Long Term: Buy and Hold

[Mike]

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http://moneycentral.msn.com/content/Savinganddebt/Savemoney/P133222.asp

This is a link to an article on inflation - including the winners/losers and how the market behaved the last time around (to summarize, the market did pretty well, with big double-digit gains in six of the ten years).

A few interesting points:

Don't bother aggressively paying down fixed rate debt. Even when inflation isn't going nuts, you're still paying the bulk of this debt with devalued currency. A 2006 dollar could be worth 4% less than this year's. A 2016 dollar could be worth a lot less than that. Keep this in mind if you have a 30 year mortgage (like I'm about to have ).

Don't bail on stocks or bonds just because of inflation. As I said earlier, the market beat inflation even during the worst inflationary period in 50 years. As a hedge, invest in commodities, which tend to keep up well with inflationary pressures (imagine that).

For the frugal consumers out there - be prepared to substitute. I've already done this many times, particularly with beef prices skyrocketing in recent times (switched to poultry - and now that bird flu is hitting globally, I'll have to switch to pork).

It's definitely worth a read.

 

[cowboy]

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Mike the consumer! You need to eat beef it's whats for dinner! Besides the cost of the others are just as high when u figure out that half of it is bone or fat! Besides u can't eat that dollar anyway and it is going down in value! LOL!! Cowboy up city slicker and pay for 2 decades of biting the hand that feeds you! We need that low dollar to heal the working man and rural economies!

 

[Mike]

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As long as it doesn't give me food poisoning, I gotta say ten packs of chicken drumsticks for $10 is a steal. That works out to about $0.15 per drumstick!

Fat's good... greases the ol' digestive tract. :^

 

[Wimpy]

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Stagflation is a term in macroeconomics used to describe a period of characteristic high inflation combined with economic stagnation, unemployment, or economic recession.

Stagflation is thought to occur when there is an adverse shock (a sudden increase, say in the price of oil) in a country's aggregate supply curve. The effects of rising inflation and unemployment are especially hard to counteract for the central bank. The bank has one of two choices to make, each with negative outcomes. First, the bank can choose to pursue a loose money policy to stimulate the economy and create jobs by increasing the money supply (by lowering interest rates) and exacerbate the inflation problem further. Or second, pursue a tight money policy (by increasing interest rates) to try and rein in inflation at the cost of perhaps increasing unemployment further.

http://en.wikipedia.org/wiki/Stagflation


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Stagflationwas seededduring the Nixon and Ford era and came into full bloom during Carter's term. I think we are heading there again. In my opinion this economy is rolling over. It will continue to tease and tempt the perma bulls as it continues to grind sideways. In an inflationary evironment, grinding sideways means your position is losing money. The DOW points remain relatively static while inflation erodes away atthe foundation of one’s portfolio.

Once the recession and/or depression becomes more apparent, even the perma bulls, en masse, will throw in the towel and capitulate but probably after the DOW hits 7500 or so and the S&P hits 850. The DOW will most likely find a final resting place around 3500 and the S&P around 400 and they both will remain there for quite some time. Stocks, in general, will be the most hated and despised investment vehicle of all time.

Since we are hearing more and more about stagflation these days, let’s go back and take a look at some interesting data during the time frame Nixon, Ford,and Carter were in office. The DOW was capped at 1000 from 1966-1983 http://www.stockcharts.com/charts/historical/djia1900.html. That was 17 years of sideways chop. Can you imagine listening to a perma bull saying this rocket is about to launch for 17 years only to listen to the fuse sizzle, crack, sputter, fizzle and refuse to stay lit, over and over and over again? Like broken clocks we ALL can be right twice a day, if we pick a spot to fixate on and remained glued to it forever. Eventually, the perma bulls were right in the same fashion a broken clock is right twice a day, but many of them missed wonderful opportunities during that time frame to make money in oil, gold, and silver. There is a price to be paid for being a perma bull in any market. Everything that goes up…gotta come down. That was also true in oil, gold, and silver. Gold peaked in early 1980 at around $850.00 an ounce and silver peaked at around $50.00 per ounce. By the way, I think interest rates peaked around 18% or more in 1981. Both gold and silvercame down pretty rapidly in price with a tease here and there (bear rally) that drew more suckers in at prices that still haven’t been recovered for over 25 years for those Johnny Come Latelys that bought gold at 500.00 and above. I think gold bottomed in 2001 at 255.00 or thereabouts and has almost doubled in price in the last 4 years during the stealth phase of the gold bull market. The stealth phase (Phase I) of any bull market is when the smart money is slowly and methodically accumulating so they are fully positioned to aggressively accumulate (Phase II), via trading, as fund managers pile in on the good news and out on the bad, over and over and over again. The smart money and the nimble fund managers finally sell their over bought positions to the not so nimble fund managers, along with Flo at Mel’s Diner, hair stylists, shoe shine boys, and dentists, during the final blowoff in phase III of the bull market.

