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ECONOMIC FACT AND ECONOMIC FICTION By Mike Gasior In my seminars and consulting projects during this year, it has been fascinating to me how often the economy at large becomes a topic of conversation. Needless to say I'm a lightning rod for this sort of talk, thanks to thirty years spent around the markets and my background in economics has had people engaging me in this way my entire adult life. It's just that I've never had this many people across such a wide spectrum of the population pulling me aside to ask my opinion. Just recently, in a matter of 24 hours I had the CFO of a Fortune 500 company and the cashier at the 7-11 where I buy my Big Gulps ask me the same question verbatim: "Do you really think the recession is over?" Many of you have been reading these newsletters for years and some also check my blog posts and comments on Twitter, and think you might already know my opinions. Perhaps you might know my summary opinions, but I think it is important to understand all the reasons behind why I feel the way I do. This is why I love to teach people as much as I do; because I want everyone to understand the difference between information and knowledge. Right now I find that people have an assortment of random information without having the ability to turn it into knowledge. To understand what I mean, consider the Internet. It's a vast, almost infinite ocean of information. Knowledge is what it becomes when you can sew it and stitch it together so that it becomes something that is actually useful. That is what I plan to do this month; take a lot of the noise we are all hearing via the media and try to assemble it into something resembling knowledge. By the way, if you haven't found my blog or me on Twitter, here are those respective links: Now a couple of quick business items before I get to the subjects at hand. REMAINING SCHEDULE FOR 2009 I have been offering training to the institutional investor community for 20 years, but this education has never been as important as it is right now. With all the turmoil we have just endured and the confusion surrounding many of the assets held by investors, staffs need appropriate knowledge to operate effectively under these historic conditions. With many organizations reducing the headcount in a variety of departments, cutting back on education for the remaining personnel in this environment could be potentially catastrophic. I will be presenting nine of our most timely programs in New York, Los Angeles and Chicago during the remainder of the year and you can view the entire schedule at the following link: http://www.afs-seminars.com/schedule.html Although my schedule has become fairly tight, there are still dates available if your organization would like to host one of our standard or custom sessions for your staff on an in-house basis. Please contact my offices at (860)347-6568 for more information. I have been a speaker at various events on a variety of financial and economic topics this year but the subject of investment fraud has been quite popular. If you would be interested in having me address your group, please call me directly. Finally, I will be doing presentations for the Chartered Accountant associations of both Bermuda and the Cayman Islands later this year, so if you're a member of one those groups, please check with them for availability. THE ALPHABET SOUP OF RECESSIONS Nothing is more ludicrous to me than listening to the parade of gasbag stooges that the various media outlets parade in front of the camera to make predictions about what kind of recession this one is going to be. "V", "W", "U" or "L" shaped are all fairly common answers. While I agree that the attention span of most of the public is quite short, it is far too difficult to sum up an organism as complex as the United States or global economy into a sound bite like that. Not to mention that nearly every single one of these Bozos never predicted the recession was even coming. (I have vivid and total recall about how small the group I was part of was.) I wrote about it for many years (you'll find over 1,000 pages of my writing spanning almost a decade at this link http://www.afs-seminars.com/newsletter.html) and there was also Peter Schiff, Nouriel Roubini and a handful of others who talked about the horrible course we were on under Greenspan and Bush and how we were destined to end up in this condition. I'm not going to speak for anyone else but I think that Obama, the current Congress and Bernanke, have only made the economic situation much worse. Let me sum up my opinion of the economy in one sentence: The economy is in worse shape today than they were a year ago, two years ago or three years ago. One needn't have an economics degree to put the pieces of this simple puzzle together and understand my opinion. Nearly everyone in America and the rest of the world knows that we got ourselves into this situation because of a "debt bubble"...that there was just too much debt. Right? Well, you know what? The economy of the United States has MORE debt outstanding now than it did one year ago, two years ago and three years ago. Period. Paragraph. Sure, the consumer has "deleveraged" a little teeny bit and some corporations have reduced their debt somewhat. But the U.S. government, states, counties, cities and towns have all been issuing massive quantities of debt to fill gigantic budget deficits. So if too much debt is what gets you into an economic condition like we find ourselves in today, then how can being more in debt mean the economy is improving? Does this make sense to you? It certainly doesn't make sense to me. To start stitching and sewing information together into knowledge, I suggest that you remind yourself of some things you might already know and add them to the previous couple of paragraphs. --The U.S. and global economy has shrunk and is
