More bad news from the land of the rising sun.  Deflation in Japan continues across a wide swath of goods and services, even while the country sees some of its highest economic growth rates in years.  Consider this recent Bloomberg post:  Japan Deflation Concern Rises Even as Growth Quickens

Bloomberg writes,

The domestic demand deflator, a measure of price levels that excludes the cost of imports, fell 2.6 percent in the third quarter from a year earlier, the most since 1958, Cabinet Office figures showed yesterday in Tokyo. At the same time, gross domestic product jumped 4.8 percent, the most since early 2007.

Sustained price declines threaten to curtail a corporate- profit rebound that’s already been insufficient to spur a rally in Japan’s shares this quarter.

Here are some other downright scary points in the article:

• Consumer prices have fallen for seven straight months.
• Even after seven months of gains in factory output, about one third of Japan’s factories sit idle.

It is our view, as we have written in other posts, that Japan is quickly approaching meltdown.  The country has had the loosest monetary policy in the world for nearly two decades, and fiscal spending that has been so out of control that it almost makes Presidents Bush and Obama seem prudent and responsible by comparison.

Once you enter a deflationary spiral, it is nearly impossible to get out of it.  It took World War II and the ensuing Baby Boom to get the United States out of its last period of prolonged deflation.  What could possibly pull Japan out of its current malaise?

Look at the bullet points again: prices have fallen for seven straight months and fully one third of Japans factory capacity is idle — and this is one of the premier manufacturing countries in the world!

At this point, it would appear to us that the only thing that could make prices rise again in Japan would be a massive currency crisis — and we believe that it is highly likely we will see one of those in the coming years.

All of the gold bugs and fanatical dollar bears might want to take a look across the Pacific to see what the real conditions for currency collapse look like.

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

Gary Shilling gave an interview with Yahoo! Tech Ticker in which he lays out a scenario very similar to that of HS Dent:







Mr. Shilling is taking a hard contrarian view here. It’s accepted as near “gospel truth” that inflation — BIG inflation — is coming down the pipeline. But where is the proof? Yes, the monetary base has expanded. But what of it? Banks, businesses and consumers all continue to deleverage. Money is being destroyed faster than it can be created. And prices, outside of volatile items like food and fuel, continue to show mild signs of deflation. We suspect that those investors currently piling into gold when it is sitting at all-time highs will soon be sorely disappointed when hyperinflation fails to appear.

Charles Sizemore, CFA

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

We are shocked — SHOCKED! — to find that Bank of America and other large institutions did not respond to Treasury Secretary Geithner’s entreaties to lend more freely:  “Geithner Saying ‘Be Like Buffet’ Can’t Make JP Morgan Lend More.”

Bloomberg writes,

While financial institutions including Citigroup Inc. and Bank of America Corp. have received more than $200 billion in capital from the government, they are limiting loans at a time of mounting unemployment, rising company bankruptcies and increasing regulatory oversight. Commercial and industrial lending has dropped 17 percent since October 2008, according to Federal Reserve data.

Economic growth will be slower and short-term interest rates will stay lower for longer than economists and investors expect because of banks’ reluctance to lend, says Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc. in New York. Bank profits may be restrained and bond prices boosted as institutions put money into safe Treasury securities rather than making riskier, more lucrative loans.

Bank executives are not fools (the lax mortgage lending standards of the mid 2000s notwithstanding).  When they look at the economic environment — even after recent improvements — they do not like what they see.  Rather than lend money in a risky, uncertain, and politically-charged environment, many would rather keep their funds in US Treasuries.

This is why, despite the record expansion of the monetary base, we had yet to see convincing signs of inflation.  When risk appetites wane, credit creation stops, and the velocity of money slows.  And that is where we continue to find ourselves today.

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

Continuing our theme of the “New Normal,” we thought we’d share this tidbit from the Financial Times: “Industrialists fear return to growth is long way ahead.”  Writing for the FT, Richard Milne says,

Some industries may never see demand return to pre-crisis levels as manufacturers learn to live with much lower growth rates in the coming years, according to leading chief executives.

