Here is a graphic to behold:

This chart shows fixed investment in equipment and software.  This is the primary “non construction” segment of fixed investment, a major component of GDP.

The falloff in investment spending over the past two years has been mind boggling.   It’s more than three times the decline of the “dot com” bust–when virtually every company in the world had massive overcapacity in computer and telecom infrastructure!

What this tells us is that non-construction business investment should pick up in the coming quarters, even if in absolute terms it remains below the levels of the mid-2000s for several years.   You can’t have 30% year-over-year declines forever.

We’re not nearly as enthusiastic about the other components of GDP.  We expect modest improvement over 2009’s devastating lows.  But we expect overcapacity and deflationary forces to be with us for quite some time.

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

Nearly a year ago, we first commented that professional sports were getting slammed by the recession (see “Bailout Culture Spreads…to Basketball?” and “Now the Recession Has Hit the NFL“)

This isn’t a garden-variety recession we are experiencing.  It’s something bigger this time; a psychological tipping point has been reached.  The mid-to-late 2000s witnessed the gentrification of professional sports.  Beer and hot dogs were replaced with saki and sushi…or Starbucks!  And perhaps nothing symbolized the excesses of the era more than the Dallas Cowboys and their billion-dollar stadium (subsidized by Arlington taxpayers, of course).  But today, a little more than a year after the financial meltdown, these excesses appear more and more to be a high-water mark of sorts.   Team owners seemed to have forgotten that most sports fans are not the champagne and caviar crowd; they are  far more likely to be found with beer and pretzels…and that’s regular domestic beer, not the microbrew or imported stuff.

So, after the building spree of the past 15 years, we find ourselves with overcapacity in professional sports.  Expensive overcapacity.  We also find ourselves with sagging demand: “NBA ticket revenue slides 7.4 percent”

CBS Sports writes,

Average paid attendance is down 3.7 percent in the NBA through the first quarter of the regular season, sending gate receipts plummeting 7.4 percent, according to league documents obtained by CBSSports.com.

Net gate receipts, the money teams make from ticket sales, fell to an average of $828,985 per game, down from $894,823 at the same point last season. Only nine teams were up or flat in average net gate receipts through Nov. 29, while 21 teams saw a decline.

Excess supply and tepid demand can only mean one thing — falling prices.  Could it be that the bubble in professional sports — including everything from ticket prices to player salaries — could be giving way to deflation?  2010 is supposed to be an enormous year for NBA free agency; if current trends continue, there might be a lot of disappointed free agents.

Charles Sizemore, CFA

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

In a second follow-up to our prior post “Who’s Next?“, we now see that Spain is at risk for a ratings downgrade: “Spain’s Debt Woes Echo Europe’s Uneven Rebound”

This is a big deal.  Currently, the US dollar seems to be the primary worry among fretting investors.  And to be fair, the US fiscal position is horrid.  But the situation in Europe is potentially so much worse.  What would happen to the value of the euro or the stability of the Eurozone if a major country — say, Italy — were to leave the monetary union or get kicked out?  This is not idle conjecture; it is a real possibility.

Returning to Spain, the WSJ writes:

Spain became the latest euro-zone country to face a possible downgrade of its government debt, raising fears Wednesday that similar fiscal woes triggered this week in Greece are spreading.  The situation highlights the divergent paths that euro-zone countries are taking out of the most severe economic downturn since the 1930s. Ireland and a number of Southern European countries that outpaced larger nations during flush times are emerging from the crisis with their economies and finances in much worse shape than Germany and France.

This is not to say that things are rosy in Germany and France, of course.  But luckily, these two European giants did not lose their inhibitions in the mid-2000s wild bacchanalian debt orgy the way that much of Southern Europe did.  Furthermore, German and French demographics (though again, not good) are not nearly as bad as those of Spain, Italy, or Greece.   These three Southern European nations are facing a permanent loss of economic clout and possibly even their cultural identities due to plunging birthrates that guarantee significant population shrinkage in the years to come.

The fact that Spanish government debt yields only 0.7% more than German is puzzling to us given the risk that Spain represents.  But then, if Japan has managed to keep yields across its yield curve low even while the the country amassed the largest debts in the developed world, we suppose it’s not that shocking.  Government yields around the globe seem unreasonably low given the risk.  Investors, unfortunately, have few places to go for income these days.

Charles Sizemore, CFA

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

Remember the “roving blackouts” that plagued California in the mid-2000s?  Well, we believe that is a good analogy for the state of the world capital markets circa 2009.  We’ll call it “The Roving Financial Crisis.”