The soft landing we used to hear about was all about creating opportunities for the smart money and nimble fund managers to unass their positions without getting gored. This has been accomplished quite nicely, thus far. The only speculators left in general equities, at these valuations and per Alan Greespan, are those that have a propensity for losing money. Flo at Mel’s Diner, hair stylists, shoe shine boys, and dentists have yet to be taken to THE woodshed, but their time is close at hand and it won’t be pretty. They’ve all been spanked and spanked pretty hard, but since they still haven’t figured out where we are in the business cycle and are still singing the perma bull, “In it For the Long Haul”, song, they are destined for the flogging of a lifetime. If they don’t plan on retiring until 2035, many of them may break even.

So, why will the DOW collapse to 3500 and the S&P to 400 if we are comparing ourselves to the Carter era of stagflation? Why won’t the DOW and S&P simply grind sideways in the 10,000-10,500 range for the next few years before making a run for 30,000?


Essentially, what was different about the 1970s from where we are at today?

In the 1970s this country had a manufacturing base and companies representing that base were not in bankruptcy. We also had a central bank that exercised a bit of restraint. In the 1970s the CPI wasn’t based on a phoney factoring whereby housing, food, and fuel were excluded because they offended a loose monetary policy. In the 1970s Social Security recipients and retirees, in general, were getting COLAs based on real CPI figures. Today, companies using wage scales based on these phoney CPI figures are short changing their workers. On the other side of the coin, real inflation is eroding the purchasing power of those artificially fabricated low wages. So, wage earners and retirees are taking a double hit from inflation and fraudulent CPI figures. REAL (factoring inflation and phoney CPI numbers) wages have been and will continue to go down.

In the 1970s the central bank didn’t lower interest rates to 50 year lows like they have just recently. Prior to Nixon closing the gold window in 1971, there was a natural governor on the printing presses that kept the central banks honest for fear of foreigners rushing the banks and cashing in their dollars for gold and rush the window they did. The very reason Nixon closed the gold window was because foreign central banks WERE trading their dollars for gold. Foreign central banks saw the handwriting on the wall and gold began a steady climb from $35.00 an ounce to $850.00 an ounce in less than a decade. After 1971, the dollar was only as “good as gold” if you believed it was and that belief was fading pretty rapidly. After 1971, the only governor the money supply was hitched to was manufacturing. Manufacturing has long since evaporated.

The only thing currently supporting the U.S. economy is DEBT. It is the only thing of significance the U.S. produces and exports. That is exactly what the difference is between then (1970s) and now. Not very diversified are we?

What kind of foundation is this pyramid of DEBT sitting on? What did a 1.25% federal funds rate spawn? It spawned business activity way out kelter with the reality of markets. It has caused a misallocation of resources on many fronts.

In 1999 we had massive off-budget infusions of liquidity for Y2K. In 2001 we had massive off-budget infusions of liquidity for 911. And since then, there are continued off-budget liquidity infusions for the war in Iraq and Afghanistan along with infusion of liquidity for those expensive ladies (Katrina and Rita) who stormed across center stage in the Gulf states.

Currently, we have the fraud of the fed raising rates on one hand while priming the pump with the other. That seemingly creates warm and fuzzies for the naïve hard money wannabes and wails of anguish from the easy money ‘gotta have it now’ crowd. Hey, guess what? It is still easy money when rates are being raised on one hand while massive infusions of liquidity are taking place on the other. The rate game is simply smoke and mirrors and the foreign central banks are sniffing a skunk in the cabbage patch. The foreign holders of our debt are no longer going to hold their nose and sign blank checks. They are easing very gently out of their dollar positions on every rise in the dollar.

What’s up with the so called recent dollar strength? Has anything fundamentally changed with the triple deficits to warrant this little turnaround. Not hardly. The dollar’s recent strength is based on the Euro’s weakness tied to the burning of Paris and other cities in France. Sooner or later the Euro will be recognized for the basket of junk it is and the dollar and the Euro will go down together. Care to guess what currencies will go up, relative to the U.S. dollar and Euro, when this happens? Resource rich countries. Why? Because China is resource poor but coming into their Industrial Age with a vengeance. Because of technology transfer from the West, the China industrial age will be compressed beyond our wildest imaginations driving commodity prices through the roof. Watch resource rich Canada and their currency over the next few years. Seeing is believing. China is buying up resource companies in Canada right now.

Speaking of Paris. Does anyone think that can’t happen here?

A disenfranchised immigrant population, from North Africa (former French colonies), not liking being ‘have nots’among the French ‘haves’ are burning the town down. I hear the turmoil is spreading outside of France. There has been a lot of immigration into the Eurozone from these third world countries and we, in the U.S., have our share of immigrants as well.

How long will disinfranchised immigrants in the U.S. remain happy and contented as they watch food, fuel, and housing costs go up and their REAL wages go down? The most passive and loveable animal will bare its fangs when backed into a corner. And Bush is worried about Avian Flu? How about immigrant flu instead? They will probably come out with a vaccine for that also…they could call it Immiflu.

