Owner Earnings

HP/MP restored! But you're still hungry.

2009-10-17T05:51:00.000-04:00

Unanswered Question
I’m not convinced the recession is over, but for arguments sake lets assume it is. Why didn’t the stock market bottom lower than it did? Given the S&P 500 at 666 and assuming, generously, $60 earnings equals a PE of 10. That’s a much higher bottom than it’s bottomed before.

I believe there just isn’t enough pain out there. Or maybe more appropriately the pain isn’t being distributed properly. The bottom 17% of the US that is un or underemployed is receiving the majority of the pain. Of that 17% many of them are collecting generous unemployment benefits. Another good portion of them may have sizable savings to fall back on. This whole situation needs to be given more time before some serious pain is felt.

What are we fighting for?
How much of this stimulus money is being spent on something worth sustaining? Sustaining the finance industry in its current state is a complete waste of resources (time, oil). It’s becoming more and more obvious that the finance industry is a giant leach on the rest of the economy by sucking money out of it while increasing, not decreasing, the costs of capital. Sustaining the majority of the auto industry is a disappointment. I could understand sustaining and auto industry where everyone could afford to drive an Acura TL, but most of the cars produced are garbage that merely get you from point A to point B. Is that really what a driving experience is about? What’s the point of sustaining a farming industry that pays farmers to not produce? What’s the point of sustaining an airline industry that, after the first 3 hours that includes driving to the airport and going through security, after delays, takes 6 hours for a 3 hour plane ride? What's the point of sustaining state and local governments where politicians and high ranking or tenured emergency workers make 5 times as much as an average government worker but don’t add anywhere near 5 times the value, if any value. I hate for this whole rant to be viewed as a healthcare rant, but I’ll end by saying with all those problems the worst problem of all is that the US can’t even take care of its own people, medically. I hate to imagine how many children or young adults will never become Doctors and Engineers because either they themselves became ill or because someone in their family became ill and the financial problems associated with it prevented them from moving forward.

How’s this going to play out, economically?
When you think about it it’s all very simple. Especially when you throw out what needs to be done or what should be done and just face the facts as to what will actually be done. The government is going to keep trying to stimulate the economy because that’s what the majority of voters want. The government won’t be able to afford to pay it’s debt when they come do so they’ll have to print the money to pay for them. Interest rates will go up as a result. Certain commodity prices will go up as a result. The quality of life for many Americans will decline.

Are prices YOU pay increasing or decreasing?
I’m talking about prices you actually pay. Not some government estimate. One example is not enough to make a conclusion about, so here are few examples.

Price decrease wise (aka Deflation, but a decline in the money supply really Deflation), here is what I see:

Total spending on natural gas used for residential heating will be as much as 50% lower than 2008.
Monthly rental prices for residential apartments have come down almost 20% in some very livable locations near me.
Many restaurants have been offering some sort of coupon.
The cost of high quality chicken and beef at the grocery store has declined almost 20%.
When on sale, which used to be only a Christmas time, the cost of dress clothes at department stores are the lowest in 5 years.
When on sale, which used to be never, the cost of power tools has decreased to the lowest in at least 4 years.
The price of televisions, although hard to measure because of increasing technology, has decreased 5% from last year.
Home prices continue to decline in my area. Considering that such a high percentage of someone's expenses that offsets a lot of price increases.
When on sale, which this is the first year I’ve seen them on sale, middle class lawnmowers are about 20% lower than the prices on the 2007 models.
Cement construction (aka cement driveways) are about 20% lower than 2008 prices.

Price increase wise (aka Inflation, but Inflation is technically an increase in the money supply such as the increase in the Federal Reserves balance sheet), here is what I see:

Trash removal costs have gone up. However the trash company advised that the increase was a direct result of passing on higher land fill taxes to the consumer.
Another increase due to higher taxes: Registration costs for automobiles have gone up.
Electricity distribution costs have gone up. For the time being this has been offset by the lower cost of the electricity itself.
Home owner’s insurance rates have increased; possibly because less people are actually paying their insurance.

Prices that have not gone down.

Gasoline. I don’t see any reason for it to go down for a sustained period of time either. It’s simply going to cost a lot more money to extract new oil to replace the oil currently being pumped.
Healthcare. Of the people that have money and/or jobs, they simply have more money available to spend on healthcare. More money chasing the same amount of resources leads to higher prices. Not to mention the inefficiencies of insurance, which easily increases the price.
The decline in rent and house prices doesn’t help most people. Only 40% of the population either rents or has a mortgage that they can walk away from.

Thoughts

Much sooner than later the supply of treasury bonds will be too big for the current group of bond investors to buy and the natural way to entice other investors to buy them will be for the rates to go up. However, the Fed can simply step in themselves to buy the bonds or they could do some unnatural things like make the interest on treasuries tax free. Lately the Fed is doing all kinds of unnatural things to prevent rates from going up (like all these bailouts, without the bailouts rates would be much much higher right now) so it’s very hard to say if the rates will actually go up.

So should rates go up? Naturally they should. Will the Fed do something unnatural to keep them down? Probably. How well will it work? I think the 10 year treasury could go to 4.5% from 3.5% now, but at 4.5% the Fed will really start doing some unnatural things to keep it from going any higher.

If rates do go up that will be one more deflationary thing on what's turning out to be a long list of deflationary things: High unemployment, reduced hourly wage rates (unless you make minimum wage, in which case your pay actually went up), reduced hours per work week, reduced equity value in your house, reduced equity value in your stock investments (401k etc.), high gas prices in relation to prices from just a few years ago (2005), reduced credit availability, higher tax rates (especially state taxes in CA and NY), lower tax revenue, reduced income from interest bearing investments (this really hurts people that live on a fixed income from CD’s etc).

In regards to inflation, I just don’t see how it’s possible except for oil. In 2007 the US produced 15 million cars. In 2009 it looks like the US will produce 10 million. That means there is enough spare capacity to build 5 million more cars. Until that spare capacity is used up the auto makers will have a tough time increasing prices. This is the same for housing. There are millions of vacant houses out there. Until those houses are sold it will be very tough for house prices to go up. In regards to farming, it has one of the lowest barriers to entry so quite a few of these unemployed people will take up some sort of farming, which will reduce demand at the grocery store, which will entice grocery stores to reduce prices to increase demand. In regards to going out to eat, there are simply too many restaurants and not enough people that can afford to go out to eat anymore. You’ll notice all kinds of coupons and all you can eat gimmicks enticing people to go out to eat. Again, prices will have a tough time going up until people start going out to eat without needing a coupon to entice them. Clothing stores, especially the high end/mall type stores, are having an even harder time than restaurants, because at least if you go out to eat you satisfy a need (aka you need to eat). There is no need for high end clothing stores. Just read the latest Abercrombie & Fitch quarterly earnings release to hear how much things have declined in retail clothing. Also check out the latest Caterpillar Tractor earnings report to see how drastically thing have declined in the industrial equipment industry. Their revenue is down 47% if I remember correctly. This has a lot to do with residential house, but also because of commercial real estate. There is so much excess commercial real estate that rents are declining in an attempt to entice renters to rent more/fancier space. This caused General Growth Properties to miss their debt payment and forced them to file for bankruptcy. Most commercial real estate companies will experience the same problem as General Growth Properties, aka having so much debt that even a slight decline in revenue (from reducing rent rates and/or a decline in occupied capacity) leaves them without enough money to make their debt payment. All of these things lead to a decrease in tax revenue, although not necessarily a decrease in the tax rate as many states/cities have raised their income and/or sales tax rates. Except for oil, it’s going to be very difficult to get inflation under those conditions. Naturally, the price of oil should go down under those conditions, but it won’t take much to have a supply shock that could cause prices to go up drastically and that would really sink the economy.
Did I forget to mention the consumer and all the problems the consumer has?
China

At first glance you would think that there are better investment opportunities out there for China, but when you look closer you realize they really have no choice. If they don’t buy the US bonds then the interest rates on Treasuries will rise, which will set off a chain reaction of increasing interest rates with the end result of even lower house prices (as if they won’t go lower anyways).

The amount of treasuries is already larger than the amount of money current buyers (including China) have. That is why the Fed is buying Treasury bonds and mortgage bonds. So the question becomes under what circumstances can the Fed no longer afford to buy the bonds? Some of those circumstances would be that buying more bonds causes either oil prices or interest rates to rise.

Unfortunately, all things financial can be delayed for a very long time. Those levy’s in New Orleans lasted for decades. So the point when the Fed can’t afford to buy bonds may be years away.

At some point the deflation will be obvious enough that interest rates will decline (in fact we may be seeing that now with interest bearing investments that mature in less than 12 months), however I think it will take higher interest rates (10 Year treasury at 4.5%) to spark the chain reaction of events that leads to events that will create blatantly obvious deflation.

China is very cleverly getting rid of dollars right in front of our eyes. They are doing it by offering to pay drastically more for natural resources than any other rational investor would. Problem for China is very few countries are allowing China to become major investors. At some point these countries will have no choice because they’ll need the money. As with all things financial that could take years.

Bottom line, leave your money in investment grade corporate bonds while you’re waiting around for things to happen. In the short run, you may not make as much money as speculating in the stock market. In the long run, things will be a different story.

A list of things that the government has done to prevent (delay) a depression:

Banned short selling.
Eliminated minimum listing requirement for stocks on the NYSE
Eliminated mark to market.
Allowed Vikram Pandit to send a memo saying (lying?) that things were going well back in March. The rally started shortly after.
Reduced interest rates to 0%.
Extended unemployment benefits.
Running a $1 trillion budget deficit.
Reduced finance rates for banks via the Discount Window.
Bailed out Fannie Mae
Bailed out Feddie Mac
Bailed out AIG
Bailed out GM, though temporarily
Bailed out Chrysler, though temporarily
FDIC has spent billions closing down insolvent banks
Credit of $8,000 first time home buyers credit.
Credit of $4,500 via Cash for clunkers.
Credit of $600 via a rebate check.
Guaranteed $250,000 bank account balances via FDIC, up from $100,000
Guaranteed financial bonds
Guaranteed money market accounts
Guaranteed Bear Stearns assets
Bought preferred stock in financial companies
Bought agency bonds
Bought Treasuries

A list of things that the government has yet to do, but probably will do:

Bail out State governments (Bond guarantee?)
Bail out Local governments (Bond guarantee?)
Guarantee health care (which I would approve of)
Raise taxes (The republicans will try to force democrats to admit it before the 2010 election. The democrats will have to admit it once the 2010 election is over.)
Significant devaluation of the dollar. This is already playing out compared to the emerging markets, but will begin to play out more against the Euro and the Yen.
Significant reduction in Social Security and/or Medicare benefits.
Allow companies and or officials to either avoid telling the truth and/or flat out lie.
Manipulate or stop providing data that shows how bad things are. Transparency anyone?

Reviewing The Previous 6 Months Forecast and Updating it for the Next 6 Months

There isn’t much point to having a forecast if you don’t monitor it and acknowledge when you’re wrong. Half way through the year this is where things stand:

