Despite being in “bunker mode,” in which virtually all non-essential spending has been trimmed or eliminated, consumers have continued to buy shoes by the box loads (see “A Not-So-Guilty Pleasure“).

The question begs to be asked: Why?

The New York Times writes “Retailing executives and analysts offer varying, occasionally wacky, explanations. The one favored by many of them is that consumers consider shoes more of a necessity than, say, dresses, cuff links or handbags, so people feel less guilt about buying them.”

Shoes are generally cheaper than most of the other items mentioned. Perhaps this is a better explanation, however:

Shoe buyers for major retailing chains said sales were also driven by styles for children and babies, especially during the back-to-school months. Children regularly grow out of shoes and parents, while willing to sacrifice when it comes to themselves, are typically loath to scrimp on their children.

When a child’s foot grows, you really have no choice but to buy shoes for him.  In this sense, children’s clothes can be thought of as a recession resistant sub-industry, particularly given the recent surge in births.  This recent baby boomlet gives the market for children’s clothes strong demographic support in the next decade.   Even if an adult man or woman is content to turnover their wardrobe a little less frequently when times are hard, some amount of spending is needed for their growing kids.  They might buy cheaper brands and buy fewer pieces overall, but some amount of spending is going to happen.  You can’t rightfully send your kid to school with sleeves and pants legs that are half a foot too short.

The Times also had another interesting theory to explain the resiliency of shoe sales:

Among the more curious explanations proffered for the relative strength of shoe sales is that women — who make up the lion’s share of the American shoe market — get an emotional lift from shoe shopping in a way they do not when trying on jeans and cocktail dresses.

During depressions, people are…well…depressed.  The “retail therapy” of shoe buying might create a sense of escapism from current economic woes.

At any rate,  this goes to show that in a bad economy, pockets of strength can be found in some unexpected places.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Fannie and Freddie have a new program - when you default on your mortgage, you can trade in your mortgage through foreclosure and in return get a rental agreement.  Through rapid deterioration of the housing market and now prime loans, Fannie Mae and Freddie Mac have found themselves with around 100,000 homes that they own.  What to do with them?  Flooding the markets with excess inventory seems like a bad idea, so they chose instead to go into the landlord business.  The WSJ reports that the program will charge “market rents,” which are lower than the previous mortgage.  That seems obvious.  But it also brings up an obvious question - if rents are lower than the old mortgage payment, are the rents also lower than a mortgage based on current sales prices?

What the entities are doing is betting on an improvement in the housing market, waiting to sell inventory when things are better.  These are the same entities that told us in no uncertain terms in the summer of ‘08 that they needed no government funds, and are now $100 billion into our pockets as taxpayers, most likely needing more in the months ahead.  Having these entities become real estate speculators doesn’t make me feel better.

In the bizarro world of financial markets, our narrowly measured unemployment rate rose above 10% in the month of October and now the markets have inched higher. 

I did see a couple of people taking solace in the fact that the number of job losses is slowing, indicating that on the current slope we will be in positive territory by late spring of 2010.  I understand that.  I don’t agree with it, but I understand it.  The measure of the civilian labor force, or the number of people eligible for work, has continued to slide, which makes the measure of unemployment look better than it actually is.  We’ll see.

There is no good way to spin a move higher that goes over 10%. 

A friend of mine looking to sell his home in suburban Fort Worth got a rude awakening.  The estimated market value of his home dropped $20,000 almost overnight.  When he asked the realtor what happened, he found out that the last comparable sale in the neighborhood was a foreclosure.  And even though that foreclosure price was not a “normal” market price, by virtue of being the last sale in the neighborhood, it became the new market price, dragging every other home in the neighborhood down.

The greatest benefit of a liquid market is it role in allowing “price discovery.”  The interactions of buyers and sellers send the signal of what an object is worth via the clearing price.  But the key here is “liquid.”  When sales are infrequent, prices become stale and no longer reflect reality.

