Saturday, June 10, 2017

Recession or Depression

Are we headed for the "greatest stock crash ever?"  Maybe not.   Whoops, wrong Mr. Rogers!

The financial press is often full of bullshit.  People put articles up that generate clicks more than they tell truth.  And maybe, some of these "financial experts" make statements or write articles to influence markets and drive prices of stocks they already own - or shorted.   And recently there have been a lot of articles published with scare stories about the future.

Some recent articles note that consumer debt is at an all-time high, higher than even before the crash of 2008. Whether this is troubling or not depends upon your view.  It's been nearly a decade since that market collapse, and as you might expect, debt increases over time, if nothing else due to inflation.  Whenever you hear one of these stories that such-and-such an indicia is at "an all-time high" you have to ask first whether they are talking percentages, absolute dollar amounts, or dollar amounts adjusted for inflation.

Others, including myself have noted the decline in auto sales in recent months.  After a nearly decade-long streak of record sales, the market is finally slowing down.  And this may be less of a cause for alarm than a natural business cycle in the auto industry.  People tend to buy cars all at once, then demand is satiated for a number of years.  Their car turns into an old jalopy after several years, and they trade it in.   It is a cyclical business, historically.

Still others have noted the increase in defaults on subprime loans.  In the news today, an increase in the number of write-offs on bad credit card debt -  a steep increase compared to the last few years, supposedly.  But when you look at the overall trend, particularly the long view, it isn't so alarming.   Nothing even close to 2009.

Yet others predict utter gloom and doom, the worst depression in modern history and the entire world collapsing. For example "Legendary Investor" (who I never heard of) Jim Rogers predicts the worst market crash in his lifetime maybe coming in the next year or so.  It is hard to parse his comments, as he claims the entire United States is going to collapse which is why he is moved to Asia and his teaching his children Mandarin.  He advises investing in Russia and Japan, only one of those two countries probably being a good investment (hint: it's not Russia).  I am not sure advice from someone as wacky as that should be taken seriously.

Are we headed for a great depression or merely a recession? I think the latter and here's why.

First of all, as Mr. Rogers states correctly, our economic system is indeed cyclical. We have had nearly a decade of rising markets, low inflation, and decreasing unemployment.  It is only natural that the business cycle might take a turn at this point. Markets are always due for corrections, particularly when people buy ahead of a particular stock - which lately they have been doing.  The entire "Trump Bump" is based on the fantasy that new regulations and laws will make American businesses become wildly profitable overnight.   What American Businesses want is predictability not radical changes.  When it takes years to plan and develop a product, a sudden change in the business environment throws a wrench in the works - it does not make things easier.

So the market is buying ahead of itself, thinking that relaxing environmental standards on coal will produce a Republican paradise-on-earth.  But it won't - not unless we outlaw natural gas, first.   Similarly, car makers may find that state regulations for emissions are still in place, even if Trump relaxes federal standards.   So many states may sign on to California standards, that making high-pollutin' cars for Texas and Alabama markets may not be cost-effective.  It is not clear that enough will change and that these changes will be permanent enough for businesses to profit from them.   And it is not clear that environmental and other regulations have indeed harmed these businesses.  As I have noted before, regulations have a pro-business effect in that they act as a bar to newcomers in the business, restricting competition to those organizations large enough to absorb the cost of new regulations.   Barriers to entry keep out low-cost newcomers.  Ask any legacy airline about this and how deregulation ruined their party.

We are due for a correction,  And once again, as in the past, Tech will probably lead the way in this correction.  Companies with P/E ratios in the hundreds are certainly overvalued and will likely see corrective action in the not-too-distant future.  People - little people like you and me - are buying these stocks based on euphoria and hype.  But when a company pays no dividends and shows no real profits, eventually something has to adjust. This will make up a large portion of the financial correction.

And housing, in some selected markets, may slow down.  While some markets are skyrocketing in price, it is still cheaper (by a thin margin) to buy than rent even in those hot markets.  However, as more and more rental stock comes online, this trend may reverse somewhat.   But we are not seeing the ridiculous over-speculation that we saw in South Florida and Nevada back in 2005.   Back then, high-rise condos were being overbuilt with ridiculous prices and only "investors" buying them.

As I have noted before, in 2005, we saw one building in Pompano Beach (hardly a glamorous address) that listed a one-bedroom condo for $850,000 with a $3000-a-month condo fee, "designer ready" with bare concrete walls and stubbed-in piping and wiring.   You could rent a whole house nearby for half the monthly condo fee alone.  And let's not talk about the $10,000 property tax bill and $4000 in hurricane insurance.  When I saw this, I knew it was time to get out of the market.  And yes, that building went bankrupt.