Hans-Paul Bürkner, chief executive of Boston Consulting Group, said companies such as manufacturers of trucks and machines - which have seen revenues plummet 50-70 per cent during the economic crisis - would struggle to return to the levels they achieved at the peak of the boom in 2007.

“Some will never get back to those [levels] because they have lost competitiveness and will be taken over,” Mr Bürkner told the Financial Times in a video interview .

In the New Normal, we start at a lower level and we accept a slower rate of growth.  Expectations have to be moderated.   There are casualties along the way, but the economy  more or less moves sideways with a slight upward bias.

What might some of those casualties be?  Bloomberg reports that GM and Chrysler, even after bankruptcy washed away most of their legacy debts, may still be at risk of ultimate failure.  Who else might join them on the scrap heap of economic history?  Sears and K-Mart, perhaps?  An airline or two?  We shall see.

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

We don’t buy into conspiracy theories that the government intentionally distorts economic data as part of some kind of diabolical scheme to fleece the voting public.  These allegations pop up routinely, usually (though not always) in off-beat investment newsletters, and are particularly focused on the reported stats for inflation and unemployment.  (Somehow, using a core inflation gauge that excludes volatile items like food and fuel or using hedonic adjustments to account for technological improvements are forms of government chicanery…)

At any rate, while the numbers may not be lies or intentional distortions, this does not imply that they are complete or that they tell the whole story.  Read the rest of this entry »

We’ve used words like “timid” or “cautious” to describe consumer behavior, but we now rather like the term “gun shy.”  What a great mental image — that of a brash cowboy consumer with a reputation for quick-drawing the credit card at every cash register suddenly losing his swagger.

This is more or less what has happened in the Great Recession.  The Washington Post reports that credit card usage has waned in the past two years, but debit card usage has surged (see “For Gun-Shy Consumers, Debit is Replacing Credit“).  This shows that consumers value the convenience and safety of paying with plastic but have adopted a more responsible way of doing it.  The days of throwing down the credit card with “devil may care” reckless abandon are over.  We’re in a more sober era now, and it’s all part of the process of deleveraging, which continues apace.

The Wall Street Journal echoed these sentiments on Thursday (see “Drought of Credit Hampers Recovery“), though they also rightly point out that this is a two-way street.  Not only are some consumers choosing to spend and borrow less, but many banks are more or less forcing them to by limiting the amount of credit available.   Read the rest of this entry »

In case you needed more proof that inflation is not much of a concern at the moment: “Great Time for U.S. Consumers: America Is on Sale.”

“There has never been a better time to be a consumer,” writes Rachel Beck.  “What’s happening now has been building for years. Wal-Mart Stores Inc. introduced ‘every-day low prices’ many years ago.  Amazon.com redefined the idea of bargain prices during the late 1990s when it helped introduce online shopping.  After the 2001 recession, automakers introduced zero-percent financing to boost sales.  McDonald’s “Dollar Meals” made fast food even cheaper.  But until the Great Recession came along, consumers hadn’t seen anything yet.”

As we  have written in prior posts, this is the New Normal.   And it’s part of the process of deleveraging and deflation.  Cut-rate prices erode the profit margins of both manufacturers and retailers, which reduces the retained earnings they can use for capital investment.  Eventually, weaker and less financial agile competitors fail, taking excess capacity offline and enabling businesses to raise prices again.

Needless to say, we’re not there yet, and we won’t be for a while.

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

The War on Deflation is still far from won, despite the  stimulative efforts by the Federal Reserve (and what gargantuan efforts they were — the monetary base has more than DOUBLED since the onset of the crisis).  Consumer prices in all but basic staples and highly volatile commodities like gasoline continue to be extremely weak.  With consumers stubbornly refusing to open their wallets, retail stores simply have no pricing power or bargaining leverage.

Today, Wal-Mart announced that the company would be cutting the prices of 100 popular toys to below $10 this Christmas season.

The fourth quarter of 2009 should prove to be interesting.  Year-over-year, we might see some degree of improvement over 2008 — but this is only because 2008’s numbers were already so incredibly bad.

Still, we would expect much of the same: bigger than usual discounting this Christmas season in an attempt to persuade reluctant investors to fork over their money.  They’ll have to work for it this year.  Welcome to the “New Normal” holiday sale.

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