I've been doing a lot of research with my friend JT Smith (CIO of Aristar Funding), trying to figure out exactly what was driving this market.
The 'this market is cheap' argument hasn't made any sense to me for some time. Cheap does NOT refer to stock prices relative to where they've been, contrary to what is implied by a lot of folks. Historically, bear markets have bottomed at roughly 7-8x earnings. We only got to 10.2x forward earnings at the bottom in March - not low enough for my liking. Now we're trading at... sit down... 17.8x FORWARD earnings. Put another way, the S&P is more expensive than it has been in the past FIVE YEARS or more.
I might be 'of a certain age,' but my memory isn't so weak that I can't remember that the economy at least appeared to be much more robust at almost any time in 2004, 2005 or 2006 than it does now. And yet we're paying significantly more for a dollar of next year's S&P earnings now? Makes no sense. Unless...
What if this market isn't discounting future earnings right now? It's my belief that a lot of times the animal spirits of the market discount things without really knowing what it is they're discounting. So, what if... just what if... this market is actually discounting the inflation that almost certain to come? Gold over $1000 an ounce is telling us that either everyone is scared to death of this market (not confirmed by the VIX), or that inflation might be rearing it's ugly head. And yesterday's rumors that two Fed officials were ready to vote to tighten! Even today's Philly Fed numbers pointed out that the Prices Paid component is ticking up. Inflation.
Yeah, I know we've been seeing deflation in food and consumables. But that can turn quickly. And more importantly... how else are we going to dig ourselves out of this debt pit unless we pay it off with cheaper dollars?
If we're heading into inflation, folks, the game plan changes.
Showing posts with label economy. Show all posts
Showing posts with label economy. Show all posts
Thursday, September 17, 2009
Tuesday, September 1, 2009
View from the Top
For those of you who haven't been to the Seattle area, that's Mount Rainier up there, taken from the SE side of the mountain. I took the picture a couple of weeks ago. Mountain tops are beautiful, aren't they? Problem is you can't stay at the top forever, you eventually have to go back down the other side.
In my opinion, today's sell off has been a long time coming. Of course, if you've read this blog at all, seen me on TV, heard me on radio, or seen me quoted in print... you already knew that.
What really killed me this morning was listening to some folks trying to hype the economic releases as positive. Look, we're in a pretty down time right now. If you don't think that the folks who put out those releases are trying to highlight the happiest stuff they can, you're naive. Let's take them one by one.
ISM Manfacturing: Headline number was better than expected, coming in at 52.9 vs expectations for 50.5. HOWEVER, you have to look behind the headline number. Looks like Cash for Clunkers is part of the pop – drew down inventories and there’s some restocking going on there. Is it sustainable? No, but the lower level wasn’t sustainable either. Employment is still declining – manufacturers aren’t confident about this or they’d be hiring. Prices paid is going up, which could mean that inflation is coming down the road, perhaps at a faster pace than most expect.
Yes, right now we're dealing more with deflation than inflation. But what if we can't sell bonds and need to increase interest rates? Yes, the dollar has been getting stronger. For me, that's a head scratcher. I certainly don't think the US is the safety currency or economy at this point. In fact, for our clients, I'm deliberately betting that the dollar gets weaker, strengthening commodities.
Pending Home Sales: Those are sales contracts... NOT completed sales. People still have to get loans, which are darn hard to get these days. Which leads to my next topic...
Construction Spending: This is the one that kills me... Year over year residential spending is down 26.4% (not-seasonally adjusted). But everything's okay folks. Really.
If you need a reason that the market tanked today, part of it was the stuff above. Part of it was what's coming down the pike at us. If you want more insight into what joy may be coming, follow jtsmith24 on Twitter - smart guy, good insights into the economy. You can follow me there too (PattyEdwards) for more timely, intraday, updates.
Take some profits folks. There's no reason to be a hero.
Sunday, August 16, 2009
Wall Street vs Main Street
I guess Alan Abelson of Barron's and I are thinking a bit alike lately. I don't know whether to be comforted or scared about that.
I mentioned last week on CNBC that I thought this was coming down to a struggle between Wall Street and Main Street. Aparently Alan (you don't mind if I call you Alan, do you Alan?) agrees with me.
Go ahead, tell me the story about how good things are again. My opinion, for whatever it's worth, is that the market just isn't worth 16.8x next year's earnings. I know all the bulls think that we're going to have company after company guiding earnings upward and that earnings will be like a huge coiled spring that launches us into the next realm of the market. I also know that the market is a discounting mechanism, and that you really want to buy in some cases as much as 6-9 months before we expect to be out of the recession. But someone forgot to tell 70% of the economy that things were better.
Let's look at life for Joe and Jane Consumer for a moment. Not only is unemployment off the charts, but we're seeing people use all their benefits and drop off the backside of the statistic. The backside, you know, the part where there isn't any more money? Yeah. Comfy place. Doesn't tend to inspire a rebound in spending.
Despite there being a slight pick up in the number of homes being sold, Joe & Jane's home isn't worth anymore today than it was a month or two ago. And statistically it's probably worth somewhere around 33% less than it was a couple of years ago. Since Joe & Jane put 20% down (at most), that means it's worth less than they paid for it in many cases. And all those foreclosures going on down the block, not helpful. Luckily, though, their Alt-A mortgage doesn't reset for another few months. Oh, and that checkbook that wrote against the home equity line of credit? Might as well use it for fire starter this winter (especially if you can't afford the traditional heating bill), 'cause it's quite literally not worth the paper it is printed on.
If it comes down to choosing one payment over another, the credit cards aren't getting paid just so the mortgage can be made for one more month. That's not good for the banks or retailers. If they are making card payments still, chances are their interest rates have risen and their credit limits have fallen - can't use the revolving card for spending anymore because the only revolving it's doing is spinning in the grave of consumer spending.
Luckily, in order tohelp the car companies yet again stimulate the economy and help consumers drive more fuel efficient cars, the government launched Cash for Clunkers. Fabulous idea. Sold lots of cars. Also gave something like 300,000 people who had a paid off clunker of a car a gift that goes on giving - A CAR PAYMENT! So there goes another $400 a month out of discretionary income.
Yes, there's a lot of the stimulus bill that hasn't been issued yet. Why issue it when people really need it? Better to wait so that any positive effects come just a few months before the election... not that I'm saying the government planned it that way... Oh. Wait. I am saying that. I guess I have little skepticism as far as the benefits of this. Sure, our roads out here in the Seattle area are much better now that road construction projects are coming through. But I'm still waiting for the trickle up effect to show through. Geez, even beer isn't selling the way it was. What more of a sign do you need?
I guess the thing that tickles my oh-so-ironic funny bone the most is the belief from the Wall Street pundits (you know, those OTHER people who flap their lips on TV all the time) who think all the money on the sidelines is going to come pouring back in the market. A couple of thoughts on this:
First - if you're a baby boomer who just saw 40% of your savings evaporate before your eyes, you're panicked and not likely to want to jump back in the overheated market.
Second - and I think this is the part that those on Wall Street who never walk around in the rest of the country will never get - when your friends, family, boss, neighbor has their job, savings or future hit by the closing of one of those little banks that is NOT 'too big to fail', confidence errodes really quickly. No, it's not about the deposits so much because the FDIC has those covered. I'm talking about the business and construction loans that are not being picked up by the acquiring banks, leaving projects halfway completed with no further funding. I'm talking about grown men in tears because their lives as they know it have just evaporated. Doesn't tend to make for a lot of trust for those folks that got the bailout money, know what I mean?
If you totally disagree with me, so be it. But remember this one piece of information if nothing else: in a bear market rally it doesn't take a selling climax to end the rally - it just takes a lack of further buyers.
Be careful out there.
I mentioned last week on CNBC that I thought this was coming down to a struggle between Wall Street and Main Street. Aparently Alan (you don't mind if I call you Alan, do you Alan?) agrees with me.
Go ahead, tell me the story about how good things are again. My opinion, for whatever it's worth, is that the market just isn't worth 16.8x next year's earnings. I know all the bulls think that we're going to have company after company guiding earnings upward and that earnings will be like a huge coiled spring that launches us into the next realm of the market. I also know that the market is a discounting mechanism, and that you really want to buy in some cases as much as 6-9 months before we expect to be out of the recession. But someone forgot to tell 70% of the economy that things were better.
