Market Commentary: September 6, 2013
A collection of today's economic, market, political, geo-political, and human interest news, thoughts, and analysis.
In This Month’s Edition:
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Borrowing, Tapering, and Syria…Oh My!
The Tide Shifts
Creative Destruction
Sequester Is Working
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Some of Us Are Just More Equal
Random Thoughts
Critic’s Corner
Borrowing, Tapering, and Syria…Oh My!
Following a 4.4% August decline in the DJIA, September looms large. There is only one
month of the year where the average change in market values is negative…September
which is down 60% of the time. So far defying the odds, September is up over 2% in the
first five trading days of the month.
The normal drivers of the market as we head into the autumn months will be
employment, earnings, housing, and changing trends. Consumer confidence is rising as
we head into the ever important pre-holiday season. Inflation remains tame and GDP is
still positive albeit barely keeping its head above water.
A few other one off events will influence markets one way or another. Less than a year
ago, Europe’s economic future was all pegged to the outcome of this month's German
elections. Let’s see what happens. Emerging markets are stressed by rising interest rates
anticipating what our Federal Reserve will do. Is the U.S. economy really accelerating or
is it weakening? There are several issues that could cause a significant hiccup:
 Federal Borrowing Cap: We will again have to endure the partisan bickering as
Congress politicizes what has become a regular event where they have to raise
the debt ceiling in order to borrow more so they can spend more. This little
dance keeps inching us ever closer to what will, left unchecked, see the U.S.
become like Greece or Detroit or ancient Rome…take your pick. The right will
insist that any increase in the debt ceiling must be coupled with equivalent
decreases in spending. The problem with that stance is that it just makes too
much sense, so it will be doomed to failure under political pressures from the
left who just wants to spend and tax more and more. The closer we get to
reaching the debt ceiling (estimated to occur in early October) without a
resolution where the threat of a government shut down (which in reality isn’t a
shut down) becomes imminent, the markets will become more and more
nervous due to the possibility of entering unknown territory.
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Federal Reserve Tapering: We recently saw what the mere rumors of the Fed
tapering their monthly purchases of $85 billion in treasuries and mortgage
backed securities did to the market. Everyone knows that stimulus source cannot
go on forever and that tapering will occur. What the probable impact will be on
the markets is a bit of an unknown (hint: it’s not a positive impact). We just don’t
know when and to what degree. The hint of taper sent interest rates up. My
guess is that it will happen before Bernanke steps aside at the end of the year
and we get a new Fed Chairman. The odds on favorite to take the reigns is
former Secretary of the Treasury Lawrence Summers who is hawkish which
suggests not only a tapering, which Bernanke will try to get in front of, but also
the beginning of a rising fed funds rate to shortly follow. Neither of these things
will bring down the market in the long run, but can in the shorter term until we
see how the overall economy responds.
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Syria: Talk about a damned if you do, damned if you don’t scenario. The current
administration has painted itself into the corner of all corners. Just as there was
no doubt that Saddam Hussein used chemical weapons against his people, there
is no doubt that chemical weapons were deployed in Syria. There are doubts,
however, as to who actually released them…the rebels or the regime. Regardless
of what happens, the market will probably be pretty resilient. If Obama does
attack, just like the rest of the world, the market will not be surprised but will
temporarily pull back to make sure it is the short term action being advertised. If
we do nothing, our enemies will be emboldened and we will be weakened in the
eyes of our allies and the rest of the world. If we eventually cause the fall of the
Assad regime, the powers rising to fill the void may well be worse that what we
have now. If we arm the rebels, they are more than likely the future enemy that
will point those very weapons back at us. The markets will probably only pause
briefly in any event. In the theater of the absurd (Washington DC), the air is thick
with hypocrisy as many of those who supported the war in Iraq are speaking
against attacking Syria while many of those who vehemently decried attacking
Iraq now hawkishly support an attack. My head is spinning and the world is
watching.
I personally don’t see anything that by itself will be a game changer. However,
collectively the three issues outlined above could cause a significant but probably
healthy correction. So many unknowns, so much stress...the markets can take only so
much. Many are looking for this possible draw down as the next potential buying
opportunity in a market that is predicted by most to be higher in the next 12 – 18
months. While this seems to be the consensus opinion of the majority of economists
and strategists, the wealthiest investors may be signaling something else…read on.
