Looking Forward to Labor Day

As Labor Day approaches, the school year is off to the races.  Pardon my ignorance, but I figured this out standing in line at Rite-Aid this weekend.  There were throngs of kids buying pencils, backpacks, and colorful folders.  I just wanted a diet coke, but their angry parents wouldn’t let me cut in front of them.  We recently moved to the suburbs for the first time in our adult lives and it turns out “back to school” is quite the local event. 

As family vacations come to a close, Labor Day coincides with investors getting back to serious business each year.  Sadly, this holiday is the brain child of labor unions in the US.  Over a century ago, our government gave in to jealousy of foreign communists.  I enjoy my day off, so I won’t complain all that much.

The markets have found some solid ground to stand on over the past week and anxiety significantly subsided.  That doesn’t mean the roller coaster is over.  But chances are, market action will pick a direction fairly quickly and move with conviction. 

While we wait for this to happen, a few headlines piqued my interest today.

One of America’s serious economists writes serious nonsense here: http://www.tnr.com/article/economy/94275/shiller-infrastructure-debt-stimulus.  Why would he advocate raising taxes, then spending the funds on some sort of government labor pool?  I guess Dr. Shiller thought he would put a new twist on Keynesian economics, but this just sounds crazy.  Dropping money from helicopters on the masses would be a better solution to our current economic malaise.  Our private sector needs direct stimulus, not a new bureaucratic spending program.  Regardless, I don’t know any out of work mortgage brokers or car salesmen ready to pick up a shovel to dig ditches.  They would rather collect unemployment.

This story shows how the economy is healing itself in new and interesting ways: http://www.bloomberg.com/news/2011-08-30/grandma-bunks-with-jobless-kids-as-multigenerational-homes-surge.html.  Nobody likes living next to a multi-generational (communal) home with six cars in the driveway.  But people do what they must to survive.  Ironically, the communal living concept comes to us courtesy of communist states like China and the former USSR, just like Labor Day.

 

Economic Anxiety Ferris Wheel

As the market figures out a direction this week, let’s examine three headlines; each worrisome for different reasons:

Some very bright men opine on the Euro’s future here:  http://www.bloomberg.com/news/2011-08-21/el-erian-joining-feldstein-fels-on-prospect-of-euro-evolving-into-new-core.html.  If you want to be part of a union, strong partners must support weaker partners in times of need.  Partners in a union also work out compromises when they disagree.  Kicking the PIIGS (Portugal, Italy, Ireland, Greece, Spain) off the Euro currency presents a real potential shock to global markets and at this time the EU will likely sidestep this immense policy blunder.  To put this issue in perspective, most US citizens would love to be rid of “housing bubble and illegal immigration” states like Florida, Arizona and Nevada.  I leave out California because it’s simply too darn big and important to the US as a whole.  You could argue the “parasite” sates are dragging the dollar down with big budgets, falling tax revenue, and localized economic problems the folks in Illinois and Virginia just don’t care about.  You can see how this argument can quickly turn to political civil war and roil markets.

Warren Buffett’s tax rhetoric gains supporters: http://economix.blogs.nytimes.com/2011/08/23/what-the-rich-can-afford-in-income-tax/.  Bruce Bartlett is a conservative guy when it comes to economics.  Why is he talking about tax increases for the rich at a time when populist headlines are all the rage?  I won’t discuss the specific merits of his argument, but opening yet another pitch fork stand for angry villagers doesn’t seem like a great idea.  It is important to note that changes in the tax code represent a shift in the distribution of wealth–markets get depressed when this happens, no matter the direction of the shift.  Losers hate losing more than winners like winning: that’s basic behavioral economics. 