Original Forecast: I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.
- That has happened. The 10 year treasury currently stands a 3.54%. I think it will continue to increase over the next six months. China, Pensions, and Individual Investors simply don’t have the money to buy all the treasuries. And of course now that the stock market is going up Pensions and Individual Investors are looking to take more risk.
Original Forecast: As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.
- That hasn’t exactly happened. However, I believe the 10 year treasury will continue to increase to the 4.5-5% range. I don’t think it will go much further than that because mortgage rates will begin to increase and the Fed will be forced to increase its “buyback program.” Not to mention there simply isn’t enough private wealth being created (people producing more than they are consuming) to buy all these treasury bonds. Sure, as a % of debt to GDP there are other countries worse off, but the size of their economies are much smaller than the US. I think the % of debt to GDP takes a back seat to the issue of the total size of the debt the US is issuing.
Original Forecast: The inflationary result of this will be seen mostly in oil.
- That has happened. Oil currently stands at $64.99 a barrel. (I believe they are 40 gallon barrels, no?) It is possible that an international conflict could arise, especially since, from what I’ve read, Iran is roughly 6 months away from developing a nuclear weapon. Can issues like this really be factored in? I think they should. So the way I’ll factor that in is by adding the international conflict issue to the list of reasons why stocks are overvalued. As far as the oil goes, an international conflict would increase the price drastically, but it wouldn’t last more than a few months. So barring an international conflict, I believe that oil will slowly decline over the next 6 months to the $45 range. I think it will decline because there is simply more supply than demand. However at $45 I believe that demand does increase and supply does decrease. From what I’ve read, the variable cost to deliver oil is roughly $25. So $25 would be the ultimate floor, but I think that is unlikely in the next 6 months, but possible in the next 18 months.
Original Forecast: There won’t be much inflation in food.
- There hasn’t been much inflation in food. I’m not certain the best way to measure it, but I haven’t noticed many headlines about food inflation nor have I noticed any price increase at the grocery store. (Though that is very hard to measure) My farming contacts have advised me that grain prices have declined quite a bit in the past few weeks. Going forward I think food prices, especially end user prices, will continue to decline. People simply can’t afford to waste food they way they used to so demand will be down. Farming has one of the lowest barriers to entry so supply will be up. Food processors had raised prices during the inflationary times of 2008 and have yet to fully roll them back, not to mention that they will be reducing prices to offset the loss of demand.
Original Forecast: Real estate will continue to decline.
- That has happened, especially in commercial real estate. I believe both residential and commercial real estate will continue to decline, probably for years unless some event causes a major decline in the next 6 months. Real estate isn’t as liquid as the stock market so it takes more time for the true prices to be uncovered. There is simply too much supply and not enough demand. (At least not enough demand from people that can actually afford to buy.) Not only are there a bunch of vacant houses and apartments, but many houses are large enough for more than one generation to cohabitate. It should be no surprise that more and more families have more than one generation living in the same location. They simply can’t afford to do otherwise.
Original Forecast: Natural gas prices will continue to decline.
- That has happened. Prices are a little under $4 for the next month’s delivery. I’m not sure how much further they can decline because the variable costs start to become higher than $4/mcf. I don’t think they’ll decline much further than that, though I think it will be possible to see $4/mcf even during the winter months. Anecdotally I can tell you that many rigs have been shut down with the hopes of starting them back up in 6 months.
Original Forecast: Higher oil prices will force the consumer to reduce spending further.
- That isn’t really much of a forecast. Going forward I will reword that to say “Consumers will continue to reduce spending.” That has happened. I believe it will continue to happen especially since millions of unemployed will be losing their unemployment benefits. How exactly that is going to play out should be interesting. I’d hate to be president of a country that has more unemployed young males than personnel enrolled in the military. That’s grounds for some real change, which may include some violence, but hopefully minimal death. What's more is that many people are underemployed and those that had any saving have seen it decline because of the declines in the stock market and the real estate market. Not to mention the retirees living off the interest on their bonds are receiving less money. To top it off, credit has been drastically scaled back. To sum it all up, people simply don’t have the money or the credit to keep spending.
Original Forecast: Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.
- The most important forecast of all and I have been wrong. I’m disappointed that I didn’t factor in one of the most basic rules of all time: The market can be irrational longer than you can be solvent. I still believe that stocks are overvalued. I think they’ve gotten more overvalued. However the heard thinks otherwise and they want (need) to think otherwise in order to avoid depression. (Both economically and psychologically.) Over the next 6 months, even after factoring in irrational investors, I think the stock market will be flat. Fundamentally, stocks are overvalued and the more time that goes by the more investors will realize this. That won’t be the main reason stocks decline though. It will be because investors won’t be able to afford to prop it up any longer. (The Government included.) People will be forced to cash out their investments in order to pay their living expenses. The government will be forced by higher interest rates on Treasuries to reduce the budget deficit. The only investors left to buy will be investors such as myself that aren’t willing to pay current prices. This is going to take longer than 6 months to play out. Especially since the government has a vested interest in keeping stock prices high for both social and economic reasons. So, unfortunately, over the next 6 months stock prices may be flat or decline 15% at most. Investors will probably get all excited about the results of the 3rd quarter, but towards the end of the 4th quarter reality will set in. The reality will be that a double dip recession is on the horizon and the Government can’t afford to do much about it because the Treasury rates are prohibitive. Not sure if that would be a checkmate or a stalemate. So over the next 24 months, as people consume more than they produce, the stock market could (should) fall much further.

Fundamentals vs. Everything Else
I’m not sure if a discussion on fundamentals is even worth having. That’s not a new phenomenon. For as long as I can remember the stock market has been over priced only to get more over priced. The real phenomenon occurred in March when stocks were actually on their way to being fairly priced. Holding investment grade corporate bonds while waiting around for stocks to become cheap may not appear to be the best idea in the short run, but the long run, or as Hussman calls it “the full cycle” is what counts.

Economic and Stock Market Forecast

I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.

Supporting Arguments:

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Opposing Arguments:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year (Updated 20090807)

The recession to last all through 2009. (Does 1 quarter of positive GDP end a recession?)
State and local governments continue to reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package in 2010 that focuses on rebuilding the US.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it. I doubt March 2009 was it.
Big name retailer declaring chapter 11 if not 7.
Big name home builder declaring chapter 11 if not 7.
Big name mortgage insurer declaring chapter 11 if not 7.
Big name airline declaring chapter 11 if not 7.
Big name regional bank declaring chapter 11 if not 7.
Big name casino declaring chapter 11 if not 7.
Home prices to continue declining.
Increased savings.
Decreased spending.
Unemployment to rise to 10% (That’s a HUGE number)
Very few Private Equity buyouts.
Underfunded unemployment trusts.
Very few IPO’s.

Things to Anticipate that Happened (Updated 20090807)

Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late. Looks like that answer to this one is too much liquidity and it’s all in the banking industry.
Car manufactures did go bankrupt, but no one else significant has since Lehman.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt. You see this especially in the REIT industry and the banking industry.
All time low interest rates. Happened as of 3-25-09.
No IPO’s. There have been very few IPO’s. Happened as of 20090807.
Net earnings on the S&P 500 to be $25. Happened as of 20090807.
No Private Equity buyouts. Happened as of 20090807

Things to Anticipate that Didn’t Happen (Updated 20090807)

Borderline depression near the middle of 2009 if things get worse than the current trajectory. Didn’t happen as of 20090807.
GDP to decline 5%. More like 3%. Didn’t happen as of 20090807.
Limited corporate bond issuance. Things seem to be fine in the IB area. Didn’t happen as of 20090807.
Underfunded unemployment trusts. Didn’t happen as of 20090807.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and airlines all going bankrupt at the same time, their stocks and bonds go to zero, and they start over. Didn’t happen as of 20090807.

Things to Anticipate of the Next Decade

Under funded Medicare (Federally Run) and probably more pressing Medicaid (State Run).

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

Best Type of Investments As of 20090807

5 to 10 year corporate bonds of non financial companies that have significant amounts of cash and/or consistent revenue streams.
Cash

Which Companies Will Be The First To Go Bankrupt?

Naturally, it would be companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments. However, we know nothing happens naturally with as many politicians as there are living in the US.

Quotes

Unknown: “The more things change the more they stay the same.” The new sound, just like the old sound.
Someone from the beginning of time: “A bird in the hand is worth 2 in the bush.”
JFK: “A nation that is afraid to let its people judge the truth and falsehood in an open market is a nation that is afraid of its people.” China? US in regards to the Fed?
LeFevre, Edwin (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Einstein, Albert: "Never expect the people who caused a problem to solve it."
Munger, Charlie: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
Morrow, George:"When you’re a little guy operating out of a garage, you pay all your own bills.
When you get a bit more successful you get a line of credit, and the bank starts paying your bills.
When you get even more successful your vendors start paying your bills.
When you get even more successful venture capitalists pay your bills.
When you go public then the public starts paying your bills.
Then when you reach the pinnacle of success – insert your favorite government run company – you’re so successful that you can’t be allowed to fail, and the government starts paying your bills."
Chuck Prince “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” FT July 2007.

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Chain reaction of events that leads to blatantly obvious...

2009-08-24T17:17:00.000-04:00

Thoughts

Much sooner than later the supply of treasury bonds will be too big for the current group of bond investors to buy and the natural way to entice other investors to buy them will be for the rates to go up. However, the Fed can simply step in themselves to buy the bonds or they could do some unnatural things like make the interest on treasuries tax free. Lately the Fed is doing all kinds of unnatural things to prevent rates from going up (like all these bailouts, without the bailouts rates would be much much higher right now) so it’s very hard to say if the rates will actually go up.

So should rates go up? Naturally they should. Will the Fed do something unnatural to keep them down? Probably. How well will it work? I think the 10 year treasury could go to 4.5% from 3.5% now, but at 4.5% the Fed will really start doing some unnatural things to keep it from going any higher.

If rates do go up that will be one more deflationary thing on what's turning out to be a long list of deflationary things: High unemployment, reduced hourly wage rates (unless you make minimum wage, in which case your pay actually went up), reduced hours per work week, reduced equity value in your house, reduced equity value in your stock investments (401k etc.), high gas prices in relation to prices from just a few years ago (2005), reduced credit availability, higher tax rates (especially state taxes in CA and NY), lower tax revenue, reduced income from interest bearing investments (this really hurts people that live on a fixed income from CD’s etc).

In regards to inflation, I just don’t see how it’s possible except for oil. In 2007 the US produced 15 million cars. In 2009 it looks like the US will produce 10 million. That means there is enough spare capacity to build 5 million more cars. Until that spare capacity is used up the auto makers will have a tough time increasing prices. This is the same for housing. There are millions of vacant houses out there. Until those houses are sold it will be very tough for house prices to go up. In regards to farming, it has one of the lowest barriers to entry so quite a few of these unemployed people will take up some sort of farming, which will reduce demand at the grocery store, which will entice grocery stores to reduce prices to increase demand. In regards to going out to eat, there are simply too many restaurants and not enough people that can afford to go out to eat anymore. You’ll notice all kinds of coupons and all you can eat gimmicks enticing people to go out to eat. Again, prices will have a tough time going up until people start going out to eat without needing a coupon to entice them. Clothing stores, especially the high end/mall type stores, are having an even harder time than restaurants, because at least if you go out to eat you satisfy a need (aka you need to eat). There is no need for high end clothing stores. Just read the latest Abercrombie & Fitch quarterly earnings release to hear how much things have declined in retail clothing. Also check out the latest Caterpillar Tractor earnings report to see how drastically thing have declined in the industrial equipment industry. Their revenue is down 47% if I remember correctly. This has a lot to do with residential house, but also because of commercial real estate. There is so much excess commercial real estate that rents are declining in an attempt to entice renters to rent more/fancier space. This caused General Growth Properties to miss their debt payment and forced them to file for bankruptcy. Most commercial real estate companies will experience the same problem as General Growth Properties, aka having so much debt that even a slight decline in revenue (from reducing rent rates and/or a decline in occupied capacity) leaves them without enough money to make their debt payment. All of these things lead to a decrease in tax revenue, although not necessarily a decrease in the tax rate as many states/cities have raised their income and/or sales tax rates. Except for oil, it’s going to be very difficult to get inflation under those conditions. Naturally, the price of oil should go down under those conditions, but it won’t take much to have a supply shock that could cause prices to go up drastically and that would really sink the economy.
Did I forget to mention the consumer and all the problems the consumer has?
China

At first glance you would think that there are better investment opportunities out there for China, but when you look closer you realize they really have no choice. If they don’t buy the US bonds then the interest rates on Treasuries will rise, which will set off a chain reaction of increasing interest rates with the end result of even lower house prices (as if they won’t go lower anyways).

The amount of treasuries is already larger than the amount of money current buyers (including China) have. That is why the Fed is buying Treasury bonds and mortgage bonds. So the question becomes under what circumstances can the Fed no longer afford to buy the bonds? Some of those circumstances would be that buying more bonds causes either oil prices or interest rates to rise.

Unfortunately, all things financial can be delayed for a very long time. Those levy’s in New Orleans lasted for decades. So the point when the Fed can’t afford to buy bonds may be years away.

At some point the deflation will be obvious enough that interest rates will decline (in fact we may be seeing that now with interest bearing investments that mature in less than 12 months), however I think it will take higher interest rates (10 Year treasury at 4.5%) to spark the chain reaction of events that leads to events that will create blatantly obvious deflation.

China is very cleverly getting rid of dollars right in front of our eyes. They are doing it by offering to pay drastically more for natural resources than any other rational investor would. Problem for China is very few countries are allowing China to become major investors. At some point these countries will have no choice because they’ll need the money. As with all things financial that could take years.

Bottom line, leave your money in investment grade corporate bonds while you’re waiting around for things to happen. In the short run, you may not make as much money as speculating in the stock market. In the long run, things will be a different story.

A list of things that the government has done to prevent (delay) a depression:

Banned short selling.
Eliminated minimum listing requirement for stocks on the NYSE
Eliminated mark to market.
Allowed Vikram Pandit to send a memo saying (lying?) that things were going well back in March. The rally started shortly after.
Reduced interest rates to 0%.
Extended unemployment benefits.
Running a $1 trillion budget deficit.
Reduced finance rates for banks via the Discount Window.
Bailed out Fannie Mae
Bailed out Feddie Mac
Bailed out AIG
Bailed out GM, though temporarily
Bailed out Chrysler, though temporarily
FDIC has spent billions closing down insolvent banks
Credit of $8,000 first time home buyers credit.
Credit of $4,500 via Cash for clunkers.
Credit of $600 via a rebate check.
Guaranteed $250,000 bank account balances via FDIC, up from $100,000
Guaranteed financial bonds
Guaranteed money market accounts
Guaranteed Bear Stearns assets
Bought preferred stock in financial companies
Bought agency bonds
Bought Treasuries

A list of things that the government has yet to do, but probably will do:

Bail out State governments (Bond guarantee?)
Bail out Local governments (Bond guarantee?)
Guarantee health care (which I would approve of)
Raise taxes (The republicans will try to force democrats to admit it before the 2010 election. The democrats will have to admit it once the 2010 election is over.)
Significant devaluation of the dollar. This is already playing out compared to the emerging markets, but will begin to play out more against the Euro and the Yen.
Significant reduction in Social Security and/or Medicare benefits.
Allow companies and or officials to either avoid telling the truth and/or flat out lie.
Manipulate or stop providing data that shows how bad things are. Transparency anyone?