The Tide Shifts
All of a sudden the warnings bells are ringing all over. Many who have expressed bullish
sentiment over the last year or so are now doing an about face…at least for the next
couple of months. It seems that many are choosing to step aside and get out of the way
of a correction that almost looks too predictable. Billionaires are selling stock holdings in
meaningful amounts. Let’s look at some recent examples:
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Warren Buffet recently drastically reduced his exposure to stock by selling 19
million shares of JNJ. He also sold 21% of his consumer products stocks and his
entire INTC position. He seems to be worried about consumer spending.
John Paulson's hedge fund recently sold 14 million shares of JPM and its entire
position in Family Dollar and Sara Lee.
George Soros recently sold all of his bank stocks including JPM, C, and GS.
While most will dramatically discount economist Robert Wiedemer's suggestion in his
best selling new book Aftershock that the markets could correct by as much as 90%,
many very wealthy people are reducing risk. While he admits that this is clearly a worst
case scenario, Wiedemer carefully presents an intelligent argument why once the
inflationary spiral begins; the pieces begin to fall into place that could cause a massive
correction.
What do I think? Well the structural problems and economic uncertainties are certainly
present that could result in another 50% draw down. However a 90% correction is sort
of end of world-ish. As we all know, the world can only end once and if it does, this part
of the deal won't really matter much. Thus we all have to plan that the world is likely to
continue and we have to protect ourselves as best we can while still giving assets a
realistic opportunity to grow.
Creative Destruction
Creative destruction is an often miss-used term in modern economic theory. In simple
terms, creative destruction defines the capitalistic process where economic
development occurs out of the destruction of some prior economic order. A negative
interpretation of this process assumes that it's a zero sum game where one can only
occur at the expense of the other. That assumption is of course silly.
Creative destruction can find its roots in the writings of Karl Marx; however modern free
market economists use it to define progress and not the evil narrative intended by Marx
and later economists who lean more towards socialism than capitalism.
In a free market, capitalistic society, creative destruction is by its very nature the result
of progress. In the business world, enhanced productivity is the implementation of more
efficient policies, procedures, and processes that replace less efficient ones. New and
better replaces old and outdated. Only in government do you continually layer new on
top of the old.
New industries have grown out of and eventually succumbed to the creative destruction
process. Let's look at a few examples:
 The introduction of electricity into our daily lives virtually eliminated the need
for candles that were a mainstay of daily life for hundreds and hundreds of
years. However, candles didn't go away. The industry went from supplying a
staple to offering a discretionary accessory for our daily lifestyle.
 The Pony Express and wagon trains were the primary way to send
correspondence in the old west. This was replaced by the railroad and telegraph.
Eventually, cross country mail was handled mostly by aircraft and trucking. Now,
electronic communication has rendered 'snail mail' virtually obsolete.
 In a few short years, the rapid growth of the automobile decimated the horse
and buggy industry serviced by blacksmiths across the country. Blacksmiths
evolved into service stations and mechanics. Buggies went into museums, and
the demand for horses plummeted.
 Almost overnight we watched as the entire photographic film industry was
displaced by digital cameras.
 The vast power of computers has displaced millions of manual jobs from
accounting to manufacturing yet ushered in millions of new jobs. In certain
industries, powerful unions prevented the adaptation of these advancements so
many, less efficient procedures (jobs) were preserved. We have all seen how well
that worked for the auto industry which has needed taxpayer funded bailout
after taxpayer funded bailout.
 Not too long ago you could find a payphone on every corner and in every retail
store or restaurant. When was the last time you even saw one...forget about use
one. How about land lines in your home. Most Millennials don't even have one
and those of us old fogies that still do employ cordless models. The old dial
phone attached to a wall by a cord has gone the way of the horse and buggy.
 The same is true for the ice man or the guy who delivered coal into your
basement. The only one still providing that kind of service these days is the mail
man who still goes door to door. The only reason he/she hasn't disappeared is
because it's a government controlled entity.
If it were left to the geniuses in Washington, we would still be reading by candlelight,
washing coal soot out of our clothes (by hand), and every car would have to come with a
buggy whip in addition to seatbelts.
Creative destruction and progress are synonymous. It is a necessary and vital part of
industrial and societal evolution. Are there any of the above examples of progress that
you would like to see reversed? Now let's take that thought a step further. During my
lifetime a certain ideologically leaning thought process suggests that we are suffering
unnecessarily as a country because we are sending jobs and businesses overseas. I
respectfully disagree. Jobs and industries moving overseas is part of a natural evolution
and lifecycle that has been repeated over and over again over the last 150 years.
The entrepreneurial spirit fostered by a free market capitalistic environment continues
spawn the creation and development of industry after industry resulting in
unprecedented wealth for millions of people. The maturing process includes the
introduction of efficiencies that improve productivity as the industries evolve. At some
point in each industry's lifecycle, the ability to continue to introduce difference making
productivity improvements reaches a point of diminishing returns.
At that point we see a tendency for those industries to be copied, adopted, or moved
overseas where they can take advantage of benefits like a less expensive labor force or
easier and cheaper access to raw materials. The American public benefits from lower
cost of goods and services and a cleansing process that leaves space for new ideas and
industries. This progress always includes elements of creative destruction.
Unfortunately, the need for politicians to turn anything that might enhance their status
into a political football leads many to demonize what is a natural and healthy process.
They rail against progress that would lead to many new, albeit it different, jobs for the
sake of preserving older, less efficient ways. This ultimately leads to higher cost of goods
for the average consumer. Again, look no further than what happened to the
automobile industry.
24/7 Wall Street recently published a piece that listed the top 10 fastest disappearing
jobs in America based on Bureau of Labor Statistics data for the ten year period from
May 2002 through May 2012. Some may surprise you. They are:
 Semiconductor processors (-51%)
 Prepress technicians (-54%)
 Word processors & typists (-54%)
 Textile knitting & weaving machine setters & operators (-57%)
 Computer operators (-59%)
 Brickmasons, stonemasons, tile & marble setters (-60%)
 Drilling & boring machine tool setters & operators (-60%)
 Plasters & stucco masons (-61%)
 Carpenter’s helpers (-63%)
 Advertising & promotions managers (-65%)
Much of this was do to the poor economic conditions we have seen in the period
studied, but certainly a significant portion can be attributed to ‘creative destruction’.
What are some current cutting edge developments that can lead to a new wave of
creative destruction? Goldman Sachs came up eight themes that can be industry game
changers or trends that are big and disruptive enough to lead to creative destruction
and opportunities for early adopter investors:
1. 3D Printing
2. Electronic Cigarettes
3. Cancer Immunotherapy
4. LED Lighting
5. Natural Gas Engine Technology
6. Software Defined Networking
7. Cloud Computing
8. Catastrophe Bonds - threatens the reinsurance industry
These are mega trends that will change behaviors and require the respective industry to
either "adapt or die." The evolution of this country from being dependent on foreign
sources of energy to becoming energy independent and even dominant will be a huge
game changer in the next generation. With thousands of years of cheap and plentiful
natural gas resources, the entire transportation industry and those industries linked to
transportation will have to 'adapt or die'. Easy access to petroleum will impact almost all
industries in one way or another...almost all for the better.
Forty three years ago on a sunny Boston morning in September of 1970 as a freshman at
Babson College, I witnessed a terrific but aging marketing professor walk into the first
day of class, stare at the young skulls full of mush in front of him, and introduced us to
marketing with the following statement. "You either move or you die." It was the irony
that this gentleman looked as if he were about to expire on the spot that made this
phrase stick with me all these years. The meaning, however, was clear and applies as
much, if not more, today as it did back then. Change must be embraced, not demonized.
Progress is a good thing and change is the byproduct. Old must make way for new.
Sequester Is Working
Sequestration was poorly constructed as no one thought it would ever happen. As part
of the Budget Control Act of 2011 that was designed to resolve the debt-ceiling crisis, a
bipartisan 'super-committee' was formed to come up with budget cuts of $1.2 trillion
over ten years to bring an out of control deficit in line. Sequestration was the automatic
budget cuts across the defense and discretionary portions of the federal budget that
would automatically kick in if Congress failed to come to an agreement on cuts.
