"The only function of economic forecasting is to make astrology look respectable." - John Kenneth Galbraith
I do not envy Janet Yellen, but I have to say that I am warming to her as the Federal Reserve Chair. Last week the FOMC had its meeting and the results are a slight testimony to the Federal Reserve in that she pretty much admitted that the data presented was too unclear to formulate a decisive direction for the main Federal Reserve's policies. Finally someone has come forward and admitted that they really have no clue where the economy is going and that they will have to wait to see what happens next before proposing a solution. This is refreshing in that she is owning up to what we already knew, the Federal Reserve is reactionary rather than being preemptive. For all of those who believed that the Federal Reserve had a "special" set of metrics that it could use to steer the economy on an even keel, this bubble has finally been burst. There never has been a magic number and there is no magic formula, they are just as constrained and confused as everyone else, the only difference is that they have massive sway over the markets and have used it to manipulate it for the supposed benefit of all.
Looking at their forecasts shows this first hand. While unemployment is expected to fall to 5.3% over the long run, inflation is expected to continue below the Federal Reserve target of 2% and GDP is expected to remain around 2.5%. I find these numbers very interesting as with anemic economic growth it will be increasingly hard to reduce unemployment much further than the current level so either the unemployment number is overly aggressive or GDP and inflation are too low. In response to this line of questioning Yellen responded that incoming data could prove stronger than expected and potentially invite rate
hikes that occur sooner and more rapidly than now envisioned but she also added that incoming data could go the other way too, and lead to rates
staying lower for longer than now envisioned. So in other words she is on the fence and other than continuing to reduce the monthly buy of Treasuries to zero by October the Federal Reserve is in a wait and see mode.
In order to track movements in the economy she has opened up that her dashboard of indicators is far larger than her predecessors. In other words the more data the better. The problem with all that data is that there is also a lot of noise infiltrating the decision making process but at least she is not confining herself to a short list of metrics that really have no baring on the economy. Using the underemployment rate, changes in consumer spending and the job quits rate are all better metrics than the unemployment rate. So while these are giving her a better indication of the labor market it could mean that the Federal Reserve remains in limbo for an extended period while they wait for an uptick across the dashboard during which time inflation could be rearing its head in metrics other than the Core PCE, her preferred metric.
The result could be that the Federal Reserve keeps interest rates low for an extended period (through 2016) only to be forced into trying to extinguish an accelerating inflationary fire after it has already burned half of the country. Once again acting in a reactionary way to data that the rest of us are witnessing first hand right now. At least she is more honest than her predecessors in saying that she has no ability to guess the future but outside of that know that you need to protect yourself rather than rely on the Federal Reserve.
Friday, July 25, 2014
Friday, July 18, 2014
Rule of 20
"A measure of stock valuations called the Rule of 20 states that the stock market is fairly valued when the sum of the average price earnings ratio and the rate of inflation is equal to 20."
The Rule of 20 is interesting in that should the total of these two numbers be less than 20 then the rule states that stocks are cheap and should be purchased and if they exceed this number then they are expensive and should be sold. Based on today's S&P500 index reading of 1965 and dividing this number by the expected total earnings per share of the S&P500 of $109, the price to earnings ratio of the S&P500 is just above 18. Add to this number the Federal Reserve's expectation of inflation of 1.5% and you can see that at this level in theory the S&P500 is slightly undervalued as the total is 19.5.
Looking at the ratio in a little more detail shows just how quickly this indicator can swing. If you take for example a more realistic inflation number of 4% (I am not sure that even this number is that realistic but it is closer to reality than the Federal Reserve's cooked number) suddenly the total is 22 and the indicator shows that stocks are overvalued. Furthermore if stocks cannot earn $109 this year and earn say $100 the index is suddenly flashing sell as it is now 23.65 a number not seen since before the 2008 crash.
The problem with looking at one indicator in isolation is thus highlighted. The numbers are based on expectations and once these change and the real numbers come in the indicator can swing pointing clearly to a buy or sell signal that was not present in the moment. This dilemma is normally present when an indicator of this nature reaches an inflection point. Were it to print a number of say 10 (which it did near the bottom in 2009) it is a clear buy indication, as was the sell signal it printed in 2007. At inflection points it is important that investors look at additional indicators to get a better understanding of the risks before deciding on a direction for the market.
