Friday, December 26, 2008

Another Turn in the Works

The tick-tock of the economic cycle clock continues to force the hands of time forward and another sector is set to make the turn. The most recent significant event was the receipt of bank holding company status by GMAC. GM has gained access to FOMC and TARP funds. Zero interest rate, no money down, auto loans on very competitively priced autos will lead to a rebound in sales. Share prices are likely to rise before, during and after the increase in sales. The risk of bankruptcy restructuring is real but prices have discounted the risk.

In the old days, US auto companies were at the top of the market cap weighted list of consumer cyclical stocks. Today, Ford is number 10 and GM is number 23, wedged between Mohawk Carpets and Stanley Works Tools. Of the top 8 S&P 500 consumer cyclical companies, the only domestic company is Nike at number 6. Three foreign auto companies, Toyota, Honda and Daimler, lead the list and Nike is wedged between Panasonic and Sony. Fuji Film follows Nissan, number 7, and the handbag maker, Coach, is pushing Ford for the tenth spot. The big truck builder, PACCAR, holds the 9th spot. Is it not unreal that a handbag company is currently valued about the same as Ford or that a hand tool maker is worth more than GM?

While a gaggle of footwear, apparel and jewelry companies dominate the rest of the list, audio and video equipment companies, home appliance companies and furniture/furnishing companies are other segments that sell at deeply depressed prices. These companies should see major rebounds now that the refinancing index has rebounded sharply. Most people do not borrow money to buy their gasoline but many do to update their living room furnishings.

Today, Boxing Day, is the big retail sales day in England. This year, 70% discounts are common. The volume of goods sold will be huge but, in money terms, total sales are likely to be down. Too many goods chasing too little money is the definition of deflation and that is what we are seeing in the short run. After the need for basic goods has been met, the savings is likely to be spent on durable goods. The savings is just getting started, for example, wholesale gas prices are forecasting retail gas at $1.39 in early 2009.

The decline in interest rates will be a more significant factor in the coming economic up-turn than even the decline in the price of consumer goods. Less than half the worlds assets are financed but during these times of depressed asset values, many assets are financed close to or, in some cases, even above 100%. The huge decline in mortgage rates, combined with lower prices, in most countries around the world, has made the purchase of assets much more affordable. Many who who have steady incomes are beginning to realize just how wonderful deflation can be.

It is certainly not all bad for businesses. A significant part of the decline in the monthly payment needed to buy a car does not come out of GM's pockets. When GM offered interest free loans a few years ago, it cost GM 9% to borrow the money, today, with new alternatives in place, GM will borrow the money for as little as .25%. Consumers can in effect lock-in .25% car loans through the purchase of "interest free car loan promotions". GM will increase its sales by passing through most of the low cost financing savings to its customers.

Years from now, millions of people will tell about how they made out or could have made out during this recession. They will tell how they purchased or could have purchased prime real estate in the middle of town for ridiculously low prices. Yesterday, I drove through the small town of Clemmons and noted a number of homes for sale, in the business district, on the main street. In downtown Winston-Salem, I noted several prime locations up for sale. Trillions of dollars worth of real estate is changing hands at low prices. Class A office space can be locked-in at very attractive lease rates. REIT's with money are having a field day. The financially strong are gradually accumulating great future wealth.

While financial stocks turn-up about the half way point of recessions (as the big real estate battle ship makes its difficult turn), consumer cyclical stocks tend to move-up about three quarters of the way through. Small cap stock value stocks, which includes many small banks and retailers, also tend to begin their move well before the recession has ended. Broad indexes such as the Dow and the S&P 500 will show negative relative strength though three or four years of recovery but even they will start to fly near the end of the recession. The peak of the bell curve investment bubble has recently been over the top of treasury bonds but it is clearly moving forward as the junk bond market has made significant gains recently. Junk bonds also move-up before recessions are over and they continue to move-up during the early years of the recovery.