Original Forecast: I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.
- That has happened. The 10 year treasury currently stands a 3.54%. I think it will continue to increase over the next six months. China, Pensions, and Individual Investors simply don’t have the money to buy all the treasuries. And of course now that the stock market is going up Pensions and Individual Investors are looking to take more risk.
Original Forecast: As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.
- That hasn’t exactly happened. However, I believe the 10 year treasury will continue to increase to the 4.5-5% range. I don’t think it will go much further than that because mortgage rates will begin to increase and the Fed will be forced to increase its “buyback program.” Not to mention there simply isn’t enough private wealth being created (people producing more than they are consuming) to buy all these treasury bonds. Sure, as a % of debt to GDP there are other countries worse off, but the size of their economies are much smaller than the US. I think the % of debt to GDP takes a back seat to the issue of the total size of the debt the US is issuing.
Original Forecast: The inflationary result of this will be seen mostly in oil.
- That has happened. Oil currently stands at $64.99 a barrel. (I believe they are 40 gallon barrels, no?) It is possible that an international conflict could arise, especially since, from what I’ve read, Iran is roughly 6 months away from developing a nuclear weapon. Can issues like this really be factored in? I think they should. So the way I’ll factor that in is by adding the international conflict issue to the list of reasons why stocks are overvalued. As far as the oil goes, an international conflict would increase the price drastically, but it wouldn’t last more than a few months. So barring an international conflict, I believe that oil will slowly decline over the next 6 months to the $45 range. I think it will decline because there is simply more supply than demand. However at $45 I believe that demand does increase and supply does decrease. From what I’ve read, the variable cost to deliver oil is roughly $25. So $25 would be the ultimate floor, but I think that is unlikely in the next 6 months, but possible in the next 18 months.
Original Forecast: There won’t be much inflation in food.
- There hasn’t been much inflation in food. I’m not certain the best way to measure it, but I haven’t noticed many headlines about food inflation nor have I noticed any price increase at the grocery store. (Though that is very hard to measure) My farming contacts have advised me that grain prices have declined quite a bit in the past few weeks. Going forward I think food prices, especially end user prices, will continue to decline. People simply can’t afford to waste food they way they used to so demand will be down. Farming has one of the lowest barriers to entry so supply will be up. Food processors had raised prices during the inflationary times of 2008 and have yet to fully roll them back, not to mention that they will be reducing prices to offset the loss of demand.
Original Forecast: Real estate will continue to decline.
- That has happened, especially in commercial real estate. I believe both residential and commercial real estate will continue to decline, probably for years unless some event causes a major decline in the next 6 months. Real estate isn’t as liquid as the stock market so it takes more time for the true prices to be uncovered. There is simply too much supply and not enough demand. (At least not enough demand from people that can actually afford to buy.) Not only are there a bunch of vacant houses and apartments, but many houses are large enough for more than one generation to cohabitate. It should be no surprise that more and more families have more than one generation living in the same location. They simply can’t afford to do otherwise.
Original Forecast: Natural gas prices will continue to decline.
- That has happened. Prices are a little under $4 for the next month’s delivery. I’m not sure how much further they can decline because the variable costs start to become higher than $4/mcf. I don’t think they’ll decline much further than that, though I think it will be possible to see $4/mcf even during the winter months. Anecdotally I can tell you that many rigs have been shut down with the hopes of starting them back up in 6 months.
Original Forecast: Higher oil prices will force the consumer to reduce spending further.
- That isn’t really much of a forecast. Going forward I will reword that to say “Consumers will continue to reduce spending.” That has happened. I believe it will continue to happen especially since millions of unemployed will be losing their unemployment benefits. How exactly that is going to play out should be interesting. I’d hate to be president of a country that has more unemployed young males than personnel enrolled in the military. That’s grounds for some real change, which may include some violence, but hopefully minimal death. What's more is that many people are underemployed and those that had any saving have seen it decline because of the declines in the stock market and the real estate market. Not to mention the retirees living off the interest on their bonds are receiving less money. To top it off, credit has been drastically scaled back. To sum it all up, people simply don’t have the money or the credit to keep spending.
Original Forecast: Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.
- The most important forecast of all and I have been wrong. I’m disappointed that I didn’t factor in one of the most basic rules of all time: The market can be irrational longer than you can be solvent. I still believe that stocks are overvalued. I think they’ve gotten more overvalued. However the heard thinks otherwise and they want (need) to think otherwise in order to avoid depression. (Both economically and psychologically.) Over the next 6 months, even after factoring in irrational investors, I think the stock market will be flat. Fundamentally, stocks are overvalued and the more time that goes by the more investors will realize this. That won’t be the main reason stocks decline though. It will be because investors won’t be able to afford to prop it up any longer. (The Government included.) People will be forced to cash out their investments in order to pay their living expenses. The government will be forced by higher interest rates on Treasuries to reduce the budget deficit. The only investors left to buy will be investors such as myself that aren’t willing to pay current prices. This is going to take longer than 6 months to play out. Especially since the government has a vested interest in keeping stock prices high for both social and economic reasons. So, unfortunately, over the next 6 months stock prices may be flat or decline 15% at most. Investors will probably get all excited about the results of the 3rd quarter, but towards the end of the 4th quarter reality will set in. The reality will be that a double dip recession is on the horizon and the Government can’t afford to do much about it because the Treasury rates are prohibitive. Not sure if that would be a checkmate or a stalemate. So over the next 24 months, as people consume more than they produce, the stock market could (should) fall much further.

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Opposing Arguments:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year (Updated 20090807)

The recession to last all through 2009. (Does 1 quarter of positive GDP end a recession?)
State and local governments continue to reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package in 2010 that focuses on rebuilding the US.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it. I doubt March 2009 was it.
Big name retailer declaring chapter 11 if not 7.
Big name home builder declaring chapter 11 if not 7.
Big name mortgage insurer declaring chapter 11 if not 7.
Big name airline declaring chapter 11 if not 7.
Big name regional bank declaring chapter 11 if not 7.
Big name casino declaring chapter 11 if not 7.
Home prices to continue declining.
Increased savings.
Decreased spending.
Unemployment to rise to 10% (That’s a HUGE number)
Very few Private Equity buyouts.
Underfunded unemployment trusts.
Very few IPO’s.

Things to Anticipate that Happened (Updated 20090807)

Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late. Looks like that answer to this one is too much liquidity and it’s all in the banking industry.
Car manufactures did go bankrupt, but no one else significant has since Lehman.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt. You see this especially in the REIT industry and the banking industry.
All time low interest rates. Happened as of 3-25-09.
No IPO’s. There have been very few IPO’s. Happened as of 20090807.
Net earnings on the S&P 500 to be $25. Happened as of 20090807.
No Private Equity buyouts. Happened as of 20090807

Things to Anticipate that Didn’t Happen (Updated 20090807)

Borderline depression near the middle of 2009 if things get worse than the current trajectory. Didn’t happen as of 20090807.
GDP to decline 5%. More like 3%. Didn’t happen as of 20090807.
Limited corporate bond issuance. Things seem to be fine in the IB area. Didn’t happen as of 20090807.
Underfunded unemployment trusts. Didn’t happen as of 20090807.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and airlines all going bankrupt at the same time, their stocks and bonds go to zero, and they start over. Didn’t happen as of 20090807.

Things to Anticipate of the Next Decade

Under funded Medicare (Federally Run) and probably more pressing Medicaid (State Run).

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

Best Type of Investments As of 20090807

5 to 10 year corporate bonds of non financial companies that have significant amounts of cash and/or consistent revenue streams.
Cash

Which Companies Will Be The First To Go Bankrupt?

Naturally, it would be companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments. However, we know nothing happens naturally with as many politicians as there are living in the US.

Quotes

Unknown: “The more things change the more they stay the same.” The new sound, just like the old sound.
Someone from the beginning of time: “A bird in the hand is worth 2 in the bush.”
JFK: “A nation that is afraid to let its people judge the truth and falsehood in an open market is a nation that is afraid of its people.” China? US in regards to the Fed?
LeFevre, Edwin (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Einstein, Albert: "Never expect the people who caused a problem to solve it."
Munger, Charlie: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
Morrow, George:"When you’re a little guy operating out of a garage, you pay all your own bills.
When you get a bit more successful you get a line of credit, and the bank starts paying your bills.
When you get even more successful your vendors start paying your bills.
When you get even more successful venture capitalists pay your bills.
When you go public then the public starts paying your bills.
Then when you reach the pinnacle of success – insert your favorite government run company – you’re so successful that you can’t be allowed to fail, and the government starts paying your bills."
Chuck Prince “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” FT July 2007.

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

A list of things that the Government has done to prevent (delay) a Depression

2009-08-07T19:01:00.000-04:00

Thoughts

How many large companies (even entire industries), either by terms of revenue or employees, are on the brink of bankruptcy? It’s amazing that they’ve lasted this long.
The writing is on the wall for the telecom industry. The future involves buying a device that has a broadband connection and using a program on that device to make calls over the broadband connection. All you buy from the phone company is the broadband connection, if that.
The euphoric market action reminds me of the infamous Chuck Prince quote “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” FT July 2007. It should be no surprise to anyone that things are looking like 2007 again (although the liquidity is coming from the government), implying that the “herd” has already forgotten what happened next. Most people in the government and the investment industry are breathing a major sigh of relief due to this bear market rally. This is precisely the time when a Minsky Moment is most likely occur.

How does a jobless recovery play out? Unemployed people, who are milking the benefits right now, will become more and more thrifty (planting their own gardens, washing their own clothes) once their benefits run out and they realize that the only jobs available pay much less than their previous job. Not to mention they will be spending less because they simply wont have the money to spend, which is a key ingredient in the deflationary feedback loop. The longer they remain unemployed the more likely they will be to take the lesser paying job even if it’s doing essentially the same thing as before. This is another key ingredient in the deflationary feedback loop. I don’t expect this to happen until the end of 2010 when unemployment peaks. This is a secular event, most likely the result of globalization (China).
It may take a major natural disaster to force the US to show its hand; the hand being the fact that when the time comes the US will print money at any cost. The cost will be high considering they’ve used so much money to bail out the banking industry, which has tangibly produced absolutely nothing.
You might as well buy a nice car while you wait around for all of this to play out. I’d hold off on the nice house.

A list of things that the government has done to prevent (delay) a depression:

Banned short selling.
Eliminated mark to market.
Allowed Vikram Pandit to send a memo saying (lying?) that things were going well back in March. The rally started shortly after.
Reduced interest rates to 0%.
Extended unemployment benefits.
Running a $1 trillion budget deficit.
Reduced finance rates for banks via the Discount Window.
Bailed out Fannie Mae
Bailed out Feddie Mac
Bailed out AIG
Bailed out GM, though temporarily
Bailed out Chrysler, though temporarily
FDIC has spent billions closing down insolvent banks
Credit of $8,000 first time home buyers credit.
Credit of $4,500 via Cash for clunkers.
Credit of $600 via a rebate check.
Guaranteed $250,000 bank account balances via FDIC, up from $100,000
Guaranteed financial bonds
Guaranteed money market accounts
Guaranteed Bear Stearns assets
Bought preferred stock in financial companies
Bought agency bonds
Bought Treasuries

A list of things that the government has yet to do, but probably will do:

Bail out State governments (Bond guarantee?)
Bail out Local governments (Bond guarantee?)
Guarantee health care (which I would approve of)
Raise taxes (The republicans will try to force democrats to admit it before the 2010 election. The democrats will have to admit it once the 2010 election is over.)
Significant devaluation of the dollar. This is already playing out compared to the emerging markets, but will begin to play out more against the Euro and the Yen.
Significant reduction in Social Security and/or Medicare benefits.
Allow companies and or officials to either avoid telling the truth and/or flat out lie.
Manipulate or stop providing data that shows how bad things are. Transparency anyone?