Looking at a second indicator, the Price to Sales ratio, things look a lot different. The P/S ratio takes the value of the S&P500 and divides it by the total revenue of those companies. Sales is used for the simple reason that the sales number is the hardest number in the profit and loss statement to manipulate (readers of this blog can refer to the article on IBM and see just how badly earnings can be manipulated) so using this number gives a better idea of the market health. If sales are growing profits should follow but at present sales are actually contracting so this indicator is now at an all time high.
Another indicator is the price to GDP level. GDP is the total output of the nation and so a high price in relation to GDP shows over priced stocks. At present this indicator is back to its 2007 levels. I could go on but you get the picture that adding these indicators together shows a market that is in dire need of continued Federal Reserve stimulation and that is being tapered at a rate of $10 billion a month. Continuing on this path and it could spell trouble for the market right around October which has historically been one of the worst performing months in the history of the market - it gave us Black Monday and the Flash Crash among other fun meltdowns.
So while the indicators are signaling trouble there is still time to pull in your horns. Do not get caught holding the proverbial hot coal that the professional money managers are desperately trying to palm off onto any new comers to the market, or if you really need to be in the market make sure you have adequate protection or have the investment on a very short leash.
The Rule of 20 is interesting in that should the total of these two numbers be less than 20 then the rule states that stocks are cheap and should be purchased and if they exceed this number then they are expensive and should be sold. Based on today's S&P500 index reading of 1965 and dividing this number by the expected total earnings per share of the S&P500 of $109, the price to earnings ratio of the S&P500 is just above 18. Add to this number the Federal Reserve's expectation of inflation of 1.5% and you can see that at this level in theory the S&P500 is slightly undervalued as the total is 19.5.
Looking at the ratio in a little more detail shows just how quickly this indicator can swing. If you take for example a more realistic inflation number of 4% (I am not sure that even this number is that realistic but it is closer to reality than the Federal Reserve's cooked number) suddenly the total is 22 and the indicator shows that stocks are overvalued. Furthermore if stocks cannot earn $109 this year and earn say $100 the index is suddenly flashing sell as it is now 23.65 a number not seen since before the 2008 crash.
The problem with looking at one indicator in isolation is thus highlighted. The numbers are based on expectations and once these change and the real numbers come in the indicator can swing pointing clearly to a buy or sell signal that was not present in the moment. This dilemma is normally present when an indicator of this nature reaches an inflection point. Were it to print a number of say 10 (which it did near the bottom in 2009) it is a clear buy indication, as was the sell signal it printed in 2007. At inflection points it is important that investors look at additional indicators to get a better understanding of the risks before deciding on a direction for the market.
Looking at a second indicator, the Price to Sales ratio, things look a lot different. The P/S ratio takes the value of the S&P500 and divides it by the total revenue of those companies. Sales is used for the simple reason that the sales number is the hardest number in the profit and loss statement to manipulate (readers of this blog can refer to the article on IBM and see just how badly earnings can be manipulated) so using this number gives a better idea of the market health. If sales are growing profits should follow but at present sales are actually contracting so this indicator is now at an all time high.
Another indicator is the price to GDP level. GDP is the total output of the nation and so a high price in relation to GDP shows over priced stocks. At present this indicator is back to its 2007 levels. I could go on but you get the picture that adding these indicators together shows a market that is in dire need of continued Federal Reserve stimulation and that is being tapered at a rate of $10 billion a month. Continuing on this path and it could spell trouble for the market right around October which has historically been one of the worst performing months in the history of the market - it gave us Black Monday and the Flash Crash among other fun meltdowns.
So while the indicators are signaling trouble there is still time to pull in your horns. Do not get caught holding the proverbial hot coal that the professional money managers are desperately trying to palm off onto any new comers to the market, or if you really need to be in the market make sure you have adequate protection or have the investment on a very short leash.
Friday, July 11, 2014
The Unskilled Issue
I recently read an article that made a case for the next recession in the United States coming from the large drop in the wages of the lowest portion of the population. According to the study when there is a negative real rate of growth of the lower income this normally results in the onset of a recession for the simple reason that the in the economy most of the population falls below the median income due to the skewness of the income curve. Losing their spending power results in cutting back on goods and services and this leads to a recession as companies are unable to sell their wares into the market.