In the housing market, this can be seen in a couple different ways.  If demand is in freefall and it’s been a while since there was a sale, the “market” price will grossly overstate the “real” price.  But likewise, if demand is relatively strong but the last sale was an aberration (such as a low-ball foreclosure sale), the market price can understate the real price.   In either event, it can make the sale of a house complex and downright tricky to negotiate for both buyer and seller.

The NY Times ran a good story this morning about this topic: “Getting Real About Home Prices”

The Times writes,

Even in the best of times, it’s hard for individuals to objectively value their homes, which often reflect their sense of self and personal style. Making things even more difficult has been general market inactivity lately, if not paralysis, which has provided little in the way of pricing guidance. But by using online resources, investigating neighborhood trends, consulting real estate experts and perhaps even asking the opinions of brutally honest friends, homeowners can arrive at a reasonably accurate appraisal even in these uncertain times.

Of course, as the Times tells us, in the end “the value of a home is the price the buyer is willing to pay.” And in most areas, it is still very much a “buyers market” in the sense that sellers have very little negotiating power.  This is not something we see changing any time soon.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Earlier this week, we wrote of the “Sinking Ship That Is Japan.”  Today, we’re going to take a look at what the bond market has to say about the Land of the Rising (or perhaps “Setting”?) Sun.

In an almost unfathomable vote of confidence in Japan’s credit worthiness given the county’s debt load and horrendous demographic picture, bond investors have priced the ten-year Japanese treasury at a yield of only 1.4%.  Investors are willing to accept a paltry return of less than a percent and a half from a borrower with the state finances of a banana republic — with government debt now closing in on 200% of GDP!

This prompts the question:  WHY?

The standard answer has been that,

1. Since Japan in experiencing deflation the real interest rate is higher, making the bonds more attractive, and
2. Japan’s domestic population, with its high savings rate, has a voracious appetite for “safe” fixed income, essentially willing to buy at any price.

Of course, for a lot of Japanese, the yield is not sufficient, and a fair number invest their savings in foreign stocks, bonds, and currencies.  They will almost certainly be happy that they did, as we view the likelihood of a full-blow currency crisis in the yen being very high within the next decade.

At any rate, international investors may not be as sanguine on Japan’s credit risk.   Consider the chart below, from Bloomberg Read the rest of this entry »

Ford Motor just announced quarterly profits of nearly a billion dollars.  So, that’s it.  The recession must be over.  Time to pop open the champagne bottles.

You no doubt detect more than a hint of sarcasm in my words.  Yes, Ford’s results are good news for the company’s shareholders.  Ford managed to claw some market share away from its domestic rivals — both of whom were distracted by their respective bankruptcies.  Ford also had a better lineup of  fuel-efficient cars, allowing the company to better take advantage of the Cash for Clunkers windfall.

But this is where the celebration stops.  As you can see from the WSJ chart below, even with Cash for Clunkers, car sales are FAR below the levels of the early and mid 2000s.  And now that Cash for Clunkers is finished, sales are beginning to falter again.

The WSJ writes: “Clunker-driven sales peaked in August at a 14.1-million-unit pace, but payback was rough: Sales tumbled in September to a rate of 9.2 million units… Auto makers sold, on average, 17 million cars annually from 1999 to 2007. It might be years, or another credit bubble, before sales get anywhere near such levels.”

The Journal has taken to calling this mild recovery — in which expectations are lowered — the “New Normal.”  This is a term we’ve used quite often of late in recent posts.   And we expect to be using it quite a bit going forward.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Apparently state governments are fightin’ mad at the fact that foreclosures are wrecking their economies.  They are eyeing mortgage lenders for creating the debacle, and on top of that, those pesky banks and other lenders are not helping to remedy the situation, often taking much too long to deal with loan modifications and other initiatives aimed at slowing the rate of foreclosure.  In an effort to take control,  states are weighing the possibility of suing mortgage lenders for fraud.  Take a moment to ponder this.  State governments, who have wildly over-promised what they can support through their own funding, are contemplating suing mortgage lenders for fraud because they potentially lent money to people who couldn’t pay it back.  This falls into the “I can’t understand that” category.