Let's look at life for Joe and Jane Consumer for a moment. Not only is unemployment off the charts, but we're seeing people use all their benefits and drop off the backside of the statistic. The backside, you know, the part where there isn't any more money? Yeah. Comfy place. Doesn't tend to inspire a rebound in spending.
Despite there being a slight pick up in the number of homes being sold, Joe & Jane's home isn't worth anymore today than it was a month or two ago. And statistically it's probably worth somewhere around 33% less than it was a couple of years ago. Since Joe & Jane put 20% down (at most), that means it's worth less than they paid for it in many cases. And all those foreclosures going on down the block, not helpful. Luckily, though, their Alt-A mortgage doesn't reset for another few months. Oh, and that checkbook that wrote against the home equity line of credit? Might as well use it for fire starter this winter (especially if you can't afford the traditional heating bill), 'cause it's quite literally not worth the paper it is printed on.
If it comes down to choosing one payment over another, the credit cards aren't getting paid just so the mortgage can be made for one more month. That's not good for the banks or retailers. If they are making card payments still, chances are their interest rates have risen and their credit limits have fallen - can't use the revolving card for spending anymore because the only revolving it's doing is spinning in the grave of consumer spending.
Luckily, in order to
Yes, there's a lot of the stimulus bill that hasn't been issued yet. Why issue it when people really need it? Better to wait so that any positive effects come just a few months before the election... not that I'm saying the government planned it that way... Oh. Wait. I am saying that. I guess I have little skepticism as far as the benefits of this. Sure, our roads out here in the Seattle area are much better now that road construction projects are coming through. But I'm still waiting for the trickle up effect to show through. Geez, even beer isn't selling the way it was. What more of a sign do you need?
I guess the thing that tickles my oh-so-ironic funny bone the most is the belief from the Wall Street pundits (you know, those OTHER people who flap their lips on TV all the time) who think all the money on the sidelines is going to come pouring back in the market. A couple of thoughts on this:
First - if you're a baby boomer who just saw 40% of your savings evaporate before your eyes, you're panicked and not likely to want to jump back in the overheated market.
Second - and I think this is the part that those on Wall Street who never walk around in the rest of the country will never get - when your friends, family, boss, neighbor has their job, savings or future hit by the closing of one of those little banks that is NOT 'too big to fail', confidence errodes really quickly. No, it's not about the deposits so much because the FDIC has those covered. I'm talking about the business and construction loans that are not being picked up by the acquiring banks, leaving projects halfway completed with no further funding. I'm talking about grown men in tears because their lives as they know it have just evaporated. Doesn't tend to make for a lot of trust for those folks that got the bailout money, know what I mean?
If you totally disagree with me, so be it. But remember this one piece of information if nothing else: in a bear market rally it doesn't take a selling climax to end the rally - it just takes a lack of further buyers.
Be careful out there.
Wednesday, August 12, 2009
It's been a big month here at Lake Woebegon...
Let me start by apologizing for a month of silence. Some of you, no doubt, found it refreshing that I'd shut up for a bit.
We at Storehouse have been somewhat gratefully busy converting our firm from one platform to another. It's a goood move over all, but painful.
But enough of all that. I've been doing a lot of CNBC lately, and if you're following you probably know that I'm pretty much the Princess of Darkness right now. No, I don't believe the rally. No, I don't think it's supported by fundamentals. I certainly don't think the valuation of the market is warranted. At all. Revenue growth is beyond anemic. But most importantly...
FALLING LESS QUICKLY DOES NOT EQUAL GROWTH.
There are a myriad of reasons why we're happily playing the market using chicken methodologies. I intend to post those over the next few days. In the meantime, here are today's two appearances on CNBC, which should give you some insight into what I'm thinking. In the afternoon appearance (first one below), Scott Wapner had all the finese of a pit bull with rabies, in my humble opinion. Of course, I was on the receiving end of the questions. I'm just saying, from my perspective, he was out of line.
We at Storehouse have been somewhat gratefully busy converting our firm from one platform to another. It's a goood move over all, but painful.
But enough of all that. I've been doing a lot of CNBC lately, and if you're following you probably know that I'm pretty much the Princess of Darkness right now. No, I don't believe the rally. No, I don't think it's supported by fundamentals. I certainly don't think the valuation of the market is warranted. At all. Revenue growth is beyond anemic. But most importantly...
FALLING LESS QUICKLY DOES NOT EQUAL GROWTH.
There are a myriad of reasons why we're happily playing the market using chicken methodologies. I intend to post those over the next few days. In the meantime, here are today's two appearances on CNBC, which should give you some insight into what I'm thinking. In the afternoon appearance (first one below), Scott Wapner had all the finese of a pit bull with rabies, in my humble opinion. Of course, I was on the receiving end of the questions. I'm just saying, from my perspective, he was out of line.
Tuesday, March 24, 2009
::thwap:: ::thwap:: ::thwap:: ::thwap:: ::thwap::
You might have heard that President Obama is getting a brand-spanking new helicopter That noise overhead? That's just the sound of Helicopter Ben Bernanke doing a test flight while dropping a couple trillion dollars over the landscape.
Bernanke said Friday that the purchases of Treasuries and mortgage securities were meant to address the widening credit spreads. Honestly, that doesn't hold much water with me. As a client rightly pointed out, the Fed is out of their normal arsenal of bullets and is having to bring in other artillery to try to kill the beast. Through the purchase of these securities, they drive the prices up, the yields down - a good move for the mortgage securities, but not really a big deal on the Treasuries. Thirty year Treasuries are trading at a yield of 3.66%, not exactly a problem. On the other hand, the spread between Corporates (high quality and high yield) and the Treasuries is just out of hand. As of 3/31/06, the spread between the 9 year Treasury and the AAA Corporates was 1%, between Treasuries and High Yield Corporates it was 3%. Today, three years and a little credit crisis later, it's 3.5% for Treasury/AAA and 12% for the Treasury/High Yield spread.
I have to believe that part of what they're trying to do is buy in the Treasuries so money managers will migrate those $$ to bonds with more credit risk. However, it puts a lot of currency into circulation really fast. All the stimulus prior to this led me to believe that if we were going to have inflation we'd see it sometime in late 2010 (if at all), given that so much of the money being thrown at the crisis would be used by consumers to pay down their amazingly high debt loads. This new addition has me certain that there's no way that this won't be inflationary at some point, and that point has moved significantly closer - best guess now is early 2010.
I'd suggest that sometime between now and when that inflation hits going to gold might not be a bad idea. Other hard commodities should also do well in that type of environment. The trick, however, is that between now and whenever the inflation hits, I expect a continuation of the deflationary trend we're currently seeing.
In light of the Treasury's announcement Monday, there's obviously another layer of complexity to things, although not much more clarity. The announcement on Monday of a public-private partnership to help clear the toxic waste off of the banks' balance sheets has some good points and some bad points. Essentially, five yet-to-be-named private firms will be approved to bid on "assets" that banks want to sell. The private firm who bids the most for the asset will have to put up a small amount (roughly 7%), the Fed will put up an equal amount and the FDIC will guarantee up to 78%. If the asset goes up in value, the private firm and the government split the profit. If the asset goes down in value from whatever the purchase price is the private firm and the Fed can lose their entire investment and the FDIC steps in to absorb any further losses.
While this will help set some sort of a market price for the toxic assets, the private firms have very little skin in the game and obviously the potential for pretty impressive returns. On the other hand, it uses the expertise of the private firms to set appropriate prices and keeps the government from overpaying (too much anyway) for the assets and they won't be 100% responsible.
Monday's market rally was in my mind more of a "oh, thank goodness they finally at least came up with SOMETHING!" rally rather than specific expectation that this plan will be the saving grace for the economy. I still expect that the significant systemic problems in the economy will take time to unwind themselves. While I know that I'm going against some pretty impressive market experts on this, I don't believe that this is the beginning of the next bull market - I'm firmly in the bear market rally camp. Valuations are still too high. Just because the banks will be more able to lend after the toxic waste is off their balance sheets doesn't mean that a) they will lend or b) that the American consumer really should take them up on any loans offered. The over consumption by American consumers has led to personal balance sheets bloated by debt and lacking in savings. Add to that a 45% reduction in the value of their retirement accounts and at least a 20% reduction in the value of their homes, and I don't see how this economy that is 70% fueled by the consumer can bounce back in a healthy way in the short term. The stock market may bounce... but the underlying economy has more pain to come.
