Thursday, February 25, 2010

Someday We’re Going to Party Like It’s 1995

“I was dreamin’ when I wrote this, forgive me if it goes astray”

Everyone is asking the same question: When will things get back to normal? I think the more important question is: What is normal? We tend to want to define normal as the conditions that existed before The Great Recession hit.

But 2007 was far from normal. We had an economy fueled by an artificially stimulated housing market and out of control conspicuous consumption. This was funded by large financial entities taking extreme risks and consumers running up unreasonable levels of debt. This was very abnormal. We would like it to be normal because times were so good, but it was far from normal.

The rest of the aughts (00’s) were not normal either. The beginning of the decade featured a recession caused by the dot com bust and after that came the run up of the housing bubble. The 2001 recession turned out to be mild because we had two bubbles going at once. The dot com bubble burst, but the growing housing bubble kept consumer spending propped up.

The period of 1996-2000 was not normal. This was the run up of the dot com bubble and the beginning of the housing bubble. In addition, Robert Rubin (Treasury Secretary under Bill Clinton) figured out that you could have strong economic growth with low inflation by importing cheap goods from China. This strategy resulted in an erosion of the manufacturing base and created high trade deficits, but it resulted in an increase in the standard of living, so it was deemed to be good. We tend to enjoy abnormal, as long as it provides positive outcomes.

Many charts of economic and consumer trends start to make an unusual accent around the 1994-1996 time period, so I am deeming 1995 as the last year of “normalcy”. This is significant because it was so long ago. If you are under 40 years of age, you have no concept of “normal” because you didn’t have enough business experience at the time to understand it. If you are older than 40, you may just have trouble remembering that far back.

I can’t tell you when we will get there, but here is what I expect the “new normal” to look like:

Interest Rates: The current prime rate is 3.25%. It was 8.5% in 1995. Interest rates may spike due to inflation but should eventually return to levels resembling 1995. Mortgage rates were around 10% in 1995. Banks will return to the more tradition ways of making money. No more wild speculation, they will have to earrrrrrn it.

Inflation: Inflation may also jump in the short term as the Fed has a big challenge ahead. It has to try to put the brakes on the monetary stimulus by pulling money out of the system (let’s hope the Fed isn’t driving a Toyota!). Inflation was only 2.8% in 1995 and 2.7% in 2009, but now you have too much money in the economy and too much debt. The Fed will eventually stabilize the inflation between 3.5%-5.0%.

Home Ownership: Home ownership peaked at 69% in 2007. It was 64% in 1995. We don’t know how far this will drop before housing stabilizes. Ultimately, the 64% rate seems reasonable. Demand for housing will be impacted by the higher interest rates and lower ownership percentages.

Savings Rate: The savings rate was 1% in 2008. Some economists predict it will hit 8%. The 1995 rate was 6%. After the smoke clears and people become more confident, look for the savings rate to settle in around 4%-5%.

Imports/Exports: Imports from China were $268 million in 2008 versus $33 million in 1995. Of course we can never get back to 1995. However we have to implement fair trade practices and programs that increase exports and decrease imports. Trade balances have to even out in the long run and we have been on an import binge for over 15 years.

Taxes: We have created a huge federal debt due to reckless spending. Taxes may need to be increased to pay for all the bubbles and excesses of the past 15 years (you know what they say about paybacks). Expect a value-added tax to reduce the debt. This could even work if the tax has an end date and the money is used for debt reduction only (and you trust the politicians to do this, right?). Also expect an increase in the gasoline tax as the government attempts to squeeze every nickel it can out of people without raising income taxes.

Unemployment: Unemployment was between 5.6%-6.1% in 1995, it is around 10% now. We sacrificed some jobs by importing too many goods. We sacrificed more jobs due to consolidation. While mergers increase efficiencies, at some point you stifle competition and create “too big to fail” banks.

