In some ways, the economic crisis is a crisis no longer. Business analysts still discuss it and there are still news articles about it, but in most parts of the country the crisis has simply morphed into a bad recession. In fact, as time goes by and the actual statistics get compared to other recessions, the claim that this has been the worst since the Great Depression may or may not hold up.
As in all recessions, the underlying fundamentals of the economy need to find the appropriate level to regain stability and start to grow again. The growth we had in 2005-2007 was based on unsound fundamentals, driven largely by inflated real estate prices. Correcting that has been painful, but the worst part of that correction is over and generally we should start to see some more appropriate valuations in that market.
At some point, the fact that houses get foreclosed on, businesses fail and people lose jobs, is part of every economy. What is the normal numbers we should see? Our perception on that changes over time, but the level of unemployment we have now will not destroy the country, it has been at and above these levels before.
Monday, August 31, 2009
Sunday, August 30, 2009
American Economy
One thing that those of us who live in the United States should never forget is how wonderful a country this really is. Now, if you consider arable land, natural resources, educational levels, level of technological development, population density, and standard of living, there really is no comparable country in the world.
There are those who point to the current economic problems and predict Armageddon. Yes, people are suffering in some cases, unemployment is higher than we would like, but generally the country is carrying on quite nicely. Americans are making tough choices about whether to buy a new car or save more. Home prices are down and unfortunately many people have lost their homes (many of these were in homes they really couldn't afford in the first place). But the great majority of Americans are doing better than almost any citizens of any other country in the world.
Now, we are running a deficit that is higher than we would like, we are spending too much on health care, we face serious shortfalls in social security and medicare funding but does anyone really want to equate this to the horrors Europe, China and Japan faced after World War 2? In fact, if you consider the great depression, the turmoil in this country, which after all was intensified by the dust bowl drought, did not lead to fascism, or communism. In fact, while Americans became thrifty and cut back from the excesses of the 20s, the standard of living for most Americans in those years was still generally better than anywhere else in the world.
As we move into the future, we face some challenges, but really, even if China decides it won't but more Bonds from us, does anyone really think the country is going to collapse? We have contracted from what were the excesses of the early 21st century and in a few years we will have regained economic stability.
A lot is being made about bank failures. In the depression when a bank failed, the depositors lost their money. Now, the bank is renamed, depositors are safe and business continues as usual, with the losses from bad loans absorbed into our bank insurance system.
A lot of people in this country are having to make do with less right now. Lobster prices are very depressed as are many other commodity prices. In fact, while we continue to hear people worry about inflation, some sectors in this economy would love a little inflation right now. Yes, common sense tells us that prices will go up again in the future but it isn't likely to happen in the short term.
We are beginning to see renewable and national energy resources replace oil, slowly, but if you think about it, every barrel of oil replaced helps keep energy prices down, reduces carbon emissions and helps the trade deficit. You don't have to stop all oil use all at once, you simply have to work at the margins.
This country is going to have problems and issues, but we are the greatest economic power in the world. China, to use a Mao quotation, is really a paper tiger. With a population that exceed the U.S. by a multiple of 4 and a GDP that is about half. The economy is extremely dependant on exports and if they were to stop buying US bonds, Americans wouldn't be able to buy their exports. Realistically, until we start to equalize the trade deficit, bonds are the only way to equalize the currency equations.
Suppose the worst case was to happen and the United States couldn't sell treasuries any more, or the interest rates became inflationary. Well, imports and exports, while important, are still a very small part of the US economy as a whole. If foreign goods became unaffordable, especially energy, it would become disruptive, but we would adjust and really do much better than just about all our trading partners. Imagine the impact of American exports getting cheaper and cheaper? OK, we would have to replace oil with natural gas or coal or renewable, we would drink California wine instead of French, but we wouldn't collapse. In fact, we might have a boom!
There is a big difference between stock prices going down and Armageddon. Those who like to predict the worst ofter either want to sell bonds or want to make money shorting stocks. Meanwhile the average American, while a little worried about the future, is actually doing quite well.
There are those who point to the current economic problems and predict Armageddon. Yes, people are suffering in some cases, unemployment is higher than we would like, but generally the country is carrying on quite nicely. Americans are making tough choices about whether to buy a new car or save more. Home prices are down and unfortunately many people have lost their homes (many of these were in homes they really couldn't afford in the first place). But the great majority of Americans are doing better than almost any citizens of any other country in the world.