This article interested me as Africa is a continent with massive unskilled worker problems. More than 40% of unskilled workers in South Africa are unemployed which is why crime levels are so high. So if the United States is having a problem that may drag it into recession, what of Africa and how does one manage to get these masses employed and their real rates of income higher?
This is a global problem and one that is rapidly being exacerbated by the continued influence of technology on society. More and more there is a requirement for the unskilled to become skilled and so access to training and education is the obvious solution. Now while this may seem obvious the next issue facing the United States is one of massive student debt. I believe that it is imperative that the government provide assistance to students, the problem is that there are plenty of schools that are not providing the level of education required to ensure gainful employment once they depart the school. Furthermore while shortages are still prevalent in technology and other skilled sectors of all economies the problem is that the high school proficiency in science and mathematics are lacking so there is not a large enough pool of college entrants to fill these spots.
Taking this one step further spending money on higher education is wasted until you get your primary education house in order and in this respect the United States and South Africa are both lacking. In comparison the eastern economies place high regard on academic studies at the high school level there is a total disdain for this in these two countries. Now as always this is a very broad brush I am painting with as there are institutions in both countries that prize their level of education but overall the masses are pushed through the system with little regard for the follow on options required to stimulate the economies.
The obvious solution would be to target this as a place for large scale investment and new government policy to align the desired level of education with the expected challenges and opportunities of life beyond high school. No child left behind was flawed in that the result was that schools were rewarded for making sure that the bottom tier passed forgoing the rest of the kids in the grade. The thing to remember is that not everyone will be a science and mathematical whizz but with all the new technological developments being created unless this tertiary education can be improved these problems will remain.
This article interested me as Africa is a continent with massive unskilled worker problems. More than 40% of unskilled workers in South Africa are unemployed which is why crime levels are so high. So if the United States is having a problem that may drag it into recession, what of Africa and how does one manage to get these masses employed and their real rates of income higher?
This is a global problem and one that is rapidly being exacerbated by the continued influence of technology on society. More and more there is a requirement for the unskilled to become skilled and so access to training and education is the obvious solution. Now while this may seem obvious the next issue facing the United States is one of massive student debt. I believe that it is imperative that the government provide assistance to students, the problem is that there are plenty of schools that are not providing the level of education required to ensure gainful employment once they depart the school. Furthermore while shortages are still prevalent in technology and other skilled sectors of all economies the problem is that the high school proficiency in science and mathematics are lacking so there is not a large enough pool of college entrants to fill these spots.
Taking this one step further spending money on higher education is wasted until you get your primary education house in order and in this respect the United States and South Africa are both lacking. In comparison the eastern economies place high regard on academic studies at the high school level there is a total disdain for this in these two countries. Now as always this is a very broad brush I am painting with as there are institutions in both countries that prize their level of education but overall the masses are pushed through the system with little regard for the follow on options required to stimulate the economies.
The obvious solution would be to target this as a place for large scale investment and new government policy to align the desired level of education with the expected challenges and opportunities of life beyond high school. No child left behind was flawed in that the result was that schools were rewarded for making sure that the bottom tier passed forgoing the rest of the kids in the grade. The thing to remember is that not everyone will be a science and mathematical whizz but with all the new technological developments being created unless this tertiary education can be improved these problems will remain.
Friday, July 4, 2014
Risk or Opportunity?
"The man who knows it can't be done counts the risk and not the reward." - Elbert Hubbard
Currently I am in South Africa visiting friends and family and I have spent a lot of time trying to bring myself up to speed with the business and economic environment. After asking numerous questions and digesting the information it is clear that where some investors see only risk while others see opportunity. Like most investments the difference between determining whether the opportunity presents itself as an investment or something to be shunned comes down to your assessment of the risk of the investment and the expected reward, however there is more to the equation than first meets the eye.
When you look at investing in Africa as a foreigner the idea is daunting. The capital risk is enormous as not only can the investment be lost to government nationalization but strikes, bribes, extortion, corruption, blackouts and worker and social unrest are the norm, spending on protection is common place and governments can change overnight. In addition trying to find and retain skilled workers is becoming increasingly difficult and you start to wonder why anyone in their right mind would bother to invest at all. It is also no wonder that most African currencies are taking a beating against the dollar and the Euro.