now smaller Does adding those seven bullet items to an economy with more debt sound like things are improving to you? It is simply foolish for anyone to say the economy is improving. It might be acceptable to say it has stopped getting worse as fast as it was, but nothing has improved in the macro economy. Now let me make some quick and concise points about various things. THE STOCK MARKET IS NOT THE ECONOMY First, I have no idea why the Dow Jones Industrial Average closed above 9,300 on Friday, August 14th, 2009, which is the day I began writing this edition. I think it's ridiculous and I have an enormous amount of my own, personal net worth bet on a massive decline in the markets. But the market is not the economy and traders can push the indexes to whatever levels they desire without it having to make sense. I know you all have probably heard that earnings for the most recent quarter were actually quite good and beat expectations. They did beat "expectations", but unfortunately almost all of them reported earnings lower than they had for the same period a year ago. Is that really things getting "better"? This is the problem when things are left up to human perception, emotion and opinion. You might be "expecting" Junior to bring home straight "F's" on his next report card and the little marvel manages to pull of a few "D-'s". Certainly the kid has beaten your expectations of him but the kid is still a certifiable moron. The simple fact that corporate America still has to come to grips with is that they will be operating in an environment with lower revenues and a much more conservative consumer. The stock market seems to be expecting that before too long, corporate earnings will be back to 2007 levels and are pricing stocks with that in mind. Trouble will come when it becomes apparent that earnings are not going back there anytime soon and we are likely to lose many companies when the contraction is more obvious. Almost every company that has recently reported earnings has exceeded expectations about their earnings but has been disappointing in their revenue numbers. What that means is that they managed to stay profitable through serious cost cutting. But cost cutting is not a business model, and it will only take them so far before earnings eventually slip. My opinion of the stock market is that this was a reactive, bear market rally and I am confident we have to go back to the lows we touched in March. I actually feel the odds are 50/50 that we might see the Dow Jones get into the 5,000's if even for only a brief period of time. Let us take a look at some other issues that trouble me about the economy. UNEMPLOYMENT The markets wet themselves about the exciting news from July that only 247,000 more Americans lost their jobs. There was talk about how much of an improvement that was over the past months. Even more thrilling was the fact that the unemployment rate dipped from 9.5% in June to only 9.4% in July. Fantastic! Please apply some common sense here. If net/net, the economy has nearly a quarter of a million people LOST their jobs during a given month, HOW can the unemployment rate drop? Even on face value, I would hope this would be a contradictory situation for most people. Well most people don't understand that when the Labor Department develops the unemployment statistics of what percentage of Americans are unemployed, it only counts people that are actually looking for work. Simply explained, if you were actively looking for a job in June, you were unemployed. If you gave up looking for a job in July, you don't count anymore. You've become what the Labor Department considers a "discouraged" worker or if you just haven't looked in the past 4 weeks you are "marginally attached". Basically if you take ALL the Americans who have jobs and add that to those who are looking for jobs, then 9.4% of that group are currently "unemployed". Read this excerpt from the report from the Bureau
of Labor Statistics about their July report: About 2.3 million persons were marginally attached to the labor force in July, 709,000 more than a year earlier. (The data are not seasonally adjusted.) These individuals, who were not in the labor force, wanted and were available for work and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey. (See table A-13.) Among the marginally attached, there were 796,000 discouraged workers in July, up by 335,000 over the past 12 months. (The data are not seasonally adjusted.) Discouraged workers are persons not currently looking for work because they believe no jobs are available for them. The other 1.5 million persons marginally attached to the labor force in July had not searched for work in the 4 weeks preceding the survey for reasons such as school attendance or family responsibilities." So let's do some simple math. We've got 14.5 million people unemployed and looking for work, 8.8 million who are working part-time who would rather be working full-time and another 2.3 million who aren't working and not looking for a job. Add those all together and we get 25.6 million Americans who are unemployed or underemployed. That makes 16.59% of the work force who is of legal age and able-bodied who aren't working enough. Sounds a lot worse than the media or the politicians make things sound, doesn't it? Please don't take my word for any of this and visit the Bureau of Labor Statistics report for yourself: http://www.bls.gov/news.release/empsit.nr0.htm One last interesting statistic you might enjoy is the fact that because of population growth in the United States, the economy has to produce 135,000 new jobs every single month in order to keep the unemployment rate from increasing. Add to that number the 7,000,000 jobs that have been lost since this recession began and ask yourself when you think the economy will be that robust again anytime soon. CONSUMERS You'll hear that with the economy