Original Forecast: I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.
- That has happened. The 10 year treasury currently stands a 3.54%. I think it will continue to increase over the next six months. China, Pensions, and Individual Investors simply don’t have the money to buy all the treasuries. And of course now that the stock market is going up Pensions and Individual Investors are looking to take more risk.
Original Forecast: As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.
- That hasn’t exactly happened. However, I believe the 10 year treasury will continue to increase to the 4.5-5% range. I don’t think it will go much further than that because mortgage rates will begin to increase and the Fed will be forced to increase its “buyback program.” Not to mention there simply isn’t enough private wealth being created (people producing more than they are consuming) to buy all these treasury bonds. Sure, as a % of debt to GDP there are other countries worse off, but the size of their economies are much smaller than the US. I think the % of debt to GDP takes a back seat to the issue of the total size of the debt the US is issuing.
Original Forecast: The inflationary result of this will be seen mostly in oil.
- That has happened. Oil currently stands at $64.99 a barrel. (I believe they are 40 gallon barrels, no?) It is possible that an international conflict could arise, especially since, from what I’ve read, Iran is roughly 6 months away from developing a nuclear weapon. Can issues like this really be factored in? I think they should. So the way I’ll factor that in is by adding the international conflict issue to the list of reasons why stocks are overvalued. As far as the oil goes, an international conflict would increase the price drastically, but it wouldn’t last more than a few months. So barring an international conflict, I believe that oil will slowly decline over the next 6 months to the $45 range. I think it will decline because there is simply more supply than demand. However at $45 I believe that demand does increase and supply does decrease. From what I’ve read, the variable cost to deliver oil is roughly $25. So $25 would be the ultimate floor, but I think that is unlikely in the next 6 months, but possible in the next 18 months.
Original Forecast: There won’t be much inflation in food.
- There hasn’t been much inflation in food. I’m not certain the best way to measure it, but I haven’t noticed many headlines about food inflation nor have I noticed any price increase at the grocery store. (Though that is very hard to measure) My farming contacts have advised me that grain prices have declined quite a bit in the past few weeks. Going forward I think food prices, especially end user prices, will continue to decline. People simply can’t afford to waste food they way they used to so demand will be down. Farming has one of the lowest barriers to entry so supply will be up. Food processors had raised prices during the inflationary times of 2008 and have yet to fully roll them back, not to mention that they will be reducing prices to offset the loss of demand.
Original Forecast: Real estate will continue to decline.
- That has happened, especially in commercial real estate. I believe both residential and commercial real estate will continue to decline, probably for years unless some event causes a major decline in the next 6 months. Real estate isn’t as liquid as the stock market so it takes more time for the true prices to be uncovered. There is simply too much supply and not enough demand. (At least not enough demand from people that can actually afford to buy.) Not only are there a bunch of vacant houses and apartments, but many houses are large enough for more than one generation to cohabitate. It should be no surprise that more and more families have more than one generation living in the same location. They simply can’t afford to do otherwise.
Original Forecast: Natural gas prices will continue to decline.
- That has happened. Prices are a little under $4 for the next month’s delivery. I’m not sure how much further they can decline because the variable costs start to become higher than $4/mcf. I don’t think they’ll decline much further than that, though I think it will be possible to see $4/mcf even during the winter months. Anecdotally I can tell you that many rigs have been shut down with the hopes of starting them back up in 6 months.
Original Forecast: Higher oil prices will force the consumer to reduce spending further.
- That isn’t really much of a forecast. Going forward I will reword that to say “Consumers will continue to reduce spending.” That has happened. I believe it will continue to happen especially since millions of unemployed will be losing their unemployment benefits. How exactly that is going to play out should be interesting. I’d hate to be president of a country that has more unemployed young males than personnel enrolled in the military. That’s grounds for some real change, which may include some violence, but hopefully minimal death. What's more is that many people are underemployed and those that had any saving have seen it decline because of the declines in the stock market and the real estate market. Not to mention the retirees living off the interest on their bonds are receiving less money. To top it off, credit has been drastically scaled back. To sum it all up, people simply don’t have the money or the credit to keep spending.
Original Forecast: Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.
- The most important forecast of all and I have been wrong. I’m disappointed that I didn’t factor in one of the most basic rules of all time: The market can be irrational longer than you can be solvent. I still believe that stocks are overvalued. I think they’ve gotten more overvalued. However the heard thinks otherwise and they want (need) to think otherwise in order to avoid depression. (Both economically and psychologically.) Over the next 6 months, even after factoring in irrational investors, I think the stock market will be flat. Fundamentally, stocks are overvalued and the more time that goes by the more investors will realize this. That won’t be the main reason stocks decline though. It will be because investors won’t be able to afford to prop it up any longer. (The Government included.) People will be forced to cash out their investments in order to pay their living expenses. The government will be forced by higher interest rates on Treasuries to reduce the budget deficit. The only investors left to buy will be investors such as myself that aren’t willing to pay current prices. This is going to take longer than 6 months to play out. Especially since the government has a vested interest in keeping stock prices high for both social and economic reasons. So, unfortunately, over the next 6 months stock prices may be flat or decline 15% at most. Investors will probably get all excited about the results of the 3rd quarter, but towards the end of the 4th quarter reality will set in. The reality will be that a double dip recession is on the horizon and the Government can’t afford to do much about it because the Treasury rates are prohibitive. Not sure if that would be a checkmate or a stalemate. So over the next 24 months, as people consume more than they produce, the stock market could (should) fall much further.

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Opposing Arguments:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year (Updated 20090807)

The recession to last all through 2009. (Does 1 quarter of positive GDP end a recession?)
State and local governments continue to reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package in 2010 that focuses on rebuilding the US.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it. I doubt March 2009 was it.
Big name retailer declaring chapter 11 if not 7.
Big name home builder declaring chapter 11 if not 7.
Big name mortgage insurer declaring chapter 11 if not 7.
Big name airline declaring chapter 11 if not 7.
Big name regional bank declaring chapter 11 if not 7.
Big name casino declaring chapter 11 if not 7.
Home prices to continue declining.
Increased savings.
Decreased spending.
Unemployment to rise to 10% (That’s a HUGE number)
Very few Private Equity buyouts.
Underfunded unemployment trusts.
Very few IPO’s.

Things to Anticipate that Happened (Updated 20090807)

Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late. Looks like that answer to this one is too much liquidity and it’s all in the banking industry.
Car manufactures did go bankrupt, but no one else significant has since Lehman.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt. You see this especially in the REIT industry and the banking industry.
All time low interest rates. Happened as of 3-25-09.
No IPO’s. There have been very few IPO’s. Happened as of 20090807.
Net earnings on the S&P 500 to be $25. Happened as of 20090807.
No Private Equity buyouts. Happened as of 20090807

Things to Anticipate that Didn’t Happen (Updated 20090807)

Borderline depression near the middle of 2009 if things get worse than the current trajectory. Didn’t happen as of 20090807.
GDP to decline 5%. More like 3%. Didn’t happen as of 20090807.
Limited corporate bond issuance. Things seem to be fine in the IB area. Didn’t happen as of 20090807.
Underfunded unemployment trusts. Didn’t happen as of 20090807.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and airlines all going bankrupt at the same time, their stocks and bonds go to zero, and they start over. Didn’t happen as of 20090807.

Things to Anticipate of the Next Decade

Under funded Medicare (Federally Run) and probably more pressing Medicaid (State Run).

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

Best Type of Investments As of 20090807

5 to 10 year corporate bonds of non financial companies that have significant amounts of cash and/or consistent revenue streams.
Cash

Which Companies Will Be The First To Go Bankrupt?

Naturally, it would be companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments. However, we know nothing happens naturally with as many politicians as there are living in the US.

Quotes

Unknown: “The more things change the more they stay the same.” The new sound, just like the old sound.
Someone from the beginning of time: “A bird in the hand is worth 2 in the bush.”
JFK: “A nation that is afraid to let its people judge the truth and falsehood in an open market is a nation that is afraid of its people.” China? US in regards to the Fed?
LeFevre, Edwin (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Einstein, Albert: "Never expect the people who caused a problem to solve it."
Munger, Charlie: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
Morrow, “George:"When you’re a little guy operating out of a garage, you pay all your own bills. When you get a bit more successful you get a line of credit, and the bank starts paying your bills. When you get even more successful your vendors start paying your bills. When you get even more successful venture capitalists pay your bills. When you go public then the public starts paying your bills. Then when you reach the pinnacle of success – insert your favorite government run company – you’re so successful that you can’t be allowed to fail, and the government starts paying your bills."
Chuck Prince “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” FT July 2007.

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Reviewing The Previous 6 Months Forecast and Updating it for the Next 6 Months

2009-07-22T17:19:00.000-04:00

There isn’t much point to having a forecast if you don’t monitor it and acknowledge when you’re wrong. Half way through the year this is where things stand:

Original Forecast: I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.
- That has happened. The 10 year treasury currently stands a 3.54%. I think it will continue to increase over the next six months. China, Pensions, and Individual Investors simply don’t have the money to buy all the treasuries. And of course now that the stock market is going up Pensions and Individual Investors are looking to take more risk.
Original Forecast: As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.
- That hasn’t exactly happened. However, I believe the 10 year treasury will continue to increase to the 4.5-5% range. I don’t think it will go much further than that because mortgage rates will begin to increase and the Fed will be forced to increase its “buyback program.” Not to mention there simply isn’t enough private wealth being created (people producing more than they are consuming) to buy all these treasury bonds. Sure, as a % of debt to GDP there are other countries worse off, but the size of their economies are much smaller than the US. I think the % of debt to GDP takes a back seat to the issue of the total size of the debt the US is issuing.
Original Forecast: The inflationary result of this will be seen mostly in oil.
- That has happened. Oil currently stands at $64.99 a barrel. (I believe they are 40 gallon barrels, no?) It is possible that an international conflict could arise, especially since, from what I’ve read, Iran is roughly 6 months away from developing a nuclear weapon. Can issues like this really be factored in? I think they should. So the way I’ll factor that in is by adding the international conflict issue to the list of reasons why stocks are overvalued. As far as the oil goes, an international conflict would increase the price drastically, but it wouldn’t last more than a few months. So barring an international conflict, I believe that oil will slowly decline over the next 6 months to the $45 range. I think it will decline because there is simply more supply than demand. However at $45 I believe that demand does increase and supply does decrease. From what I’ve read, the variable cost to deliver oil is roughly $25. So $25 would be the ultimate floor, but I think that is unlikely in the next 6 months, but possible in the next 18 months.
Original Forecast: There won’t be much inflation in food.
- There hasn’t been much inflation in food. I’m not certain the best way to measure it, but I haven’t noticed many headlines about food inflation nor have I noticed any price increase at the grocery store. (Though that is very hard to measure) My farming contacts have advised me that grain prices have declined quite a bit in the past few weeks. Going forward I think food prices, especially end user prices, will continue to decline. People simply can’t afford to waste food they way they used to so demand will be down. Farming has one of the lowest barriers to entry so supply will be up. Food processors had raised prices during the inflationary times of 2008 and have yet to fully roll them back, not to mention that they will be reducing prices to offset the loss of demand.
Original Forecast: Real estate will continue to decline.
- That has happened, especially in commercial real estate. I believe both residential and commercial real estate will continue to decline, probably for years unless some event causes a major decline in the next 6 months. Real estate isn’t as liquid as the stock market so it takes more time for the true prices to be uncovered. There is simply too much supply and not enough demand. (At least not enough demand from people that can actually afford to buy.) Not only are there a bunch of vacant houses and apartments, but many houses are large enough for more than one generation to cohabitate. It should be no surprise that more and more families have more than one generation living in the same location. They simply can’t afford to do otherwise.
Original Forecast: Natural gas prices will continue to decline.
- That has happened. Prices are a little under $4 for the next month’s delivery. I’m not sure how much further they can decline because the variable costs start to become higher than $4/mcf. I don’t think they’ll decline much further than that, though I think it will be possible to see $4/mcf even during the winter months. Anecdotally I can tell you that many rigs have been shut down with the hopes of starting them back up in 6 months.
Original Forecast: Higher oil prices will force the consumer to reduce spending further.
- That isn’t really much of a forecast. Going forward I will reword that to say “Consumers will continue to reduce spending.” That has happened. I believe it will continue to happen especially since millions of unemployed will be losing their unemployment benefits. How exactly that is going to play out should be interesting. I’d hate to be president of a country that has more unemployed young males than personnel enrolled in the military. That’s grounds for some real change, which may include some violence, but hopefully minimal death. What's more is that many people are underemployed and those that had any saving have seen it decline because of the declines in the stock market and the real estate market. Not to mention the retirees living off the interest on their bonds are receiving less money. To top it off, credit has been drastically scaled back. To sum it all up, people simply don’t have the money or the credit to keep spending.
Original Forecast: Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.
- The most important forecast of all and I have been wrong. I’m disappointed that I didn’t factor in one of the most basic rules of all time: The market can be irrational longer than you can be solvent. I still believe that stocks are overvalued. I think they’ve gotten more overvalued. However the heard thinks otherwise and they want (need) to think otherwise in order to avoid depression. (Both economically and psychologically.) Over the next 6 months, even after factoring in irrational investors, I think the stock market will be flat. Fundamentally, stocks are overvalued and the more time that goes by the more investors will realize this. That won’t be the main reason stocks decline though. It will be because investors won’t be able to afford to prop it up any longer. (The Government included.) People will be forced to cash out their investments in order to pay their living expenses. The government will be forced by higher interest rates on Treasuries to reduce the budget deficit. The only investors left to buy will be investors such as myself that aren’t willing to pay current prices. This is going to take longer than 6 months to play out. Especially since the government has a vested interest in keeping stock prices high for both social and economic reasons. So, unfortunately, over the next 6 months stock prices may be flat or decline 15% at most. Investors will probably get all excited about the results of the 3rd quarter, but towards the end of the 4th quarter reality will set in. The reality will be that a double dip recession is on the horizon and the Government can’t afford to do much about it because the Treasury rates are prohibitive. Not sure if that would be a checkmate or a stalemate. So over the next 24 months, as people consume more than they produce, the stock market could (should) fall much further.

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Opposing Arguments:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $25.
State and local governments will be reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 10% (That’s a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
Underfunded unemployment trusts.
All time low interest rates. (Accomplished 3-25-09)

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

JFK: “A nation that is afraid to let its people judge the truth and falsehood in an open market is a nation that is afraid of its people.”
Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
George Morrow:"When you’re a little guy operating out of a garage, you pay all your own bills.
When you get a bit more successful you get a line of credit, and the bank starts paying your bills.
When you get even more successful your vendors start paying your bills.
When you get even more successful venture capitalists pay your bills.
When you go public then the public starts paying your bills.
Then when you reach the pinnacle of success – insert your favorite government run company – you’re so successful that you can’t be allowed to fail, and the government starts paying your bills."