As an example when the South African mobile phone operator MTN expanded into Nigeria they had factored in the cost to build the cell phone towers only to discover that the power grid was so poor that each tower required its own generator to provide power. Once these were installed they soon found that a new expense was required in that the generators were soon being stolen so now they had to hire security guards to protect the generators. Fortunately for them the opportunity was so vast that they were able to manage these expenses while continuing to profit which brings me to the first addition to the equation, recurring revenue. MTN can make a go of this because of the recurring revenue model that is the cell phone industry. Were this a one off project I doubt these expenses could possibly be borne.
The next thing to look at for MTN was that they had essentially maximized their opportunity in South Africa and so to expand they needed to look elsewhere. This is similar to a Apple or Microsoft in the United States who seek to grow their markets by expanding into new regions. For a South African country moving into Africa is the obvious choice as the expertise is there and they are already familiar with the lay of the land. This expertise is critical and has led to some other South African companies expanding based on first exploiting their local knowledge before taking on the rest of the world.
South African Breweries springs to mind. They started as a local brewer and soon managed to become the preeminent brewer in South Africa. They then tried to expand into Africa with minimal success until they realized that their lack of success was due to the lack of refrigeration. So they began delivering refrigerators to their distributors around the continent and sales started to boom - who doesn't want a cold beer on a steaming African safari? They are now one of the largest brewers in the world having acquired numerous other breweries including Miller.
The opportunity therefore presented itself to these businesses because of their proximity to the opportunity, their expertise and the recurring revenue that was present (once the refrigerator was installed the only cold beer in town was SAB's or the refrigerator was removed). So the next time that you determine an opportunity is worth an investment do not limit yourself to the risk and the reward equation but expand it to include expertise and recurring revenue!
Currently I am in South Africa visiting friends and family and I have spent a lot of time trying to bring myself up to speed with the business and economic environment. After asking numerous questions and digesting the information it is clear that where some investors see only risk while others see opportunity. Like most investments the difference between determining whether the opportunity presents itself as an investment or something to be shunned comes down to your assessment of the risk of the investment and the expected reward, however there is more to the equation than first meets the eye.
When you look at investing in Africa as a foreigner the idea is daunting. The capital risk is enormous as not only can the investment be lost to government nationalization but strikes, bribes, extortion, corruption, blackouts and worker and social unrest are the norm, spending on protection is common place and governments can change overnight. In addition trying to find and retain skilled workers is becoming increasingly difficult and you start to wonder why anyone in their right mind would bother to invest at all. It is also no wonder that most African currencies are taking a beating against the dollar and the Euro.
As an example when the South African mobile phone operator MTN expanded into Nigeria they had factored in the cost to build the cell phone towers only to discover that the power grid was so poor that each tower required its own generator to provide power. Once these were installed they soon found that a new expense was required in that the generators were soon being stolen so now they had to hire security guards to protect the generators. Fortunately for them the opportunity was so vast that they were able to manage these expenses while continuing to profit which brings me to the first addition to the equation, recurring revenue. MTN can make a go of this because of the recurring revenue model that is the cell phone industry. Were this a one off project I doubt these expenses could possibly be borne.
The next thing to look at for MTN was that they had essentially maximized their opportunity in South Africa and so to expand they needed to look elsewhere. This is similar to a Apple or Microsoft in the United States who seek to grow their markets by expanding into new regions. For a South African country moving into Africa is the obvious choice as the expertise is there and they are already familiar with the lay of the land. This expertise is critical and has led to some other South African companies expanding based on first exploiting their local knowledge before taking on the rest of the world.
South African Breweries springs to mind. They started as a local brewer and soon managed to become the preeminent brewer in South Africa. They then tried to expand into Africa with minimal success until they realized that their lack of success was due to the lack of refrigeration. So they began delivering refrigerators to their distributors around the continent and sales started to boom - who doesn't want a cold beer on a steaming African safari? They are now one of the largest brewers in the world having acquired numerous other breweries including Miller.
The opportunity therefore presented itself to these businesses because of their proximity to the opportunity, their expertise and the recurring revenue that was present (once the refrigerator was installed the only cold beer in town was SAB's or the refrigerator was removed). So the next time that you determine an opportunity is worth an investment do not limit yourself to the risk and the reward equation but expand it to include expertise and recurring revenue!
Tuesday, June 24, 2014
Procrastination - The Investors Friend?