If a lender makes a loan that can’t be paid back, isn’t that sort of a bad business practice?  To say that the lender did it for profit is a bit confounding, since the business model - lending to people who were marginal borrowers - seems like it is doomed from the beginning.  In fact, many of those lenders are out of business.

But let’s entertain the idea for a moment.  Someone out there is responsible for creating a boom in economic activity through the promise of cheap home ownership - or at least that is the working theory here.  That boom created an unsustainable flow of capital and economic activity within states that they became accustomed to having.  Now the spigot is turned off, so let’s blame the group that created this mania.  To do this, you have to keep asking for the next step.

It can’t be the mortgage lender.  Barring out and out fraud (which of course happened, and was always illegal), we are talking about the sweet talk of easy home ownership at a low price, getting in on the fastest game in town, the real estate bubble, and directed at those who were at best marginal buyers and at worst non-qualified buyers.  This of course came through the lenders, but it started a little further up the chain.  You have to look at the Fed with their insanely low interest rate policy, which kept prices low.  But that’s not the end of the line. 

For the end of the line, you have to look at the bucket of money that eventually purchased a big chunk of those mortgages backed by low income borrowers who are now in trouble.  That would be me and you, through our agents Fannie Mae and Freddie Mac.  In the 1990s we gave direction to those two government sponsored entersprises (GSEs) to make sure that a large percentage of the loans they purchased were those backed by low or modest income borrowers.  So in this line of thinking - that someone, somewhere, created all this mess in housing by making homes TOO affordable and persuading people to buy homes they couldn’t afford - would have to lead you back to the big buckets of money that kept buying the loans.

When are the states going to sue the federal government for fraud?  I don’t know, but if it does, it will be interesting to watch!

Don’t get me wrong, I do not think Congress is responsible for this mess.  I think this was a group effort - CDS’s which were gussied up insurance contracts with no capital behind them, rating agencies who pandered to issuers, the Federal Reserve, and Congress had a bit part.  There are many others, including borrowers themselves.  In this post I’m just addressing a current issue with states, I’m not agreeing with their analysis.

Once in a while, you have a “me too” moment when you see an article that you wish you had written.  Barry Ritholtz posted on of those today: “Worry About Japan, Not America.”

Ritholtz, though he doesn’t cover the demographic angle, is one of the few analysts out there who understands debt deflation and why the effective insolvency of America’s large banks is such a big deal.  The decisions being made today in Washington are, unfortunately, the same that have been made by Japan for nearly two decades now.  Finally, it appears that Japan is reaching the end of the line.  The country may already be to the point where its sovereign debts are unpayable.  What happens when this realization sets in?  What will happen to the yen?  Or to the “carry trade”?  What will happen when the second largest economy in the world “blows up” like a banana republic?

Honestly, we don’t know.  But we may be much closer to finding out than most analysts think.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy

Falling fertility

Oct 29th 2009
From The Economist print edition

Astonishing falls in the fertility rate are bringing with them big benefits

The above story appears in the latest edition of the Economist, a magazine we read faithfully as it gives an interesting “outside America” perspective on things.  This story has no political leaning, but instead quantifies the effects of falling birth rates.  In very un-typical fashion, the analysis couldn’t be more wrong in it’s conclusion.  The Economist points to the wonderful virtues of falling birth rates, clearly identifying a “goldilocks” generation where there are fewer children and fewer aged than there are workers.  So far, so good.  The article goes on at length about how wonderful this is, with its increase in output, more opportunities for women to join the workforce, increased productivity, etc.  Many countries are cited as examples of how this story goes - most of Europe and the US - and there are many countries cited as being in this storybook chapter of thier history right now.  But what comes next?  That question is not answered.  Only in passing is Japan mentioned as having issues because of  few workers per retiree and with almost no children coming along to revivie the economy.