All in all, everything looks just peachy. DOW 30,000…no problemo...sunshine and roses everywhere we look….a chicken in every pot…you got it. Free housing, free health care, free cars…and free money dropped from helicopters courtesy of Bubble Ben Bernanke. Why save when we can spend ourselves into prosperity? I’ll drink to that. Zippity, dooh daah… WHOOPS! One minor hiccup in the ole esophagus…the people (foreign central banks) signing our debt checks are starting to get a little irritated with us…imagine that :shock:

 

[Birchtree]

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Wimpy,

In a previous incarnation were you known as DMA? Because if you were you missed your golden praise party that would have been a wondeful event.

Any way - don't make me cry - I was raised in the investing world with all that history - my college of hard knocks you know. Now I realize the world won't end unless Hillary is elected - that would be a sad day.

As far as the disinfranchised immigrants are concerned if my property were subject to attack someone unfortunate little bastard would get shot. No questions asked. Fortunately most of the immigrants I have seen and dealt with come from Mexico and they have proven to be hard working and honest family people.

But it's good to come in contact with your view points - we all have opinions and I have enough courage of my convictions to put my money where my thoughts rest.

Dennis-#2 perma bull

 

[Quips]

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Mike wrote:

I don't see double digit interest rates anytime soon. The major inflationary pressure on our economy is coming from energy costs, which by definition are extremely volatile. Wage growth isn't all that tremendous, and core inflation is relatively tame. What this tells me is the Fed funds rate won't clear 6-7%.

I just talked with Flo at Elmer Fudd'sDiner; she happens to be my financial analyst.

Flo tells me that a Fed funds rate at 6-7% is enough to satisfy our nation's creditors without torpedoing their own economies. Interest rates at that level would definately slow down the accumulation of more debt. Hopefully from that time forward it would take cash -- and not debt -- to buy things.

Oil prices are decreasing now, and the financial markets have taken notice. Less money in thegas tank means more money in the retail stores; less money in the gas tanks also means lower trade deficits; and so it goes to a dollar that depreciates at a slower rate, i.e. the dollars that would have gone up in fumes and to the oil producers will now buy retail goods from overseas producers.

Hate to think of someone taking out a loan to fill up a gas tank ... and no, those who use credit cards for such things are the one's who pay them off within 30 days.

Flo too doesn't understand two different inflation rates: one that tells us inflation is about 2% a year and another that figures it at 4.7%. Flo thinks that there is a difference between inflation and a devalued currency.

The I-Bond now pays about 6.72% interest for the next 6 months, while theEE savings bondis something like 3.23%. Talk about a yield curve! Talk labout losing to inflation! So, yeah, I can easily see the Fed FOMC interest rates continuing to climb to 5% in the hope that long term interest rates will increase as well. The spread between the EE rate and the I Bond rate has to find some kind of middle ground.

If oil falls to $50 a barrel the Fed will be in a fix. If it continues to raise its overnight rate while the price of oil decreases, the yield rate will surely invert at some point, and Greenspan himself said that he doesn't think that is as important now as it used to be.

Anyhow, Flo watched some kind of Senate committee meeting on C span with the CEO's of five major oil corporations. Flo, while no fan of Big Oil, said why blame them for higher oil prices when consumers could pay less just buy owning a more fuel efficient means of transportation or using it less often?

 

[Show-me]

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Interesting little tid-bit. Not something I would run out and buy today. At least there are some advances going on.It's coolfor those of us with mechanical/maint. backgrounds. Car engine that runs on air pressure w/ 200km range. Price is right also. $7k to $12k

http://www.theaircar.com/

 

[Quips]

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The dollar may lose a little of its luster soon as the European Central Bank will increase its interest rate.

Will affect the I fund:

http://www.bloomberg.com/apps/news?pid=10000085&sid=aWrYhv_b4Eko&refer=europe

 

[Quips]

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I can appreciate the pessimistic point of view since one needs to be prepared for the worse, but hope for the best.

It is hard to say who is in the driver's seat now a days since many of our trading partners hold American debt in spades and so may exertconsiderable leverage from that advantage. But anything they may do to take advantage of that situation will affect their own peoples and economies as well.Trouble startswhen the advantages outweigh the disadvantages on either side.

It is safe to say with a standard of living near the highest in the world, America has had that advantage for a long time now. So what could reduce that standard?

As we have seen, high energy prices reduce it. But so far we have seen that deficit spending and trade deficits -- so far -- have had little effect because of the trickle down effect even such debt produces. Yet far from deflationary, such policies can lead to worthless money and hyperinflation. But I think excess foreign capital has something to do with it as well as its excess labor.

Talk about a conundrum!