So ridiculous, it’s worrisome: http://www.marketwatch.com/Story/story/print?guid=CF3F1872-CCE9-11E0-BE2D-00212803FAD6.  The future is always scary, I agree.  Human civilization will successfully deal with the challenges a more populous planet Earth presents.  We are capable of immense innovation at an exponential rate relative to what we believe is possible today.  Gloom and doom stories like this about post-apocalyptic investment ideas are about as useful as umbrellas at Chernobyl.  if you feel inspired, don’t log into your Schwab account.  Go out and buy a Nissan Leaf with some roof-mounted solar panels.

Put Economic Growth Fears in Perspective

Volatility is back in equity markets today and headlines point to slowing economic growth across the globe.  First, the market is a discounter of known information.  If you understand that, you know GDP revisions by analysts and the same old stories about high unemployment don’t move stocks.  Second, volatility is normal; it’s why stocks earn a premium over other asset classes over time.  But guessing why stocks do what they do any given day is best left to fortune tellers.  Let’s take our eyes off today’s bleeding ticker and focus on economic data from the World Bank and IMF. 

Apparently European economic growth slowing may be contagious to the rest of the world.  The 27 nations of the European Union (EU) are no poster child for growth and haven’t been for a very long time.  2001-2010 EU real GDP growth was a “massive” 1.18% on average.  The trend doesn’t look good when you look at prior decades: 2.14% on average during the 1990s, 2.38% during the 1980s and 3.03% during the 1970s.   To provide some perspective, Asia ex-Japan and Emerging Markets GDP expanded 7.06% and 5.75% 2001-2010, respectively.  The US posted consistent showings in the low 3% range during the 70s, 80s and 90s.  US real GDP grew just 1.64% on average 2001-2010.

Economies can slow during expansions just like a stock can take a step back before heading to new highs.  Worries over the European Union’s economy are not new and add little credibility to global recession/depression fears.  Equity investors should build portfolios with powerful global exporters in mind.  This will help minimize exposure to structurally slowing economies and maximize exposure to the new engines of economic growth.

Real Clear Markets

http://www.realclearmarkets.com/ is an excellent site reposting the day’s headlines relevant to global markets from a variety of media outlets.  From time to time, I will repost articles I believe to be particularly relevant, impactful and/or ridiculous with my own commentary.  Here are a few: 

  1. Richard Salsman’s dog and pony show for a return to the gold standard: http://www.forbes.com/sites/richardsalsman/2011/08/16/gold-reagan-and-the-reds-from-degraded-dollar-to-downgraded-debt/3/.  Life is immitating art:  remember the movie “Lord of War,” where the African dictator asks the arms dealer character played by Nicholas Cage for a solid gold machine gun?  The 007 series also comes to mind with a shadowy New World Order set to control the globe’s currencies and natural resources.  I say ask the Treasury Department to hold endangered species as collateral for currency.  I think the dollar is worth its weight in black rhinos, giant pandas, and beluga sturgeons.  Caviar is the new black gold. 
  2. http://www.realclearmarkets.com/articles/2011/08/17/gov_rick_perrys_red-hot_bernanke_slam_99198.html.  A blurry picture is forming of the 2012 competition for leader of the free world.  Governor Perry says “Printing more money to play politics at this particular time in American history is almost treacherous, or treasonous, in my opinion.”  Mr. Perry is certainly no economist.  And Mitt Romney reminds me of John Kerry with a more obscure religious profile.  Doesn’t look like Barak and Michelle need to worry about packing up just yet.  Whether you approve of the President’s performance or not, Mr. Obama is more camera shy than he was during his first year.  What has he accomplished so far?  I recall something about healthcare reform and a promise to pull back from global conflicts; and oh yeah, he said he would fix the economy and create jobs.
  3. http://www.nytimes.com/2011/08/17/opinion/why-we-should-end-homeownership-subsidies.html?_r=2&ref=opinion.  The NYT proposes we kill GSEs Fannie and Freddie currently financing the vast majority of US home purchases at a time when private investors want to sit on the sidelines.  Let’s assume these are good ideas.  Unfortunately, stories like this are used by nasty politicians to argue for crazy notions like removing mortgage interest as a tax deduction.  This article says GSEs cost $700 billion in lost revenue over five years, whatever that statistical mumbo jumbo means.  That is the tiniest of fractions in relation to our aggregate spending on the military industrial complex.  Where would you rather cut?
  4. http://www.nakedcapitalism.com/2011/08/bank-of-america-death-watch-unloading-non-core-assets-aggressively.html.  This story would not be worth discussing were it not for what transpired in the US financial sector over 2008 and 2009.  Words sometimes equate to Chinese water torture.  Each word holds little weight, but add them up over time and Bank of America could end up in the hands of a competitor for pennies on the dollar.  There are only seven and a half dollars left as of this writing, so caveat emptor.  This is not some gloom and doom prediction, but confidence is key to market stability.  Just remember that Wall Street is even better at spreading rumors and manipulating feelings than making money and political contributions.

