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

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

We’ve written about the Amazon Kindle in prior posts, specifically on it power as a disruptive technology to revolutionize the centuries-old industry of book publishing.  (We use the Amazon Kindle by name by personal choice, but competing e-book readers such as Sony’s are certainly part of the revolution too.)

Now, we read in the New York Times that the revolution is coming to the public library (see “Off the Shelf, Onto the Laptop, Libraries Turn to Digital Books“).

Thus far, libraries have barely gotten their feet wet.  But the changing economics of the industry make us believe that e-books will quickly become a large percentage of new purchases.  In explaining the model, the Times writes,

Most digital books in libraries are treated like printed ones: only one borrower can check out an e-book at a time, and for popular titles, patrons must wait in line just as they do for physical books. After two to three weeks, the e-book automatically expires from a reader’s account.Some librarians suggest that because digital books never wear out, take up no shelf space and could, in theory, be read by multiple people at the same time, the purchasing model for e-books should be different than it is for print…

But some publishers worry that the convenience of borrowing books electronically could ultimately cut into sales of print editions.

Publishers are right to worry.  They saw what happened to the music recording industry, and they shudder to think that it can happen to them too.  But like it or not, it will happen, in some form or another.

The competitive forces of capitalism — made all the sharper by the deepest and longest recession since the Great Depression — will continually lower prices for consumers when not restricted.   The delivery of intellectual property via electronic means — be it software, music, or a book — is virtually free, as is reproduction of the material.  It’s also “greener” and better for the environment, requiring less physical plant, storage space, and fuel.  The price savings here represent “good deflation,” the innovation-driven kind that makes our society as a whole richer.  (This is not to be confused with “bad deflation,” which is due to falling final demand.)

Piracy is a problem, but not an insurmountable one.  Microsoft manages to remain profitable despite widespread piracy of its software, and it mitigates this with product keys.  Apple experimented with digital rights management to avoid MP3 piracy, though this has been less successful.

Authors, like musicians, may have to find a new business model.  Perhaps they could generate revenues through consulting services the same way that musicians do concert tours?  It’s hard to say exactly how this will all play out.  Authors (alas, ourselves included) may find book publishing less lucrative in the future, though we believe most of the pain will be felt not by the authors but by the middlemen that are increasingly becoming obsolete.

It’s hard to know what direction the industry will go and who will be left standing once the dust settles.  But that is the beauty of a revolution — it will be fun to watch!

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 »

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

Anyone who has recently attended college or who has children who have recently attended college probably experienced “sticker shock” when they found out how much it cost.  It’s no secret that the price inflation in university tuition has far outstripped virtually every other sector of the economy over the past decade.

HS Dent has explained this phenomenon with demographics.  As you can see in the chart below, the number of 18-year-olds fell throughout the 1980s as the small Generation X came of age.  But in the early 1990s, the number of 18-year-olds began to rise again…and rise it did.

This massive surge of 18-year-olds is, of course, the Echo Boomer generation.  Assuming no increase in the percentage of kids that go to college, demand for college education still would have exploded throughout the 1990s and 2000s due to the fact that there are simply a lot more kids of college age.   When demand rises substantially while supply remains more or less unchanged, basic Economics 101 would tell you that prices have to rise.  And that is exactly what has happened.

Interestingly, an explosion in school loans have been both a cause and an effect of the price increases.  

According to the Wall Street Journal, two-thirds of college students borrow for college with an average balance of $23,186.  Unfortunately, this debt appears to be contributing to a bubble.  The Journal writes,

…the rising levels of borrowing may ironically be contributing to the accelerating cost of college, say some college-finance experts.  Loans can give colleges an artificial sense of a family’s ability to pay tuition.  To some extent, that false sense of security gets built into the assumptions schools make when setting prices, say experts.  The idea is that as prices rise, families borrow more and more, spurring prices to rise further, which in turn requires more borrowing.

This has all the markings of a classic bubble.  So, the question now becomes, “how does this end?”  

Our answer would be that it will end as all bubbles do, in a deflationary bust.  The number of 18-year-olds will begin to fall this year and will continue to fall for about seven years.  This means that, barring a sudden surge in the percentage of kids applying to school, demand for education will fall.  And with falling demand should come falling prices, or at least moderating prices.

An outright drop in the price of tuition seems somewhat unlikely to us, because lowering the price could be viewed as damaging to a school’s prestige.   But prices can fall in “hedonic’ terms.  In other words, while the quoted price remains unchanged, you might get a lot more for that price, with added sweeteners thrown in.    Free or discounted books, room, or board?  It’s hard to say.  Regardless, for the first time in well over a decade, university education is about to become a “buyer’s market” again.

Charles Sizemore, CFA

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

Continuing our ongoing discussion of inflation and deflation, we read in Barron’s today that Paul McCulley, managing director at PIMCO — the largest private money manager in the world –has some thoughts on the subject:

“Serious inflation is of no concern now, with all the excess labor and industrial capacity that exists and the speed with which wage cuts are occurring in this cycle”  (from ”Cataclysm Averted, Expectations Diminished“).

Of all market participants, bond investors have the most to fear from inflation.  A prolonged surge of inflation is bad for stocks, but it is absolute destruction for bonds.  So, the fact that one of the chief decision makers at the largest bond fund manager in the world sees no real risk of inflation certainly strengthens our case that deflation — not inflation — remains the threat. 

That’s our story, and we’re sticking to it.

Charles Sizemore, CFA

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

We periodically read David Rosenberg’s “Breakfast With Dave” economic report, which he publishes daily.   It’s good research, but we find we can’t read it everyday because it’s just too depressing. (The analytical Mr. Rosenberg can really put the “dismal” in the dismal science when he wants to.)

We commented on the deflationary effects of oversupply and sluggish capacity utilization two days ago in “One Step Forward, Several Steps Back.”  Now, let’s take a look at what Mr. Rosenberg has to say about deflation in his June 18 comments.  

The CPI rose a negligible 0.1% in May, and the PPI actually fell by a full percent.  Mr. Rosenberg believes headline consumer inflation falling to -2.0% by the end of the summer — meaning significant outright deflation. Read the rest of this entry »

We got a small flood of economic releases this morning and, not surprisingly, the picture remains very mixed.  

“May Housing Starts Rose 17.2%,” but…

“Industrial  Output At 11-Year Low“ 

The same article in Investors Business Daily informs us that capacity utilization has fallen to its lowest levels in the history of the data series, going back to 1967.   Read the rest of this entry »