It is like a bubble economy; it reminds me of the internet bubble of 2001-2002. All investors -- from insurance companies, to banks, to utilities, to corporations, and to individuals -- were burned badly by creating a capacity that far surpassed any demand. It was a mania that infected all but a small minority. It affected the Kudlows and the Abbey Joseph Cohensfar less that those on main street and those who were guided by their advice. A small minority of people were unaffected by it and were in cash during that time.

It would seem to me that much of the excess foreign capital and labor has been a result of American/western investments and -- especially -- its debt. A debt backed by the US government and its printing presses ... haha.

Well, the US government -- last time I heard -- was a government of the people, by the people and for the people. So the American people are ultimately responsible for its government's fiscal and economic deficits. There will be hell to pay to make good on thatoverseas capital and labordebt and you can bet it will fall on the shoulders of the little guy. Chances are the littler the guy, the greater the burden will be. And they will really pay for theGreat Societyall haveenjoyed via tax cuts and deferred payment plans/debt up until then.

And that is the best case scenario: a nation of survivors. It is hard to imagine the American lifestyle regressing tothat of the late 1930's-early 1940's. But instead of owning one's soul to the company store, it will be owning one's soul to those who hold the reigns ofcapital and labor. So it makes me wonder if the American people now have the character to endure such times and such an onerous burder without canabalizing each other or some patsy nation.

Yet what will it take to bring that on? Well, I would suppose the best case scenario would be when other central banks quit buying American debt.Interest rates would climb, climb, climb. The spending of the peopleand itsgovernment -- except in cash --would inevitably have to be reduced while debt repayment would have to be increased. Just look at the repudiation of labor contracts/pensions and benefits over the last 20 years! Those contracts, like the peace treaties in Europe during the 1930's and 1940's, were seen as little more than scraps of paper by some then as they are even now. The eligibility age for Social Security would go up, while its payments certainly would stay the same if not decrease. Medicare deductables would go up, co-pays would go up and would as its eligibility age.

The worse case scenario would bethecomplete rejection of the dollar by its overseas holders and their attempts to dump it. But they couldn't avoid hurting their own interests by dumping it en mass; if any major holder (or two or three) would try such a thing it would hurt the interests of others as well as our own, but to a lesser extent. It could be seen as cutting one's loses, cutting off one's nose to spite one's face, or being that first creditor to get something back from a bankrupt economy. The result ofsuch actionswould come in the form of inflation.

So to hope for the best, but to be prepared for the worst one would has to eschew debt. Yet, alas, what if the piper that holds our debt also demands higher taxes or user fees? Who is to say they won't? Who is to say what new taxes or user fees would be enacted? There would be no place to hide. It would be like the perfect storm. I can't see that happening, but hey, at the start of the Iraq war the military talked about bombing them back into the stone age. The same thing would happen in the worst case scenario, but American would be bankrupted into the stone age.

Again, I can't see that happening. But Floridians know what happens when Nature has its way during hurricane season and when its eye cuts a path through metropolitan areas. No electricity, no gasoline, no water. Again though, the perfect financial storm -- or war -- would also affect the dumpers of our currency. And while cutting off America -- their nose -- they would spite their own faces. It would look like Kudlow's or Cohen's or Kramer's financial portfolio in March of 2003 as opposed to the average "market savy" TSPer's porfolio during that same time.

 

[Wimpy]

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Quips wrote:

I can appreciate the pessimistic point of view since one needs to be prepared for the worse, but hope for the best.

Quips,

I agree. A differing point of view, whether perceived as pessimistic or optimistic, is no reason to ‘shoot the messenger’. I may see a turd floating in the punch bowl while others, with a different point of view, may see a bobbing Baby Ruth. That’s what makes markets.

Matter of fact, every trade is based upon a fundamental disagreement. One person sells a position he feels is no longer worth hanging onto, at the going price, while the one purchasing it believes it IS worth owning at that price. They have a fundamental disagreement. What is agreed upon is the price at which the trade is executed. Essentially, traders agree to disagree.

We simply need to evaluate the information to see if it has any practical application and act accordingly. Over time we can also evaluate the source (the messenger) of the information, as to credibility, and shortcut the information gathering process. By cutting through the ‘noise’ and getting to the heart of a matter more efficiently we create more opportunities for productive activity.

Cheers,

 

[Sr]

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Wimpy wrote:

Quips,

I agree. A differing point of view, whether perceived as pessimistic or optimistic, is no reason to ‘shoot the messenger’.

Cognitive dissonance makes one do stranger things than that

 

[Wimpy]

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Discontinuance of M3

On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. The Board will also cease publishing the following components: large-denomination time deposits, repurchase agreements (RPs), and Eurodollars. The Board will continue to publish institutional money market mutual funds as a memorandum item in this release.

Measures of large-denomination time deposits will continue to be published by the Board in the Flow of Funds Accounts (Z.1 release) on a quarterly basis and in the H.8 release on a weekly basis (for commercial banks).

http://www.federalreserve.gov/releases/h6/discm3.htm

Is that Bubble Ben Bernanke (BBB)with his head in the sand or is this simply an image in BBBsmind (wishful thinking) ofthe Chinese finance minister?