Under these conditions, it will take time to bring down the unemployment rate. A new, intelligent, job creating strategy is needed. Perhaps we can go back to the old days when the country relied on its advantages in innovation and education to provide economic growth. Without a new strategy, it may be difficult to get unemployment under 7%.

Consumer Spending: The rate of growth will decline due to a myriad of factors including, increase savings rate, higher interest rates, higher unemployment, higher taxes, and higher inflation.

GDP: Is very difficult to predict GDP as we pull out of this recession under very abnormal circumstances. Maybe 2%-3% average GDP growth is all we can expect for a few years based on all the factors listed above.

Two thousand zero eight party over
Ooops, stop this jive
Someday we gonna party like it’s 1995

Thursday, February 11, 2010

Come Together – Right Now ….

Previous posts have discussed the government’s inability to deal with our current economic problems. While libertarians will argue the government should stay out of the process, others will say the severity of the situation dictates federal action.

I believe government has some responsibility to improve things since it was partially responsible for the financial crisis. Government is supposed to act in a security function to prevent overzealous capitalists from greedy exploitation. In this case, our guards resembled Barney Fife (one bullet, so many crooks) and Sergeant Schultz (who could easily be bribed by chocolate bars).

With unemployment near 10% and the economy just starting to heal after the worst recession in over 60 years, we need our best and brightest people in Washington working closely together as a team to develop the solutions that will lead us out of this mess and into prosperity. This is what we need, but it is not what we’re getting. Here are some reasons why:

1. Economic Problems – Political Solutions

Politicians are experts at getting re-elected, not solving economic problems. They apply politically based solutions when faced with any issue. The health care reform bill wasn’t even finalized and there were already three deals made to essentially “buy” votes. Do you really think the deal making regarding health care was going to end when the bill was passed? It was only the beginning.

It is great when the business networks interview small business owners and get their opinions on the impact of various government proposals (healthcare, jobs, cap and trade, etc). These people are very intelligent because have to understand all facets of their business and are also close enough to their employees to understand the concerns of the average worker.

It would be more productive to have 20 small business owners get together and write legislation that impacted commerce. Then have the politicians vote on the bills without the endless political posturing and deal making.

2. No Teamwork

We are facing the biggest economic crisis of our time and fighting two wars and our political parties are fighting each other. This is insane. We don’t want the Democrats to get together and develop a “Democrat Plan” and we don’t want the Republicans to form a “Republican Plan”. Just get together, develop the best solution available, and then vote based on what is best for the people without regard to party loyalty and lobbyists.

Sometimes good ideas are rejected because the “other party” came up with them first. This reminds me of my difficulties of counseling my mother. She will reject any solution I come up with just because it came from me (remember,if someone has powdered your butt, they won’t take your advice).

There needs to be an attitude adjustment soon. Our politicians often resemble junior high brats rather than educated adults. When you have old ladies attending tea parties in the streets instead of in the parlors, there is something seriously wrong.

3. Limited Political Debate – Unlimited Name Calling

Calling your opponents names is not a substitute for political debate. It would help if we could actually have televised debates on some issues with skilled, objective, moderators forcing participants to give real answers.

The political commentators are not helping this process. As the political conflict intensifies, advocates from both sides are intensifying the rhetoric and making more inflammatory comments. It helps their ratings, but it may prevent productive debate.

It would also help if reports of good economic news were not immediately disparaged by some commentators for partisan purposes. This also goes for causing unnecessary fear about “what could happen”. Remember, there is a psychological element involved in recovering from a recession and scaring people doesn’t help the process.

4. Keep it Simple

The healthcare bill was much too long and complex and tried to do too many things at the same time. Doesn’t it make more sense to just focus on reducing healthcare costs first? If you are successful at lowering costs, you improve things for the vast majority of people and businesses. By driving down the costs, you give more people access to affordable insurance and it becomes much easier to devise a plan to help the rest.

And regardless of your opinion of the healthcare reform bill, the problems still remain and need to be addressed soon. I agree with the president, something needs to be done and the status quo is not acceptable. But it needs to be the right thing. Maybe a team of small business owners working with the stakeholders in the healthcare industry could come up with a plan.