"Nothing is so fatiguing as the eternal hanging on of an uncompleted task." - William James
Procrastination is loathed by society. Psychologists try to rid people of the problem and in the investment world it is often seen as a better option to jump before making sure that all the research is done - rather trade than miss the trade altogether. But it appears that modern society has taken the need for action too far. Our lives are filled with devices that demand but do not require instant response and more and more people are living with this burden which is taking away their ability to think rationally and this is feeding into their investments with disastrous consequences.
Take for example the cell phone. We can text, take calls and receive messages; we can look up the answer to any question instantly on the Internet and it ensures we never get lost, plus we can take a picture of the view once we are there and instantly broadcast it to all of our so called friends. This one device has taken control of our lives and it is feeding into all we do. How many times have you been in a conversation when someone hears a buzz on their phone and either takes the call or stops to read a text? The entire conversation is broken by this intrusion and the thought process is lost. Not only is it rude but it has ruined any logical process associated with the prior discussion. Now as with everything there are exceptions to this but by and large the majority of these interruptions are noise.
The same is happening in investing. Noise is taking over people's ability to focus on the real issues and instant action is required which most of the time results in a poor outcome or huge fees. Far better to give the noise time to dissipate. We as humans are poorly wired to make rational decisions based on short term inputs, we are far better at basing investment and other decisions on the important facts after the dust has settled and the noise has died down so often times giving it a little time is a better option.
Now the issues is the that some times the decision is required to be made in short order so how to decide when to wait and when to act? In reality it is not that difficult. Take the example of a broken arm versus moderate back pain. The first requires immediate attention while the later often times is fixed with some exercise or rest and normally does not require a spinal fusion. Or how about making sure you get to the airport early so that you do not miss your flight? Unless you own the plane procrastinating about this is not a wise decision. We are mentally wired to make the determination as to which decisions require our immediate attention versus which do not however the increase in the level of noise is starting to distort our natural filters.
In the investment world it is normally better to take the time to prepare and do your homework rather than act. Take the idea of a "hot" tip; if it really is going to go to $1,000 a share from $1 then there is plenty of time to do your research and buy the stock. Sure you will have given up some bragging rights but if you get in at $20 you will still be in a great position.. If the market were to crater 5,000 points tomorrow it would not be the time to dump every stock that you own as the damage is already done; a better solution would be to survey the damage and selectively determine how to react.
Taking this a step further and looking at the Federal Reserve they have definitely bought into the requirement to act. Following on from last week's blog on GM I wonder if they really would have jumped in to save the company had they taken a little longer to decide. Now at the time that they made the decisions there was a lot of noise from the general public to act and action was required. The financial markets were broken and it was their job to maintain some kind of order in these markets but the question is whether they made a rational decision or acted on noise and you know my answer.
So while I am not advocating that everyone sit on the fence forever preparing, I am advocating that people take a little more time to make their investment decisions and spend more time making sure that their overall portfolio is tailored to their requirements rather than trying to chase another "hot" opportunity. With markets continuing their ascension to new all time highs you will be far better served spending time preparing for and avoiding any future meltdowns than trying to prosper by trading the noise.
Procrastination is loathed by society. Psychologists try to rid people of the problem and in the investment world it is often seen as a better option to jump before making sure that all the research is done - rather trade than miss the trade altogether. But it appears that modern society has taken the need for action too far. Our lives are filled with devices that demand but do not require instant response and more and more people are living with this burden which is taking away their ability to think rationally and this is feeding into their investments with disastrous consequences.
Take for example the cell phone. We can text, take calls and receive messages; we can look up the answer to any question instantly on the Internet and it ensures we never get lost, plus we can take a picture of the view once we are there and instantly broadcast it to all of our so called friends. This one device has taken control of our lives and it is feeding into all we do. How many times have you been in a conversation when someone hears a buzz on their phone and either takes the call or stops to read a text? The entire conversation is broken by this intrusion and the thought process is lost. Not only is it rude but it has ruined any logical process associated with the prior discussion. Now as with everything there are exceptions to this but by and large the majority of these interruptions are noise.
The same is happening in investing. Noise is taking over people's ability to focus on the real issues and instant action is required which most of the time results in a poor outcome or huge fees. Far better to give the noise time to dissipate. We as humans are poorly wired to make rational decisions based on short term inputs, we are far better at basing investment and other decisions on the important facts after the dust has settled and the noise has died down so often times giving it a little time is a better option.