Given that we all just lived through it, a full history lesson is not warranted.  But to review briefly, the crisis that began in the subprime mortgage market morphed into a broader housing crisis which in turn caused a meltdown in the capital markets and led to the failure or reorganization of virtually every Wall Street firm save Goldman Sachs (and even Goldman gladly accepted government bailout money as a precaution).

Well, it was rough, but we survived it.  The question now becomes “What happens next?”

According to Reuters, “The credit crisis that rocked U.S. residential mortgages and corporate credit markets may roil commercial real estate and sovereign debt markets next, senior investment managers said on Monday.” (see full article)

The “debt payment moratorium” (a.k.a. default) by Dubai World brought these risks to the forefront.  We commented on this recently in “Who’s Next.”  We wrote then that the growing consensus was that Greece was most likely to default, and today we see that the credit ratings agencies agree: “S&P Puts Greece, Portugal on Notice.”

Shockingly, given given the state of Greece’s finances (deficits this year are forecast to be an almost unbelievable 13% of GDP), Greek debt is yielding only  2% more than Germany.  To say the least, this would seem an insufficient risk premium…

So, the roving financial crisis continues.  Time will only tell where it pops up next.

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

The New York Times ran a story that goes well with our post from Nov 30, “Who’s Next.” — “In Wake of Dubai, Trying to Predict the Next Blowup.”

Check out the graphic from the article:

Link to graphic.

Interestingly, while the United States does have significant exposure to the “at risk” countries such as Greece and Russia, it is the European Union that would be most damaged by a default.  European exposure dwarfs that of the United States, adding support to Harry Dent’s belief that the next major wave of debt crisis will originate in Europe (see July 2009 issue of the HS Dent Forecast).   This is something we intend to monitor in the months ahead.

Charles Sizemore, CFA

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

“There is a $1 trillion stash of cash idling in the banking system,” writes Peter Eavis in this morning’s Wall Street Journal. “It’s too big to ignore, and it’s a cause for concern.”  (see “The U.S. Economy’s $1 Trillion Question“)

Banks are required by the Federal Reserve to hold a small amount of funds in reserve to meet their liability needs. But these bank reserves now exceed the minimum by over $1 trillion — up from a surplus of just $2 billion in September of 2008.

By now, most our readers should have seen the inflation scare chart — the expansion of the monetary base.   With such an explosion in the potential money supply, it is understandable why inflation hawks have caused a stir.  As Eavis continues, “In theory, these sleeping funds could be ‘activated’ to support a huge volume of new loans, which in turn could fuel demand and inflation… [But] for now, though, the inflation fears look overdone. Bank credit is actually falling, despite the excess reserves. That raises an opposing fear: That banks remain nervous, even after all that has been done to support them. They would rather cling to low-yielding cash than lend it.”

In case anyone wonders where all of the Fed’s newly “printed”money has gone, you now have your answer.  Rather than lending out the massive bulge of liquidity you see in the link above, banks have decided to sit on it — all one trillion dollars of it!

So, what does this actually mean? It means that inflation is not an imminent threat.  Until banks recover their appetite for risk (and consumers recover their appetite for new debt), the velocity of money will remain depressed and deflation — not inflation — will remain the primary concern.

Charles Sizemore, CFA

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

“After Dubai, will Greece be next?” asks the Financial Times this morning.  They are speaking of sovereign default, of course.  The debt payment moratorium by Dubai World has investors asking these kinds of questions for the first time in nearly a year.

In late 2008, the question was “which bank is next?”  Today, the question is “which sovereign state?”  Might it be one of the usual suspects?  Perhaps Russia, Turkey, or one of the South American republics?  Or might it be someone new and exciting — like another Iceland!

Interestingly, one country is conspicuously off the list of candidates: the United States.  Yes, it appears that investors like to talk good game about dumping US dollars in favor of “safe” havens like gold (for our views on the barbarous relic, see here).  Yet somehow, when the world suddenly looks risky again, it is not gold that offers protection (gold fell sharply on the Dubai news, in fact).  It is the US dollar and US government debt that investors run to.

These are certainly interesting times.  We’ll refrain from attempting to call the exact top on the gold bubble.  We already tried that on the euro (see here), and thus far we’ve been wrong, or at least “early” on that call.

We continue to advise caution on both the euro and gold.  There is absolutely nothing wrong with attempting to earn a quick speculative buck on either, so long as you understand the risk being taken.  But both would appear to be very highly vulnerable, and their current bull markets are based on very questionable assumptions about the US dollar.

Charles Sizemore, CFA

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

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.

Read the rest of this entry »

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