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

All Eyes on the Unemployment Situation

2009-06-10T17:46:00.000-04:00

All Eyes on the Unemployment Situation (Rate For Simplicity)
The final stage of this downward economic cycle (defined as a recession or not means nothing to me) that leads to economic stability (though this stability will be non expansionary) will be the topping out of the unemployment situation. I consider the unemployment situation to be job losses, pay cuts, and hour cuts, known to many as the unemployment rate. Many other pundits believe that the bottoming in the real estate market is the thing to watch. I believe the bottoming in the real estate market will be the result of interest rates, oil prices and the most importantly the unemployment rate. Not the other way around.

Where do you start when trying to analyze something as complex as the unemployment rate? Well, let’s start with how much higher it could go. How it got here doesn’t concern me as much. After all and as Warren Buffett would say, if history was an accurate guide we would all be librarians.

Consider how many employees are barely hanging on to their job. If you have trouble answering that question and you’re the entrepreneur type then put yourself into the owner’s shoes of almost any type of company you can think of and ask yourself, based on fundamentals (not politics or social values), how many more people could you fire right now without a significant decline in the quality of the business? If you’re more the anti-socialist type, then put yourself in the shoes of any government organization and see if any part of the government could be eliminated without a significant impact on society. If that doesn’t work then observe how many people you see working any job that aren’t actually working and estimate how much of the time they spend not working. Lastly, talk to people you know that still have jobs and see just how much of the time they actually do work. (The service industry is notorious for employees doing nothing all day. Is it sustainable?)

When I run through this exercise myself I can easily guess that at least 1 out of 50 jobs (2%) could be eliminated, if not 1 in 25 (4%). That would bring the unemployment rate (U3) to 11% if not 15%. Many companies are so bureaucratically run that it would take at least another year for this to happen, if not 2 years, but it could (should) happen.

Many employees are starting to realize this and have cut down on their spending accordingly. Not to mention they flat out can’t get credit to spend more money than they earn like the gold old days, but I don't want to get off topic.

What will be the catalyst for this final stage? Well, the obvious reason would be the winding down of the stimulus program in the middle of 2010. You might think that the government will just pass another stimulus program, but higher interest rates on the 10 year treasury and higher oil prices will limit either the amount of the stimulus or the effects of the stimulus as any positive effects will be more than offset by higher oil price and higher interest rates. In fact the higher oil prices and interest rates are starting to play out now. This will have a negative feedback loop on consumer spending and construction, which will have an inevitable negative feedback loop on unemployment.

What are the results of this? Well first off the results of losing a job isn’t immediately felt in the economy. There is a lag because the unemployed have an emergency fund to fall back on that consists of their own personal savings (considering how many people live from paycheck to paycheck, the odds of this are low), donations/loans from friends and family, discretionary items that they can sell, and of course they have unemployment insurance. So even if this final stage begins in mid 2010, it may not be felt until late 2010 or even mid 2011.

Unfortunately for the individuals themselves, the emergency fund(s) is being exhausted. Especially for the people that have been unemployed for almost a year now and that number is growing larger every day. This will have a negative feedback loop on the economy and speed up the topping out of the unemployment rate.

I say the individuals themselves because I believe that the sooner the unemployment rate peaks the better. Why? Well because resources will be misallocated until the unemployment rate peaks. That doesn’t mean resources won’t be misallocated after it peaks, but the sooner people stop getting paid for sitting around the better.

Once the unemployment rate reaches 11% then the problem will begin to be social instability. You have to consider the hard numbers, not just the percentages. 11% unemployment doesn’t sound as bad as 15,000,000 of the highest paid people in the world unemployed, which is bigger and smarter than the largest army.

At a 1 to 1 ratio, a 10% increase in the unemployment rate from 5% to 15% would lead to a 10% decrease in GDP aka company revenue. Then offset the stimulus program 1 to 1 with the consumer that is holding back on spending because they think they will lose their job etc. A 10% decrease in company revenue leads to a hard 5% decrease in profit market (i.e. 10% profit margin to a 5% profit margin). If the profit margin on the S&P 500 was roughly 10% in 2007 (or $100) then once the final stage of the unemployment situation kicks in around 2010 the profit margin will be 5% (or $50). At $50 on an S&P 500 at 950 that's a 5.2% yield of which you’ll only get 3% of it in dividends. And that’s assuming the $50 in earnings is legitimate. Seems overvalued to me when you can buy a Telephone or BBB rated bond yielding 6% for 10 years.

Unfortunately, the more research I do on individual companies the more I realize that the best way to create wealth is to avoid the stock market and invest in bonds until you have enough money saved up to go out and buy a majority steak in an existing business.

Also, the more research I do the more I realize that the stock market is a political and social tool. The same can be said about gas prices and obviously interest rates. (The Fed is buying $300 billion worth of treasuries.)

That said I will pay much more attention to macro economic events like unemployment than to individual stocks until the S&P 500 is yielding at least 9% on a 5% trough profit margin.

Where is the money going to come from to create new jobs? It looks like they will come from the printing of money, which means that everyone will suffer via inflation in order to employ a few million marginal people.

Weekly Thoughts

Anecdotally I can tell you that if there was a run on some of the money market funds that investors would only get $.86 on the dollar.
How many home owners are hanging on to their houses at the margin?

Economic and Stock Market Forecast

I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.

Arguments supporting this thesis are:

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Arguments against this thesis are:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $25.
State and local governments will be reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 10% (That’s a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
Underfunded unemployment trusts.
All time low interest rates. (Accomplished 3-25-09)

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

JFK: “A nation that is afraid to let its people judge the truth and falsehood in an open market is a nation that is afraid of its people.”
Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."
George Morrow:"When you’re a little guy operating out of a garage, you pay all your own bills.
When you get a bit more successful you get a line of credit, and the bank starts paying your bills.
When you get even more successful your vendors start paying your bills.
When you get even more successful venture capitalists pay your bills.
When you go public then the public starts paying your bills.
Then when you reach the pinnacle of success – insert your favorite government run company – you’re so successful that you can’t be allowed to fail, and the government starts paying your bills."

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Great News For The Young Generation

2009-05-12T18:25:00.003-04:00

One of the best things to come out of this depression (the depression has only been delayed or at best case spread out of multiple years) for the young generation is that the problems of Social Security, Medicare, Medicate and practically any government guarentee has been moved forward by at least 5 if not 10 years.

This article from Bloomberg elaborates: Here

The only result of the stress test is:

2009-05-06T19:44:00.002-04:00

Keep in mind that the end result of the stress tests, the banks converting their preferred to common, is that the banks can lower their interest expense. That’s it. The only thing that does for them is buy them time to try and earn their way out of the hole in their balance sheet. The government is giving them the chance to try and do this which in turn is just the continuation of the zombification of banks. The problem is the losses on their balance sheet are going to be larger than their earnings for the next 12 months.

The only decline the government has succeeded in stopping is the decline in stock market. I doubt they can keep it that way much longer.

Here’s why:

Technically
- Just like the longs will capitulate on the way down, the shorts will capitulate on the way up. After a 40% rally it’s safe to say that many of the shorts have capitulated.
- Volume, as seen in the SPY ETF, has not been increasing.
- The market has gone up for almost 2 months straight.

Fundamentally
- Many employees are hanging onto their jobs by a thread. This would include:
  - Car salesmen
  - Farm equipment salesmen
  - Investment Bankers
  - Realtors
  - Stock Brokers
  - Mutual Fund Managers
  - Reporters
  - Journalists
  - Retail Cashiers
  - Pilots
  - Hotel managers
  - Travel agents
- Many other employees are running around like turkeys, not realizing that thanksgiving is coming early this year and their job will be cut off:
  - Mortgage brokers (How many people are left to refinance?)
  - Waiters (Restaurants have barely kept afloat on coupons. The coupons have to end sometime.)
  - Nurses (Believe it or not, less people are going to the Dr./Hospital)
  - Pharmacists (People can’t afford their drugs.)
  - Teachers (Wait till that tax levy fails)
- More homeowners are hanging onto their houses by a thread. Why?
  - More homeowners are losing their jobs.
  - More homeowners that aren’t losing their jobs are taking a pay cut.
  - More homeowners that are unemployed will lose their unemployment benefits.
  - Taxes are increasing on things like license plates, sales tax, state income tax.
  - This isn’t getting much attention, but gas prices have increased recently too.
Valuation
- If after tax earnings on the S&P 500 will only be $50, then at 920 on the S&P 500 that’s a 18.4 PE. An 18.4 PE is 5.5% yield. If the growth rate going forward is only going to be 2%, then that’s a 7.5% rate of return.

None of these reasons will come as a surprise. Unsurprised investors won’t sell in a panic, but instead will sell because they are discouraged at the results of the market. That will be a slow steady decline. Slow declines aren’t great for shorts and are best for bond investors.

Events to Anticipate in the Next 6 Months

2009-05-04T22:00:00.000-04:00

If everything below seems negative to you, then maybe this would be more your liking: Here

GM shutting down plants for 9 weeks if not longer. This will ripple through the supply chain. Anecdotally I can tell you that companies with great credit cannot get a loan at any interest rate if the majority of their business is tied to the auto industry.
A second wave of layoffs is taking place now. The first wave was the “lets get rid of anyone that we don’t absolutely need.” The second wave will be “lets trim this thing down to a skeleton shift.” The third wave, which is a ways away, will be “we can’t even profit on the bare minimum, lets shut it down.” This results in the unemployment rate rising to 10% and staying there.
The first wave of unemployed people will start to lose their unemployment benefits.
States will run out of money for the second wave of unemployed people.
Higher interest rates. The 10 year treasury is well on its way. 30 year mortgage will follow. Somewhat bittersweet as this is great for savers, bad for borrowers.
Hurricanes in Florida.
No summer vacations for the kids; at best going out to dinner.
No bullets.
Increased foreclosures now that the moratoriums have been lifted.
Increased violence from the large number of unemployed people. This is especially true for young males, which happen to have the highest unemployment rate of any demographic. Of all the things out there I hope that something like this doesn’t get out of control.

Myth’s to Dispel

Experts like to quote the statistic that 1 million households are created every year and this should bring the housing supply down quickly. What they’re not factoring in is how easily households can be combined, which can more than offset the new household that are created. My point here is that the housing bust still has years to go, not a year.
Similar to “1 million household created per year,” experts like to quote a statistic that 12 million new cars are needed each year. There a few things they are not factoring in. Unemployed people can share a car with their spouse etc. College kids that live at home can share their parents’ car. Households already had about 2.5 cars per drive and can consolidate. Drivers can drive the same car longer.
I haven’t heard this one year, but I’m sure the same can be said for computers. However, the basic computer (word processor, internet, video) is so advanced that I can’t see needing to replace one for a decade.

Warren Buffett Disappointments
It’s unfortunate, but he’s done a few things to disappointment me lately.

He changed the format of the annual meeting so that the early birds don’t necessarily get the worm in regards to being able to ask him a question.
He suggested that he would buy Wells Fargo and didn’t actually do it. I’ve never in my life read/heard him say anything like that.
He continues to hold newspapers even though their fate is sealed. Would he have held a buggy whip company until it’s last day?
He worked so hard (thinking about investing and having the patience is hard work) his whole life only to give it away to a charity that he has no control over. He won’t even be sure the charity uses the money wisely. He won’t live to see hardly any results either.

Lastly, if the DJIA (which I don’t follow at all, but goes back much further than the S&P 500) goes from 100 in 1915 to 10,000 2015 that’s only a 5% annual rate of return. I’m afraid that’s all the stock market can produce. Why not just buy bonds?

See You In Berkshirehathawayville

2009-04-30T18:14:00.001-04:00

http://www.berkshirehathaway.com/sharehold.html

Stock Market Reversal Today Get Your Attention?

2009-04-30T17:23:00.004-04:00

Weekly Thoughts

Possibly the best blog out right now, which just came online on January 9th 2009, is http://www.zerohedge.blogspot.com/

His post http://zerohedge.blogspot.com/2009/04/comparing-todays-vegas-back-lot-to-real.html had the following data set:

I'll try to make the bull case here, even though I don't believe it:
- 0% interest rates sure make it easy for consumers and the government to carry a high amount of debt.
- Consumers only have a slightly higher debt service ratio in nominal terms.
- Equities as a % of net worth makes the stock market VERY IMPORTANT to the average person’s psychology so the government will do everything it can to prevent it from going down.
- Consumers don’t need to save anymore because the government will take care of them via Social Security, Medicare, Medicaid or some other program that hasn’t been invented yet.
- A higher PE ratio in 09 is justified because this is a lower rate of return world.
- You needed a 6.7% dividend yield in 82 to compete with inflation.

Economic and Stock Market Forecast

I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.

Arguments supporting this thesis are:

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Arguments against this thesis are:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $25.
State and local governments will be reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 10% (That’s a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
Underfunded unemployment trusts.
All time low interest rates. (Accomplished 3-25-09)

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Sell in May and Go Away

2009-04-30T07:50:00.003-04:00

For those of you long, take advantage of this rally as it may be years before the S&P 500 index is this high again. The next decline in the market may happen too quickly for you to get out.

5 to 10 year investment grade corporate bonds look great.

I don't care much for gold because it only costs $500 to get it out of the ground and it's selling at $900 and it doesn't pay interest (in fact it costs money to hold it via ETF).

Speculative Trade

2009-04-23T21:58:00.004-04:00

Positioned the portfolio to 40% short XLF at the close today.

By no means am I a trader. I don't even follow any type of technical indicators. However, just by watching the price changes of about 150 stocks simultaneously throughout the day I can tell you that the rally is losing steam and topping out.