Now the issues is the that some times the decision is required to be made in short order so how to decide when to wait and when to act? In reality it is not that difficult. Take the example of a broken arm versus moderate back pain. The first requires immediate attention while the later often times is fixed with some exercise or rest and normally does not require a spinal fusion. Or how about making sure you get to the airport early so that you do not miss your flight? Unless you own the plane procrastinating about this is not a wise decision. We are mentally wired to make the determination as to which decisions require our immediate attention versus which do not however the increase in the level of noise is starting to distort our natural filters.
In the investment world it is normally better to take the time to prepare and do your homework rather than act. Take the idea of a "hot" tip; if it really is going to go to $1,000 a share from $1 then there is plenty of time to do your research and buy the stock. Sure you will have given up some bragging rights but if you get in at $20 you will still be in a great position.. If the market were to crater 5,000 points tomorrow it would not be the time to dump every stock that you own as the damage is already done; a better solution would be to survey the damage and selectively determine how to react.
Taking this a step further and looking at the Federal Reserve they have definitely bought into the requirement to act. Following on from last week's blog on GM I wonder if they really would have jumped in to save the company had they taken a little longer to decide. Now at the time that they made the decisions there was a lot of noise from the general public to act and action was required. The financial markets were broken and it was their job to maintain some kind of order in these markets but the question is whether they made a rational decision or acted on noise and you know my answer.
So while I am not advocating that everyone sit on the fence forever preparing, I am advocating that people take a little more time to make their investment decisions and spend more time making sure that their overall portfolio is tailored to their requirements rather than trying to chase another "hot" opportunity. With markets continuing their ascension to new all time highs you will be far better served spending time preparing for and avoiding any future meltdowns than trying to prosper by trading the noise.
Friday, June 20, 2014
General Mediocrity - The Ticket to Failure
"Competition is always a good thing. It forces us to do our best. A monopoly renders people complacent and satisifed with mediocrity." - Nancy Pearcey
After reading about General Motors' 30th recall of the year I began to wonder why it was that this company was worth saving with tax payer money? Considering that the government's investment lost $10.5 billion of taxpayer (that is your and my money) I think it worth looking at the company in more detail.
Since saving it the company has recalled millions of cars, killed 13 people due to faulty ignition switches and continues to pour out mediocre cars and trucks. I understand that the idea was to save jobs but if the company was of some strategic importance or was producing a technological break through that would be one thing but to save a company that was doomed to failure because of its own ineptness rather than market problems is intervention of the Japanese kind.
Sure there are those that remember the famed American heyday of the automobile but to compete in the car market today you either need to differentiate yourself through either building excellent cars like the Japanese and the German's or innovating like Tesla or you need to be the cheap alternative like the Koreans. Sitting in between differentiation or low cost is prone to failure and that is exactly what GM had done. In his famous book on Competitive Advantage, Porter explains in detail how companies fail unless they achieve one or the other and GM had at the time of being rescued neither going for it.
Fast forward to today and it is clear that regardless of the support they have gone back to business as usual. They were given an opportunity to develop into a world class company but this has been squandered. Sure, sales have grown but the net income margin has shrunk from around 6% in 2011 to just over 3% in 2013 and it looks like it will fall further. Worse still, if you add back the original cost of debt that the company had pre-rescue, net income would be zero.
Now I am not opposed to saving jobs but would the loss of GM really have had that big of an impact. Consider the brands that GM holds and some of the makes and models of cars I firmly believe that many of these brands would still be operating today but under new management with better efficiencies than GM. I would be highly surprised if the brands of Chevrolet or Cadillac were not still around and I would also be highly surprised if they were not profitable. These companies would be independent of one another and would rely on innovation and excellence rather than just brand loyalty. The problem with brand loyalty is that after a while it wanes particularly when people are dying due to the company's mediocrity.
If I am right it undermines the argument that the company was so big that if it failed it would drag down the supply chain and hurt millions of individuals ans companies. Now while this may have been the case temporarily the idea behind capitalism is to let things die that are inefficient so that the new company or companies can prosper and provide opportunity for the people that work there.