Kinda of funny...the U.S.powers that becriticized China for a lack of transparency related totheir currencypeg and now we have theFed announcing their hide and go seek strategy with the M3.This is really starting to get fun to watch.

 

[Quips]

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Securitizing Reserves May Be Clever, And Risky: Andy Mukherjee
Nov. 14 (Bloomberg) -- Two economists at the International Monetary Fund have devised a plan for Asian nations that want to keep their foreign-currency reserves from further swelling while avoiding pressure to let their currencies rise too much.

According to Eswar Prasad and Raghuram Rajan, the conflicting goals can be reconciled. The trick, the researchers say, lies in securitizing of a part of the reserve assets.

Rather than paying for low-yielding U.S. Treasuries by issuing costly public debt, Asian central banks can more efficiently export excess capital by letting privately owned mutual funds pool local savings to buy foreign stocks and bonds.

The central bank would take local currency from these mutual funds in exchange for dollars. Investors wouldn't be able to withdraw their money, though they would be able to sell their shares to others on the stock market. Thus, domestic money supply wouldn't increase, and there would be no inflationary pressure.

Each quarter the government would auction licenses to fund managers who want to bid for the privilege of offering wealthy households a chance to internationalize their assets -- an opportunity normally not available to retail investors in Asian nations that have restrictions on capital account transactions.

The IMF researchers' proposal is an intermediate approach that they say could be used to prepare the ground for eventual capital-account convertibility with the authorities controlling the timing and quantity of outflows in the transition period.

Group of Eight

Rajan is the IMF's chief economist, and Prasad heads the Fund's financial studies division in Washington. Their recommendation, recently published in a policy discussion paper, doesn't constitute the lender's official policy.

It's nevertheless an idea that merits consideration.

Eight of the world's 10 biggest reserve holders are from Asia, with Japan ($823 billion) at the top and China ($769 billion) close behind.

This Group of Eight, which includes India, South Korea, Taiwan, Hong Kong, Singapore and Malaysia, has, in the past five years, more than doubled its combined official holdings of foreign securities, mostly Treasuries, to $2.5 trillion.

Reserves in each of these economies now stand between 20 percent and 108 percent of gross domestic product.

Three Theories

Theories abound as to why Asian nations have pursued such aggressive accumulation.

The ``Asian mercantilism'' argument says that by building reserves, central banks in the most-populous continent counter pressure on their undervalued currencies to appreciate, letting their exporters maintain a trading advantage.

According to the ``Revived Bretton Woods'' theory, cheap Asian currencies are the cornerstone of a mutually beneficial agreement between the U.S., which is the world's financial ``core'' and Asia, which is its ``periphery.''

The periphery is allowed to expand its exports by keeping its currencies undervalued, as long as it supplies capital to the core to pay for its spending excesses.

There also is the ``insurance'' argument, which says that the Asian financial crisis of 1997-98 so badly shook the region's confidence about its ability to sustain inflows that it decided to build a war chest, a ``do-it-yourself IMF,'' to prepare for a sudden flight of capital.

`Everything Except Armageddon'

Whatever the motivation, eventually ``reserves are enough to protect against everything except Armageddon,'' say Prasad and Rajan. ``With the precautionary value falling, and explicit financing costs rising, reserve accumulation creates a growing strain on government finances, in addition to creating a perception of exchange rate manipulation in some cases.''

The U.S. Treasury is under pressure from some members of Congress to label China a currency manipulator in the Department's semi-annual report to lawmakers.

Will Prasad and Rajan's approach find any takers in China, where anyone buying U.S. shares at the current rate of about 8.09 yuan to the dollar may have to take an exchange-rate loss when the fund is liquidated five years later? By the time the fund's dollar proceeds are converted back into the Chinese currency, the yuan is almost certain to have risen.

Although the authors don't answer the question directly, they do appear to think that their plan might work in China: ``Even taking exchange rate appreciation as a given, in countries where deposits in fragile state-owned banks constitute the only viable domestic financial asset, there could be considerable interest in alternative investment opportunities that include foreign bonds and equities.''

And that could be more risky than the plan not taking off.

What if It Did Work?

Consider the extreme situation in which China hands over the entire $250 billion or so that it adds to reserves every year to mutual funds to invest overseas.

The Chinese central bank wouldn't have to sell more bonds to ``sterilize'' its money supply. The currency risk on the central bank's balance sheet would get capped at the existing level. That would buy China more time to hold on to its undervalued yuan.

The dollar may slide and U.S. interest rates may rise on the news that People's Bank of China is fed up with buying Treasuries.

It's a highly improbable scenario because retail Chinese investors are unlikely to pour $20 billion of their savings every month in mutual funds that invest overseas.