It would have been much more enlightening for the article to delve into the truly long-term implications of a falling birth rate in the context of the current economic systems in place around the world.  A 20, 30, or even 40 year view is not enough.  We need to understand our obligations and abilities on a full 80 year cycle to clearly see how our policies of today will help or hinder the generations of tomorrow. 

As we contemplate phenomenal increases in government responsibility and liability, we need to do so with our eyes wide open.  To say such programs have worked elsewhere is only compelling if such programs worked during both goldilocks times and times of contraction.  So far such analysis has not made it to the scene. 

 In a seemingly unrelated article, Evan Ambrose Pritchard wrote a great piece in the Telegraph on why Japan should be the worry of the world instead of the US, as their financial situation is deteriorating by the day.  I say seemingly unrelated because it is an article about the failure of Keynesian economics as employed by the Japanese over the last 20 years, but the real driver of the failure is the totally wrong response of the Japanese government to their real problem - falling birth rates fifty years ago.  In the face of such a demographic shift, taking on more economic burdens at the government level was the complete wrong thing to do as the expectation going forward is for economic contraction.

I’d love to see the Economist take their analysis to the next step, asking what comes after the goldilocks period when you have an aging workforce and no replacement children.  It’s difficult to get much of anyone to look that far over the horizon.

This might be our favorite headline of the past year: “Free ketchup off the menu as companies stay focused on costs.”

The article relates the story of a Houston, Texas hamburger joint that charges 15 cents per extra packet of ketchup.  Some other examples of Spartan cost cutting:

Across Houston, this downsizing has taken many subtle forms. Some pizza delivery companies now ask take-out customers if they want crushed red pepper and Parmesan cheese with their orders, instead of just throwing them in the bag. Some have started giving customers just one napkin, instead of a stack.

Dentists who before the downturn gave customers fluoride treatments as part of their annual cleaning are charging $30 (£18) extra for the cavity prevention.

The New York Times also had an interesting example of changing pricing and spending patterns: “The sky used to be the limit for the price of designer jeans.  Now the sky is falling.”  It appears the bubble in jeans prices has officially burst.

The NY Times writes,

The $300 pair of designer jeans is now, courtesy of the recession, the $200 pair of designer jeans…  Like any commodity that becomes overpriced, there eventually comes a market correction. And denim’s day of reckoning was long overdue…

But the denim bubble has burst, and only a handful of such extravagantly priced jeans remain at the jeans bar…   During the modern gilded age, the spiraling prices of designer clothes had more to do with driving profits than the actual design or construction of a garment. Designers found they could charge a lot for the perception of prestige. Dresses and suits and handbags were priced like cars, and consumers didn’t blink. But with jeans, it just felt more obvious that some kind of game was being played; the basic elements, after all, had not changed substantially in decades: five pockets, cotton, some rivets.

Oddly enough, even with the price implosion of the ludicrous designer jeans market (isn’t the whole point of jeans comfort and the idea of simple ruggedness?), total sales remain high.  As the Times continues, “though average prices were down 1 percent, according to the research firm NPD — the pricing shift is reflective of a broader reset taking place in luxury stores.”

We like the term “pricing reset,” and we think the writer is on to something there.  We have our own word for it: deflation.  When demand falls, so do prices — and profits.  At any rate, we are not completely bearish on the luxury sector.  The Baby Boomers are now in their 50s — a prime age for many luxury purchases.   Demand in emerging markets has also proven to be robust.  Still, the recession did a fine job of taking some of the froth out of the luxury market.  The well-to-do might still spend some of their discretionary income on the finer things — but absurdities like $600 blue jeans will likely not make the list.

Charles Sizemore, CFA
Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy