars that were being made during the last boom. During boom times, consumers have tons of money and even more tons of credit. They buy to keeping up with the Jones family. During tight times, the brag from the Jones Family is the payoff of a credit card.
We are currently dealing with the Paradox of Saving. Stimulus packages such as the $600 checks sent out earlier this year are considered Keynesian stimulus packages, but Keynes was well aware of the Paradox of Saving, which is that recessions are largely the result of an increased propensity to save. Give the public a rebate check right now and he is likely to use it to reduce his debts. Once again, there is a big difference in short term results and long term results. In the long term, savings are necessary for economic growth, but in the short run a rise in savings results in slower economic growth.
The great news is that new products are in the marketplace and there is pent up demand. The Wii has been a huge success but it is just now coming out of the early adoption phase. The Kindle has been a huge success but it is just coming out of the early adoption phase. Knee replacements have been a huge success but the baby boom generation is just reaching the peak demand phase. The real per seat mile cost of airline tickets is at 50 year lows just as the retiring baby boom generation is ready to travel.
Having mentioned the Kindle, I must say again that Billions of Trees and Trillions of Dollars of other resources are going to be saved now that an excellent mobile reader has been developed. Last week, US News and World Report announced that its content is being moved to the Internet. Over the next several years, you should expect a massive move away from the printed page. The world wide resource savings will be more stimulative than all the government bailouts combined.
Thousands of free books are available. Thousands of bloggers will go mobile. Trillions of dollars will be earned by millions of people who published books in the past. Billions of bloggers will enjoy getting paid for their work.
Anne Coulter has sold millions of books by calling democrats dumb. Democrats politicians are smart. The blocking actions of Senate Majority Leader Harry Reid cost our short term economy dearly in many areas, but exit polls showed that 30% of the people who voted democratic did not know who Harry Reid is. Politically smart blocking actions helped Obama win, even though these actions hurt the economy. Obama is likely to govern far to the right of Harry Reid; still left of center. Obama's new chief of staff is a partisan bully but his economic philosophy is far to the right of Harry Reid's philosophy. We will learn a lot when we see the next stimulus package. A "good package" will encourage investment.
Using Larry Kudlow's analogy, mustard seeds are being sown. The decline in fuel and other commodity prices are providing more stimulus than all the government programs combined. The natural cycle is stronger than government. All the stimulus packages of all the governments cannot stop the relative decline in commodity prices. Sometimes it seems that the government would try to stop the fall of leaves from trees.
Martin Pring breaks the economic cycle into six phases: 1) stocks up 2) commodities up 3) bonds down 4) stocks down 5) commodities down and 6) bonds up. These 6 phases can be drawn by placing them as points on a wheel or as three smooth but out of sync sine waves. In other words, there are overlaps, during the early expansion phase of the economic cycle, bonds are still going up when stocks begin to climb but by the middle expansion phase commodity prices start to rise soon before or soon after bond prices begin to fall.
There is always "noise". Outside events happen. While the economic cycles are not as smooth as our weather cycles, they are just as certain and nearly as uncontrollable.
The more commodity prices go down, the more likely the price of bonds will go up and the more bonds go up, the more likely the price of stocks will go up. Last week, the value of the 5-year UK bond made one of the largest price climbs ever.
Number 6 in the cycle is bonds up and number 1 is stocks up. Just as winter follows fall, stocks will go up after bonds go up. No surprise here!
Posted by Courtney at 11/10/2008 08:58:00 AM