Bernanke said Friday that the purchases of Treasuries and mortgage securities were meant to address the widening credit spreads. Honestly, that doesn't hold much water with me. As a client rightly pointed out, the Fed is out of their normal arsenal of bullets and is having to bring in other artillery to try to kill the beast. Through the purchase of these securities, they drive the prices up, the yields down - a good move for the mortgage securities, but not really a big deal on the Treasuries. Thirty year Treasuries are trading at a yield of 3.66%, not exactly a problem. On the other hand, the spread between Corporates (high quality and high yield) and the Treasuries is just out of hand. As of 3/31/06, the spread between the 9 year Treasury and the AAA Corporates was 1%, between Treasuries and High Yield Corporates it was 3%. Today, three years and a little credit crisis later, it's 3.5% for Treasury/AAA and 12% for the Treasury/High Yield spread.
I have to believe that part of what they're trying to do is buy in the Treasuries so money managers will migrate those $$ to bonds with more credit risk. However, it puts a lot of currency into circulation really fast. All the stimulus prior to this led me to believe that if we were going to have inflation we'd see it sometime in late 2010 (if at all), given that so much of the money being thrown at the crisis would be used by consumers to pay down their amazingly high debt loads. This new addition has me certain that there's no way that this won't be inflationary at some point, and that point has moved significantly closer - best guess now is early 2010.
I'd suggest that sometime between now and when that inflation hits going to gold might not be a bad idea. Other hard commodities should also do well in that type of environment. The trick, however, is that between now and whenever the inflation hits, I expect a continuation of the deflationary trend we're currently seeing.
In light of the Treasury's announcement Monday, there's obviously another layer of complexity to things, although not much more clarity. The announcement on Monday of a public-private partnership to help clear the toxic waste off of the banks' balance sheets has some good points and some bad points. Essentially, five yet-to-be-named private firms will be approved to bid on "assets" that banks want to sell. The private firm who bids the most for the asset will have to put up a small amount (roughly 7%), the Fed will put up an equal amount and the FDIC will guarantee up to 78%. If the asset goes up in value, the private firm and the government split the profit. If the asset goes down in value from whatever the purchase price is the private firm and the Fed can lose their entire investment and the FDIC steps in to absorb any further losses.
While this will help set some sort of a market price for the toxic assets, the private firms have very little skin in the game and obviously the potential for pretty impressive returns. On the other hand, it uses the expertise of the private firms to set appropriate prices and keeps the government from overpaying (too much anyway) for the assets and they won't be 100% responsible.
Monday's market rally was in my mind more of a "oh, thank goodness they finally at least came up with SOMETHING!" rally rather than specific expectation that this plan will be the saving grace for the economy. I still expect that the significant systemic problems in the economy will take time to unwind themselves. While I know that I'm going against some pretty impressive market experts on this, I don't believe that this is the beginning of the next bull market - I'm firmly in the bear market rally camp. Valuations are still too high. Just because the banks will be more able to lend after the toxic waste is off their balance sheets doesn't mean that a) they will lend or b) that the American consumer really should take them up on any loans offered. The over consumption by American consumers has led to personal balance sheets bloated by debt and lacking in savings. Add to that a 45% reduction in the value of their retirement accounts and at least a 20% reduction in the value of their homes, and I don't see how this economy that is 70% fueled by the consumer can bounce back in a healthy way in the short term. The stock market may bounce... but the underlying economy has more pain to come.
Tuesday, March 10, 2009
One day does not a bull market make
I suppose I now know what the bulls have felt like for the past 6+ months. I don't know about them, but for me today made me question what I believe. I suppose a bit of healthy skepticism is a good thing, but it sure doesn't feel so good.
I hear that a lot of what happened on the floor today was short-covering, thanks to Barney Frank saying that he wants to reinstate the uptick rule as well as the threat to make short sellers show their hands. I totally agree with both of those moves, by the way.
If we are indeed in the Super Bear Market that I believe we're in, this isn't going to be long-lived. Reality will rear its ugly head, the economy will still suck, and we'll put in the lows down where I think they belong.
I don't know if anyone caught this, but Jeremy Grantham who had been known as a perma-bear is telling everyone that will listen that it's time to get into the market before you miss the big rally, while Benjamin Graham's methodology says the market is still overvalued by about 27% (that was yesterday... so I suppose it's closer to 33% now).
I'm going with the dead cat bounce theory for now, but I'm watching it all pretty closely.
Be careful out there.
I hear that a lot of what happened on the floor today was short-covering, thanks to Barney Frank saying that he wants to reinstate the uptick rule as well as the threat to make short sellers show their hands. I totally agree with both of those moves, by the way.
If we are indeed in the Super Bear Market that I believe we're in, this isn't going to be long-lived. Reality will rear its ugly head, the economy will still suck, and we'll put in the lows down where I think they belong.
I don't know if anyone caught this, but Jeremy Grantham who had been known as a perma-bear is telling everyone that will listen that it's time to get into the market before you miss the big rally, while Benjamin Graham's methodology says the market is still overvalued by about 27% (that was yesterday... so I suppose it's closer to 33% now).
I'm going with the dead cat bounce theory for now, but I'm watching it all pretty closely.
Be careful out there.
Tuesday, March 3, 2009
It's only worth what someone else will pay for it
One of my pet peeves has been all the talking heads... including the President this morning... trying to tell me (and you) that the valuation of the stock market is amazingly low and needs to be bought at these levels because it's 50% lower than it was last year.
Let's have a little lesson on valuation:
* The long-term Price/Earnings ratio for the stock market is 10x.
* The trough market valuation in the 1980-82 recession (as well as other recessions) was 6.8x earnings.
* The earnings estimates for the S&P 500 have dropped almost $2 over the past week.
* The current forward P/E ratio for the S&P 500 is 11.3x
What's that all that mean?
* Assuming earnings do not drop further, the market is still currently valued at 13% above median long-term valuations.
* Assuming earnings do not drop further, the market is 40% above trough valuations. That means we could see the S&P get close to 400 and the Dow get close to 4000.
* My assumptions include this recession/whatever-you-want-to-call-this-pain not being any worse than the 1980-82 downturn and EARNINGS NOT DROPPING ANY FURTHER.
You might have picked up on the fact that the assumption that earnings will not drop any further is a big stretch for me. And if earnings do drop... then what? Well, if earnings drop by 25% from here? Hmmmm. That means that the forward P/E would currently be 15x... meaning it would be 55% above the trough valuation.
Sleep well tonight.
Let's have a little lesson on valuation:
* The long-term Price/Earnings ratio for the stock market is 10x.
* The trough market valuation in the 1980-82 recession (as well as other recessions) was 6.8x earnings.
* The earnings estimates for the S&P 500 have dropped almost $2 over the past week.
* The current forward P/E ratio for the S&P 500 is 11.3x
What's that all that mean?
* Assuming earnings do not drop further, the market is still currently valued at 13% above median long-term valuations.
* Assuming earnings do not drop further, the market is 40% above trough valuations. That means we could see the S&P get close to 400 and the Dow get close to 4000.
* My assumptions include this recession/whatever-you-want-to-call-this-pain not being any worse than the 1980-82 downturn and EARNINGS NOT DROPPING ANY FURTHER.
You might have picked up on the fact that the assumption that earnings will not drop any further is a big stretch for me. And if earnings do drop... then what? Well, if earnings drop by 25% from here? Hmmmm. That means that the forward P/E would currently be 15x... meaning it would be 55% above the trough valuation.
Sleep well tonight.
Sunday, March 1, 2009
Spare the change, spoil the child
If you spend much time at all chatting with me about the markets and the economy, you’ve probably heard my socio-economic theory on how we got here. But while I think I’m a pretty keen observer of patterns and trends, I didn’t have much hard core data to back me up… until Friday.
‘This American Life’, a radio show produced by Chicago Public Radio, has done some amazing work explaining the mortgage crisis, and followed up this past week with a show explaining the banking crisis in non-investment-geek English. I love the show and highly recommend tuning in.
Anyway, one of the experts that they chatted with was David Beim, a former banker turned professor at Columbia Business School, who has a graph that exactly illustrates why we’re this pickle… and which fits my theory exactly. Those of you who are impatient will want the graph now, but I’m going to make you wait (patience is a virtue). First, the theory.
Our grandparents (or great-grandparents, depending on your age) had a seminal event in their lives that changed how they approached everything: the Great Depression. Times were tough: unemployment at 25%, no social safety nets, record bank failures. These are people for whom thrift wasn’t just a good idea: it was the only way to survive. Credit? Not so much. Now I recognize that the credit card industry as we know it didn’t even exist until the 1950’s (Diner’s Club) or 1965 (BankAmericard) depending on how you define it. Still, the use of credit really wasn’t that tempting to that Depression generation. My 89 year old grandfather didn’t have a credit card until he was in his late 60s, and then he only got it in order to establish a credit file that was needed even though he was going to pay cash for whatever it was.
One of the things that I’ve observed (and I’m sure there’s a sociological study out there somewhere to support it, but I’m not going to go look it up) is that we all not only want a better life for our children, but most of us also want our kids to be raised differently than we were. Sometimes that takes the form of allowing a later curfew (or earlier if you yourself were a wild child). It probably also explains why grandparents and grandkids get along so well: they were most likely raised the same way and have a common enemy – the parent.
In monetary terms, though, I’ve seen time and time again that parents and grandparents continue to baby their children long past the time when they should have been self-sufficient. So the grandparents, those who lived through the Depression, provided more for their children than they could have ever had when they were growing up: dance lessons, a car to drive in high school, college education, more clothes, etc. And of course, because the children got more, they grew to expect more. Salaries hadn’t increased so much that when those kids went out on their own they could keep up the life style to which they had become accustomed, so the grandparents continued to help here and there so that their poor little darlings didn’t feel the awful pinch of want that they themselves had to live through.
Case in point? The baby boomers will receive the largest generational wealth transfer in history. Their parents not only took care of themselves through retirement, but in many cases provided the money their children will be using for retirement… unless they blow through it first. A generation or two of that, and you end up with some mighty spoiled consumers. Take a quick look around and you can see what (and who) I mean. Ummm, darlin’, don’t forget to look in that mirror over there.
So I suppose you could say I’m blaming the grandparents, but really it’s about the very natural greed of humans combined with the fading influence of the church’s (any church’s) values of charity and putting others above self. (Don’t even get me started on that here… but if you’d like to chat offline, email me.) Regardless, we haven’t spared the change, so we’ve not only spoiled the child… we’ve spoiled the economy.
How bad is it? Ahhh, glad you asked. This is where David Beim’s graph comes in (although I should add that there is attribution to Credit Suisse as the possible original source of the chart). I give to you a vision that should explain why it is that I’m not expecting this little downturn to end in 2009 (or 2010… or 2011…)
The graph measures the ratio of household debt to Gross Domestic Product. Don’t let the different lines throw you… they’re basically the same thing, but the government apparently changed the data series midway through the graph. What should you take away from this? The last time and ONLY time we Americans have had this much debt on our PERSONAL balance sheets was 1929. Folks, it's at 100% of GDP. One. Hundred. Percent. It seems apparent to me my friends that we’re in for one of those lovely life-changing experiences just like grandma and grandpa had. Fasten your seatbelts… it’s going to be a bumpy ride.
‘This American Life’, a radio show produced by Chicago Public Radio, has done some amazing work explaining the mortgage crisis, and followed up this past week with a show explaining the banking crisis in non-investment-geek English. I love the show and highly recommend tuning in.
Anyway, one of the experts that they chatted with was David Beim, a former banker turned professor at Columbia Business School, who has a graph that exactly illustrates why we’re this pickle… and which fits my theory exactly. Those of you who are impatient will want the graph now, but I’m going to make you wait (patience is a virtue). First, the theory.
Our grandparents (or great-grandparents, depending on your age) had a seminal event in their lives that changed how they approached everything: the Great Depression. Times were tough: unemployment at 25%, no social safety nets, record bank failures. These are people for whom thrift wasn’t just a good idea: it was the only way to survive. Credit? Not so much. Now I recognize that the credit card industry as we know it didn’t even exist until the 1950’s (Diner’s Club) or 1965 (BankAmericard) depending on how you define it. Still, the use of credit really wasn’t that tempting to that Depression generation. My 89 year old grandfather didn’t have a credit card until he was in his late 60s, and then he only got it in order to establish a credit file that was needed even though he was going to pay cash for whatever it was.
One of the things that I’ve observed (and I’m sure there’s a sociological study out there somewhere to support it, but I’m not going to go look it up) is that we all not only want a better life for our children, but most of us also want our kids to be raised differently than we were. Sometimes that takes the form of allowing a later curfew (or earlier if you yourself were a wild child). It probably also explains why grandparents and grandkids get along so well: they were most likely raised the same way and have a common enemy – the parent.
In monetary terms, though, I’ve seen time and time again that parents and grandparents continue to baby their children long past the time when they should have been self-sufficient. So the grandparents, those who lived through the Depression, provided more for their children than they could have ever had when they were growing up: dance lessons, a car to drive in high school, college education, more clothes, etc. And of course, because the children got more, they grew to expect more. Salaries hadn’t increased so much that when those kids went out on their own they could keep up the life style to which they had become accustomed, so the grandparents continued to help here and there so that their poor little darlings didn’t feel the awful pinch of want that they themselves had to live through.
Case in point? The baby boomers will receive the largest generational wealth transfer in history. Their parents not only took care of themselves through retirement, but in many cases provided the money their children will be using for retirement… unless they blow through it first. A generation or two of that, and you end up with some mighty spoiled consumers. Take a quick look around and you can see what (and who) I mean. Ummm, darlin’, don’t forget to look in that mirror over there.
So I suppose you could say I’m blaming the grandparents, but really it’s about the very natural greed of humans combined with the fading influence of the church’s (any church’s) values of charity and putting others above self. (Don’t even get me started on that here… but if you’d like to chat offline, email me.) Regardless, we haven’t spared the change, so we’ve not only spoiled the child… we’ve spoiled the economy.
How bad is it? Ahhh, glad you asked. This is where David Beim’s graph comes in (although I should add that there is attribution to Credit Suisse as the possible original source of the chart). I give to you a vision that should explain why it is that I’m not expecting this little downturn to end in 2009 (or 2010… or 2011…)
The graph measures the ratio of household debt to Gross Domestic Product. Don’t let the different lines throw you… they’re basically the same thing, but the government apparently changed the data series midway through the graph. What should you take away from this? The last time and ONLY time we Americans have had this much debt on our PERSONAL balance sheets was 1929. Folks, it's at 100% of GDP. One. Hundred. Percent. It seems apparent to me my friends that we’re in for one of those lovely life-changing experiences just like grandma and grandpa had. Fasten your seatbelts… it’s going to be a bumpy ride.
Tuesday, February 24, 2009
Loans loans everywhere and not a cent to spend
Before I even start, I want to be clear that I am not espousing a political opinion here. I hate politics. I'm not interested in them. But I do like investing (well, up until recently). And we all know I *LOVE* retail (well, up until recently). I want to go back to the good ole days of making and spending stupid amounts of money just as much as you do. But it would be disingenuous to suggest that it were possible to do so. I firmly believe that we are in the midst of a Great Adjustment not unlike that which our grandparents experienced... but different because we got here differently.
So, what I'm trying to figure out how we get out of this mire in which we're muddling. I'm all about common sense, or at least I'd like to be. The President just talked about 'new common sense rules of the road' (that's a direct quote from the President's speech... just a second ago), but then he's talking about increasing the lending again. He mentioned that it was only through borrowing that Americans could buy homes (okay), buy cars (can't we buy cheaper cars?) and attend college (a little help is fine, but those kids coming out of college with $110k in debt are in a world of hurt that will take YEARS to dig out from.)
Okay, the banks have shut off the faucet completely. For businesses. For consumers. For everyone. That's not good. We know what happens when there is no credit - there is no economy. I don't like that. You don't like that. Heck, no one in the world likes that. On the other hand, when there's too much credit, problems also ensue.
I am so very very concerned that all the talk is about getting lending moving again so that the consumer can bounce back. Our consumers have been consuming too much, have collected too much debt already, and they're going to be digging out for a long long time. I'm not saying I'm an expert, but I play one on TV. Every indicator I can find shows the U.S. consumer is tapped out, drowning in debt, swimming in stuff that they thought they needed but really didn't.
Let's think about this. Home mortgage default rates (delinquent loans as a percentage of total loans) are over 5%. Maybe that's because the long-term average percentage of Americans who own homes is 65%... and even with all the foreclosures we're still at roughly 67.5% owning homes. Too many people who couldn't afford a home were allowed to buy a home anyway, at least for a time.
We all know about the problem with subprime loans, but no one is really talking about the next pig in the python: the Option Adjustable Rate Mortgage problem that is staring us in the face. These Option ARMS are even more toxic than the subprime mortgages, maybe that's why no one wants to talk about them.
I gave a talk last weekend on the economy entitled "Fairy Tales Retold: Today's Economy Explained."
In the case of consumer credit, my point is that you can wait for Prince Charming all you want, but he's not going to pay off your debt... he can't afford to pay off his own! Okay, we're a little off the highs, but consumer credit (not including mortgages, just credit card-like stuff) is over 21% of personal income. Back in 1974 we were closer to 15%. Of course, we didn't all have fabulous designer handbags and great technological toys back then either.
I can't tell you how many folks I've had tell me that their home is their savings account. Great thought until home prices fall 20%. A better place for savings might be, wait for it, a savings account. But as a culture we apparently don't believe in those either, maybe because they don't give you the rush that the stock or housing markets do. They also don't turn your stomach like the stock or housing markets.
In the graph above I've shown the personal savings rate as a percentage of disposable income since 1959. The average over that time period is indicated by the gold line across the middle: 6.9%. It doesn't take a statistician to see that the average is only that high because of the early years in the graph. In fact, since the beginning of 2005, the average is only 0.8%. No, that's not a typo. Less than 1% of our disposable incomes are being saved. No wonder we're living on debt, we don't have anything in savings for emergencies. And up until last quarter, a sale at Macy's qualified as an emergency.
So when the tap got turned off by the banks and it looked like they were really serious this time, is it any wonder that retail sales took a nose dive down the rabbit hole?
That little graph there shows the year over year change in retail sales since 1992. That drop-off on the right side? Unprecedented. Ugly too.
So we have no savings in our homes or savings accounts. We have lots of credit card debt. We have lots of people defaulting on their mortgages and more to come. We're a consumer economy (70% of the economy is consumer driven), and we're not buying any more... because we can't.
I'm not saying we won't get out of this, because we will. But anyone who's believing it's going to be quick or easy? Not so much. I don't have the answer, but I'm pretty sure we can't leverage ourselves out of it this time.
So, what I'm trying to figure out how we get out of this mire in which we're muddling. I'm all about common sense, or at least I'd like to be. The President just talked about 'new common sense rules of the road' (that's a direct quote from the President's speech... just a second ago), but then he's talking about increasing the lending again. He mentioned that it was only through borrowing that Americans could buy homes (okay), buy cars (can't we buy cheaper cars?) and attend college (a little help is fine, but those kids coming out of college with $110k in debt are in a world of hurt that will take YEARS to dig out from.)
Okay, the banks have shut off the faucet completely. For businesses. For consumers. For everyone. That's not good. We know what happens when there is no credit - there is no economy. I don't like that. You don't like that. Heck, no one in the world likes that. On the other hand, when there's too much credit, problems also ensue.
I am so very very concerned that all the talk is about getting lending moving again so that the consumer can bounce back. Our consumers have been consuming too much, have collected too much debt already, and they're going to be digging out for a long long time. I'm not saying I'm an expert, but I play one on TV. Every indicator I can find shows the U.S. consumer is tapped out, drowning in debt, swimming in stuff that they thought they needed but really didn't.
Let's think about this. Home mortgage default rates (delinquent loans as a percentage of total loans) are over 5%. Maybe that's because the long-term average percentage of Americans who own homes is 65%... and even with all the foreclosures we're still at roughly 67.5% owning homes. Too many people who couldn't afford a home were allowed to buy a home anyway, at least for a time.
We all know about the problem with subprime loans, but no one is really talking about the next pig in the python: the Option Adjustable Rate Mortgage problem that is staring us in the face. These Option ARMS are even more toxic than the subprime mortgages, maybe that's why no one wants to talk about them.
I gave a talk last weekend on the economy entitled "Fairy Tales Retold: Today's Economy Explained."
In the case of consumer credit, my point is that you can wait for Prince Charming all you want, but he's not going to pay off your debt... he can't afford to pay off his own! Okay, we're a little off the highs, but consumer credit (not including mortgages, just credit card-like stuff) is over 21% of personal income. Back in 1974 we were closer to 15%. Of course, we didn't all have fabulous designer handbags and great technological toys back then either.I can't tell you how many folks I've had tell me that their home is their savings account. Great thought until home prices fall 20%. A better place for savings might be, wait for it, a savings account. But as a culture we apparently don't believe in those either, maybe because they don't give you the rush that the stock or housing markets do. They also don't turn your stomach like the stock or housing markets.
In the graph above I've shown the personal savings rate as a percentage of disposable income since 1959. The average over that time period is indicated by the gold line across the middle: 6.9%. It doesn't take a statistician to see that the average is only that high because of the early years in the graph. In fact, since the beginning of 2005, the average is only 0.8%. No, that's not a typo. Less than 1% of our disposable incomes are being saved. No wonder we're living on debt, we don't have anything in savings for emergencies. And up until last quarter, a sale at Macy's qualified as an emergency.
So when the tap got turned off by the banks and it looked like they were really serious this time, is it any wonder that retail sales took a nose dive down the rabbit hole?
That little graph there shows the year over year change in retail sales since 1992. That drop-off on the right side? Unprecedented. Ugly too.
So we have no savings in our homes or savings accounts. We have lots of credit card debt. We have lots of people defaulting on their mortgages and more to come. We're a consumer economy (70% of the economy is consumer driven), and we're not buying any more... because we can't.
I'm not saying we won't get out of this, because we will. But anyone who's believing it's going to be quick or easy? Not so much. I don't have the answer, but I'm pretty sure we can't leverage ourselves out of it this time.
Wednesday, January 7, 2009
Take your medicine like a good boy
Something occurs to me. Those who feel good about the economy's prognosis for the next year are constantly saying that "everyone" is bearish, making it the bottom for the market and a buying opportunity. Those who believe the sky is falling (yours truly included) hear nothing but talking heads opining about how this is the buying opportunity of their career. (If you want to know what I think about that comment, read this.)
There are folks who are certain that Bernanke has studied the Great Depression enough to know how to avoid it again. But knowing how to avoid the problems of the 1930's doesn't necessarily mean he knows how to avoid all the problems we're facing now. The consumer is on strike, and not by choice. And while I could be wrong, so far I haven't seen or heard anything that my buddy Ben can do to help the consumers feel flush and start buying again. Frankly, I don't think that would be the right answer anyway. We're lancing a boil on the butt of consumerism, folks. It's a painful procedure, but it's the only way for the economy to heal. The recuperation period needs to include recovery from the excessive spending of the recent past as well as resetting what the economy expects from the consumer. We're nowhere near done with that process yet.
Just call me Nurse Ratched.
There are folks who are certain that Bernanke has studied the Great Depression enough to know how to avoid it again. But knowing how to avoid the problems of the 1930's doesn't necessarily mean he knows how to avoid all the problems we're facing now. The consumer is on strike, and not by choice. And while I could be wrong, so far I haven't seen or heard anything that my buddy Ben can do to help the consumers feel flush and start buying again. Frankly, I don't think that would be the right answer anyway. We're lancing a boil on the butt of consumerism, folks. It's a painful procedure, but it's the only way for the economy to heal. The recuperation period needs to include recovery from the excessive spending of the recent past as well as resetting what the economy expects from the consumer. We're nowhere near done with that process yet.
Just call me Nurse Ratched.
Thursday, December 11, 2008
Try to keep up, please
Times, they are a changin'. It was just about 6 months ago that I sat down with Costco management and heard things that gave me chills. Part of it, I'm sure, was the fact that it was the day before they preannounced a Q4 (August fiscal year end) earnings shortfall, so they were glum anyway (although we didn't know about that until 12 hours later).
Back in July the discussion was all about inflation: food inflation, gas inflation. Remember that it was mid-July that gas prices peaked nationwide. Gas prices are now down 58% from that level. Fifty. Eight. Percent. Today on their first quarter conference call Costco confirmed that they are now also getting price concessions from suppliers on goods that had gone up significantly just a few months ago. While I want to be clear that they didn't specify where they are currently getting concessions, some of the major price increases had been for goods that used petroleum products (plastics, etc). You can bet those prices are headed down. In fact, it was a source of great pain for them that they had to take the price on their rotesserie chickens up from $4.99 to $5.49 to $5.99 all within the course of 6 weeks because of food price inflation. Guess what? They're back down again.