The earnings for the big banks are out and all financial earnings have been offset by losses (even though they didn't report it that way, if you read the FS properly you can easily see that). The only play left for "the bulls" (or maybe I should say "the government") is the "distress" test, which I'm speculating will work like this: banks will be given letter grades of A - D and the worst any bank will be graded is B+. No details will be given, just ranges of capital that need to be raised.

The market hates uncertainty like that.

In the intermediate run I have 12% unemployment by 2010 backing me up as well as a roughly 20 PE ratio on the S&P 500 assuming earnings are $45. Not to mention that unemployment will stay above 10% for years and earnings growth will be non existent.

Margin interest rate is reasonable too these days, possibly aiding this rally as it's cheap for margin players to lever up.

Weekly Owner Earnings

2009-04-23T21:35:00.000-04:00

Weekly Thoughts

When it comes to picking stocks I can’t read all the financial statement and I can’t read all the notes on every individual company I’m interested in. I can and have read quite a bit of them, but not all of them. To compensate for that, I look for companies where the notes in the financial statement and the details of the financial statements shouldn’t be material. These types of companies are well established, have consistent revenue and earnings, a solid product, and good balance sheet.
Once you have established the requirement above, the 4 most important things become:
- What % of their revenue do I think is sustainable.
- What profit margin do I think is sustainable.
- What growth rate do I think is sustainable.
- What multiple I’m willing to pay. AKA what rate of return I require for taking the risk.
Those estimates are mostly based on what I think is going to happen in the macro economy. Obviously what happens within a sector matters, but 2008 was a great example of how important the macro economy is.

Economic and Stock Market Forecast

I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.

Arguments supporting this thesis are:

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Arguments against this thesis are:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $25.
State and local governments will be reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 10% (That’s a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
Underfunded unemployment trusts.
All time low interest rates. (Accomplished 3-25-09)

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Weekly Owner Earnings

2009-04-16T19:10:00.001-04:00

Weekly Thoughts

The market wont stop going down until investors have a sustainable base, which would include a 7% savings rate like it used to be.
A few good things have happened as a result of this depression:
- For the younger generation the problem of funding social security, Medicare and Medicaid has been moved forward by a few years. The sooner this problem is addressed the better. An ounce of prevention is worth a point of cure.
The initial decline in the economy may have happened at light speed, but the remaining decline will happen much more slowly. My anecdotal example of this is country clubs. Members are dropping out of the country club scene left and right and some country clubs have been forced into bankruptcy. The decline in membership is going to stop, temporarily however, as golf season begins. Once golf season is over and the economy has deteriorated further I would expect the declines to continue forcing even more clubs into bankruptcy. This is going to take at least a year to play out if not 3-5 years.
After reading the financial statements for many banks I can tell you that the only thing keeping them afloat is all these bailouts, legalizing of lying about asset values (aka mark to model), and non stop televised propaganda, none of which changes the fundamentals. This bear market rally isn’t going to shake most shorts because they are positioned to be solvent longer then the market can afford to be irrational, myself included.
Economic Forecast: House prices will find a temporary bottom based on a 5% 30 year fixed mortgage rates. Once the Fed loses control of the mortgage rates (technically they already have lost control of them, which is why they have to print money to buy them) and they go to 8% house price will continue their decline. This is going to take years to play out. Lets stop right there and think about how anticompetitive that whole concept of subsiding mortgage rates is. Subsidies lead to 1 thing: inefficiency. And inefficiency leads to low low low rates of return. Just ask K-Mart or GM. With that said the stock market is at best fairly valued, the real estate market will be declining for years, municipalities are going to doing worse not better (and so will their bonds), treasury bonds would seem to be a good investment, but the government is buying treasury bonds and as a rule of thumb you never want to be buying what the government is buying, commodity prices go down in low return world or a deflationary world (the CPI just deflated for the first time in 55 years), and why not just keep the money under the mattress with money market rates are less than 1%. That that only leaves you with high grade corporate bonds to get any type of decent return. Why put any more money into a 401k then what they match you (if they even still match you) when the only investment option is equity mutual funds (which are overvalued), bond mutual funds (which don’t work because the manager trades the bonds too much and you end up own bad quality bonds or the wrong duration), money market funds (which are yielding less than 1% if not less than .25%), or stable value funds (which Chryslers stable value fund just declined 11%, real stable.) You’d be better off investing the money into an IRA and buying high grade corporate bonds. If my forecast is right, then by the time most investors (aka the “herd”) catch on to this idea, high grade corporate bond yields will have declined from 5% to 3% and you can sell at a profit to buy the S&P 500, which will have declined from 900 to 500 (When that happens it will be a 25 year low just like Japan).
Bottom line: This is going to be a very low return world going forward, especially in the US. 3 to 10 year investment grade corporate bonds look like great investments. When the stock market bottoms out in 3-5 years you can sell the bonds and buy stocks. The US is now Japan.
How many people are going to plant gardens this year? How many unemployed people are watching their own kids? This is very deflationary.

Economic and Stock Market Forecast

I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.

Arguments supporting this thesis are:

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Arguments against this thesis are:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $25.
State and local governments will be reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 10% (That’s a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
Underfunded unemployment trusts.
All time low interest rates. (Accomplished 3-25-09)

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Low Mortgage Rate Game Theory

2009-04-10T07:24:00.002-04:00

The reason the Government is trying to get as many people to refinance into a 5% 30 year fixed mortgage is unforeseen by most investors.

First off, I think that 5% 30 year fixed mortgage will be the lowest it will go.

Sooner rather than later I expect the government to lose control of longer term interest rates. (As if they have much control now.)

Once that happens, you'll see rates rise back up to 8%.

House prices are a function of interest rates and rental rates so house prices will have to fall much further with an 8% interest rate.

A significant amount of the people that have refinanced into a 5% mortgage will be underwater. They will be asking themselves if they should just default on the mortgage or keep the current payment. It will be a much tougher decision for someone who has a 5% rate. The Government is hoping that the lower rate will be enough to keep them from deciding to default. Unfortunately the government isn't factoring in a sustained 10% unemployment rate. With unemployment that high people wont have a choice to keep making their mortgage payment because they wont have money to make it with.

If I were in the market to buy a house I would wait until the prices fell further and write off the higher mortgage interest rate on my taxes. You can't write off the decline in your home value on your taxes. (Unless you sell it.)

As an investor I don't want anything to do with mortgage bonds.

If I had to make a non speculative non cash investment right now then I would buy a 5 to 10 year Verizon or AT&T bond yielding 6.5%.

Invest accordingly.

Speculative Trade

2009-04-10T06:34:00.003-04:00

Brought the portfolio to an equivalent of 30% short XLF.

Wells Fargo and others will lie about their earnings, but I believe I can hold this position longer than they can keep their lies going.

10% unemployment is on my side, especially since it wont go down quickly. So is 180% consumer debt.

PE Ratio of a Farm

2009-04-09T06:57:00.003-04:00

Paul Kedrosky brought up the "Farm PE" with this link: Click Here.

I sent that to my farmer contact from Kansas and here is what he had to say:

"We sold/leased back some of our ground for a 5% lease to price yield. Unfortunately, the price kept increasing but rent has not, so far. Current cash yields in our area are less than 5% on average meaning P/Es are around 20. For the damn longest time I couldn't figure out why anyone would want to own farm-ground. Rents were pitifully low because incomes farmers could earn off the land were low or even negative. So good farm ground at even $400/acre didn't seem attractive because cash rent was only $20-25/acre. Remember this was during a period when nearly every other asset class outperformed farm RE. Now the tide has turned and that same ground is $800 and rents are $40/acre. Extremely low interest rates are powerfully pushing farm real estate higher. Recent comparable land that sold for $600 in mid-2007 has brought $800 in late 2008. Land prices have not been negatively affected by the financial crisis. "People are going to eat......probably" - Jim Rogers"

Reading that article also reminded me of this magazine from 2006 called "Trader." It had Eric Bolling on the cover. He is a report for Fox Business Chanel now. In the magazine he has some model wife and it estimated that he made $15 million per year trading natural gas. He called it playing at the "$1,000 table at the casino" because natural gas futures are traded in $1,000.

Then I thought how he probably lost his ass and now its the farmers that should be getting the models, though they probably aren't interested. According to my contact in Kansas, the money in farming isn't there just yet, but I believe it's coming in 2 ways: Increased profits to farms and decreased profits to everyone else.

The anecdote on farming also reinforces my view on what's going to happen with inflation and deflation. I believe that residential and commercial real estate will continue to decline. There is simply too much supply. I believe that stocks will continue to decline. They are not cheap by any fundamental measure and investors that own them will be forced to sell for various reasons. I believe that interest rates will rise, not because investors demand higher interest rates to offset inflation, but because investors demand higher interest rates to offset the increasing default risk. I believe food prices will be flat. The demand for food will decline as people become less wasteful because they have less money to waste. I can't tell you how much food I see wasted by corporations and wealthy people. I believe oil and natural gas prices will be flat too, if not down. The demand for energy by corporations has declined significantly and individuals watching their budgets are using less too.

However, the oil clock is ticking. In 3-5 years when we get through this mess oil prices will skyrocket, which will put the economy back in shambles and keep the S&P 500 on pace with the Nikkei for 2 lost decades in the stock market.

If that forecast comes true then there is no need to rush in to buy stocks. In fact, long term bonds (I prefer Telecom bonds) would be one of the best performing investments. Don't let yourself get influenced by all these irrational investors you see on TV. Remember, most of them have called this thing wrong the whole time. Have patience and invest accordingly.

Speculative Trade

2009-04-03T19:26:00.003-04:00

The "Bear Market Rally" continues.

I added to my short position to bring it up to an equivalent of 20% of the portfolio short XLF.

I do this not because I have tunnel vision that the banks will fail, but because everything that I've read indicates that the banks will go to $1 and stay there for a long time. Japan 1990's = US 2000's.

Whether the banks "officially" declare bankruptcy or not means nothing to me. I don't own CDS's that depend on that. What matters to me is that they go lower from here.

If it takes until the 2nd half of 2010, when this double dip depression really starts to drag on, then I want to make sure I can be solvent longer than "they" can be irrational.

Walmart and Dicks are SOLD OUT OF AMMO

2009-03-29T17:22:00.001-04:00

Anecdotally I can tell you that all the Walmarts near me and all the Dick's Sporting Goods near me are sold out of all ammo except for .22 and shotgun shells.

Draw your own conclusions.

Speculative Trade

2009-03-26T19:19:00.003-04:00

This sure has been a large bull market rally.

Initiating a short position in XLF at 10% of the portfolio value. No short squeeze here.

Weekly Owner Earnings

2009-03-25T17:23:00.000-04:00

Economic and Stock Market Forecast

I think the yields on long treasury bonds will continue to rise even though the Fed’s are buying.

Arguments supporting this thesis are:

1. Investors that used to buy the bonds (China, pensions, and individual investors) simply don’t have new money coming in to buy with.
2. Investors are concerned about inflation risk.
3. Investors are concerned about default risk. Although, default risk is really just inflation risk because they Fed will simply print money to pay for the bonds.

Arguments against this thesis are:

1. Flight to safety will continue. Treasury bonds are “said” to be safe or at least less risky.
2. Investors will shift their asset allocation to bonds.
3. Investors will increase their savings rate, hence increasing the demand for all investments.
- a. This creates a slippery slope though, where more savings means less spending, and less spending means more people unemployed, which would mean less money to invest with.

As the yields rise, the Fed will buy even more Treasuries, hence increasing the money supply.

Arguments supporting this thesis are:

1. The Fed just announced it is going to purchase $300 Billion worth of treasuries. In the last 24 months the Fed has not reduced the size of any program like this. Instead, the Fed has only increased not only the size, but the scope as well.

Arguments against this thesis are:

1. Somehow the government steps in to prevent the Fed from devaluating the dollar. It appears Congress has no control over the Fed so this appears unlikely.
2. The dollar decline becomes so significant that the Fed will be forced to stop or risk civil unrest.

The inflationary result of this will be seen mostly in oil.

Arguments supporting this thesis are:

1. Oil supply in Mexico has been declining significantly over the last 12 months.
2. Drilling has declining significantly.
3. Oil supply everywhere would be declining naturally. (The world does not naturally produce 85 million barrels of oil a day, but it does consume it.)
4. World population is increasing.

Arguments against this thesis are:

1. Demand for oil is declining along with the rest of the economy. This decline is enough to offset any of the arguments supporting the thesis.
2. Alternative energy is reducing the demand for oil.
3. Technology (fuel efficiency) is decreasing demand.

There won’t be much inflation in food.

Arguments supporting this thesis are:

1. People will be less wasteful and use less food to meet the same demand.

Arguments against this thesis are:

1. Food supply is at decade lows.
2. Population growth.
3. Land is producing less yield because of over farming.

Real estate will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. Real estate is not consumed the way food and oil is.

Argument against this thesis is:

1. Buyers have money for a down payment, have a good credit score, have a job and actually want to buy real estate at these prices.
2. The government is giving an $8,000 subsidy to buy a house.

Natural gas prices will continue to decline.

Arguments for this thesis are:

1. There is simply too much supply.
2. The decrease in economic activity make the over supply even worse.

Arguments against this thesis are:

1. Producers will stop producing; reducing supply.

Higher oil prices will force the consumer to reduce spending further.