in or nearing a recovery, the consumer is going to be back with a vengeance. No they're not. The consumer is still up to their ears in debt, has lost massive amounts of their net worth in their home and 401K, is worried about their job if they haven't already lost it and are very emotionally scarred right now. I personally predict that many are going to remain scarred and conservative for the rest of their lives, just like my Grandparent's generation did coming out of the Great Depression. My opinion is that anyone who is pinning their hopes to a dramatic increase in consumer spending is building their future on a house of cards. Consumer behavior is permanently changed for decades to come. REGULATION You would think that after enduring "the worst financial crisis since the Great Depression" the government would have passed sweeping regulatory changes to rein in all the excessive leverage in the system and clamp down on products that have contributed to the collapse. But what exactly has the government done to make certain we couldn't melt down again sometime soon? Effectively nothing. We've got a "Pay Czar" looking at the compensation levels of a handful of people working at institutions that the government has a large investment in. Who cares honestly? And was that really the problem anyway? It certainly makes for good press and splashy headlines in the media, but for the most part it's meaningless. Goldman Sachs changed their status to a commercial bank last year in order to make themselves eligible to receive TARP funding and they remain a commercial bank and not an investment bank. What does that mean exactly? It would mean that they should be operating not much differently than any other bank. Taking in deposits from customers and making loans while under the strict supervision of the Federal Reserve, FDIC and others. But what are they REALLY doing? They are borrowing from the Federal Reserve at a 0% rate and investing in the markets using leverage well in excess of 15X and making huge profits. Mostly this is thanks to the fact that major competitors like Bear Stearns, Lehman Brothers, Merrill Lynch and others have all but disappeared. The government ran around like a chicken with it's head cut off and threw a bucket of water on anything that seemed to be on fire last year. Congress held bunches of hearings and Obama called out the evil "speculators" who didn't think that secured creditors should be shoved from the front of the line to the back. What they DIDN'T do was change the system whatsoever to prevent something else from happening. TAXES Any sort of even itty bitty recovery is going to be continually crushed with one massive tax increase after another at all levels of government. This isn't even a prediction on my part. This is an absolute fact. The federal, state and local governments have all been issuing staggering amounts of debt and all that money is going to have to be paid back. Just like consumers are learning themselves right now, racking up massive amounts of debt can be accomplished very quickly, but paying back all that debt can take seemingly forever. Especially in an environment where tax revenue is drying up every single month. Income tax revenues are down. Sales tax is down. Property tax is down. Capital gains tax...WAY down. So anytime the economy shows any signs of life whatsoever, you can count on the politicians rolling out one new tax after another and/or creating some new system that will cost taxpayer money. Cap and trade. Healthcare reform. Something. Any possible recovery in the economy will be immediately killed with constantly rising taxes. HOUSING While the decline might have slowed, the declines in real estate continue and we are still going to have a nightmare scenario in the commercial market that plenty of people know is coming and no one is talking about. We have a staggering amount of inventory already overhanging the housing market and housing starts somehow continue at over 500,000 new homes being built monthly. Who exactly is going to be buying all these homes? Standard consensus estimates within the industry is that there is at least another 10% to 15% decline yet to come in real estate values. I'm thinking there's at least a decline of 20% or more. Foreclosures continue to accelerate monthly and show no signs of slowing, so ask yourself when any sort of housing recovery can begin. THE LEGACY OF "LEGACY ASSETS" If you haven't gotten yourself hip to the terminology, "toxic assets" is out. The hip, new, more polite term that is used is "legacy assets". All the large banks along with plenty of pension funds, insurance companies and others are still holding this sort of garbage on their balance sheets and almost nothing has changed from a year ago. Except one thing. Under government pressure on the accounting profession and the Financial Accounting Standards Board (FASB), these institutions were allowed to begin lying about how much these assets are worth and the accountants were forced to sign off that the value was legitimate. I've been speaking to audiences about FAS 157 for years now, and how it was going to impact my client companies. Without boring you with a dissertation on arcane accounting rules, here's a quickie article from the Wall Street Journal about what happened this past April: http://online.wsj.com/article/SB123854595878676211.html In the most simple terms, this accounting rule was relaxed earlier this year with regard to how institutions were allowed to "mark to market" their investments giving them much more flexibility in their methods. Suddenly seemed to change everything. Many large, money center banks that seemed to be certain bankruptcies in March were reporting record profits by May. Kind of interesting change of trajectory, no? Please understand how these "legacy" assets trade. They don't. They aren't at all like IBM stock where it is quite