3rd Quarter 2009 Market Update
By Jason Tillberg October 1, 2009
Stock markets around the world roared up in the third quarter amidst economic data that did not justify such a rally. As such, risks remain very high in nearly all asset classes, including the U.S. dollar. Tillberg Capital will continue to manage risk as rationally as possible. This market update provides some of the research and ideas that are the basis of my investment decisons.
The Macro Perspective
Based on my research earlier, two important peaks would occur between 2008 and 2009: the Tech Boom and then the Spending Boom. After these peaks, the economy would slow for a long period of time and potentially enter another great depression. These peaks have occured. The Tech Boom peaked when 90% of households had internet and cell phones, which was in 2008 as demonstrated in the chart below. The chart shows the year over year percentage change in e-commerce retail sales. This should make for a fair representation of the peak in household internet market saturation.
The high double digit rates of growth from the tech sector have likely come to an end. As the internet has reached full market penetration, e-commerce sales is already declining along with the rest of the retail sales.
The reason this trend is relevant and important is because part of the boom of the 90's and 2000's was driven by great investment and innovation in cell phone and internet technologies. The years ahead should prove to be more difficult for the technology sector. NOTE: In my opinion, the current valuations of many technology stocks appear very overvalued and are not reflecting this reality.
The second peak is largely driven by baby boomers aging beyond their peak spending years (46 - 48). The consumer is some 70% of the U.S. economy. Consumer spending is very important to our economy.
Over the last 30 years, Americans have dramatically slowed their saving. Sometimes it takes a crisis like we just had to remind them of the importance of saving. Below is a chart showing the savings rate over the last 50 years.
As Americans save a bigger percentage of their disposable income, less money is spent in the economy. The restaurant industry is an example of where Americans spend their extra discretionary income. The current recession has caused Americans to change their spending habits. The Association’s Restaurant Performance Index (RPI) shown below is a monthly composite index that tracks the health of and outlook for the U.S. restaurant industry. The index has been contracting now for 24 months in a row and is already double dipping.
The reasearch about these peaks has been justified by the data. I will say though, that knowing this slowdown would come has not been as helpful as I had hoped in making investment decisions. The investment environment has been more complex and has gone to further extremes than I could have imagined.
Similiarly, the $8,000 house credit that is due to expire on November 30th will pre-sell homes to first time home buyers. After the program ends, I expect that house sales will drop off dramatically as well.
The slowdown in consumer spending is not a short term trend. This is a long term trend; we will have 10 to 15 years of saving more and spending less. Any growth in the economy will likely be anemic.
The Housing Crisis - It's not over
House prices are rising again. The Fed has succeeded in bringing mortgage rates down and the banks have succeeded in keeping the glut of foreclosed homes off the market for now. These actions have prevented the spiraling free fall of house prices from continuing for now.
Below is a chart of the year over year % change in overall retail sales (excluding food services).
To help lower borrowing costs for home owners, the Fed set the goal of buying up to $1.25 trillion of agency MBS, $300 billion of Treasuries, and $200 billion of agency debt in 2009.
The Fed's purchases have helped lower mortgage rates, and thus halted the natural decline in house prices from the artifical highs of recent years. In my opinion, the recent increase in house prices shown in the chart below will look like a tiny ski jump when we look back in a year or so from now. I expect further declines in home prices going foward, with a bottom ocurring between 2012 and 2015.
The U.S. Monetary System
There used to be a time in America where gold and silver were equivalent to money. You could find a golden nugget in your back yard, take it to the U.S. Mint and have it converted into coined money. You could then buy something with that coin and it would be put into circulation.
Since the introduction of the Federal Reserve in 1913, that system of using gold and silver as money ended. The U.S. converted to a debt based money system. What's a debt based money system? It's a system where all the money is debt. When the Federal Reserve prints paper money, called Federal Reserve Notes (examine your dollar bills), and uses them to exchange for Treasurys, and recently for mortgages and other forms of debt, that money they printed gets pumped into the economy through government spending or new bank lending.
The problem with this system of money is that there is compounding interest on all that debt, which grows larger and larger every day until it becomes impossible to pay off. This is why we have inflation and why the dollar has lost 95% of it's value since the introduction of the Federal Reserve system.
For example, when there is $1 trillion in money (i.e. debt outstanding) with an interest of 4%, the repayment in 1 year is $1.04 trillion. Well, where does the extra $0.04 trillion come from? One option is from newly created debt. We create money in America by creating new debt. And over the course of several decades, we have created a lot of new debt.
As the chart below will show, only the Federal Government is creating new money via debt now and that is the life blood of the American economy right now.
This chart from the NY Times speaks very loudly about the state of our debt levels.
It always baffles me when pundits say that there is "all this money on the sidelines waiting to be invested in the stock market." There is only about $3.4 trillion in money market funds now and that is only a fraction of the household debt outstanding ($13.7 Trillion).
When a decrease in money or debt occurs, it's deflationary. Deflation is bad. There was a lot of deflation in the Great Depression and there has been deflation in Japan for the past 20 years. Currently, deflation is running at -1.48%.
There is less money flowing in the economy now. Americans are scrambling for money to pay bills or pay off debts. Because the lack of "credit growth" or "new money" being created to pay off that ever increasing debt that is growing day by day with interest, the ability to pay off that debt becomes impossible and default is necessary. This includes not only individuals on their mortages or credit card debts but businesses with lots of debt as well.
Unless we expand our money supply by going deeper into debt as a nation, we'll go bankrupt. Our Vice President knows this and said it back in July. I hate to bring this to you out of context, but he's right in what he says.
The fear of massive defaults and bankrupcies was very high in the beginning of this year. Any company with a lot of debt saw its shareprice fall to multi year lows as it seemed the liklihood of bankruptcy became quite high.
This fear seems to have gone away for now to my surprise.
As the recent credit growth data suggests, the ability to get dollars is becoming more difficult each and every month. It's getting harder to get a job or a loan as well.
The question remains on how much strain this is going to put on the banking system. The FDIC is now broke and is currently working on way to shore up its funds. Another banking crisis is coming. I don't know when, but I feel 99% sure it's coming.
To conclude, my short term outlook, similar to my outlook last quarter, is that this recent stock market rally is and was nothing but a relief rally fueled with the help of massive amount of money from the Fed to help prop up house prices, bonds and stocks.
Disclosure: This newsletter is not a means to solicit any of the securities mentioned nor does it recommend it for any person before they speak with a licensed professional investment advisor for their own suitability. Investing in Equities bears risk of capital loss. This newsletter is strictly the opinion of Jason Tillberg, President and founder of Tillberg Capital Management, Inc. and shall not be held responsible for investment loss from this newsletter.
Special Government Programs - Are they helping?
I'd like to highlight auto sales. The cash for clunkers program in the summer enticed people to trade in their old gas guzzling cars for more efficient, new cars. This program helped to increase car sales, and was considered a huge success. I disagreed. All it did was pre-sell cars that would have been bought anyway. Below is the chart showing monthly car sales up to September 2009 and proves my thinking correct. September car sales will prove very weak.