The bottom made in financial stocks and REIT's on November 20 is holding firm, even though GDP numbers for the fourth quarter are expected to be among the worst ever reported. US GDP may have fallen as much as 6%. I suspect, equity markets, and especially the financial sector, will weather this next storm of bad news much better than most anyone expects. Again, the bad news has already been discounted by low prices. The November bottom is likely to hold and positive surprises are likely to be met by significant gains.

By suggesting that mortgage rates are on the way to 4.5%, the FOMC has slowed the turn. While the suggestion is probably true, it has encouraged anxious home buyers to wait for even lower pirces and lower interest rates. Still, day after day, the best real estate bargains are being picked off. The price of many parcels of raw land, once ready for development, but now to lie fallow for 10 years or more, have dropped by 60% or more in value. Many of these parcels will be held for investment for ten to fifteen years, at which point they will be sold at prices 500%, 1,000 percent or more than their current value.

For those wanting to buy a home or second home, the rates available on adjustable rate mortgages makes waiting a fools game. In most markets, the supply of available homes is coming down and the remaining sellers are not inclined to lower prices. Resort areas that are normally accessed by auto travel, such as Myrtle Beach, will see the biggest bounce as the cost of travel to and from these areas has been cut more than half.

Terrible numbers in places such as Las Vegas continue to skew the national averages, but there are numerous good stories out there, for example, some of the Florida markets that were collapsing have turned. Foreign buyers are part of the reason. When the bounce in the US dollar reversed itself, foreign buyers have been given another chance to scoop up the best bargains they have seen in years. Real estate is at its most affordable real price in scores of years. With new construction at it's nadir, supply is being absorbed.

The timing of the auto turn is being carefully manipulated. The most faithful of Republican voters still find it hard to believe how much money the Obama campaign was able to collect from big business. Voters sometimes forget that big business are much more concerned about profits than politics; they give to both conservative and liberal campaigns. It is in the self interest of GM and political leaders for the big sales gains to occur only after the "best bailout deals" can be made. By spring, you can expect to see very attractive terms on even the most fuel efficient of cars. Again, share prices will move long before sales increase.

Other "News"

A war between India and Pakistan seems eminent. The US has signaled that it will not stand in the way if India wants to go after Pakistani terrorist groups. It does not appear that the Pakistani government is politically strong enough to attack these "freedom fighters" (in all wars, both sides believe they are fighting the "just" cause). There are always wars being fought but it is relatively rare for two nuclear armed nations to be at war.

The good news is in the fact that more and more nations are agreeing to become nuclear power nations while giving their pledge to not develop bombs. The UAE is the most recent nation to sign-up to receive low cost fuel and low cost removal of waste by a nuclear power consortium supervised by the UN. Nuclear power plants are being built in scores of countries.

India and China are leading in the development of even lower cost nuclear power. India is making great progress in the use of abundant supplies of Thorium and China is now building nuclear power for half of what it cost in the US. In the US, Obama wants us to divert massive quantities of concrete and steel to the building of roads and bridges at a time when it is needed in the construction of alternative energy plants.

Microbes to the Rescue

A few days ago, a US company received $75 million of start up money. In the lab, this company has developed techniques to increasing the rate at which methanogens digest coal. These one celled creatures eat coal while breathing carbon dioxide. The products produced are clean burning natural gas and oxygen. Some scientist believe the speed of the digestion process will ultimately be increased by 1,000%; others suggest that it can be increased 10,000%. Methanogens are already hard at work digesting organic matter in swamps, peat bogs, coal seams, tap pits and in millions of hectares of shale formations.

Steven Chu, Obama's new Secretary of Energy, has worked on molecular generation of energy for 20 years or so. He has received grants of over $400 million from BP to support the work of hundreds of lab technicians and scientist. Other one celled creatures are adept at producing hydrogen.

While I would like to see more use of private funding and less intervention by the inefficiency of government, major microbial efforts are underway. Ultimately, we will wonder why we burned so much stuff!