Gas, which was a source of huge LIFO charges because of inflation (if you want an explanation of how and why that accounting even exists, you'll need to find someone smarter to explain it), has now swung completely the other way. And whereas it was at best a teeny profit margin (perhaps even sometimes a bit of an unintentional loss leader) in July and August, it was for a bit of time these last few months 'wildly profitable' according to Costco. (Because they sell so much gas, they buy gas cheaper faster as the price is dropping, but can still stay at really cheap prices to consumers while their cost drops faster.)
There's been a lot of consternation about the huge amount of economic stimulus the government has been pumping into the economy in the name of stabilization, mostly because the great fear of further inflation. Eventually that may happen. Heck, look at what happen when they took interest rates down and flooded cash into the market at the turn of the century (see my August 2008 Post Modern fairy tale for more information). But I'm here to tell you, we can't see the whites of inflation's eyes from this vantage point. We'll remain vigilant. But in a really quick turn of events, we're much more troubled by the looming deflation at this point.
Back in July the discussion was all about inflation: food inflation, gas inflation. Remember that it was mid-July that gas prices peaked nationwide. Gas prices are now down 58% from that level. Fifty. Eight. Percent. Today on their first quarter conference call Costco confirmed that they are now also getting price concessions from suppliers on goods that had gone up significantly just a few months ago. While I want to be clear that they didn't specify where they are currently getting concessions, some of the major price increases had been for goods that used petroleum products (plastics, etc). You can bet those prices are headed down. In fact, it was a source of great pain for them that they had to take the price on their rotesserie chickens up from $4.99 to $5.49 to $5.99 all within the course of 6 weeks because of food price inflation. Guess what? They're back down again.
Gas, which was a source of huge LIFO charges because of inflation (if you want an explanation of how and why that accounting even exists, you'll need to find someone smarter to explain it), has now swung completely the other way. And whereas it was at best a teeny profit margin (perhaps even sometimes a bit of an unintentional loss leader) in July and August, it was for a bit of time these last few months 'wildly profitable' according to Costco. (Because they sell so much gas, they buy gas cheaper faster as the price is dropping, but can still stay at really cheap prices to consumers while their cost drops faster.)
There's been a lot of consternation about the huge amount of economic stimulus the government has been pumping into the economy in the name of stabilization, mostly because the great fear of further inflation. Eventually that may happen. Heck, look at what happen when they took interest rates down and flooded cash into the market at the turn of the century (see my August 2008 Post Modern fairy tale for more information). But I'm here to tell you, we can't see the whites of inflation's eyes from this vantage point. We'll remain vigilant. But in a really quick turn of events, we're much more troubled by the looming deflation at this point.
Sunday, December 7, 2008
Not your father's recession
Maybe I'm a total pessimist. Maybe. But I don't think so.
Last week I watched so much financial TV that my head came close to exploding. The message, repeated ad nauseum, was that it's time to buy because things are so cheap and the recession must be close to over. Okay. If you think so. But let me give you a few things to think about before you bet your entire retirement account on black.
Yes, the last two recessions have lasted about 8 months. And yes, we're already 12 months into this little piece of recessional happiness. So, that means we're almost done, right? Nope. Why not? Keep reading.
Last week I watched so much financial TV that my head came close to exploding. The message, repeated ad nauseum, was that it's time to buy because things are so cheap and the recession must be close to over. Okay. If you think so. But let me give you a few things to think about before you bet your entire retirement account on black.
Yes, the last two recessions have lasted about 8 months. And yes, we're already 12 months into this little piece of recessional happiness. So, that means we're almost done, right? Nope. Why not? Keep reading.
Most recessions come from inventory build-ups. Think back to the year 2000. What tanked technology? All the parts everyone needed to build out the internet were in short supply, so everyone double/triple/quadruple ordered. And then the factories were actually able to deliver what had been ordered... and those who had ordered only needed a fraction of the stuff the other companies were trying to deliver to them. In other words lots of inventory, few corporate buyers. This usual scenario then leads to companies cutting jobs because they have to make less stuff. At this point, the consumer starts feeling the pain and cutting back... and we're almost out of the woods.
This time it's different. Really. It is. Let's look at this recession. Corporate inventory levels haven't been an issue, at least until recently. We got here differently this time. This time what fell apart first? Homes. Who owns homes? Consumers. So, instead of starting with industry and then having the issues filter through to the consumers at the end, we're leading with the consumer.
Let's review what Joe and Jane Consumer have had to deal with over the past couple of years:
- Their home has lost at least 15% of it's value... but more likely somewhere between 25-50% of it's value.
- Their retirement accounts have lost 40% or more of their value.
- The company holding their home equity loan has put the kibosh on further withdrawals.
- Their credit card companies have cut their credit limits and/or raised their interest rates... unless the darn things just got canceled outright.
- Gas and food prices went up astronomically. I'll give you that gas prices are now down at 5 year lows, but with their balance sheets evaporated and their credit essentially maxed out, low gas prices are nice but not enough to make much of a difference at all for the majority of U.S. consumers.
- Oh yeah, and then there was the (un)employment report last Friday. Worst in 30-some-odd years. Sure, employment is a lagging indicator. But it's still falling. And more companies are laying people off.
So, while Black Friday sales were up nicely and Cyber Monday sales were up even better, my interviews with consumers ... and my common sense... tell me that they're buying on deep deep sales when they buy. Holiday sales (oh, heck, can we just call if Christmas please?) are probably going to fall this year. Fall. That's not good. And it will have ripple effects throughout the economy.
Hmmm. Then there's the problems in Detroit. And the still-mostly-frozen credit markets. I'm not very political. But I've been impressed by what Mr. Obama has been putting in place for the future... and by his pragmatic approach to this whole mess. But I have a very strong feeling that around March or so everyone is going to figure out that he doesn't have a magic wand, he can't make it all better quickly... and this market is going to take another dive for the floor.
Remember, stocks are only cheap on a Price/Earnings basis if you know what the earnings are going to be. Forward P/Es are based on someone's best guess of the future. But if that future isn't getting better, it's getting worse, are you really sure about that valuation?
Enjoy this Santa Claus rally. Play it if you want. But don't stay too long at the party, 'cause despite the hair of the dog that everyone seems to think is yummy right now, the hangover isn't anywhere near done.
Monday, December 1, 2008
Thanks, that was helpful
Today we have been treated to what my husband calls a blinding glimpse of the obvious: the National Bureau of Economic Research has officially declared this economic malaise to be a recession. Even better? The recession started in December 2007. Today is the first day of December 2008. The insight that the NBER has provided is astounding. The whole thing brings to mind women who supposedly never knew they were pregnant until they gave birth. Quite literally unbelievable.
So, how does this information change your life and mine? Well, I suppose the upside is that now that a recession has actually been declared, we're certainly closer to the end than we were before. Don't mistake what I just wrote - I am NOT saying the end of the recession is near. What I am saying is that getting past denial is the first step to recovery. How long recovery takes depends on the severity of the original illness.
Beyond that? Carry on. Nothing much to see here.
So, how does this information change your life and mine? Well, I suppose the upside is that now that a recession has actually been declared, we're certainly closer to the end than we were before. Don't mistake what I just wrote - I am NOT saying the end of the recession is near. What I am saying is that getting past denial is the first step to recovery. How long recovery takes depends on the severity of the original illness.
Beyond that? Carry on. Nothing much to see here.
Tuesday, August 5, 2008
A Post Modern Economic Fairy Tale
Fairy tales do not tell children that dragons exist. Children already know that dragons exist. Fairy tales tell children that dragons can be killed. ~G.K. Chesterton
Once upon a time, in a country ever so close, there were a group of peasants whose grandparents had lived through some really difficult times. As a result, throughout their lives, those grandparents (the grands) did quite strange things like save money, eat leftovers, wash and reuse aluminum foil, and mend their own clothes. The grands lived within their means. At the same time, the grands loved their children and grandchildren, and wanted nothing but the best for them – which included sparing their progeny having to endure any lack of material goods. The progeny weren’t really spoiled, they just liked nice things.
