Market Watch - June 20, 2008
The news certainly keeps us on our toes! Everywhere we look there is a new problem identified to bring the economy to its knees. Let’s take a look at the fundamental problems and discuss the economic effect of these problems as they might relate to Market Watch readers.
1. China continues to steal our jobs. China is in quite a similar position with us that Japan was during the late 1980s—they are enjoying huge inventories of dollars from trade surpluses. The U. S., which was “being buried” by Japanese products and technology in the 1980s, has done very well over the last 20 years if one measures the increase in U. S. wealth, which has been tremendous. The Japanese got their inflation under control—now the Chinese need to get their inflation under control. The Japanese currency was at an unrealistically low value relative to the other major currencies in the world. When China addresses this and gets it straightened out, the U. S. trade imbalance will come closer to a U. S. trade balance.
2. U. S. BANKS ARE GOING BROKE. At the snap of our fingers, foreign investors, led by Wall Street, put $289 billion of direct equity funding into U. S. financial institutions. This is about money, and the world’s commerce revolves around money. Wall Street controls that money. There are more than $3 trillion in sovereign funds spread around the world, more than 80% of which is in U. S. dollars. As long as the U. S. trade deficit remains a deficit, sovereign funds will grow. This money (sovereign funds) will come back into the United States in the form of investments, as the United States is the pinnacle around which the rest of the world’s economy revolves. The next time our banks fail, the banks will get bailed out again. It’s been happening for 200 years, and it will continue to happen as long as the U. S. maintains as much economic power as we have over the last several generations. These sovereign fund investments are the beginning of a dramatic shift in economic power around the world. Foreign money will have a larger say in U. S. corporate and political affairs.
3. Commodity Prices have gone through the roof. Rice, the world’s primary staple, is up 250% in cost over the last 18 months, untenable for most of the world. Increases in commodity prices favor resource rich countries. That’s us. Additionally, increases in commodity prices favor U. S. cash flow. This is the largest agricultural country in the world, and agriculture remains our largest industry. As commodity prices increase, the U. S. gets wealthier.
4. Home prices are falling like a rock, and additionally, there were only 975,000 new housing starts this year, the lowest in 17 years. The housing market is no different than the stock market—values go up and values go down. There is a huge surplus inventory out there as a result of government policies requiring loans to be made to unqualified borrowers. This current market will not only absorb the housing surplus, but it will cause prices to become realistic again.
5. We are running out of oil and the cost of gasoline is going to bring this country to its knees. There is more oil and gas in the United States, and off our shore, than we need for more than 50 years. Methods to extract the oil have become technologically superior to what they were even 10 years ago which increases dramatically the amount of recoverable reserves. In spite of $4+ a gallon gasoline, it remains the cheapest gasoline in the free world. The problem is not the business community. The problem is our U. S. and state governments. We are not allowed to explore in any of these new fields for environmental reasons when we have the best technology that’s ever existed in history before. Oil exploration would do infinitely less damage than the drunken captain who ran Exxon’s tanker ashore south of Alaska. The U. S. G. S. estimates 3.65 billion barrels of oil exists in the Bakken Field in the northern mid-west and western states—the Bakken deposit is the largest single oil find in U. S. history. The Gulf of Mexico is loaded with oil that cannot be explored as is the state of Alaska. Maybe it could be an unwritten government policy to exhaust the rest of the world’s fossil fuels before using our own vast recoverable reserves.
6. People seem to be short of cash. The Federal Reserve System has added money in record amounts since January 1st of this year to a point where there is plenty of money to borrow. Banks, however, are becoming more realistic on credit, and they are now filling up their loan portfolios with less risky loans. This assures future financial stability for our lending institutions which will bode well for our economy in the next five to ten years. Bountiful amounts of cheap capital are now available for all credit worthy borrowers.
7. China is undergoing a huge purchase of war planes and warships from Russia in the biggest military build up since Germany in 1933 - 1939. Russia is rearming, too. And both countries will end up with masses of weapons, like they had before, that are hopefully inferior to U. S. and allied produced weapons. We will continue to build our military, our allies will continue to build their military, and our “enemies” will continue to build their military, thereby guaranteeing some excellent stock market returns in the U. S .
8. These huge international trade debts could bankrupt our country. What it will do is redistribute the wealth around the world by loading up the sovereign funds of other countries. Those are dollars that will be coming back to us to purchase food, or high tech equipment, or military goods, all of which will be good for the U. S. stock markets.
9. The U. S. economy is sitting on a mountain of debt, and because of U. S. government policies, it’s continuing to increase. The U. S. government borrows 80% of the world’s loanable funds every year just to sustain its spending habits. In addition to loading the economy with cash, and bailing out a few banks, the FED has lowered its lending benchmark by 2-1/2% since September, 2007. This creates inflation, so what the FED is doing is what they have done in the past—by creating copious amounts of money to pay U. S. debts, inflation will eat away the principal amount of those debts until the debts are paid off with dollars that are substantially depreciated from when the debt was created. While this may hurt, or impede the growth of our national wealth, it does not negatively affect most companies that comprise our stock markets. “A” rated companies who have strong balance sheets, usually grow at a rate greater than inflation.
10. Middle Eastern oil resources put them in a position to control the economics and politics of the world for the next several decades. As mentioned above, we have more oil and gas in the United States than anywhere else in the world, with the possible exception of Russia, whose statistics might be suspect. The Middle East’s oil reserves are decreasing, and they will continue to become less important in the supplying of petro-chemicals. The Middle Eastern windfall in petro-chemicals may be compared to the U. S. windfall in gold and silver exploration the middle part of the 19th century. Those gold and silver deposits built up huge foreign currency reserves which became a springboard from which our industrial revolution prospered. When gold and silver was played out, we had built a base. The “sovereign funds” of foreign countries that have large petro-chemical resources are comparable to the reserves the U. S. created from our gold and silver mining. The spending of those sovereign funds will benefit the United States because much of it will be invested in U. S. businesses.
11. U. S. Wealth is eroding and is estimated at $56 trillion, down $1.7 trillion from the previous quarter’s estimate of U. S. household wealth. This is not “lost wealth” as real estate was overvalued, and the stock market remains slightly overvalued. Our “wealth” has been maintained at a level exceeding historical average values.
Conclusion
If you want to predict the future, read the Old Testament. Man and governments make the same mistakes over and over and over again because they are greedy and self indulgent. What we have to do as investors is realize which of these problems that exist can affect us negatively in our investment life. Most of the above delineated problems can positively affect our investment portfolio if we are invested in the right things at the right price.
Conservative investors will continue to look at securities that are fairly priced. Favor Dow stocks (or Dow “type” stocks) that enjoy healthy international business. Such stocks continue to include such monsters as GE, HD, IBM, JNJ, MAR, MCD, PEP, PG, TGT, SYY, WMT, and WFC. All of these are “A” rated securities selling at dividend yields that exceed their average historical yields. Their price earnings ratios are less than their average historical price earnings ratios. All of these stocks have had consistent dividend and earnings increases over the last 12 years.
Don’t be discouraged. “A” rated bargains only, with international exposure.
Carpe Diem.
George Rauch
June 20, 2008