Arguments for this thesis are:

1. People can’t spend money they don’t have when the credit markets are closed.

Arguments against this thesis are:

1. The government will give people money to spend and they’ll actually spend it unlike the last stimulus.

Stocks will continue to decline if the above theses are true. The sectors most likely to decline will be discretionary and financial stocks.

Arguments supporting this thesis are:

1. Stocks are overvalued or at best fairly valued. They are not cheap.
2. The valuation of discretionary and financial stocks can drastically change with just a small change in the economy. For example it only takes a small decline in real estate prices to wipe out all the equity in a finance company that is levered 20 to 1 and owns mostly real estate loans.

Arguments against this thesis are:

1. Stocks are undervalued and investors have the wherewithal and mentality to buy them.

Thoughts

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt). Update: This may take longer than previously thought now that the government is going to buy bad assets (presumably at prices significantly higher than current bids)

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues) Update: The price decline has clearly reversed.

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rent coming down much.
Gasoline (Still high compared to 2004 prices)
Natural Gas
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. As of 3-25-09 there are 5.5 million people on State unemployment and 1.5 million on Federal unemployment. Expect about 2 million more to become unemployed to bring the total number to 9 million. That can easily be accomplished by losing 650,000 per month for 3 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continues into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $25.
State and local governments will be reducing spending significantly unless they get bailed out.
Another $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 10% (That’s a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
Underfunded unemployment trusts.
All time low interest rates. (Accomplished 3-25-09)

Things To Be Prepared For (Not that they’ll necessarily happen)

The S&P 500 declining to 500 and staying there for 5 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely limited by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that don’t have enough money to make their interest payment. Next in line will be companies that don’t have enough cash to pay off debt that is rolling over. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

Rules to Live by

Deep breath. Relax. Slow down.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Weekly Owner Earnings

2009-03-17T21:05:00.001-04:00

Thoughts

The bottom will be in when more people are flat out crying about their stock portfolio. That’s starting to happen now, but not much.
Investing at the margin. Anecdotally I can tell you that there are many marginal investors that will never return to investing. These are investors that never could afford to invest, but they did it anyway. Instead of putting a down payment on their house, or god forbid paying their house off, they invested their money in the stock market. Now due to unforeseen circumstances (lost their job) they need the money to pay their mortgage etc and are selling at any price because they have to. The money generated from selling these investments will never return to the stock market; it has been consumed.
Employed at the margin. Anecdotally I can tell you that there are still many people employed that don't have work to do right now, but are being kept on the payroll just incase work picks up. The longer this slump lasts, the more of these employees will become unemployed.
Also employed at the margin. Anecdotally I can tell you that there are also many people employed that have work right now, but there is nothing scheduled after April. There isn’t going be anything scheduled either.

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt).

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues)

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rents coming down much.
Gasoline
Natural Gas (Though this has been offset somewhat by increased demand from
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. About 2 million more. Actually, at least 3 million more. That can easily be accomplished by losing 500,000 per month for 6 months. Or more likely 500,000 per month for 3 months and then 250,000 per month for 6 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continue into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $50.
State and local governments will be reducing spending significantly unless they get bailed out.
A $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 9% (That is a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
All time low interest rates. (check)

Things To Be Prepared For (Not that they’ll necessarily happen)

The stock market declining 70% from the high and staying there for 10 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely constrained by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that have to roll over debt in the next 12 months, but don’t have enough cash on hand to pay it off. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

Rules to Live by

Slow down, relax, deep breath.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Weekly Owner Earnings

2009-03-10T19:20:00.000-04:00

Thoughts

I’m noticing that people who were calling the November 740 low the low of the cycle and became bullish in January are now turning bearish! “It’s a race to see who can be the biggest bear.” Seems like a good contrarian indicator to me.
One of the factors I’m looking at is how many investors out there want to be (you have to have cash) buyers at this point. In general, most investors are always buyers. Now more and more bears are reducing their shorts if not becoming buyers. However there are some new sellers out there, which are the investors (who were never really investors) that just want to stop the bleeding and get out (Just sell everything and I’ll go blow all the money myself.”), investors (speculators really) with margin calls (aka deleveraging by force), and investors reducing their stock allocation (large pension funds who counter intuitively reduce stock exposure after the fact). Once those sellers are gone we’ll be very close to the bottom.
Many people are realizing they have a lot less discretionary income than they first thought. Going forward, much of what they thought was discretionary income (assuming they still have the luxury of a job) will be saved instead. Thus, you should require a higher margin of safety when buying discretionary stocks.
”Remember, this is a depression, not a recession. Both America and Chinese economies have lived in a grand, symbiotic delusion for the last 10 years.” Bill Bonner
I read that the bondholders of financials may be FORCED to convert to common stock. If the end result is the same (triggering massive CDS losses) then why not just FDIC them (aka bankruptcy)?; especially considering a forced debt swap is probably unconstitutional (as if any politician knows what the constitution is, like it was written by someone way before them who must have been stupid).
The things that are going on now (bailouts, banks still independent, increased home sales, stable oil prices, high gold prices, etc) are the types of things that happen at the beginning of a depression; in the middle of a depression everything is sold to buy subsistence items. However, the stock market usually bottoms before the economy bottoms. It will be the “I can’t believe the market is going up” feeling after every bad report that comes out. 6 months later when the economy has turned around and you’ve missed the move in the market you’ll know why.

Things To Anticipate Over The Next 2 Weeks

Major bank stocks and bonds going to $0 (not necessarily bankrupt).

20 Investing Criteria: The Time To Buy Is Near (Especially If The Current Pace Of Decline Continues)

Business Model
- Liabilities (Debt, Healthcare, Lawsuits, Pensions, Lease Obligations) are low (Balance sheet, foot notes, foreign country subsidiary etc.)
- Consistent (5 Year Rolling Average) Sustainable Owner Earnings (This translates into sustainable revenue, margins, prices, and cash flow)
- Diversified: Multiple customers and products (Not a 1 hit wonder, but no need to diversity just to diversify)
- Independent (If a competitor goes down they don't all go down. Unlike airlines, drug companies, banks, etc)
- Monopoly or close to it (Buffett's "Wide Moat")
Product
- Consumable (Translates into sustainable consistent demand)
- Established. (Product mostly sells itself) Hasn't changed in years. (Coke, Heinz, Mars, Electricity) Unlikely to change in the future. (Unlike electronics. Unlike a start up. Unlike the next "something.")
- It's what the customer needs, wants and does. You'll be surprised what customers ultimately need and want. (Cell phones)
- Value (Affordable): Price is what you pay, value is what you get. (Amazon, DeWalt, Honda, Visa)
Management
- Adaptable (It's not the strongest or the most intelligent that survives, it's the one most adaptable to change)
- CEO is realistic (You can judge this by watching them speak. VERY RARE!)
- Disciplined (Unlike Time Warner when they bought AOL)
- Employees have a good relationship with the company (Unlike Unions)
- Executes (Translates into earnings growth etc)
- Honest (Translates into reliable financial statements)
General Rule
- Simple: Simple product. Simple business model. Simple financial statements. That way any idiot can run the company.
- Know the Competition
Litmus Test
- Consumers would be affected negatively if the company went out of business
- Personally understand the company and use the product.
- Willing to invest 10% of your net worth into the company

Prices that have come down:

Real estate, but mostly if you’re buying a house. I haven’t heard of rents coming down much.
Gasoline
Natural Gas (Though this has been offset somewhat by increased demand from
Car Insurance
Restaurant Prices (Especially if you have a coupon, which I’ve seen the frequency of coupons increase.)
Interest payments (If you have debt.) However, for the people that have savings, the opposite is true and the savers are earning much less interest on their savings.

Price that have stayed the same or increased:

Electricity
Insurance (Medical, Dental, Vision, Life, Homeowners)
Clothing (Even with all the “sales” I haven’t noticed the sale prices being lower then previous sales prices I saw years ago; especially in business clothing.)
Food (Milk, Cheese, Meat, Cat Food)
Internet
Cell phone
Parking
Trash
Beer
Real estate taxes
Income taxes (Federal, State, Local, Social Security, Medicare, and Medicaid)

Reasons The US Economy Will Get Worse

Employment
- More people will lose their jobs. About 2 million more. Actually, at least 3 million more. That can easily be accomplished by losing 500,000 per month for 6 months. Or more likely 500,000 per month for 3 months and then 250,000 per month for 6 months. Once you start thinking about it 5 million job losses is possible if the 250,000 job losses per month continue into 2010.
- More people will have reduced hours.
- More people will have reduced pay or no pay increase
- More people, especially the baby boomers, who would have retired won’t retire because they need the money, hence increasing the supply of labor. This creates a negative feedback loop where baby boomers staying in their jobs prevent other generations from advancing in the labor force. The end result is the baby boomers end up doing all the work and having to give a significant amount of their money away (either as straight gifts to their children or as taxes) just to sustain all those other people that can’t get a job. This scenario partially explains the current economic situation we are in now because the baby boomers were the ones making all the money over the last few years.
Real Estate: Housing
- House prices are still unaffordable (relative to income, which is declining.). In 2000, the average home price was $150,000. (I agree, I don’t like to use averages, but this is the information I have available.) At the end of 2008 the average home price was $175,000. Do you think people are making more money, or that more people are employed, then there were in 2000? No. So for the average home price to drop to $150,000 seems very realistic. That would be a 15% decline from today. And to boot, just like prices overshoot to the upside, prices overshoot to the downside. At a 2007 median HOUSEHOLD income of $50,000 the average American can’t afford much. I’ll do some math on that later.
- House inventory is still too high. In 2008 4.5 million existing homes were sold. Problem is realtor.com has 4 million listings alone. That is at least 10 months supply. The norm is 6 months.
- Vacant houses have increased to 2.23 million.
- Home ownership was at an all time high, which means demand for houses will decrease.
- Housing starts are still higher than the amount of new houses sold. Technically, new home completions, at 750,000, are almost 100% higher then new home sales, at 400,000, as of December 2008.
- Mentality towards housing has changed and people are looking for smaller houses.
- Mentality towards housing has changed also because speculators and investors are no longer considering real estate as an investment.
- It is taking significantly longer to sell houses. It used to take 3-6 months. Now it takes 6-9 months.
- Mortgagee’s would rather default than refinancing their loan.
- More people will default on their mortgages, including Alt-A and Prime
- Shadow inventory of houses is huge. People that want to sell have not put the for sale sign up because they know they can’t sell their house at the price they want (more than it’s worth) in this environment. REO’s that aren’t listed and foreclosures that are being delayed are also adding to this.
Real Estate: Commercial
- Demand for commercial space is declining.
- For many tenants, commercial real estate is unaffordable.
- Inventory is still growing.
Credit: Consumer
- FICO score requirements have increased while many consumers have actually seen their FICO scores decrease.
- Consumers are simply reducing their demand for credit.
- Income requirements have increased while many consumers have obviously lost their job.
- Down payments requirements have increased (From zero to 20%)
Credit: Business
- Business’s balance sheets will deteriorate further.
Spending: Consumer
- Consumers are trading down in quality and quantity.
- Consumer spending is declining from an unsustainably high level.
- Spending frugally is now considered “cool.”
Spending: Business
- Many companies are reducing the amount of CapEx they will spend compared to previous years.
- State and local government are also reducing the amount of projects.
Spending: Government
- State tax revenue is down so the state budget is being cut accordingly.
- Local tax revenue is down so the local budget is being cut accordingly.
- Federal tax revenue is down, but they can just print money.
- Borrowing costs have increased for state and local governments.
The Consumer
- Consumers don’t have any savings to fall back on.
- Consumers that do have savings saved in stock. When they need to use their savings they’ll have to sell stock.
- People are saving more (paying down debt), which means they are spending less.
- Savings are still too low so consumers will have to save even more.
- Growth from real estate and stocks is no longer a substitute for savings.
- More consumers are falling behind on their mortgage.
- More consumers are falling behind on their credit cards.
Consumer Psychology
- Consumers spend less when their assets decline.
- Asset declines beget more asset declines. Aka negative feedback loops.
- Consumers with the money to spend feel guilty spending it so they save it instead.
Velocity of money will slow down further.
Less kids will go to college which means less people need to be employed at the college.
More frauds, like Madoff, will be uncovered. (As if the whole finance industry isn’t)
As the US currency weakens the demand for interest rates on US assets increases.
Investors are looking to decrease risk, not increase it.
The recession is global.
The Federal debt is increasing. It’s either going to have to be paid back or defaulted on.
The Federal deficit is increasing.
Unexpected natural or man made disaster may strike.
There is too much supply of everything except jobs and income.
There is too little demand for everything except jobs and income.
Retail inventories are too high.
Retail revenue is declining. Certainly in total cost, but maybe even units sold.
Deleveraging will continue to reduce demand.
Until very recently the dollar had been strengthening and exports have been declining.
Stimulus package won’t be enough to offset job losses etc.
Oil demand is declining, which means less oil will be sold.
Oil prices are still too high (Only at 2004 prices.)
Many companies that should be bankrupt aren’t because of all these bailouts. When these companies finally do go bankrupt there will be significant job losses.
The number of uninsured people is increasing and hospitals have to find a way to pay for them.