Now, we are running a deficit that is higher than we would like, we are spending too much on health care, we face serious shortfalls in social security and medicare funding but does anyone really want to equate this to the horrors Europe, China and Japan faced after World War 2? In fact, if you consider the great depression, the turmoil in this country, which after all was intensified by the dust bowl drought, did not lead to fascism, or communism. In fact, while Americans became thrifty and cut back from the excesses of the 20s, the standard of living for most Americans in those years was still generally better than anywhere else in the world.
As we move into the future, we face some challenges, but really, even if China decides it won't but more Bonds from us, does anyone really think the country is going to collapse? We have contracted from what were the excesses of the early 21st century and in a few years we will have regained economic stability.
A lot is being made about bank failures. In the depression when a bank failed, the depositors lost their money. Now, the bank is renamed, depositors are safe and business continues as usual, with the losses from bad loans absorbed into our bank insurance system.
A lot of people in this country are having to make do with less right now. Lobster prices are very depressed as are many other commodity prices. In fact, while we continue to hear people worry about inflation, some sectors in this economy would love a little inflation right now. Yes, common sense tells us that prices will go up again in the future but it isn't likely to happen in the short term.
We are beginning to see renewable and national energy resources replace oil, slowly, but if you think about it, every barrel of oil replaced helps keep energy prices down, reduces carbon emissions and helps the trade deficit. You don't have to stop all oil use all at once, you simply have to work at the margins.
This country is going to have problems and issues, but we are the greatest economic power in the world. China, to use a Mao quotation, is really a paper tiger. With a population that exceed the U.S. by a multiple of 4 and a GDP that is about half. The economy is extremely dependant on exports and if they were to stop buying US bonds, Americans wouldn't be able to buy their exports. Realistically, until we start to equalize the trade deficit, bonds are the only way to equalize the currency equations.
Suppose the worst case was to happen and the United States couldn't sell treasuries any more, or the interest rates became inflationary. Well, imports and exports, while important, are still a very small part of the US economy as a whole. If foreign goods became unaffordable, especially energy, it would become disruptive, but we would adjust and really do much better than just about all our trading partners. Imagine the impact of American exports getting cheaper and cheaper? OK, we would have to replace oil with natural gas or coal or renewable, we would drink California wine instead of French, but we wouldn't collapse. In fact, we might have a boom!
There is a big difference between stock prices going down and Armageddon. Those who like to predict the worst ofter either want to sell bonds or want to make money shorting stocks. Meanwhile the average American, while a little worried about the future, is actually doing quite well.
Saturday, August 29, 2009
Current earnings
Over and over again I hear analysts say that the recent good (relatively speaking) earnings were due to cost cutting and that there is only so much cost cutting you can do.
The implication of this is that earnings related to cost cutting are temporary and unless top line revenue grows, the earnings will disappear. Now, I can't imagine that is what the analysts are actually saying, but, over and over again I hear that comment and I'm beginning to wonder if they can really believe it.
If you have a company with sales of say $1 billion dollars and make a profit of 10% or 10 million dollars and then find that because of an economic contraction you are losing sales, you either reduce cost or lose money. Now, getting rid of excess inventory, reducing staff and closing facilities can be painful, but suppose sales have shrunk to 850 mil from the billion. If you have reduce costs enough to generate the same 10% profit, you will have earnings of $8.5 million.
Now, that constitutes reverse growth of a sort, but the savings and earnings will not go away unless sales continue to decline or costs are reintroduced. Since I believe the economic contraction has ended, the reasonable expectation is that sales will increase or at least stay stable.
Now, if you are thinking about investing in this company, the stock price should be lower than what it was when earning were higher. Mostly they are. I would argue, you need to analyse the company based on what is going to happen, not on what used to be.
Does the new company have growth potential from where it is? The fact that a company that is now only 85% of what it was is simply an interesting tidbit. Does it have good growth potential? Does it pay stable dividends?
Lots of analysts came up during a period when constant growth was the goal and they seem unable to adjust to the fact that we have reversed about 10 years of growth in the current economy. Businesses seem to have adjusted and have set themselves up to be profitable. The analysts seem to be a lagging indicator.