Nevertheless, Prasad and Rajan might want to include a statutory warning before sending their plan to Chinese policy makers: ``Implement in moderation; excessive use can kill global economy.''

 

[Mike]

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There are at least three fundamental differences between the current economy and the one in the 1970s.

1) The federal tax rates were MUCH higher in the 1970s than they are today. Higher tax rates suppress economic growth, and I would argue that they served as one of the reasons for a stagnant economy.

2) Energy efficiency - our economy is significantly more efficient in this area now than it was then. A 50% rise in oil prices back then certainly would have sent us intoa recession or almost totally flat GDP growth. That hasn't happened yet, even though oil prices have climbed dramatically in the last two years.

3) Structure - in the past, the US economy focused much more heavily on manufacturing / industrial production. China and India are moving through their own versions of the industrial revolution, so I believe they will become the global leaders in this area. The American economy has moved beyond manufacturing and is now focused much more on high tech / R&D / pharmaceuticals / service-based industry.

In short, I do not see stagflation in our immediate future.

 

[Show-me]

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Hello Mike,

I see at least one difference between now and then........population and our appetite to consume natural resources. How would that factor in?

 

[Pete1]

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How Not to Ruin Your Lifeby Ben Stein
Finance Home > How Not to Ruin Your Life > Cement, Steel, and Stocks



Cement, Steel, and Stocks
by Ben Stein
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Friday, November 11, 2005

If you are an inveterate reader of financial publications as I am, occasionally certain recurring themes pop up that tell a tale. The one I have been noticing lately is about two oddly basic materials: Cement and steel.

Let's go back a few months or a year ago or even a few weeks ago. The story was that because of immense building in China and India, because of the stunning U.S. housing boom, because of the need to rebuild in the Louisiana-Mississippi region after Katrina, building supplies were going to be in very short supply. This was going to drive up costs and inflation and harm the recovery. There were stories about builders in the Southeast simply being unable to get steel for building or cement for laying foundations even before the hurricane.


Now, Chinese and Indian steel mills are cutting prices dramatically to sell their products. Cement is not exactly being given away, but shortage conditions have eased very considerably. China's output of cement is growing so rapidly that it is forecast to become a net cement exporter soon (if it isn't already). This will have a huge effect on cement availability everywhere.


Inflation or Economic Slowdown?


All of this goes to a set of fundamental questions and answers about the world economy.


If building commodity prices, or at least some of them, are falling and if the supply coming from China is beginning to exceed the demand from China, what effect will this have on world prices? And if oil is collapsing in price (at least in the short run) as consumers show far more ability to conserve than had been expected, what effect will this have on the domestic inflation rate? To put it another way, if major commodity prices are falling on world markets, does this portend an explosion of demand or a world slowdown?


One of the few advantages of being 60 years old, as I am, is that I have lived through many business cycles. If memory serves, collapsing steel prices are often a harbinger of a world slowdown. If memory serves -- and here I know I am right -- collapsing prices of gasoline at the pump are a hint that the next inflation headline numbers will not be cause for alarm -- at least not for alarm in an upwards direction.


Let's step back. We have rising hotel room prices, rising air fare prices (but not for long), and rising wages for energy workers. Balanced against that is gasoline that's about 80 cents a gallon cheaper at the pump than it was a few weeks ago, steel off 30 percent from its high in the spring, and plentiful cement -- at least more plentiful than it was. The weight certainly seems to be in favor of less drama about inflation and more concern about growth.


What It Means for Investors


Surely, this means that the incoming Federal Reserve chairman, the brilliant Dr. Benjamin Shalom Bernanke, will not need to raise interest rates any further. This, in turn, means less pressure on long-term bond prices and a possible lowering of long term rates, including mortgage rates (which might breathe more life into the housing market ... this bubble may not be dead yet by a long shot). And above all for us stock market investors, a lower interest rate (or a halt in steadily rising rates) means that earnings are worth more because they are discounted back to the present value at a lower rate. This may sound complex, but what it basically means is that a dollar of earnings in 2010 is worth a lot more if interest rates are low than if they are high. This variable is one of the absolute basics of the stock market's valuations.



If the main factor working to keep stock prices in check has been inflationary fears and the interest rate fears that go along with inflationary fears, those factors may soon be gone. Alas, there is always an "on the other hand" and in this case, the "other hand" may well be forecasting an economic slowdown and a slowdown in corporate profits. But the signs of that are still few. What we are seeing is solid economic growth, a rapid return to a non-inflationary environment, and an interest rate that is friendly to stock holders.


Of course, there will be fluctuations, and there could be terrorism or a natural disaster. And a housing debacle (which I do not expect) could wreck consumer confidence. But the tea leaves about inflation are distinctly encouraging. There will always be peaks and valleys, but today looks like an awfully good time for the long term investor in broad indexes to jump in. Stocks are still trading at reasonable price-earnings ratios and price-book ratios by the most recent 15-year standards and with the inflationary haze lifting, we could see a happy moment for the man or woman building for retirement.