easy to observe what the value is by just watching complete strangers trade the shares on the floor of the New York Stock Exchange. No. These assets are often one-of-a-kind products that rarely if ever trade. Institutions are required to mathematically calculate what the asset would be worth if they were to sell it in the current marketplace. Well coming out of the Enron, WorldCom and other accounting fiascos, accounting regulations became much more strict and much more honest about the value and quality of items on company balance sheets. The accounting profession refused to let companies exaggerate and/or lie about their condition. Until it became politically inconvenient. So now we're back to a world of complete and total fiction and you should neither believe a damn thing these banks say about their financial health, nor should you listen to Tim Geithner and his silly "stress testing" results because it's all nonsense. These banks still have all this garbage on their balance sheets and lots of it isn't worth a bucket of spit. Many of them would be completely bankrupt if they either sold these securities or marked them to market in a realistic sense, but thanks to this relaxation they continue to limp along as zombies and will do this for as long as they can. They are lending almost no money at all because they need to hoard as much cash as they can for the day when it becomes apparent that these assets are going straight into the trash can and they will need all that cash to prevent insolvency. Maybe, just maybe, if they can limp along for enough years they might actually get lucky. Unless something else really bad happens. Like a meltdown in commercial real estate loans. You might have seen the beginnings of just that sort of trend beginning when Resort Atlantic City mailed the keys to the hotel/casino to the mortgage holder, Credit Suisse. The mortgage on that property is for $360 million. I've heard various numbers, but it seems the property might be worth about $200 million if Credit Suisse wanted to sell it. That would mean a $160 loss for the lender on just one loan. When you begin to appreciate how many office buildings, shopping malls, apartment buildings, hotels and other commercial properties whose mortgages are coming due in the next 12 to 18 months with the borrowers almost certainly unable to refinance it's horrifying. It could make the subprime thing look like Pee Wee's Big Adventure in comparison. The banking system is still a train wreck and will not improve soon. MY SUMMARY OPINION While I made fun of the alphabet soup of recessions at the beginning of this newsletter, if I were forced to choose a letter it has to be an "L" shape. We are still in decline but I will admit that the bottom is likely to come fairly soon. What will be disappointing for people (perhaps VERY disappointing) is that I don't expect any real recovery at all. All we will be doing is finding out what the new "normal" is and it will not be pretty. We had a false sense of how big our economy was over the past decade because of the explosion of debt issuance, but the truth we will need to grapple with is what sort of economy do we really have with people saving money as they're supposed to and beginning to finance our own growth and lending. There will be some fits, starts and fake outs as statistics confuse people like the GDP numbers of Germany, France and Japan just did when they all showed growth and it was announced their recessions had ended. And like the U.S. GDP numbers will wrongly encourage people when the third quarter numbers are announced and will be perhaps deceptively positive. I'll ask you all to drop me an email a year or so from now to tell me how I predicted this, but the fact will eventually be obvious that it wasn't really "growth" in a classic sense. Last year when it appeared the world was ending economically, companies slashed production in massive ways. Many companies cut production 40%, 50% and even 60% to save costs and be cautious. Well the simple fact is that demand was never going to fall 50%. So let's say demand has only dropped 20% to 25%. It only stands to reason that companies would need to ramp up production somewhat in order to meet demand at the new "normal" level. But once that level is met the supposed "growth" will cease once again. The talking head stooges on television will tell you at that time that we've entered a "double dip" recession. But Mike Gasior will have told you a year earlier that is was coming. So don't forget my email when it's time to thank me. YOUR AUGUST BRAINTEASER Since it's been a few months that I've offered you any sort of brainteaser and also because it's the middle of the summer, I've decided to go somewhat easy on you. I personally thought this riddle is pretty cute and money is at the center of it, so I felt it's right up my alley. Here you go: "Castor and Pollux Janus own Janus's Curiosity shop. They have the most unique collection of trinkets in the town. What is most curious about these two brothers is that they have been trying for years to sell their business. They are offering to sell the entire store with the entire inventory for only $17.51 US. The catch is that they will only accept payment in cash, and will only accept a certain combination of bills and coins totaling exactly $17.51. All coins and bills must be different from each other, but all coins and bills must also have one certain thing in common. Can you buy their shop by figuring out their secret combination of monies?" I'll give you one tiny hint: there is something to be gleaned from the names of the brothers. Give it a good shot before bailing out and checking for the answer at this link: http://www.afs-seminars.com/brainteaser_Aug2009.html Copyright 2009, Michael Gasior. All Rights Reserved AFS Seminars LLC |
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August 2009 Newsletter