“One thing I can tell you is you got to be free.
Come together, right now …”

Thursday, February 4, 2010

Taking Inventory

Warehouse workers Roy and Jim had just finished unloading and storing their first large product delivery in months. Roy looked at the shelves and said, “Wow, I can remember just a couple years ago when every shelf was packed full of goods. We even had to buy more shelving units to hold it all. But now, there are as many empty shelves as full ones.”

“That might by so,” said Jim. “But just last month we hardly had any product in here and now look at this place!”

And thus the rest of the day was devoted to debating that eternal inventory question: Is the warehouse half-empty or half-full?

There is much debate about initial Q4, 2009 GDP coming in at 5.7%. Most of this growth was due to companies replenishing their inventories after drawing them way down during the depths of the recession. The optimists see the 5.7% as a strong sign of economic recovery. The pessimists complain that the 2% “underlying growth” rate (after the inventory factor is eliminated) is weak.

It is silly to argue about this. While the growth rate of 5.7% is not sustainable, businesses were confident enough to order more goods. Now there is more inventory available in anticipation of increased future sales, and that is a good thing.

Checking the Commercial Transportation Industry

Because the commercial transportation industry is a microcosm of the general economy and the source for most of the factors that make up the Model “T”, it is a good time to check on what is happening in this sector.

▶ Truck freight improved in Q4, 2009. All of the freight indexes showed gains, although the growth was “choppy” and the increases small.

▶ Rail freight last week was up 3.9% from 2009, but still down 11% from 2008. Most categories of freight were up except for some materials used in new construction. Rail freight has been improving, but also has seen month to month variation.

▶ Spot freight (this is the equivalent of the demand for temporary workers in the employment market) was up 11% in December (third straight y/y gain) and was much improved from last year.

▶ Several large trucking fleets returned to profitability in Q4 due to cost cutting, improved productivity, and improved freight demand. Many mid-sized and small fleets are still losing money and some long-time haulers have closed their doors.

▶ Over 80,000 truck drivers remain unemployed. November payrolls were only down 0.2%. Fleets are only operating at around 75% of capacity, but utilization has increased four straight months. Fleets are expected to start hiring back some drivers in Q1.

▶ Freight Transportation Research says that truck freight has bottomed out and will return to sustained, modest, growth beginning in Q2. It predicts 3.6% freight growth for 2010.

▶ There is an excessive amount of trucks and trailers (and rail cars) sitting idle. In addition, used truck and trailer inventory remains bloated. This “slack” will severely limit new truck and trailer sales in 2010. On the other hand, ACT Research reports that new trailer inventory is at a four-year low.

What it Means: It is very good news that demand for “spot” freight is growing. Freight has bottomed out and is on its way back, but it won’t be a large gain in 2010. It appears that most industries are now recovering, except for the housing market. This would make it an economic recovery without growth in the housing market. This is similar to having a circus without clowns and animals. It’s not much of a circus and initially it won’t be much of a recovery. Oh I forgot, this recovery does have its clowns. They just aren’t very funny.

Taking Inventory

The latest data shows the Business Inventory-to-Sales Ratio at 1.28 which is back to the “normal” range. Wholesale inventories are also stabilizing. The data from the purchasing managers index shows that inventories are still tightening, but very slowly and that customer inventories are very low. The American Trucking Association says that bloated inventory levels are no longer a drag on trucking. Therefore it appears that inventories have been brought back into line with current sales levels. If we could get an increase in consumer demand, it would cause a positive ripple effect throughout the supply chain.

The Model “T” Update

Now that the transportation market is stabilizing, the timing element of the Model “T” becomes clearer. The model now predicts a bottom in the S & P 500 occurring in September-October (let’s not be concerned about where that bottom is right now). The stock market would then begin to climb very early in 2011.

From My E-mail Box: The economy is so bad that if the bank returns your check marked "Insufficient Funds," you call them and ask if they meant you or them.