Reasons The US Stock Market Will Decline

Companies will have no earnings!!! For a long long time!!!!
Commodity prices have declined drastically, especially oil, so earnings from commodity companies, which had the largest percentage of the S&P 500, will decline drastically.
Pension costs have increased because the value of the pension, which was mostly in stock, has decreased drastically.
Companies have significantly more fixed costs (manufacturing plants, hotels, etc) then there is demand for.
Revenue has declined significantly.
Share buybacks will continue declining.
Healthcare costs are increasing.
Investors will sell stocks because:
- They need the money to pay living expenses. Especially people who’ve lost their job(s).
- They are panicking and just want to stop losing money
- Pension funds that have to meet obligations
- Hedge funds have to meet redemptions
- Funds that have to sell if a company gets downgraded or share price falls too low
- Investors that have to meet margin calls

Reasons The US Stock Market Will Increase

Layoffs mean employee costs are decreasing. Problem is demand is decreasing faster than they can lay people off. The more people they lay off the less demand. Aka negative feedbacks loop.
Interest rates are decreasing. Problem is the interest rates for many companies are actually increasing if they can even get credit at all.
Commodity costs are declining. Problem is most of the earnings in the S&P 500 were from the most important commodity of all: Oil. Without that they S&P 500’s earnings will decline from $75 to $50.
Investors, who have to cash to buy with, will buy stocks because:
- Short sellers will cover their shorts
- 401k investors who blindly contribute to stock mutual funds (ever notice the market goes up on pay day)
- Long term investors that believe current prices are fair if not cheap and are able to withstand further declines (though very few have cash)
- Unfunded pensions will have to contribute to their plans. If they don’t change their asset allocation then they’ll have to buy stocks.

Reasons the US Economy Will Improve

Inflation is declining, especially oil. However, price declines don’t help on a global basis because any increased savings from cheaper prices in the consuming countries decreases the spending in the producing countries.
Interest rates are declining. Problem is credit is harder to get and demand for credit is much lower.
Unemployment benefits are increasing. Problem is the money received from unemployment benefits is less the job they had paid.
Few homebuilders have gone bankrupt, so those jobs have not been lost yet. The problem is at some point these companies will go bankrupt and the jobs will be lost.
Few banks have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few retailers have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
Few casinos have gone bankrupt, so those jobs have not been lost yet. Problem is at some point these companies will go bankrupt and the jobs will be lost.
The government is spending like mad. Problem is one day all this spending is going to have to be paid for. Of all the problems out there, this is the biggest problem. Especially if this problem is paid for via war.
The government is bailing almost everyone out. Problem is one day all the bailouts will have to be reversed somehow or another. If it’s through the natural course of inflation then expect to be in a recession (no growth or outright decline) for years if not decades.
The US dollar will reverse its recent strength and begin the decline, which is good for exports. Problem is the economy is global so any increase in exports in the US decreases exports somewhere else.

Ways to improve the economy

Let the free market work. Otherwise we will simply delay the depression. Only provide jobs for people that would have to be paid unemployment benefits anyway.
Let the automakers fail. If we don’t the whole auto industry will be worse off will worse cars.
Let the banks fail. If we don’t the whole financial industry will be worse off will higher rates.
Increase taxes on new building permits to deter building more houses.
Increase taxes on old houses and commercial buildings, especially energy inefficient ones, and provide tax break to tear them down.
Provide tax breaks for investors to buy abandoned assembly plants and build windmills.

Things To Anticipate Over The Next 90 Days

Service industries (retail, restaurants, hotels and affiliated) that had job growth in 2008 will begin to show declines along with everyone else.
Oil prices to continue falling (Still way too much supply out there in the short run)
Citigroup going the route of AIG.
Automaker(s) going bankrupt.
Significant amount of companies being downgraded, which will mostly affect on bonds.
Declining bond prices (Especially CMBS)
Some companies will not be able to afford to rollover their debt and that will bankrupt them
Even with all these problems, expect the government to NOT intervene as they wait for the new administration to take over. Looks like the short sellers are counting on it.

Things To Anticipate Over The Next Year

The recession to last all through 2009.
Borderline depression near the middle of 2009 if things get worse than the current trajectory.
Net earnings on the S&P 500 to be $50.
State and local governments will be reducing spending significantly unless they get bailed out.
A $500 billion fiscal stimulus package that focuses on rebuilding the US.
Whatever solution the Fed comes up with, they will overdue it, but not before it’s too late.
The government will continue to react to problems instead of anticipate them.
The market to bottom. Probably when you least expect it.
Retailers, homebuilders, mortgage insurers, insurance companies (think annuities), banks, casinos and car manufacturers all going bankrupt at the same time, their stocks and bonds go to zero, and they start over.
Highly dilutive secondary stock offers of which the proceeds will be used to pay down debt.
Home prices to continue declining
Increased savings. Obviously you then have decreased spending.
GDP to decline 5%
Unemployment to rise to 9% (That is a HUGE number)
No IPO’s
No Private Equity buyouts
Limited corporate bond issuance
A secular shift towards frugality
Under funded Medicare and probably more pressing Medicaid (State Run).
All time low interest rates. (check)

Things To Be Prepared For (Not that they’ll necessarily happen)

The stock market declining 70% from the high and staying there for 10 years.
The treasury market (especially long dated treasuries) declining 30% (the principal that is).
Have enough money saved up to buy the basic necessities in case you lose your job.
Have enough food in your house right now in case there is a run at the grocery store.
Have enough cash (gold?) on hand in case there is a run on the bank.
Have a way to defend yourself in case there are riots.
Have a TV antenna just in case the cable goes out.
Have a generator, but this is severely constrained by how much gas you can store.

What Type of Investments Will Work?

Short term corporate bonds of non financial companies that have significant amounts of cash.
Fairly priced stocks of non financial companies that have significant amounts of cash and pay a significant dividend.

Which Companies Will Be The First To Go Bankrupt?

Companies that have to roll over debt in the next 12 months, but don’t have enough cash on hand to pay it off. They will be forced to either reissue debt with 15% interest rates if they can get financing at all. This includes state and local governments.

Sayings (For lack of a better term)

The more things change the more they stay the same. (This is the new sound, just like the old sound.)
- The politicians who were in charge while this credit bubble was growing are the same politicians who are in charge now.
- The car manufactures haven’t changed a thing since they’ve been given the bailout money. Neither have the banks.
- Albert Einstein: "Never expect the people who caused a problem to solve it."
A bird in the hand is worth 2 in the bush

Quotes

Edwin LeFevre (1932): “Reckless fools lost first because they deserved to lose, and careful, wise men lost later because a world-wide earthquake doesn't ask for personal references.”
Albert Einstein: "Never expect the people who caused a problem to solve it."
Munger: “A small leak can sink a great ship”
US Sec. of the Treasury Andrew Mellon, 1929: “Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people."

Rules to Live by

Slow down, relax, deep breath.
Know Yourself
Think for Yourself
Execute (The other rules don’t matter if you don’t execute)
Write for YOURSELF. Especially any lessons learned.

Invest Accordingly

Brand Loyalty

2009-03-07T09:08:00.005-05:00

Interesting article on consumers trading down Here.

"Bounty, is seeing some of the steepest sales declines in its history"

Wow what a terrible and misleading article. Reminds me of when I read about how the total number of something has increased or decreased by a large amount, but in percentage terms its insignificant. I see it all the time when people talk about the "DOW." "Oh my, the DOW is down 300 points." Well when the DOW was at 12,000, 300 points was nothing. Today, with the DOW at 6,500, 300 points is much more significant.

Back to the article, notice the only numbers they use in the whole article is the % decline in the value of the stock, not the % decline in sales of Bounty etc. I'm betting (literally with my own investments now) that the decline is insignificant, maybe 5-10%, which is probably standard across the board. Now that may very well be "the steepest sales decline in its history," especially in total units because obviously with the growth of the population they are selling a lot more units. When it comes to TP and napkins, buying the cheapest ones doesn't work because they're so cheap that you end up using more. Same with the "heavy duty" batteries that use chloride instead of alkaline. People aren't going to buy knock off ketchup either, at least not a significant amount.

The majority of people will:
Drink Coke,
Eat Cheerios
Eat Heinz Ketchup
Eat Campbell's Soup
Trust Duracell Batteries
Use Charmin TP
Ship Packages via FedEx
Service Otis Elevators
Use Kleenex Tissues

Things that are easily traded down on or have no brand loyalty:
Electronics of any kind (Except maybe Intel processors)

However, I'm glad to see articles like this if they help drive the stock prices lower so I can add to my positions.

Stocks to Consider

2009-03-06T06:30:00.002-05:00

Strong balance sheet, great product, consistent earnings:

CMI

PGR

FDX

BNI

HON

TROW

XOM

MMM

CVX

KO

PG

WMI

K

ADP

INTC

PEP

UTX

JNJ

XLU

GIS

HNZ

Campbell Soup

2009-02-26T17:41:00.000-05:00

Campbell Soup

Catalysts

Distribution in place.
Low stock dilution
Consistent
Low debt

Detriments

Low cost competitor could come in. (Only if it could taste as good.)
Why is the float so low?
Lots of insider selling
Buying back stock instead of paying down debt.
If they write down the 2 billion in good will they have negative equity
How much would a major food scare (recall) cost them?
I don’t know their business model as well as I should. From what I understand most of their revenue comes from soup.
I’m not sure what other liabilities they have besides the debt on the balance sheet.
I didn’t take the time to look at the last 10 years of financial statements.

Moat
It would cost at least $1 billion to start up a soup company to compete with them. Even then it would still have to be priced lower otherwise people would just buy Campbell’s.

Share Count Trent
Their share count has declined by 7.5% over the last 5 years, but so has their stock. It would have been better to retire their debt instead. (Bad management)

Key Ratios and Competitors Key Ratios

Operating Margin 5 Year Annual Average 15.57%
ROA 5 Year Annual Average 10.03%
Revenue Growth Rate 5 Year Annual Average 3.67%
GIS Operating Margin 5 Year Annual Average 17.48%
GIS ROA 5 Year Annual Average 5.91%
GIS Revenue Growth Rate 5 Year Annual Average 5.38%
HNZ Operating Margin 5 Year Annual Average 14.97%
HNZ ROA 5 Year Annual Average 6.95%
HNZ Revenue Growth Rate 5 Year Annual Average 4.10%
PEP Operating Margin 5 Year Annual Average 17.69%
PEP ROA 5 Year Annual Average 15.94%
PEP Revenue Growth Rate 5 Year Annual Average 9.91%
KO Operating Margin 5 Year Annual Average 26.04%
KO ROA 5 Year Annual Average 15.82%
KO Revenue Growth Rate 5 Year Annual Average 8.90%

Sustainable Operating Profit Margin
15%: Looks like this is the average over the last 5 years. Considering that the last 5 years were more or less boom years, this seems high.
10% is probably more sustainable.

Sustainable Revenue Growth Rate
4%: Looks like this is the average over the last 5 years. Considering that the last 5 years were more or less boom years, this seems high.
2% is probably more sustainable.

Balance Sheet Appreciation (Depreciation)
-1%: It probably takes lots of PPE to make that soup. The equipment is bound to wear out. So their assets would actually be a negative (because they really do depreciate and they have to dispose of them).

Pollyanna Owner Earnings Yield
Revenue: $7,998 (From 2008 10K)
Operating Profit Margin: 15%
Tax Rate: 35%
Profit (Using The Above Estimates): $7,998 x .15 x .65 = $779
(This calculation is very simplified. After looking at their cash flow statement, their depreciation expense is about the same as their CapEx expense and the rest of the cash flow statement seems insignificant (though I may be missing something).)

Short Term Debt: $703
Current Portion of Long Term Debt: $300
Long Term Debt: $1,633
Total Debt: $703 + $300 + $1,633 = $2,636

Basic Shares Outstanding: 373 (From 2008 10K)
Stock Price: $28 (Rounded from 2-26-09)
Market Cap: $10,300 (Rounded from 2-26-09)

Enterprise Value: $2,636 + $10,300 = $12,936

Pollyanna Revenue Growth Rate: 4%

Pollyanna Owner Earnings Yield: $779 / $12,936 = 6.02% + 4% = 10.02%

Sustainable Owner Earnings Yield
Revenue: $7,998 (From 2008 10K)
Operating Profit Margin: 10%
Tax Rate: 40%
Profit (Using The Above Estimates): $7,998 x .10 x .60 = $479
(This calculation is very simplified. After looking at their cash flow statement, their depreciation expense is about the same as their CapEx expense and the rest of the cash flow statement seems insignificant (though I may be missing something).)

Short Term Debt: $703
Current Portion of Long Term Debt: $300
Long Term Debt: $1,633
Total Debt: $703 + $300 + $1,633 = $2,636

Diluted Shares Outstanding: 381 (From 2008 10K)
Stock Price: $28 (Rounded from 2-26-09)
Market Cap: $10,700 (Rounded from 2-26-09)

Enterprise Value: $2,636 + $10,700 = $13,336

Sustainable Revenue Growth Rate: 2%

Sustainable Owner Earnings: $479 / $13,336 = 3.6% + 2% = 5.6

The reality will probably be somewhere in between. I imagine similar companies would produce the same results. Considering this analysis, I’m not sure how anyone could say the stock market is way undervalued. To be way under valued I’d want to see Sustainable Owner Earnings at 15%. For that to happen with Campbell’s you would need to see the stock price drop to $10 a share. (By the way, that’s not a forecast by any means.)

For those that haven’t looked, many stocks are only at 2004 prices. The same with houses.