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

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

We borrowed the title of this post from Mark Gongloff’s article in today’s Wall Street Journal.  Gongloff echoes our own thoughts here at HS Dent when he writes,

The good news: U.S. companies are gearing up for higher production.  The bad news: Output remains much lower than before the recession.

This is exactly what we’ve been talking about when we say that our economy is entering a “New Normal” equilibrium in which growth expectations have to be scaled back.  No, the world isn’t ending.  But no, it’s not going to be like it was before, either.

Gongloff reiterates something we’ve said throughout the past year:  consumers and companies are not borrowing; they are, in fact, paying off their prior borrowings and are adopting a more conservative approach to managing their financial affairs. The Financial Times reported today that consumer borrowing fell at an annualized rate of 10% in July.  Even when consumers might want to borrow, it has become difficult for them to find a bank willing to lend!

This deleveraging means slow growth and probably some degree of deflation.

So, to repeat:  Yes, the economy is getting better.  But our expectations for growth must be realistic going forward.

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 »

With all the talk of “green shoots” sprouting up in the world economy, it should be pointed out that the fight against deflation is far from over.  In the United States, there appears to be a mild lull in the storm.  But in Europe, the situation continues to worsen.  Consider the following Wall Street Journal headline:
“Irish Consumer Prices Slid 4.7% in May”

The Journal writes,

Ireland’s consumer-price index fell 4.7% in May from a year ago, by far the sharpest of price drops across Europe and the worst here since 1933…. Read the rest of this entry »