Sunday, December 30, 2012

Too Much Gloom and Too Many Opportunities

There are two relatively standard question clichés about travel experience, “Are we there yet?” And, “are we rearranging the deck chairs on the Titanic?” As this post is being composed on Sunday afternoon, the 30th of December, we don’t know whether we are ‘there’ (a solution to the fiscal cliff) yet. We don’t know whether the political leaders in the US Senate can come to an agreement that the President and the majority of the members of both Houses of Congress can agree on prior to Tuesday. There is little reason not to be gloomy as to the result.  The gloom is not on the chances of an agreement, but rather on the probability that whatever agreement is made will not address the problem.

The problem is that the solution did not begin with the originator and popularizer of the term “fiscal cliff.” The Chairman of the Federal Reserve, a professor of economics from Princeton, was warning that monetary policy as controlled by him could not solve the shortage of domestic demand and that fiscal policies had to address the problem. His plea to the politicians was correct according to Stephen Roach’s latest letter, in the sense that experimental monetary policy has not worked in the US, Europe, or Japan. As I discussed in last week’s post, our economic problem is that we are suffering from a cyclical binge of too much debt combined with a multi-generational deficit.

The second question as to the rearrangement of the deck chairs on the Titanic actually may well be focused on a much bigger fundamental question. Often the deck chairs on the open decks of a cruise ship are assigned to various price classes for the voyage; the higher price tickets get the better seats, etc. In earlier days, epitomized by the Titanic, the crew and the management of the cruise line were more concerned about proper deck chair configurations than the absent life boat drills; actually there were too few life boats for the passengers and crew.

The current Presidents of the US and France want to redistribute the wealth among the passengers, akin to moving the chairs on the Titanic rather than paying attention to the life-saving needs for life boats and safety drills. Also like the Captain of the Titanic, the Presidents are not focusing on where they are going and having the best available communication equipment and personnel on board. History will determine whether the parallel is appropriate.

Staying with the ill-fated travel of the Titanic, one should point out that other ships made the crossing that night without running into an iceberg. Cruise ships have provided safe and pleasant travel to many thousands since then. The telling point is that with the correct management one can avoid some major, predictable crises. The key to that belief is the word predictable. One of my favorite Wall Street Journal columnists is Carl Bialik who writes interestingly and perceptively about statistics. In his latest column he writes about some of the pet peeves of professional statisticians. The first of Bialik's two pet peeves is that in too many cases, in the popular press and mindset, a single number is predicted without an accompanying statement as to the margin of error. The principal owner of the Titanic, his navigator, and single radio operator did not recognize a margin for error in their actions. Perhaps even more perceptively, Mr. Bialik mentions his second peeve, that the absence of evidence is not the same as the evidence of absence. (Those of us who live in New Jersey were victims of this misunderstanding when NJ Transit did not move its rolling stock to higher ground when the super-storm Sandy was approaching, for their preferred locations had never flooded. Because something hasn’t happened, doesn’t mean it can’t. The damage to the railcars will take hundreds of millions of dollars to repair and will interfere with commuter travel for many months.)

Many opportunities

I get out of bed in the morning, therefore I am an optimist. I believe that there are many opportunities offered to us every single day. Because of our own preoccupations, particularly about today’s problems, we don’t see the opportunities. In preparing for this blog, I saw information on three such opportunities.

Opportunity #1:  The growing middle class

The President of the US and his political cohorts are focusing on protecting middle class Americans from paying their share of the accumulated deficit. What he should be focused on is that there are already 500 million middle class Asians and it is expected by some to be over one billion middle class Asians in the foreseeable future, as mentioned by Kishore Mahbubani in the Financial Times. This is a  market that is currently crying out for the perceived quality of western brands. The US middle class can earn its way out of its share of the deep fiscal hole it is in by focusing on products/services marketed to this growing segment. Most of our investment portfolios recognize this opportunity by investing in multinationals and indigenous companies through selected mutual fund portfolios.

Opportunity # 2:  Net cash generation

Chip Dickson's daily letter from his firm Discern focused on US (registered) non-financial corporations that are in the longest period of sustained excess cash generation in history. I suspect that companies all over the world are awaiting similar investment opportunities. Most of the US corporate spare cash is being kept where it was earned, overseas. Often commentators blame the uncertainty of tax rates for the unwillingness to spend cash. This is not completely true. In the US, we have had changes in taxes about every two years. The retarding issue is that there is a lack of vibrant demand in the US. In the 19 quarters since the beginning of 2008, again quoting Stephen Roach, consumer spending adjusted for inflation, has been growing 0.7% per year, compared to a more normal 2-3% in the recent past, and over 4% in our halcyon days. Some of this decline is due to deleveraging by consumers, particularly in housing. These people are scared about their future and I suspect they sense the current anti-capital mood emanating from the Beltway. As shown by online buying, they want to spend wisely. The opportunity comes when they feel more confident and start spending. At that point, so will the corporations of the world.

Opportunity #3:  Technology helps

Exxon periodically produces an incisive look at the future for energy many years out. Not surprisingly, it sees growth in the demand for all elements of energy consumption and therefore production. Most of the growth relates back to the first opportunity listed (the growing middle class in Asia), but also in Latin America and Africa. What I found of interest is that this substantial growth will only be partially offset by an increase in energy efficiency. Exxon fully expects that improved technology will help produce, transmit and consume energy. This is another testimonial to the likelihood of growth in demand for technology. My guess is that in an aggregate sense, spending on technology will grow at close to double the rate of growth in the overall global economy. This growth rate is not fully discounted in many technology stock prices.

How are you going to handle the fiscal cliff, or more properly the fiscal slide or slope? Please share your thoughts.  

In last week’s post I compared the ratio of various nations’ debts to GDP.  Further in the paragraph, I referred to “Europe’s deficit as a unit.” I should have written “Europe’s debt as a unit.”

Ruth and I wish a happy, healthy and prosperous New Year to all members of this blog community.
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