Everything in the kingdom clicked along normally for quite some time: the progeny bought what they could for themselves, the grands chipped in when there was even the suspicion of want, and everyone lived a moderately comfortable lifestyle. Then, one day near the turn of the century, everything changed when the dominant industry, technology, found itself locked in the dungeon with a dragon in a fight for its life. At roughly the same time, the kingdom came under siege from terrorists, which desperately frightened the peasants. In order to fight the dual threats of dragon and siege, the kingdom’s Financial Wizard, Uncle Greenspan, decided to flood the kingdom with low interest cash. And the peasants rejoiced.
The rejoicing was contained in the peasantry though, for certain investors did not like it at all. Low interest cash made it difficult for them to earn enough interest income. So the bankers, being creative fellows, decided to package home mortgages for sale to those investors at higher interest rates than Uncle Greenspan was willing to offer. Because they needed a continuous stream of new mortgages in order to create these new investment vehicles, the bankers lent more and more of the peasants money to buy homes… including peasants who had didn’t earn enough barley per year or already had two homes. Home demand grew as rental peasants became home owners, and the average price of a hovel within the kingdom rose significantly. The creative bankers, still hungry for new loans, lent the home owning peasants even more money against the increased value of their hovels.
At first the peasants used the new loans to pay off debts owed, or to add a new porch or a better thatch roof to their hovel. But as the home prices continued to rise and the creative bankers continued to lend, the peasants started looking toward the purchasing habits of the royalty for inspiration on how to spend their new found wealth. The peasants shopped and shopped and shopped, truly enjoying the nicer things of life.
But as in all fairy tales, eventually the Evil Queen must put in her cameo appearance. In this case, the Evil Queen removed the ‘beauty’ spell placed on the investments created by the creative bankers, causing investors to flee the investments with horror. This in turn meant that there were fewer peasants able to buy homes, and soon not only were hovel prices kingdom-wide slipping, but there also was no more almost-free money to buy the nicer things in life. The kingdom’s consumer economy was under siege. Uncle Bernanke (Uncle Greenspan having since retired to the book and lecture circuit) and his friends in the turrets of Capitol Hill issued alms to the peasants in the late spring to reinvigorate their spending and restart the party. But alas, with the fall in hovel prices, the retrenching of the stock market as well as high food and fuel prices, peasants are stretched as if on the rack, despite a fairly decent employment outlook. It appears that the peasants will be recovering from their bout of affluenza for a long time to come. If only they had listened to the lessons of their grandparents. Interestingly, even the royalty seems to be at least slightly cognizant of the higher prices and economic pressures on the peasantry – not one has been heard uttering ‘let them eat cake’ – probably because it’s an election year.
Luckily, the Evil Queen’s spell has had limited affect on other parts of the kingdom’s economy. Gross Domestic Product continues to muddle along at very slightly positive rate, although our firm’s chief wizard/economist believes that the odds of the kingdom experiencing an authentic blessed-by-the-powers-that-be recession now stand at 60-70%. Of course, the peasantry all agree that we’re already in that recession, but what do they know? Interestingly, manufacturing, especially manufacturing for export to other kingdoms, continues to be decent. The net export component added about 0.8% to Q1 GDP, although it was hurt by higher oil imports (higher in dollar terms, not necessarily barrels of oil.)
That being said, medium sized companies are finding it hard to borrow money for their businesses from the not-feeling-so-creative-anymore bankers. The most visible victims of this are being seen in the retail sector, where consumers and bankers have pulled back at the same time. I am keeping a list of retailers who have filed for bankruptcy, and it is getting longer every day.
The good news is that the international kingdoms economies, especially the emerging economies of the BRIC nations (Brazil, Russia, India and China) seem to be holding their own, although slowing a mite from their torrid pace. When selecting stocks over the recent past, we have given a higher preference to companies with overseas exposure. We have also tried to minimize the financial sector exposure, emphasizing instead stocks within the energy complex. We do expect that slowing global growth should relieve some of the pressure on commodities, which should, in turn, lessen the burden on the US consumer.
The best way to survive this siege of the markets is through diversification and patience. All sieges end eventually. And even in environments like this different investment classes and sectors can perform. Case in point is the performance within the S&P 500 sectors for the second quarter. While the financial sector (home of the not-feeling-so-creative-anymore bankers) returned a miserable -18.3% and the peasant consumer discretionary sector lost -7.8%, the energy sector gained 17.3% and the utility sector returned 8.0%. One of the things that we pride ourselves on is our efforts to protect clients’ investments on the downside. We are definitely risk averse and have tried our best to position your portfolio to reflect that.
All fairy tales aside, these are the times in the market that build character. Try to remember that eventually we’ll come to the part where they all lived happily ever after.
Once upon a time, in a country ever so close, there were a group of peasants whose grandparents had lived through some really difficult times. As a result, throughout their lives, those grandparents (the grands) did quite strange things like save money, eat leftovers, wash and reuse aluminum foil, and mend their own clothes. The grands lived within their means. At the same time, the grands loved their children and grandchildren, and wanted nothing but the best for them – which included sparing their progeny having to endure any lack of material goods. The progeny weren’t really spoiled, they just liked nice things.
Everything in the kingdom clicked along normally for quite some time: the progeny bought what they could for themselves, the grands chipped in when there was even the suspicion of want, and everyone lived a moderately comfortable lifestyle. Then, one day near the turn of the century, everything changed when the dominant industry, technology, found itself locked in the dungeon with a dragon in a fight for its life. At roughly the same time, the kingdom came under siege from terrorists, which desperately frightened the peasants. In order to fight the dual threats of dragon and siege, the kingdom’s Financial Wizard, Uncle Greenspan, decided to flood the kingdom with low interest cash. And the peasants rejoiced.
The rejoicing was contained in the peasantry though, for certain investors did not like it at all. Low interest cash made it difficult for them to earn enough interest income. So the bankers, being creative fellows, decided to package home mortgages for sale to those investors at higher interest rates than Uncle Greenspan was willing to offer. Because they needed a continuous stream of new mortgages in order to create these new investment vehicles, the bankers lent more and more of the peasants money to buy homes… including peasants who had didn’t earn enough barley per year or already had two homes. Home demand grew as rental peasants became home owners, and the average price of a hovel within the kingdom rose significantly. The creative bankers, still hungry for new loans, lent the home owning peasants even more money against the increased value of their hovels.
At first the peasants used the new loans to pay off debts owed, or to add a new porch or a better thatch roof to their hovel. But as the home prices continued to rise and the creative bankers continued to lend, the peasants started looking toward the purchasing habits of the royalty for inspiration on how to spend their new found wealth. The peasants shopped and shopped and shopped, truly enjoying the nicer things of life.
But as in all fairy tales, eventually the Evil Queen must put in her cameo appearance. In this case, the Evil Queen removed the ‘beauty’ spell placed on the investments created by the creative bankers, causing investors to flee the investments with horror. This in turn meant that there were fewer peasants able to buy homes, and soon not only were hovel prices kingdom-wide slipping, but there also was no more almost-free money to buy the nicer things in life. The kingdom’s consumer economy was under siege. Uncle Bernanke (Uncle Greenspan having since retired to the book and lecture circuit) and his friends in the turrets of Capitol Hill issued alms to the peasants in the late spring to reinvigorate their spending and restart the party. But alas, with the fall in hovel prices, the retrenching of the stock market as well as high food and fuel prices, peasants are stretched as if on the rack, despite a fairly decent employment outlook. It appears that the peasants will be recovering from their bout of affluenza for a long time to come. If only they had listened to the lessons of their grandparents. Interestingly, even the royalty seems to be at least slightly cognizant of the higher prices and economic pressures on the peasantry – not one has been heard uttering ‘let them eat cake’ – probably because it’s an election year.
Luckily, the Evil Queen’s spell has had limited affect on other parts of the kingdom’s economy. Gross Domestic Product continues to muddle along at very slightly positive rate, although our firm’s chief wizard/economist believes that the odds of the kingdom experiencing an authentic blessed-by-the-powers-that-be recession now stand at 60-70%. Of course, the peasantry all agree that we’re already in that recession, but what do they know? Interestingly, manufacturing, especially manufacturing for export to other kingdoms, continues to be decent. The net export component added about 0.8% to Q1 GDP, although it was hurt by higher oil imports (higher in dollar terms, not necessarily barrels of oil.)
That being said, medium sized companies are finding it hard to borrow money for their businesses from the not-feeling-so-creative-anymore bankers. The most visible victims of this are being seen in the retail sector, where consumers and bankers have pulled back at the same time. I am keeping a list of retailers who have filed for bankruptcy, and it is getting longer every day.