The $10.5 billion is gone and I am not crying over spilt milk what I am bringing to everyone's attention is that we need to let capitalism work and stop the manipulation of the markets and companies. The too big to fail mantra needs to be dropped as it breeds inefficiency and complacency and stands in the way of innovation and development. Japan is still struggling to get their economy started after 30 years of trying and one of the reasons is their mantra of work is provided for life. This is akin to too big to fail and unless we learn from this lesson we too will be stuck muddling along for a long time to come.
After reading about General Motors' 30th recall of the year I began to wonder why it was that this company was worth saving with tax payer money? Considering that the government's investment lost $10.5 billion of taxpayer (that is your and my money) I think it worth looking at the company in more detail.
Since saving it the company has recalled millions of cars, killed 13 people due to faulty ignition switches and continues to pour out mediocre cars and trucks. I understand that the idea was to save jobs but if the company was of some strategic importance or was producing a technological break through that would be one thing but to save a company that was doomed to failure because of its own ineptness rather than market problems is intervention of the Japanese kind.
Sure there are those that remember the famed American heyday of the automobile but to compete in the car market today you either need to differentiate yourself through either building excellent cars like the Japanese and the German's or innovating like Tesla or you need to be the cheap alternative like the Koreans. Sitting in between differentiation or low cost is prone to failure and that is exactly what GM had done. In his famous book on Competitive Advantage, Porter explains in detail how companies fail unless they achieve one or the other and GM had at the time of being rescued neither going for it.
Fast forward to today and it is clear that regardless of the support they have gone back to business as usual. They were given an opportunity to develop into a world class company but this has been squandered. Sure, sales have grown but the net income margin has shrunk from around 6% in 2011 to just over 3% in 2013 and it looks like it will fall further. Worse still, if you add back the original cost of debt that the company had pre-rescue, net income would be zero.
Now I am not opposed to saving jobs but would the loss of GM really have had that big of an impact. Consider the brands that GM holds and some of the makes and models of cars I firmly believe that many of these brands would still be operating today but under new management with better efficiencies than GM. I would be highly surprised if the brands of Chevrolet or Cadillac were not still around and I would also be highly surprised if they were not profitable. These companies would be independent of one another and would rely on innovation and excellence rather than just brand loyalty. The problem with brand loyalty is that after a while it wanes particularly when people are dying due to the company's mediocrity.
If I am right it undermines the argument that the company was so big that if it failed it would drag down the supply chain and hurt millions of individuals ans companies. Now while this may have been the case temporarily the idea behind capitalism is to let things die that are inefficient so that the new company or companies can prosper and provide opportunity for the people that work there.
The $10.5 billion is gone and I am not crying over spilt milk what I am bringing to everyone's attention is that we need to let capitalism work and stop the manipulation of the markets and companies. The too big to fail mantra needs to be dropped as it breeds inefficiency and complacency and stands in the way of innovation and development. Japan is still struggling to get their economy started after 30 years of trying and one of the reasons is their mantra of work is provided for life. This is akin to too big to fail and unless we learn from this lesson we too will be stuck muddling along for a long time to come.
Friday, June 13, 2014
Austerity versus Stimulus
"Past experience with fiscal austerity at home and overseas strongly suggests that it is best for the economy's long run performance to restrain government spending rather than raise taxes." - Mark Zandi
British GDP will exceed the pre-recession level this year as the economy grows for the fifth consecutive quarter. It is now the fastest growing G-7 economy as GDP growth is expected to exceed 3% in 2014. Furthermore the government's austerity program has resulted in $108 billion in savings to date with an additional $100 billion expected in the coming two years. While these cuts may seem small to an American, the total budget is just under $1 trillion so $100 billion is equivalent to a 10% savings. The British unemployment rate is now 6.9% even though the government cut its work force by 13%. To achieve these heady numbers the British government embarked on an austerity package that, at its peak resulted in workers real incomes falling to their lowest in a decade. This pain was taken up front and on the chin rather than kicking it down the road and while debt to GDP is around 90% the pace of growth is slowing and seems well under control.