 

[Mike]

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The aging population won't be an economic issue of consequence for at least ten years. Even then, it might be much ado about nothing - longer lifespans will force a number of people to continue working at least part-time, which will offset the problem of rising vacancies in the labor market. Furthermore, I'd imagine that prices of goods and services used predominantly by the elderly will move considerably higher as more people reach old age/retire. For people on fixed incomes (pensions / 401k disbursements), this means their nest eggs will be eaten away more quickly - which becomes a source of pressure to return to work at least on a limited basis.

Resource consumption is simply a demand issue - and as long as we have a raging appetite to consume, it'll be tough for the economy to go through long periods of stagnant growth. I guess that's a bit of a good news/bad news situation, given our debt status.

Overall, I'll say that we should manage to do okay - provided that the government doesn't get too cute with its fiscal and monetary policies. A return to a neutral (no surplus / deficit) budget would bea nice start. Stable interest rates would also be a good idea... a 6% fed funds rate should be sufficient to cap the speculative / reckless investment happening in the housing market to some degree, and it would also maintain our t-bill appeal to foreign investors seeking nice returns.

 

[Wimpy]

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P.S. Re: Discontinuance of M3…

As an interesting exercise I did a google search on ‘Discontinuance of M3’. It doesn’t appear this event is attracting much mainstream[/i] news attention. I would venture to say when this is implemented in March of 2006, there won’t be any coverage then either. In March they will have the excuse it’s old news, but today they have no excuse whatsoever. Any financial news reporter worth his salt would have been all over this fed release and exposed this chicanery for what it truly is, but then again, he who pays the piper calls the tune. I just looked at the first couple of pages of search results and came up with blogs and other alternative news sites. If anyone has a different result, please let me know.

And the mainstream press sometimes speculates about why they are losing marketshare or exposure to other up and coming alternative new sites. Hmmm. Oh well, maybe there will always be enough sheeple interest in ‘runaway bride’ stories and articles about ‘water skiing’ squirrels for them to keep afloat. If that doesn’t do it they can always expand sports coverage. Yeah, thatta do it :^.

 

[Wimpy]

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Here are some interesting 1970s facts and food for thought that may allow us to see into the future a bit and give us a chance to prepare and profit.


1. Federal tax rates in the 1970s[/b] were high mainly due to ‘tax bracket creep’ resulting from inflationary pressures that the tax tables didn’t provide off-set for.


Conclusion[/b]: History has a way of repeating and I think the ‘tax bracket creep’ is no accident but rather a design feature that will be used as a revenue enhancer in the face of declining sales tax revenues associated with the eventual recession.

After a few painful years of taxpayers picking up the tab for excess federal and state spending and after the deficit is reduced, some politician, right on cue, will raise the issue of ‘tax bracket creep’ and will become a hero to the ‘little people’. Faith will be restored in the politicians ability to take care of the ‘little people’ and voter turn out in political elections will be on the increase versus the current decline we have lately experienced.



2. Energy efficiency in the 1970s versus today. [/b]Vast improvements have certainly been made in the area of fuel efficiency, but what one needs to recognize is that most third world countries were still using bicycles and mopeds as the predominant form of transportation in the 1970s. Car pooling was an art form in some of these third world countries with up to 18 people sharing a Datsun pickup with the front wheels just barely remaining on the ground. With the current industrialization going on in China and India, these populations will be desiring and able to afford a greater share of the energy pie.

Crude oil refiner acquisition costs went from an average annual price of $3.46 to $14.27 a barrel in 1979. With today’s lofty prices it doesn’t sound too terrible, does it? Let’s translate it into percentage terms. That translates to about a 412 % increase in fuel prices. And yes, we had recession in the 1970s. Since we are only talking about the 1970s, I won’t go into detail regarding the more than doubling of the average annual price of oil between 1979 to 1981.



Conclusion[/b]: Energy prices will continue to rise. Yes, there will be short term pull backs in prices, at key times,…and possibly as a result of tapping the strategic reserves, but they will be short lived. As those reserves become depleted, oil prices will skyrocket as they did in the 1970s.

If we establish $25.00 a barrel as this decade’s bottom for oil, as a comparable base line to the 1970 price of $3.46, and tack on a 412 % increase, not even factoring Asian demand, we wind up with a price of $128.00 per barrel of oil. Asian demand could take prices much higher and that is the very reason China is aggressively courting oil rich countries and aggressively involved in oil exploration off Asian coastal waters in cooperation with Vietnam and the Philippines.

Japan has laid claim to this potential oil under the seabed and the U.S. has purportedly sent a nuclear warship to the area, but quite frankly the U.S. is stretched pretty thin right now, militarily speaking. Financially speaking, China is operating from a superior position of strength. If the U.S. gets too testy with them all they have to do is quit buying treasuries for a week and the message will come across loud and clear to back off.