The implication of this is that earnings related to cost cutting are temporary and unless top line revenue grows, the earnings will disappear. Now, I can't imagine that is what the analysts are actually saying, but, over and over again I hear that comment and I'm beginning to wonder if they can really believe it.
If you have a company with sales of say $1 billion dollars and make a profit of 10% or 10 million dollars and then find that because of an economic contraction you are losing sales, you either reduce cost or lose money. Now, getting rid of excess inventory, reducing staff and closing facilities can be painful, but suppose sales have shrunk to 850 mil from the billion. If you have reduce costs enough to generate the same 10% profit, you will have earnings of $8.5 million.
Now, that constitutes reverse growth of a sort, but the savings and earnings will not go away unless sales continue to decline or costs are reintroduced. Since I believe the economic contraction has ended, the reasonable expectation is that sales will increase or at least stay stable.
Now, if you are thinking about investing in this company, the stock price should be lower than what it was when earning were higher. Mostly they are. I would argue, you need to analyse the company based on what is going to happen, not on what used to be.
Does the new company have growth potential from where it is? The fact that a company that is now only 85% of what it was is simply an interesting tidbit. Does it have good growth potential? Does it pay stable dividends?
Lots of analysts came up during a period when constant growth was the goal and they seem unable to adjust to the fact that we have reversed about 10 years of growth in the current economy. Businesses seem to have adjusted and have set themselves up to be profitable. The analysts seem to be a lagging indicator.
Friday, August 28, 2009
September Swoon?
As we approach September, we have a fair number of fear mongers worrying about September and how it is historically a bad month for the stock market and is probably when we will get "the correction".
Of course there are a number of reasons that there have been significant moves in September and October, primarily the fact that activity picks up after summer doldrums. During the summer, one of two things happen. Either the market moves in the direction that represents overall market sentiment, or it moves in a contrary direction.
Because of the low volume that we normally see during the summer, it is an opportunity for market movements that would not occur when the market is more actively traded. The old adage of sell in May and go away, has some validity. However, as technology has made it much easier to keep on top of things, even when away, not as much as it once did.
If the market has moved in accordance with general market sentiment, whatever trend it exhibits will most likely continue in September and October, barring of course other news. On the other hand, if the market has moved in a contrary fashion, especially if it has moved up, we are likely to see a significant adjustment.
So, has the market movement been part of a larger trend or has the movement during the summer been contrary to the overall trend?
If you look at projected S&P earnings for the 4th quarter of 2009 on an annualized basis, the S&P is trading at about 17 time those earnings. This is actually somewhat below what it has been doing for the last few years when it has averaged closer to 19. Now, is you consider that 10 year treasury yields are about 3.5%, the S&P yield of about 5.8% gives you a 2.3% risk premium. This is not very much out of line with what you would expect to see, although a little on the high side.
So the current level of the S&P, while much higher than it was in March, does not seem out of line with where one would expect it to be objectively. Now other things impact the market and it is possible that sentiment could drive prices down somewhat. However, there really doesn't seem to be the tremendous overvaluation that some talk about and if you want to maintain a 2% risk premium, the market still has room to go up. Now if you look at the 1st quarter of 2010 earnings, annualized, they would justify an S&P level of close to 1200. Now, earning can come in lower, but I believe most of these estimates are on the low side.
So will the market drop in September? It might, but the fundamentals don't support that the market is wildly overvalued and if it does drop I would expect it to rebound rather quickly as stocks become bargains.
Of course there are a number of reasons that there have been significant moves in September and October, primarily the fact that activity picks up after summer doldrums. During the summer, one of two things happen. Either the market moves in the direction that represents overall market sentiment, or it moves in a contrary direction.
Because of the low volume that we normally see during the summer, it is an opportunity for market movements that would not occur when the market is more actively traded. The old adage of sell in May and go away, has some validity. However, as technology has made it much easier to keep on top of things, even when away, not as much as it once did.
If the market has moved in accordance with general market sentiment, whatever trend it exhibits will most likely continue in September and October, barring of course other news. On the other hand, if the market has moved in a contrary fashion, especially if it has moved up, we are likely to see a significant adjustment.