This is in stark contrast to the United States whose stimulus package has resulted in a debt to GDP ratio of 110% which continues to rise. Furthermore the methodology being pursued is sure to result in more spending at all government levels taking this debt level even higher. The can has been squarely kicked down the road in an effort to alleviate any pain to the consumer. United States unemployment is still north of 6% and if you add in all the part time workers it is above 10%. Furthermore the participation rate is at a level not seen since 1978. This slack participation rate means that there are millions of Americans that would love to have a job but have given up. With GDP growth predicted to barely beat 2% in 2014 (I do not think that we will even come close to this number) there is little in the way to celebrate the money printing methods of the Federal Reserve.
As I have mentioned in blogs past, austerity will ultimately win out as you cannot repair a debt problem by adding more debt. Any economic benefit from adding debt are short lived and ultimately result in inflation. Inflation is now being felt as oil prices spiked on the problems in Iraq and Ukraine; food prices continue to spiral higher and medical costs and taxes jump. The United States consumer is still hurting all these years and many trillions of dollars later. So while the Federal Reserve is now slowly cutting its stimulus to me this is too little too late and as with all problems, delaying the inevitable will result in far more pain.
While this is not a happy situation I believe that we still have time to right the ship as the United States will benefit from the rising oil prices. It is also still a technology power house and the innovations from this sector continue to produce benefits that can remove competencies from other countries (take 3D printing as an example) giving the United States a continued competitive advantage. I am hopeful that once the stimulus program is ended that the new Federal Reserve Chair Janet Yellen will continue to cut these types of market manipulating policies as they do not stimulate the economy nor do they produce jobs or economic strength. What they do is erode consumer confidence and weaken the long term prospects of the country. Hopefully Yellen is learning a thing or two from her counter part at the Bank of England, but I am doubtful. It appears that once again the United States will take the road of least pain and resistance and this will not provide the required outcome but will result in long term economic weakness.
British GDP will exceed the pre-recession level this year as the economy grows for the fifth consecutive quarter. It is now the fastest growing G-7 economy as GDP growth is expected to exceed 3% in 2014. Furthermore the government's austerity program has resulted in $108 billion in savings to date with an additional $100 billion expected in the coming two years. While these cuts may seem small to an American, the total budget is just under $1 trillion so $100 billion is equivalent to a 10% savings. The British unemployment rate is now 6.9% even though the government cut its work force by 13%. To achieve these heady numbers the British government embarked on an austerity package that, at its peak resulted in workers real incomes falling to their lowest in a decade. This pain was taken up front and on the chin rather than kicking it down the road and while debt to GDP is around 90% the pace of growth is slowing and seems well under control.
This is in stark contrast to the United States whose stimulus package has resulted in a debt to GDP ratio of 110% which continues to rise. Furthermore the methodology being pursued is sure to result in more spending at all government levels taking this debt level even higher. The can has been squarely kicked down the road in an effort to alleviate any pain to the consumer. United States unemployment is still north of 6% and if you add in all the part time workers it is above 10%. Furthermore the participation rate is at a level not seen since 1978. This slack participation rate means that there are millions of Americans that would love to have a job but have given up. With GDP growth predicted to barely beat 2% in 2014 (I do not think that we will even come close to this number) there is little in the way to celebrate the money printing methods of the Federal Reserve.
As I have mentioned in blogs past, austerity will ultimately win out as you cannot repair a debt problem by adding more debt. Any economic benefit from adding debt are short lived and ultimately result in inflation. Inflation is now being felt as oil prices spiked on the problems in Iraq and Ukraine; food prices continue to spiral higher and medical costs and taxes jump. The United States consumer is still hurting all these years and many trillions of dollars later. So while the Federal Reserve is now slowly cutting its stimulus to me this is too little too late and as with all problems, delaying the inevitable will result in far more pain.
While this is not a happy situation I believe that we still have time to right the ship as the United States will benefit from the rising oil prices. It is also still a technology power house and the innovations from this sector continue to produce benefits that can remove competencies from other countries (take 3D printing as an example) giving the United States a continued competitive advantage. I am hopeful that once the stimulus program is ended that the new Federal Reserve Chair Janet Yellen will continue to cut these types of market manipulating policies as they do not stimulate the economy nor do they produce jobs or economic strength. What they do is erode consumer confidence and weaken the long term prospects of the country. Hopefully Yellen is learning a thing or two from her counter part at the Bank of England, but I am doubtful. It appears that once again the United States will take the road of least pain and resistance and this will not provide the required outcome but will result in long term economic weakness.
Subscribe to:
Posts (Atom)