3.Structure: [/b]Manufacturing is certainly going, going, and gone. There is no reason Tech, R&D, and Pharmaceuticals won’t move off-shore as well.


Conclusion[/b]: That leaves services and government. The service industry is the lowest paid. Probably the most thriving of the service industries will be medical and assisted living care for an aging baby boomer population whose penchant for fast food and fast living will catch up with them. I see immigrants filling many of these jobs as changing bed pans for minimum wage plus 50 cents probably won’t appeal to soft around the gills U.S. workers who will prefer to ‘have it their way’ at Burger King for minimum wage plus 25 cents. I’m exaggerating just a little on the low wages, but I think you get my drift.

The robotics industry will even allow surgeons to live and work off-shore to avoid malpractice lawsuits. Surgeries will be able to be performed remotely with a combination of robotics, joy sticks, buttons and video imaging. The technology is there and surgeons are getting tired of playing the litigation lotto. The medical malpractice litigation lotto entitlement will be going the way of the horse and buggy. Or…with the high price of fuel, the horse and buggy could become a hot item. I’ve started pricing horse and buggies already…you know…buy low…sell high. Seriously, if you live in a climate where weather is agreeable…buying a gas or electric moped might be a good fall back plan…especially after those huge SUVs are off the streets and in the salvage yards being recycled for scrap metal export to China. Yes, the salvage and scrap metal business might be another booming industry.

Then there is us…government workers. With declining tax revenues associated with a recession or depression, tax revenues won’t be able to support government payrolls. Heck, tax revenues don’t support government payroll now. Government employees will be asked to do more for less and pensions and benefits will be slashed as well. It began with FAA going to pay banding and is now spreading to DHS. Unions…phffffff…they will be in a back pedaling mode for quite some time, if not forever. Union dues will have to be reduced with the wage crunch or people will opt out after doing their own cost/benefit analysis.

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[/b]
Summary[/b]: Stagflation (high prices, high unemployment/underemployment, and lower wages) will most likely be with us for the next decade.

Entitlements will be slashed. Make your savings and investment decisions accordingly.

 

[Mike]

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1. You won't see federal rates approaching the level seen in the 1970s as long as Republicans are in power. Those rates are anti-growth and would only worsen a recession, which would further damage the amount received by the gov't. I think that voter pressure would rise on the spending side of things - it's difficult for the average Joe to figure out why the government needs 2 1/2 trillion dollars per year out of us just to break even.

2.$120 oil is irrelevant. Why, you ask? Such a price shock would lead to a number of things. On the supply side, you'd have more exploration, probable elimination of offshore drilling bans by states such as Florida, and a move by oil companies to secondary / tertiary recovery methods (which are currently cost prohibitive) to obtain more oil from "dry" wells. I would also venture a guess that whoever was in charge at that point would create some type of bipartisan/independent commission similar to the BRAC to assign locations in the country where new refineries are to be built to help address the problem of gas supply shortages (in my estimation, they should be doing this right now, but I digress). On the demand side of the equation, consumers would demand more hybrid / fuel efficient vehicles. The government would no longer need to set a mandatory efficiency standard, as the free market would take over. When prices spiked following Katrina, SUV sales plunged and hybrids were flying off the lots. That was with oil approaching $70. :shock: So, if people do the same amount of driving with fuel efficient cars, you cut overall gasoline consumption by a significant amount. Also keep in mind that we are the richest country in the world - if we have problems paying for gas / oil at $120 per barrel, how do you think China and India could deal with it? My underlying point here is that oil going to that price level is simply unsustainable. The resulting economic slowdown worldwide combined with longterm behavior shifts would put a rather quick end to it.

3. Tech, R&D, and pharmaceuticals all require a highly skilled workforce and top-of-the-line equipment. This quickly limits where you can locate such facilities. Would all these American scientists / researchers, etc be willing to relocate overseas along with the companies? Doubtful. Unless the workers can be completely replaced elsewhere at lower cost for the same results (or better), you won't see wholesale relocation, and instead, you will see a continuation of the multinational approach where some things are done in each area (i.e. producing computer chips in the silicon valley but having call centers in India or somewhere else). As for robotics, yes, that is the wave of the future, but the startup costs are huge. I'm very familiar with this on the medical side of things. Robotics were briefly discussed at this facility, but the costs were too high. Even for just a partial implementation of it, the cost was over $1 million, and that was in the lab alone. :shock: Costs need to drop in order to bring that type of revolution about. Also, the robotics need to be designed and built somewhere, and given our status as one of the world's leaders in technological development, I'd say at least some of that would be done here in the States.

You'll probably see my view as overly optimistic just as I see yours as overly negative. However, as long as American ingenuity reigns supreme and immigrants continue to wish to locate here, I see our future as a bright one... as long as the government doesn't try to micromanage to the point of absurdity (which is precisely what has happened in Europe and is why their economic numbers have been atrocious for years now).