 

US vs Japan Continued

August 10 I wrote the topic of Japan has died down in the media of late: http://www.cardiffassetmanagement.com/blog/2011/08/10/japan-part-deux/.  It’s back with a vengeance.  Here’s a good article about structural issues faced by the Japanese economy relative to the US economy:  http://the-diplomat.com/2011/08/17/no-the-us-isn’t-japan/.  Please ignore all rhetoric on US financial regulation.

Gold = WMD

The last time I felt this way, the year was 2003.  Newsflash: Gold is the bubble; the new tech; the new real estate if you will.  Dinner parties, hair salons, and golf courses are awash with its glory.  I don’t mean to be arrogant, but when you hear people with very low IQs adopt a new trend as their own, the froth is forming.  Unfortunately, calling a top is an impossible task and stupidity can rule for very long periods of time.  Real estate roared for another three years post-2003 before contrarian views were vindicated. 

In a round about way, it’s safe to join the lunacy for now.  The bravest among us can move to a short position in 12 months using one of the many new ETFs created just for this purpose.  But enough about gambling, let’s get to the fundamentals driving the price of gold and its standing as an investment for the masses.  First, please examine the inflation-adjusted gold price chart below:

Gold is described as a hedge against government policy errors including rampant inflation, deflation, and general world collapse.  Taking inflation into account, we are approaching the peak of the inflationary, oil-shocked 1970s before Carter moved out of the White House.  The smart folks at Barclays Bank recently commented on the forces driving this trend: “First, a structural shift in macroeconomic insecurity on the back of the heightening of sovereign debt risks and credit downgrades,” Barclays said. “Second, the sharp acceleration of broad investment demand after a mostly absent (first half of 2011). And, third, central bank buying has returned and from new corners in sizeable tranches, a trend that is set to continue.”

Gold is a WMD in my view – a Weapon of Mass Destruction.  It would make more sense if all the world’s nuclear warheads were made of the lustrous metal.  Then it might be useful someday.  There are almost no real world uses for gold aside from its value as currency prior to the advent of paper money.  The same is true of nuclear weapons.  Nuclear weapons were useful 70 years ago when their still-limited power was more manageable in very few hands. 

A primary justification for the high price of gold today relative to other points in history is government hoarding.  It seems they worry that fiat currency may go the way of the buffalo.  Government debt crises aren’t helping.  But currency crises are nothing new – think back to 1998.  It’s pretty simple: governments will curb spending on entitlements and huge military programs or be removed from power.  They never plan to use their massive troves of nuclear warheads, and the same goes for their gold. 

Below I address the remaining reasons for the high price of gold: speculation, inflation/deflation, global economic collapse, and the collapse of the US Dollar (USD) as de facto currency of the world. 

