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

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

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

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

For years, HS Dent has argued that most “discretionary” spending really isn’t all that discretionary.  The modern economy is organized around monthly payments, be they for the mortgage, the car, or even your son’s saxophone lessons.  These monthly commitments are not always easy to break, and breaking them can sometimes involve losing face.  It’s easy to forgo a restaurant meal and save money by eating at home.  But to actually take the proactive step of calling someone to cancel a membership or monthly plan…that can be hard.

At any rate, The Economist confirmed our points in a recent article: “The Triumph of the Monthly Bill”

No doubt reflecting what most readers have witnessed in their own lives, The Economist writes that throughout this recession,

As a rule, media products that are sold in shops—CDs, DVDs and magazines—have suffered… The kind of media for which people pay a monthly bill, in contrast, has not only held up better but has in some instances prospered through the downturn… “People would sooner unplug their refrigerators than their cable boxes,” says Craig Moffett, an analyst at Sanford Bernstein.

While the payment model has been durable in past recessions, we’re not so sure it will do as well this time.  Demographics are working against the model in two directions.  Baby Boomers, who would have never dreamed of cutting services in the past, are now downsizing their lives as they prepare for retirement.  And when you downsize, unused services tend to get cut.  (Changing addresses can often be the impetus that motivates you to make cuts.  For example, you may neglect to hook up a phone at your new home and opt instead to go “cell phone only” as we discussed in a prior post).

The other demographic challenge is that the large young and up-and-coming generation — the Echo Boomers — has become accustomed to getting things for free.  A newspaper home delivery subscription is simply unthinkable to them.  And some of the more tech savvy of the lot watch their favorite TV shows via Hulu or other internet sites, making cable TV redundant.  Even the internet bill itself is elusive to them:  a free Wifi signal is usually not far away, so why pay?

In “Talk is Cheap; Skype is Cheaper” we discuss yet another way to reduce the monthly payment.  Using Skype, iPhone users can route their voice calls through their data plans, thus allowing them to reduce their voice plan to the lowest possible level.

The key here is that, while the subscription model is not dead, it is far less robust than it used to be.  Changing demographics should continue to erode the model around the edges; the retention rate will not be as high as in years past, and it will be harder to attract new subscribers.  It’s not quite “dooms day,” but it certainly means that marketers will have to work harder to generate sales, and profit margins will almost certainly be lower.

Incidentally, an old associate of ours has created a blog dedicated to using the internet to streamline your life and reduce clutter.  In a lot of ways, his blog sums up succinctly many of the points we’re trying to make (check it out: “Electronically Obsessed”).  In a recent post, he profiled an Echo Boomer who had taken this neo-Spartan lifestyle to a new level, reducing his entire life “down to one suitcase and a single Blu-ray disk” (See post: “Moving to the Cloud.”)

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

Here’s a headline we all saw coming: “Mortgage applications slide as tax credit expiration looms.”
CNN Money reports that “Mortgage applications fell last week for the third week in a row, even as interest rates edged lower…  The drop in activity came as a popular tax credit for first-time homebuyers faced an uncertain future. The credit, which can be worth up to $8,000 for eligible buyers, is set to expire at the end of next month.”

Economics is always best understood “at the margin.”  The aggressive selling and lax mortgage lending practices in the mid-2000s pulled forward a significant number of sales of marginal buyers.  This includes both subprime borrowers (who probably should have never considered home ownership in the first place) and higher-quality borrowers who were persuaded to buy a home sooner than they might have due to the attractive financing options.

We see the same basic conditions today: the tax credit for first-time buyers has also convinced more than a few marginal buyers to step up and buy a house sooner than they might have in the absence of the tax credit. This has been one of the biggest forces driving the nascent recovery in new home sales.

There are two big problems with this, however Read the rest of this entry »

Hedge fund manager David Einhorn had some interesting comments on the dollar in the recent Value Investing Congress:

When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse.  So, I conclude that picking one these currencies is like choosing my favorite dental procedure.

This more or less sums up our view at HS Dent.  We agree that the dollar is a horribly mismanaged currency by an irresponsible and self-destructive government.  The problem is…so is every other major world currency!  It’s difficult to make money shorting the dollar when there is no viable option to short against.

Einhorn reaches the conclusion that, since all paper currencies appear to be in a race to the bottom, gold is the direction to go.  We’d tend to disagree with Mr. Einhorn on this count because we believe gold will face some serious headwinds in a deflationary environment — and the bond market is still telling us, in contradiction to the gold market, that deflation is the real concern.

The dollar is a despised asset right now — it is nearly impossible to find anyone who is bullish on the dollar.  This could make the dollar an intriguing contrarian investment.

Should  the stock market roll over in a new bout of risk aversion, the dollar should rally sharply.  But even if risk aversion remains benign, we would expect the dollar’s current weakness to reverse at least marginally in the next year.  Its current depressed value against the euro would appear to be unjustifiable given the economic challenges that the eurozone faces.

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

In recent posts, we’ve pretty well beaten to death the topic of e-book readers like the Amazon Kindle, but this is a significant technology trend that stands to make major revolutionary changes to large segments of the economy, so we figure one more post won’t hurt.

The Financial Times reported today on the Kindle’s adoption by some forward-thinking American universities: “Electronic Books Kindle Learning at US Universities.”

As part of a pilot program, Amazon is making its Kindle DX (large screen) readers available to a hand full of universities at a deep discount, and the universities are in turn making them available to students in certain programs for free.  Read the rest of this entry »