So, has the market movement been part of a larger trend or has the movement during the summer been contrary to the overall trend?
If you look at projected S&P earnings for the 4th quarter of 2009 on an annualized basis, the S&P is trading at about 17 time those earnings. This is actually somewhat below what it has been doing for the last few years when it has averaged closer to 19. Now, is you consider that 10 year treasury yields are about 3.5%, the S&P yield of about 5.8% gives you a 2.3% risk premium. This is not very much out of line with what you would expect to see, although a little on the high side.
So the current level of the S&P, while much higher than it was in March, does not seem out of line with where one would expect it to be objectively. Now other things impact the market and it is possible that sentiment could drive prices down somewhat. However, there really doesn't seem to be the tremendous overvaluation that some talk about and if you want to maintain a 2% risk premium, the market still has room to go up. Now if you look at the 1st quarter of 2010 earnings, annualized, they would justify an S&P level of close to 1200. Now, earning can come in lower, but I believe most of these estimates are on the low side.
So will the market drop in September? It might, but the fundamentals don't support that the market is wildly overvalued and if it does drop I would expect it to rebound rather quickly as stocks become bargains.
Thursday, August 27, 2009
Jobs
Most predictions anticipate that the unemployment rate will continue to rise slowly, eventually going slightly over 10% before it starts to decline. This is based on the fact that some lagging industries are still reducing workforce and that leading industries are reluctant to increase hiring until the recovery pattern is clear. With slow hiring and new entrants to the workforce, the prediction is that unemployment will grow a bit more.
I think there are two factors that might prove these predictions wrong. Now, I don't see unemployment dropping dramatically, but I do think the prevalent view does not account for the increase in boomer retirements based on increase in equity values and the creation of jobs related to the entrepreneurial efforts of many of those who lost their jobs during the recession.
Many boomers have become retirement eligible but were unwilling to take the step as the value of their houses and equities collapsed last year. We have seen some significant recovery in the equity market and I believe it will continue, with minor corrections until the end of the year until the S&P reaches 1200 or so. In addition, we have seen the decline in home prices slow and start to reverse. Now, remember that prices are more deflated in some prime retirement areas than they are in the Northern States. Relatively speaking, if you have a house in the north, it is worth 20% less, but you can buy a house in Florida, Nevada or Arizona that is down almost 40%. As this fact becomes clearer to many retirement eligible boomers and they see that the monthly income they can get supports a good lifestyle, I believe the number of retirements will increase fairly dramatically.
The second factor is what I call the ingenuity factor. Many Americans are coming up with creative ideas on new business opportunities, and implementing them. As these ideas bear fruit we will see small companies start to build and hire. I believe a lot of this is already happening.
I know some of these trends will take time to develop fully, but I believe they have already started. I also think they are enough to keep the unemployment rate where it is now and will perhaps bring it down a few points.
I think there are two factors that might prove these predictions wrong. Now, I don't see unemployment dropping dramatically, but I do think the prevalent view does not account for the increase in boomer retirements based on increase in equity values and the creation of jobs related to the entrepreneurial efforts of many of those who lost their jobs during the recession.
Many boomers have become retirement eligible but were unwilling to take the step as the value of their houses and equities collapsed last year. We have seen some significant recovery in the equity market and I believe it will continue, with minor corrections until the end of the year until the S&P reaches 1200 or so. In addition, we have seen the decline in home prices slow and start to reverse. Now, remember that prices are more deflated in some prime retirement areas than they are in the Northern States. Relatively speaking, if you have a house in the north, it is worth 20% less, but you can buy a house in Florida, Nevada or Arizona that is down almost 40%. As this fact becomes clearer to many retirement eligible boomers and they see that the monthly income they can get supports a good lifestyle, I believe the number of retirements will increase fairly dramatically.
The second factor is what I call the ingenuity factor. Many Americans are coming up with creative ideas on new business opportunities, and implementing them. As these ideas bear fruit we will see small companies start to build and hire. I believe a lot of this is already happening.
I know some of these trends will take time to develop fully, but I believe they have already started. I also think they are enough to keep the unemployment rate where it is now and will perhaps bring it down a few points.
Wednesday, August 26, 2009
Paying for the future
Over the next few decades we are going to see a major transitional period in America. The primary element of this transition is the aging of the Baby Boomer generation and their movement into retirement and of course eventual reduction via natural causes.
One would like demographics to look like a pyramid with each age group being slightly less than the next younger group. This would lead to a fairly stable relationship between number of people in prime earning years, retirees and students. That sort of demographic would allow for an orderly approach to the various infrastructures required to support each group.
However, the baby boomers distorted that pyramid and in fact they will in some ways continue to distort it for quite a bit longer. In addition, advances in health care and life expectancy have compounded the problem, as the boomer generation is not only getting older, but can also be expected to live longer.
The problem with this is that we have set up social systems that require current workers to pay for the retirement benefits and medical benefits of those who are retired. We never wanted to tax the boomers enough to secure either Social Security or Medicare financially in the future.
So as the ratio of workers to retiree drops the current tax structure will be insufficient to fully fund these benefits. So, we are faced with three options, increase taxes, reduce benefits or increase debt. The first two options are very difficult to accomplish politically so we see the third option being implemented.
Is this a sustainable option? Ultimately it may be, but only over a very long time period. It is certainly predictable that in the future, the demographics may return to a better ratio and that the benefits paid drop below the taxes collected. At that point we could see debt reduced. However, this is so far in the future that the problem is supporting the debt for such a long time. Also, the debt itself creates an expense related to the interest payments required.
The only real solution is to balance the expenses and the taxes. Since cutting benefits is extremely difficult, and the amount that can be saved via efficiencies is simply not enough to balance the budget, we need to consider how to increase taxes.
This of course is unrelated to any further increase in Government outlays, simply based on the deficits that will be created supporting our current systems. This tax burden can not easily be borne by the smaller percentage of the population that is of working age and needs to be shared across the demographic spectrum.
I believe the most important thing we should be doing in this country is looking at ways to increase our tax base. I believe a consumption tax that replaces business taxes would lead to two things if applied appropriately, an increase in jobs in this country and an increase in tax revenues. If jobs increase, we will either get boomers to work longer or alternately, attract immigration of younger people who will share the burden. To increase jobs we need to reduce the cost of doing business in this country and further make sure that anyone selling product in this country pays a fair share of taxes.
One would like demographics to look like a pyramid with each age group being slightly less than the next younger group. This would lead to a fairly stable relationship between number of people in prime earning years, retirees and students. That sort of demographic would allow for an orderly approach to the various infrastructures required to support each group.
However, the baby boomers distorted that pyramid and in fact they will in some ways continue to distort it for quite a bit longer. In addition, advances in health care and life expectancy have compounded the problem, as the boomer generation is not only getting older, but can also be expected to live longer.
The problem with this is that we have set up social systems that require current workers to pay for the retirement benefits and medical benefits of those who are retired. We never wanted to tax the boomers enough to secure either Social Security or Medicare financially in the future.
So as the ratio of workers to retiree drops the current tax structure will be insufficient to fully fund these benefits. So, we are faced with three options, increase taxes, reduce benefits or increase debt. The first two options are very difficult to accomplish politically so we see the third option being implemented.
Is this a sustainable option? Ultimately it may be, but only over a very long time period. It is certainly predictable that in the future, the demographics may return to a better ratio and that the benefits paid drop below the taxes collected. At that point we could see debt reduced. However, this is so far in the future that the problem is supporting the debt for such a long time. Also, the debt itself creates an expense related to the interest payments required.
The only real solution is to balance the expenses and the taxes. Since cutting benefits is extremely difficult, and the amount that can be saved via efficiencies is simply not enough to balance the budget, we need to consider how to increase taxes.
This of course is unrelated to any further increase in Government outlays, simply based on the deficits that will be created supporting our current systems. This tax burden can not easily be borne by the smaller percentage of the population that is of working age and needs to be shared across the demographic spectrum.
I believe the most important thing we should be doing in this country is looking at ways to increase our tax base. I believe a consumption tax that replaces business taxes would lead to two things if applied appropriately, an increase in jobs in this country and an increase in tax revenues. If jobs increase, we will either get boomers to work longer or alternately, attract immigration of younger people who will share the burden. To increase jobs we need to reduce the cost of doing business in this country and further make sure that anyone selling product in this country pays a fair share of taxes.
Subscribe to:
Comments (Atom)