  1. Speculation is alive and well.  The current trend has room to run, but sentiment shifts on a dime.  I hesitate betting against the trend for another 12-18 months.
  2. Emerging markets are busy making sure inflation will remain muted for decades to come.  Their cheap labor pool keeps consumer goods prices falling.  Meanwhile, their heavy use of commodities like oil and useful metals keeps deflation at bay.  As you can see, these forces are mostly a wash to the developed world. 
  3. So what of global economic collapse and depression?  Sure, it’s possible, but not likely.  If it does happen, you won’t need to worry about your stocks and bonds.  Since your gold is held in funds and electronic accounts, you won’t get a chance to touch it after our institutions collapse and your precious holdings are “reappropriated.”  If you are the type to hold the physical asset itself, the roaming militias or forces aligned with the new world dictator should take care of you.
  4. Finally, the hot topic of USD weakness.  It certainly took quite a fall on the world stage over the past decade.  This can be explained by low relative interest rates and rising economic competition from across the globe.  Keep in mind the falling USD has been a benefit to US investors in foreign securities and US corporations exporting goods abroad.  The trend did hurt US consumers traveling abroad and drove the cost of imports from other developed nations higher.  But the downward trend in USD has consolidated in the past three years.  The USD index (DXY) against a basket of major currencies barely budged during the most recent August stock market turmoil.  USD may yet push gold aside from the position of global reserve currency.  Keep an eye on the DXY index the remainder of 2011.  If it continues to move in the opposite direction of gold, 12-18 months may prove too long for gold prices to begin descending..

The Consumer Discretionary Sector: Nice Pair of “B”s

The Consumer Discretionary sector is important.  It makes up 10.55% of the S&P 500 Index including companies from industries such as media, retail, hotels, restaurants, leisure, textiles, apparel, luxury goods, household durables, automobiles, and other consumer services.  It came out of the economic storm of the past three years a shining star, rising an annualized 11.7% per year versus just 0.65% for all 500 stocks in the index and handily beating the remaining nine sectors.  Over the past 12 months, this sector has maintained its momentum and outperformed all others except Energy.

S&P 500 index sector breakdown courtesy of Standard & Poors as if August 15, 2011:
Sector Breakdown

Bulls on the stock market may simply choose to remain overweight the Consumer Discretionary sector within portfolios using a simple Exchange Traded Fund (ETF) like XLY.  Those with the desire and resources to attack portfolios with a scalpel, may choose to own individual securities within this sector. 

Best Buy Co., Inc. (Public, NYSE:BBY) and Bed Bath & Beyond Inc. (Public, Nasdaq:BBBY) are two companies investors visit during their weekend trip to the local strip mall.  Both are classified Consumer Discretionary stocks, but only one is currently in the good graces of investors and consumers alike.  BBBY is up 46% in 12 months and 10% year-to-date.  BBY is down 25% in 12 months and 28% year-to-date. 

One sells electronics and appliances to average Joes while the other sells infomercial novelties and various bed/bath trinkets.  The story isn’t too surprising, given that households have held off on durable goods purchases like TVs and washing machines.  Instead, they line up at BBBY to buy a $50 hand mixer or steak knife.  These impulse buys satisfy the consumer inside us without breaking the bank.  Given the massive divergence in performance, some may argue it’s time to switch gears and move from one position into the other.  

My last Saturday visit to BBBY wasn’t great: empty parking lot; shoppers in checkout line had very few items in their hands; too many gimmicky products.  I didn’t like what I saw at BBY either: empty stores; too much free financing shows weakness; terrible customer service both on the floor and within Geek Squad.  Management for the worse performer of the two, BBY, is no bunch of dummies.  They are capable of fixing what’s wrong as the market picks up for their products.  BBBY’s chart looks like Mt. Everest so perhaps it’s seen its best days, but fear of heights isn’t a great quality in an investor.  There is lots of room for debate here!

