FIRST QUARTER 2015

THE SMALLER PICTURE

 

  • GDP of .2% annualized, a long way from the expected 1% and the 2% the Fed needs to raise rates– in other words; no growth. Expectations are this will be adjusted downward as the first quarter trade deficit increased by 40%.
  • Corporate earnings – The high dollar makes U. S. goods more expensive abroad so profits were way down for international corporations.
  • No business investment – Companies are not investing in their own future or in the future business fabric of this country. Profits are instead being used to buy back their own stock which raises the price of the outstanding shares to enrich the CEOs whose compensation is in the form of stock options. The latest game is to buy their competition. Mergers and Acquisitions (M&A) increases their sales without actually growing their own company.
  • The consumer is not spending oil savings – oil rig count down by 50% – $25 Billion. Banks are cutting credit lines to energy companies and institutions like the Church of England are divesting fossil fuel holdings.
  • Exports down 13% – sharpest decline since the “great recession”.
  • Home sales and consumer spending – tepid.
  • Manufacturing and construction – hit the skids.
  • Decreased government spending – which contributes significantly to the overall GDP.
  • Inflation – for 34 straight months, the price index for personal consumption expenditures has been running blow the central banks 2% target.

 

Given this poor performance, it is unlikely Janet Yellen will raise rates soon, and perhaps not at all in 2015.

 

 

THE BIGGER PICTURE: THE BROKEN BUSINESS MODEL

 

This first quarter 2015 is just the latest installment of how the “borrow forever to grow forever” model is doing.   As you know, I attribute what ails our world economy to the fact that the business model that our corporate and political leaders and their economic advisors have been relying on over the last 30 years is broken. There will be periods of growth but they will not be sustainable.

 

 

World Awash in Too Much of Everything

 

A recent article in the Wall Street Journal by Josh Zumbrun and Carolyn Cui entitled, “World Awash in Too Much of Everything”, April 25th-26th, 2015, does an excellent job of cataloguing where the “produce as much as we can” model has gotten us.

Oversupply of Commodities

  • Crude oil inventories in the U. S. rose to 489 million barrels last week, an all-time high going back to 1982.
  • 110 million bales of cotton are estimated to be sitting idle at textile mills and warehouses, record high since the U. S. starting keeping records in 1973.
  • Total inventories of manufactured durable goods in the U. S. rose to $413 billion in February, the highest since 1992 when the Census Bureau began publishing data.
  • Chinese car dealers have the highest inventory of unsold cars in years.

 

What is happening here is that China, the largest source of demand for just about everything for the last two decades, is cooling off. They, like every other consumer and government, just can’t borrow any more money. This cooling off in demand caught producers off guard so they are stockpiling their goods or selling them at a reduced price which is causing deflation.

 

Oversupply of Labor

With the fall of the Soviet Union and the rise of China; one billion workers have been added to the worldwide labor force. This along with the elimination of jobs by technology has created a labor glut and driven wages down. Without wages people cannot be consumers. The Chinese Migrant Miracle, however, has come to an end. The cheap labor supply from rural China is exhausted.

 

Too Much Money

Global wealth has grown from $117 Trillion in 2000 to $263 Trillion today, more than double. There is too much savings. This keeps interest rates down because borrowers don’t have to pay a lot in interest to get investors to lend them money in the form of bonds or certificates of deposit, hence the low or negative interest rates.

As mentioned earlier, businesses are not investing in themselves so any profit they realize, unless paid out in dividends or used to buy back stock, gets saved and adds to the glut. Investor money continues to go into the stock market in search of high risk return.

 

Too Much Debt

In the U. S. since 2008, private and government debt has risen from $17 Trillion to $25 Trillion. European debt has gone from 180% to 204% of GDP and in China from 134% to 241%. If you remember in our last seminar we discussed the Keynesian solution to low growth; government spending. With this level of debt, governments are powerless to stimulate their economies through public spending without risking serious solvency problems. Stimulus is the Democrats tool of Choice. The Republican choice is to cut spending which is also not working here and the austerity policies in Europe have failed completely.

 

 

 

The Solution to Glut: Muddling Through or a New Business Model?

The current situation is being termed “secular stagnation”.   It’s a fancy way to say “the business model is broken”. In other words; low growth, low inflation, and low interest rates.

A letter to the Editor in the Financial Times on May 5th, 2015 sums up the situation;

“…the predicament faced by the advanced economies does not have quick fixes, and would require paradigms other than the traditional panaceas of economic growth and innovation if we are to overcome it.”

“…the new paradigm search is ongoing and it will take some time of trial and error if indeed some consensus does surface. Till then, alas, we will have to muddle through.”

The best and brightest are working on a better way to do things and the way out of the “More Stuff” model will have to include the word sustainability. Two current books offering innovative solutions are: “A Force for Good, Faith in Capitalism” by John Taft and “Age of Sustainable Development”, by respected economist Jeffrey Sachs.   (I will be providing you with a review of these two offerings in the near future.)

 

 

Our “Broken Model” Investment Strategy

 

 

While our political and economic leaders continue to believe in the policies of the past, we have to deal with the dangers and opportunities of the present and the probabilities of the future. I believe our current investment strategy is doing just that.

  1. Stock Dividends, Capital Appreciation, and Option Income.

If there is no demand there will be no upside to stocks other than the “wealth affect” created by the Federal Reserve’s money printing policy and the ‘forcing into risk’ affect of low interest rates.

Our covered call strategy through CWP will continue to capitalize on both of these artificial market movers as well as the dividends the stocks pay. The dividends and the income from the call contracts will act as a hedge against market pull backs resulting from the lack of any real growth in the economy.

 As you know, I do believe there will be another financial crisis since we have not corrected the causes of the past crash. With the DOW at 18,000, the market is in bubble territory by any historical reference.

See the May 4th Financial Times article by John Dizard entitled, “The Next Financial Crisis: I Told You So, and It Wasn’t My Fault“.

“There is a complete disconnect between party

politics and the financial world which is almost

numbly predicting impending disaster.”

 

For those who want or need to take risk the Covered Call Program mitigates some, but certainly not all, of the risk facing the stock market. Be sure to check your Quarterly Reports for your returns on this program.

 

  1. Interest income from bonds

The ends of paradigms or eras are always marked by instability as the old guard refuses to relinquish power and the new fights for control. This instability is our future and interest rates will reflect these struggles. I have positioned our interest rate sensitive investments (bonds and CD’s) to guard against turmoil by choosing only the highest quality paper and to maximize your return by keeping our maturities short in case rates rise.

The frustration with low rates should be tempered with the realization that with low or no inflation, touching on deflation, our real return is quite acceptable compared with inflationary times. A 2% real return today is equal to a 7% return during the 80’s and 90’s when inflation averaged 5%. What this means is that as we receive our interest and principal back from our bonds our purchasing power will not have eroded. In fact if rates have gone down, it has increased.

 The 10 year government bond in Japan and Germany is paying nearly zero and the 10 year U. S. bond pays 2%. We are doing better than that in shorter maturities and better quality.

 

We are keeping our “powder dry” for better times ahead while maximizing our current income. Remember, it is not necessarily the fittest that survive but the most adaptable. We are adapting.

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