While we are seeing steep prices in places like the Bay area, we are not seeing houses next door renting for a fraction of the monthly ownership cost.   Yes, housing is overheated, no, it ain't like 2005, not by a long shot.   Years of single-digit appreciation has brought up home prices.   But we haven't had the 20-30% annual appreciation that preceded the 1989 and 2009 meltdowns.

But you can see how a drop in the tech sector could spill over into a housing price drop in places like the Bay area, or Austin.  Overheated markets, overpaid people, companies with less-than-stellar P/E ratios, and a consumer market that is cyclical.   If there is no "must have" product in the next few years, what will Apple sell?   The smart phone market may end up being like the car market - people buy in a frenzy when the "next big thing!" comes out, and then when the mild upgrade is offered, they decide to skip a generation.   Why buy a new phone when your old one works just fine?   As more and more people drift away from "traditional" cell phone plans (which have built-in "upgrades" offered every few years - after you've paid hundreds a month in fees!) the impetus to buy the latest phone tends to drop off.

But what about the Fed?  What about unemployment?  What about the deficit?  The national debt?   These are all considerations, but I am not sure any one of them - or in combination - is going to destroy America just yet.   Fed policy doesn't seem radical at the moment, raising interest rates gradually.   It has not seemed to affect markets just yet, and years of near-zero rates had to end some time.

Low unemployment can be a mixed blessing.   As labor becomes scarce (and help-wanted signs are everywhere these days!) wages will eventually rise.   There is a time-delay between supply and demand, which is why economists wringing their hands over low labor rates need to just wait a few months, as the labor shortage gets worse.    Of course, since inflation is so low and stuff from China is so cheap, that is one reason labor rates are flat - we are effectively wealthier today even if wages are flat, as we can buy more shit with our smaller paychecks.

When wages go up - and they will - this will raise costs for many companies and cut into profit margins.   This can also lead to recession.  If companies raise prices to compensate, it could lead to stag-flation.   While this is a horrible thing to happen, we survived this in the 1970's and early 1980's.  These things go in cycles.

As for the deficit and the national debt, these are worrisome things, but again, I doubt we will default on these obligations, unless the Republicans really want to lose and lose big.  As a percentage of GDP it is at a very high 105% or so, but not nearly as high as the 140% during the war.   Bear in mind that during those years, every factory in the United States was running at capacity and our GDP was at its limit - and yet we still had more debt than we do today.  And yet we paid that back, over time.

We've dug ourselves out of worse debt-holes in the past!

For some reason, the doom-and-gloomers argue that this time around, we can't pay it back.  These same idiots claim that China will "Call our notes" and repossess the United States.  This is an argument that resonates with the lower working classes, as they are intimately familiar with how repossession and foreclosure work.   But anyone above that class (the Trump voter class) understands that if you own a T-Bill, or Note, you are not in a position to "call" your debt.  So the people making this argument are bullshitting, clearly, and you have to wonder what else they are bullshitting about as well.
This is not to say deficit spending and the national debt are good things.   And both parties have been promising to pay down this debt and reduce deficit spending through economic growth or new tax policies.  Whether this happens or not, remains to be seen.   It is heartening that the rate of increase in the national debt seems to be slowing down in recent years, however.

But what about underfunded pensions?  Social Security?   The retirement meltdown?   Also troubling things, but not enough to bankrupt a nation.   Baby boomers are dying off at a rapid clip, which is going to help this "problem".   For others, this means horrific personal outcomes, as their retirement pensions are slashed.   Social Security is solvent for at least another 20 years and even solvent beyond that (it will still pay benefits, just not at the current rates based on current tax payments - two things that can be adjusted in the next 20 years).  But a complete meltdown of the economy?   Not so sure about that.

Even during the dark days of 2009 when the stock market hit bottom, people still got out of bed every morning and went to work.  In fact, most of them did.   They still bought groceries and gasoline and new cars.  They bought houses (at foreclosure, if they were smart) and went about their business.   More people were working than not and even with "record" unemployment (which was far below actual records) the vast majority of people in the USA were doing just fine.  Within a year, most people's investment portfolios recovered - if they didn't panic and sell off their stocks and the nadir.   Companies continued to make products and thrive.   Even bankrupt companies emerged from bankruptcy and started over - or their assets were merged with other companies or liquidated and formed the basis of something new.

It is the cycle of life.  Grandma dies, a new baby is born.  It isn't tragedy, it is how things work.  So, yes, we can expect a recession.   We always can.   But to think the world is going to collapse because some wacky dude says so, I am not so sure.

Take advice from the financial press with a grain of salt!

After all, remember that Motley Fool predicted the "Great Sell-Off of 2011!" and it never happened.  But it did generate a lot of clicks!