The good news is that the international kingdoms economies, especially the emerging economies of the BRIC nations (Brazil, Russia, India and China) seem to be holding their own, although slowing a mite from their torrid pace. When selecting stocks over the recent past, we have given a higher preference to companies with overseas exposure. We have also tried to minimize the financial sector exposure, emphasizing instead stocks within the energy complex. We do expect that slowing global growth should relieve some of the pressure on commodities, which should, in turn, lessen the burden on the US consumer.
The best way to survive this siege of the markets is through diversification and patience. All sieges end eventually. And even in environments like this different investment classes and sectors can perform. Case in point is the performance within the S&P 500 sectors for the second quarter. While the financial sector (home of the not-feeling-so-creative-anymore bankers) returned a miserable -18.3% and the peasant consumer discretionary sector lost -7.8%, the energy sector gained 17.3% and the utility sector returned 8.0%. One of the things that we pride ourselves on is our efforts to protect clients’ investments on the downside. We are definitely risk averse and have tried our best to position your portfolio to reflect that.
All fairy tales aside, these are the times in the market that build character. Try to remember that eventually we’ll come to the part where they all lived happily ever after.
Monday, June 2, 2008
Enough already!
Is there no end to the pain and insanity in retail land? It's just WRONG when the economy is so bad that even a can't-lose retail concept like Lululemon has to take down earnings guidance. Seriously, what could possibly be more mission critical to Jane Consumer than spendy yoga togs? It's a trend that is a bit concerning. It was just last week that another high-end Wall Street darling, J Crew, also had to bring down guidance.
I have sick sense of humor sometimes, but I find it tremendously amusing that if the company is growing its store base and appeals to an upper income demographic, Wall Street loves it. As if $4 a gallon gas will never affect people who make over $100k a year. Let's be real folks - the only way this economy isn't putting the squeeze on you is if you don't eat or use energy. And those folks above the US median income level (which is roughly $47k/year), in many cases those are the folks that stretched themselves even further beyond their means and are hurting more now.
So how on earth does someone invest in retail stocks right now, given all that? First, one takes a heavy dose of one's favorite antacid. Then, the next step is to determine your personal outlook on the economy. (You might want to take another swig from that Maalox bottle right about now.)
If your economic glass is half empty, think about where people either shop to save money or have to shop to survive. I'm a personal believer (and holder) of companies that sell food and other consumables such as Wal-Mart and Costco. I'm hard pressed to find a stock that I like more than Wal-Mart. Really. Wal-Mart. They've finally shifted the majority of their marketing away from that hideous bouncing smiley face and it's unhealthy obsession with dropping prices. Don't get me wrong, consumers absolutely need low prices right now. But they're not so desperate for low prices that they would endure the seven levels of hell that a shopping trip to Wal-Mart used to involve. Thank goodness management finally brought some fresh blood into their little closed world of NW Arkansas, and exciting new ideas such as 'even people on a budget like to shop in a nice environment,' and 'if people aren't in a rush to leave the store, maybe they will spend more money on discretionary items' started invading the corporate consciousness. Revolutionary, no?
Retail today is more than the old adage 'stack it high and watch it fly.' Retail is both art and science. For years, Wal-Mart excelled at the science of retailing - selling stuff cheap and controlling costs. Watch the CNBC documentary "The Age of Wal-Mart" sometime. The fact that they even know that strawberry PopTarts sell best before a hurricane scares me. Even scarier: that it took them so long to understand that a clean bathroom and short checkout lines make for happy consumers. And who would have ever guessed that putting up little signs that show us what an outfit should look like would sell more clothing? Oh yeah, the competition.
Which brings me back to how Wal-Mart has changed. As one Wall Street wonk put it recently, "this isn't your father's Wal-Mart." They have made strides on employee health care and the environment, both of which were causing issues with and for investors. They finally recognized that growth for growth's sake wasn't working. US retail domination via copious store count growth is no longer a stated goal (although World Retail Domination still seems to be on the table.) Thinking about Return on Investment is back in vogue at headquarters. And the arrogance that management once displayed toward their critics seems to have been at least muted if not dissipated entirely. Thank you Leslie Dach and Eduardo Castro-Wright: whatever they're paying you isn't nearly enough.
So there are all the touchy-feely reasons for owning the stock. The bottom line for a capitalist is buying the stock low and selling higher. Wal-Mart is currently trading at 16.7 times January 2009 consensus earnings of $3.45. Personally, my model puts earnings at $3.51, or a P/E of 16.3x '09 estimates. I am looking for P/E multiple expansion (investors willing to pay higher prices for a similar level of earnings) as it becomes more and more obvious that Jane Consumer isn't going back to her lavish lifestyle any time soon. Last year's aspirational consumer is now aspiring to put food on their table and gas in their tanks! I'm guessing that at least a 18.5x next year's earnings is reasonable, or about $65. If they continue to deliver strong sales and earnings, that number may experience inflation too.
Next time: where to look for investments if your economic glass is half full.
I have sick sense of humor sometimes, but I find it tremendously amusing that if the company is growing its store base and appeals to an upper income demographic, Wall Street loves it. As if $4 a gallon gas will never affect people who make over $100k a year. Let's be real folks - the only way this economy isn't putting the squeeze on you is if you don't eat or use energy. And those folks above the US median income level (which is roughly $47k/year), in many cases those are the folks that stretched themselves even further beyond their means and are hurting more now.
So how on earth does someone invest in retail stocks right now, given all that? First, one takes a heavy dose of one's favorite antacid. Then, the next step is to determine your personal outlook on the economy. (You might want to take another swig from that Maalox bottle right about now.)
If your economic glass is half empty, think about where people either shop to save money or have to shop to survive. I'm a personal believer (and holder) of companies that sell food and other consumables such as Wal-Mart and Costco. I'm hard pressed to find a stock that I like more than Wal-Mart. Really. Wal-Mart. They've finally shifted the majority of their marketing away from that hideous bouncing smiley face and it's unhealthy obsession with dropping prices. Don't get me wrong, consumers absolutely need low prices right now. But they're not so desperate for low prices that they would endure the seven levels of hell that a shopping trip to Wal-Mart used to involve. Thank goodness management finally brought some fresh blood into their little closed world of NW Arkansas, and exciting new ideas such as 'even people on a budget like to shop in a nice environment,' and 'if people aren't in a rush to leave the store, maybe they will spend more money on discretionary items' started invading the corporate consciousness. Revolutionary, no?
Retail today is more than the old adage 'stack it high and watch it fly.' Retail is both art and science. For years, Wal-Mart excelled at the science of retailing - selling stuff cheap and controlling costs. Watch the CNBC documentary "The Age of Wal-Mart" sometime. The fact that they even know that strawberry PopTarts sell best before a hurricane scares me. Even scarier: that it took them so long to understand that a clean bathroom and short checkout lines make for happy consumers. And who would have ever guessed that putting up little signs that show us what an outfit should look like would sell more clothing? Oh yeah, the competition.
Which brings me back to how Wal-Mart has changed. As one Wall Street wonk put it recently, "this isn't your father's Wal-Mart." They have made strides on employee health care and the environment, both of which were causing issues with and for investors. They finally recognized that growth for growth's sake wasn't working. US retail domination via copious store count growth is no longer a stated goal (although World Retail Domination still seems to be on the table.) Thinking about Return on Investment is back in vogue at headquarters. And the arrogance that management once displayed toward their critics seems to have been at least muted if not dissipated entirely. Thank you Leslie Dach and Eduardo Castro-Wright: whatever they're paying you isn't nearly enough.
So there are all the touchy-feely reasons for owning the stock. The bottom line for a capitalist is buying the stock low and selling higher. Wal-Mart is currently trading at 16.7 times January 2009 consensus earnings of $3.45. Personally, my model puts earnings at $3.51, or a P/E of 16.3x '09 estimates. I am looking for P/E multiple expansion (investors willing to pay higher prices for a similar level of earnings) as it becomes more and more obvious that Jane Consumer isn't going back to her lavish lifestyle any time soon. Last year's aspirational consumer is now aspiring to put food on their table and gas in their tanks! I'm guessing that at least a 18.5x next year's earnings is reasonable, or about $65. If they continue to deliver strong sales and earnings, that number may experience inflation too.
Next time: where to look for investments if your economic glass is half full.
Subscribe to:
Posts (Atom)
Posts