Congress never got a chance to debate the issue because the super-duper committee
couldn't even come up with a workable plan amongst themselves. The cynic in me was
hardly surprised. I didn't believe for a minute that our elected leaders would be able to
come together and agree on a practical solution.
In reality, the $1.2 trillion of cuts would have been reductions in the projected increase
in spending and not spending cuts at all. Besides, how does one cut a budget that
doesn't even exist? The U.S. has been without a federal budget for 5 years ignoring the
fact that the constitution requires that one be passed each and every year. Again the
executive and legislative branches operate above the law.
To simply impose equal cuts in the increase of spending across the board is
irresponsible, yet that is exactly what has happened...50% comes from defense and the
remaining 50% from discretionary spending. Nothing comes from the biggest problem
areas of all...entitlements. Even though the cuts were indiscriminant, they have not
resulted in the disastrous outcomes predicted by all those opposed to spending cuts.
However, while it goes largely unreported in the mainstream media, the federal budget
is shrinking at a faster rate than those inside the beltway had projected. In an August
12th editorial, The Wall Street Journal's Stephen Moore reported that annual outlays
will fall below $3.45 trillion by the end of this fiscal year (Sept 30th). This will be the first
time that federal expenditures have fallen two years in a row since the end of the
Korean War. The $150 billion dollars in savings over the last two years began with the
tight spending caps established in the debt-ceiling negotiations between House Speaker
Boehner and President Obama in 2011 and includes $50 billion dollars from sequester
cuts in fiscal 2013. Has anyone noticed? Nope.
I believe that there is much more room for cutting that would also never be missed. If
those in charge of spending the dollars they confiscate from us actually focused on fraud
and waste, there is little doubt in my mind that we would be able to increase services,
cut taxes, and end up with a significant budget surplus as well.
We are seeing progress that will continue if our legislatures can resist the temptation to
tinker. If I believed for a minute that tinkering would further reduce spending, then I
would say tinker away. However, we all know that when the 535 members of Congress
start to figure out ways to work on our spending dilemma, we better all hide our
wallets...at least those of us who actually pay taxes.
As a percent of GDP, spending has fallen from nose bleed levels of 10.2% to what is
projected to be below 4% by 2014. As Moore stated in his piece, "At least for now, the
great Washington spending blitz of the Obama first term is over." He went on to say,
"...the fiscal story isn't all rosy. The major entitlements remain on autopilot and are
roaring toward insolvency." With Detroit's failure so recent, the city that once
foreshadowed economic prosperity by ushering in a new era of transportation now
foreshadows something very economically sinister.
While we have benefited from fiscal progress through the backdoor, we should not rest
on our laurels believing that all is well. The CBO reports that Social Security and
Medicaid are up $73 billion through July of this year. Food assistance programs have
doubled since 2009 with more people receiving aid than are actually employed full-time
in the private sector. These costs do not include the Affordable Care Act (Obamacare)
which projects to add over $1 trillion of new spending over the next decade.
So now we again approach a whole new nasty debate over the debt ceiling where both
parties will blame the other and predict catastrophes that will never occur as a result of
a potential government shutdown this fall. Let's hope that the eventual outcome from
the finger pointing, blame games, and fear mongering will be a more well thought out
approach to spending cuts that includes restructuring entitlements. Alas, I fear the
opposite will occur where sequester is suspended as part of a new debt ceiling
agreement, entitlements will not even be mentioned, and we move into more years of
Great Society government spending.
Some of Us Are Just More Equal
As touched on last month, in an Orwellian move Congress is exempting itself from The
Affordable Care Act (Obamacare). They will continue to get a 'Cadillac' plan. The body
whose primary responsibility is to ensure that laws are created to maintain the principle
of all men are created equal continues to make sure that they are not governed by
many of those same laws they impose upon us.