Plenty of investors remain sidelined and may not be ready for a Consumer Discretionary bet despite the overwhelming evidence presented by this sector’s performance over the past few years.  They may want to explore the sophisticated “pairs trade” commonly executed by institutional investors like hedge funds.  You simply buy one stock long and sell the other short in identical dollar amounts.  You buy the stock you think will outperform looking forward, and sell the one you think will lag.  Your net exposure to the sector and overall stock market remains zip, zero, zilch.  But you now benefit if the stock you like does better than the one you think is a dog.  This should be a fairly easy experiment to test out with a small portion of your portfolio.  It’s also a great way to stay active when you have an idea about two stocks, but wish to remain on the sidelines with respect to the sector or the stock market as a whole.

Middle Class – Hungry and Itching for Pre-Owned Wheels

Yesterday’s post Sector Weights and Limo Drivers provided a quick look at the hidden strength of middle class America.  On a same-store basis, Macy’s, Inc.’s (Public, NYSE:M) second quarter sales were up 6.4 percent.  Today, let’s look at three additional beacons of the middle class: Brinker International, Inc. (Public, NYSE:EAT), Darden Restaurants, Inc. (Public, NYSE:DRI), and CarMax, Inc. (Public, NYSE:KMX). 

Brinker is better known to you as 1,550 restaurants, mainly Chili’s.  Darden represents 1,894 restaurants, mainly Olive Garden and Red Lobster.  And CarMax operates 103 used car superstores in 49 markets.

The restaurant story is simple and that’s always best.  These stocks are beating sales and earnings growth expectations and more importantly outperforming the S&P 500 year-to-date and trailing 12 months.  Regular, working folks are voting with their feet by leaving the kitchen and lining up for a table at a nearby strip mall.

CarMax is a bit more complex.  Its outperformance of the S&P 500 isn’t all about the strength of used car sales versus new car sales.  The economy would certainly be stronger if consumers showed a greater willingness to buy new cars.  But given the success CarMax is seeing, let’s not get mad.  My firsthand experience with this business was nothing short of amazing. 

A few weeks ago I walked into a local San Diego CarMax.  I wanted to sell them my used car or at least get a reasonable quote.  I came ten minutes after they open doors on a random Wednesday.  I expected to wait another ten minutes for the appraisal.  After being greeted by a friendly member of the staff and explained the no haggle process, I knew things weren’t looking good.  The place was packed to the gills!  I had to wait for 45 minutes for the appraisal to be completed.  Was I angry?  No, I was amazed.  This business is successfully putting the shady used car lot out of business.  I would never buy a car there because they mark them up 20-30% over wholesale, but lots of people do.  The sales folks are friendly, the process is simple and the selection of cars is huge.  They keep margins high by taking the haggle out of the deal, offering three simple financing options at point of sale and paying just commission to most “sales” folks on their floor.  I chatted with a few folks and you will find remnants of the mortgage industry, new car dealers and other now-defunct industries in the CarMax HR files.  It’s amazingly rare to get an indepth look under the hood of a business from a single visit like this.

Bill Gross takes a shot at America, but misses

Interesting read from the Washing Post written by the most important man in the bond market, Bill Gross of PIMCO: http://www.washingtonpost.com/opinions/americas-debt-is-not-its-biggest-problem/2011/08/10/gIQAgYvE7I_story.html.  He makes a good point that Washington is focused on deficits when they should be worried about demand growth.  He asserts the U.S. economy could be constrained by nearsighted politicians, entitlements and deleveraging baby boomers.  As is to be expected of an ENORMOUS bond investor, he quietly pushes his agenda of long-term interest rates slowly moving to zero.  Bill Gross’ take on the stock market hasn’t been particularly prescient.  He misses the mark by failing to note the importance of thousands of thriving corporations catering to growing demand outside our small nation relative to the globe as a whole. 
 
If we take a break as consumers along with our Western European and Japanese counterparts, it may permit emerging economies to leap ahead with infrastructure projects and education.  This can in turn raise billions of human beings’ standard of living. 
 
It would behoove the developed countries to let the emerging world catch up a little to make the race to the economic top more fun.  This is not a zero sum game.  As the competition catches up, their ascent may offset a lot of populist hatred that gets easily converted to terror by despots and dictators.