Thursday, November 03, 2005



Back in July, retail sales reached a 10% growth rate, which is an unsustainable level.  My forecast is that consumer spending will be slow during the important fourth quarter.  I make this statement on the heels of a robust retail sector stock market.  You see, after the hurricanes, fear was in the air that the fourth quarter would be a disaster.  

My old friend and retired stock broker extraordinaire, Bill Lienbach, used to tell young brokers not to get too excited about the “ripples in the water”.  He said, when you throw a big stone in the lake, the water will slosh back and forth for a little while but it will soon return to normal; until another big stone is dropped.  The hurricanes were big events; we should all continue to support recovery efforts, however, in the grand scheme of things, the ripples are mostly gone.  

So, the fourth quarter will not be a disaster.  However, rising interest rates, including credit card rates and equity line of credit rates, and higher fuel prices are having their effect.  The effect is world wide.  Many central banks around the world have increased interest rates; Brazil, Mexico, Indonesia, Hong Kong, Canada and China to name a few.  Furthermore, crude oil is traded in US Dollars.  Therefore, the price of fuel has increased more internationally in the past couple of months than it has in the USA.  Many populous countries, such as Indonesia, Malaysia, India and Thailand, have taken steps to decrease oil subsidies that were “breaking the bank”.  


My forecast is consistent with that of many economist and market observers.  The big departure is in the conclusions drawn.  Many observers, some of whom are obviously democrats, are beating Bush over the head with the slowdown.  They are crying the blues over this “mid course” correction.  The truth of the matter is that a “mid course” correction is to be expected.  

The typical business cycle has a recovery from recession that is lead by consumers.  It is lead by consumers because interest rates and inflation go down during recessions and consumers find themselves with spending power.  Those who made it through the recession without the loss of jobs find themselves in a neat environment. Their income goes a long way.  Many refinance their homes, buy new cars and even buy second homes.  However, after a few years of growth, resources go from excess supply to tight supply.  It becomes time for businesses to borrow money to expand and it becomes a time when the consumer gets pushed aside.  The recovery morphs into a business expansion.  

As interest rates and other prices go up, consumers must cut back on discretionary spending.  Historically, big ticket purchases are cut out during this strong phase of the business economy.  The consumer still has his job and still has good income but the combination of interest rates and higher prices can make for tough times.  Ironically, one of the best performing stock sectors during the business expansion is consumer stocks.  The important distinction to make is that it is not the consumer discretion sector but the consumer staple area that does well.  Consumers are going to buy groceries, under-wear, socks, and other “necessities” though-out the cycle.  Most will not buy the big boat, RV or put in the back yard swimming pool during this time.  The reason the consumer staple stocks do well is not because their earnings go up so much on a nominal basis but because they continue to grow while other companies struggle.  

The news media and stock mavens often lump retailers into the same pot.  The past few days WMT has done well.  This has been a “surprise” to the TV talkers.  The assumption was that poor folks would cut spending because gasoline took all the money.  But, Wal-Mart is about daily needs. Wal-Mart is half grocery store.  If consumers’ money is tight, they will cut out going to the steak house on Friday night but continue to buy goods and groceries at Wal-Mart.


We live in a new age when many things are turned upside down.  The luxuries of old quickly become necessities.  A good example is the cell phone.  Sprint just made a deal with four of the major cable companies.  It is a fantastic deal for Sprint, the cable companies and the consumer.  The dream of using ones cell phone at home and at work without paying per minute charges is about to become reality.  Many folks are going to save money by disconnecting their old phone and using a low cost cell phone for all their calls.  The interesting thing is that the phone is going to be much more than a phone.  

The phone will allow one to communicate with ones home computer and media center.  It will allow one to listen to “the radio” and to watch TV.  Many of you will be surprised at how “necessary” it will become to have one of these new phones.  

Another way the market is turned upside down is the car business.  In the business cycle of the 1990’s, the car business was strong right through the business expansion.  You see the car companies took a big negative and turned it into a positive.  During a time when interest rates were high, the car companies offered zero interest rate loans.  Don’t be surprised when consumers buy more fuel efficient vehicles over then next few years.  

Right now, the car companies are going through “gut check” time.  They must adapt to the new environment.  Don’t count them out, they have done it before and will do it again.  Ford and GM are both selling at very low prices.  It is not the correct time to buy these stocks based on the business cycle, but, they are cheap.  

Today, a family member purchased shares in SMH, a basket of semi-conductor stocks.  This group broke off a bottom like a frog on a hot plate yesterday.  World wide sales of semi-conductor chips are at an all time high and suddenly millions of Americans will want a TV-Phone and other “wireless” devices (game machines to work machines).  

How crazy can a market get?  On the one hand, the economy is slowing, on the other hand semi-conductor sales are at all time highs.  Even crazier was that oil stocks and airline stocks were the market leaders on Tuesday.  As I forecasted months ago, the transport index hit an all-time record high at a time when oil prices are close to record levels.  Several months ago, folks would not believe me when I suggested that oil goes up when the demand for transportation goes up.  It seems very intuitive but then the world is upside down at times.  Today, there is gloom and doom about the slowing economy while ten year bonds are at their highest rate in months!


One excellent definition of a BEAR MARKET is a market that is experiencing declining market multiples.  Well the multiple on the S&P 500 has declined from around 40 to around 14 in the past 5 years and many a good company has increased earnings and seen its stock price go down.  The average multiple absolutely go lower.  Do you remember the days of 5 times earnings being a buy threshold?  Earnings growth has been in deceleration mode for three years and I believe earnings will grow even slower in the next few years.  I can understand why many folks are worn out, disappointed and even scared.

On the other hand, those who invested heavily at the market bottom in October of 2002 have had a lot of fun in the past three years.  Riding Ken Fisher’s “bucking bronco” is about as good as it gets.  Right now, the bronco is trying hard to shake riders off.  The sharp run up in CPI is enough to make an old guy like me as nervous as a cat in a house of rocking chairs. Historically, stocks do not do well when the CPI is high.

The big question for me is how long will the CPI stay high?  I have written about my forecast that oil will gradually make its way back to $55 per barrel.  I believe it will “dance” around $55 for a good while (this projection is made in the face of the futures strips averaging around $61 for the next 18 months).  I have written that commodity prices are at or near their peak.  I do not believe wages and salaries are ready to soar (the pilots and auto makers can vouch).  Global inflation is running at about 2% and like it or not we are in a global society.  World wide productivity continues to astound.  Finally, technology is working magic in combination with the law of substitution.  The cost of the newspaper is dropping to zero for folks who get their news online.  The cost of the home phone is dropping to zero for the person who converts his cell phone to a dual band internet phone.  The cost of advertising is dropping to zero in the instances where businesses are substituting fewer targeted ads and eliminating some of the “shot gun” ads.  As we approach the final days of tightening by the FOMC, it is going to be a frightening time for investors.      

In summation, markets are tricky.  Put your money in the right place at the right time and enjoy the ride!