George Orwell's 1945 novel Animal Farm comes to mind. One of the main points of this
satire about the Russian Revolution addresses how corrupt leadership is a major flaw
that manifests itself in many ways. In the beginning, there were Seven Commandments
of Animalism where the most important of which was that "all animals are equal." As
the years went on, the animal characters began to look and act like humans and the
Seven Commandments were abridged to a single phrase "all animals are equal, but
some animals are just a little more equal than others." Apparently Congress continues
to believe that they have more rights/needs than the rest of us.
Random Thoughts
The Fed's balance sheet holds over $3.5 trillion collateralized by $55 billion in capital
which means they are levered 63 times. The 2008 credit collapse occurred because
financial institutions were levered up to 40 times and the markets moved the wrong
way on them and they failed. Of course they couldn't print money. Given that the
duration of the Fed's holdings is about 8 years, a 1% increase in interest rates would
wipe out the Fed's capital six times over. This doesn't give me a lot of warm fuzzies. Any
other entity would be considered insolvent at these levels.
Not being a big fan of the Justice Department which under every President becomes a
politically focused legal authority with an obvious agenda, the current justice
department makes previous ones look like amateurs by comparison. They ignore
obvious voting irregularities but insert themselves in a settled local murder verdict that
went against a politicized motive that didn't exist. Now they seem intent on blocking the
merger of two major companies that will prevent the failure of one. Too bad the
company didn't make automobiles instead of fly people around the country. They would
have likely received a bailout instead of a lawsuit. The cartoon below sort of says it all.
School is certainly different today. The first cartoon below addresses the evolution of
technology in education. It's the second one that is more concerning. Technology makes
learning more efficient, faster, and creative. It's the societal decay that ignores
responsibility and accountability while transferring blame that we should be very
worried about going forward. The second cartoon is symptomatic of society in general.
The impact on our economic system alone will change our nation's future path. Let's just
hope not irreparably. I went to public schools through 8th grade. My parents always
sided with the teacher and applauded the several occasions that the principal at my
junior high had me grab my ankles exposing a target for that elegantly honed paddle
that had several strategically drilled holes along its surface. There are still times when
the memory smarts, but I would happily thank him today for the solid message the
delivered discipline sent.
The fall of the Roman Empire is largely attributed to the following:
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Decline in morals and values
Public health issues caused by increased use of drugs and alcohol
Political corruption
Unemployment
Inflation
Urban decay
Inferior technology – government suppression of technological advances
Reduction in military spending
Sound familiar?
The Labor Participation Rate reached its lowest level since the 1970s. Fewer than 64%
of people in this country who are able to work are employed in any capacity, and yet the
official unemployment rate continues to slowly fall. Hmmmm!
I have always held in high regard those individuals who have served our country and
especially those who have given their lives to preserve our freedoms and way of life. I
recently came across a statistic that shocked me. If you had to guess how many
Americans are listed as missing in action (MIA), what would you guess? Find the answer
after the next section.
Critics Corner
As many of you know, Sue plays the cello in an adult string ensemble at DePaul University, so it
was only natural to surprise her for her birthday by taking her to see world renowned cellist Yo
Yo Ma and his Goat Rodeo Tour at Ravinia. Ending up at Ravinia was the first part of the surprise
which was followed finding a group of friends and family waiting and only then she found out it
was Yo Yo Ma performing. His interpretation of Appalachian bluegrass music was interesting and
entertaining, but most of the fun came from the close in entertainment around our lawn seats
bolstered by lots of food and wine.
We also attended two other musical performances over the last month both of which I entered
with modest expectations and left being impressed and pleasantly surprised. Each was a great
trip down memory lane. Collectively, we saw 11 performers from the 60s and 70s who had
amassed 46 top ten singles, over 100 gold and platinum records/albums, 5 Grammys, 1
Academy Award, 1 Golden Globe Award, and a male vocalist of the year award.
Being a product of the 60s, I am a living testament to the saying, "if you can remember the 60s,
you weren't really there." However, as I listened to these great songs from my teenage and
young adult years, many long forgotten memories escaped from the deep, inner resources of
my mind. Those voices had certainly lost their youth, but they were unmistakable. The band was
more like a garage band, but perfect for the era being rekindled before us. It was a little harder
to accept the several aging teeny boppers in the crowd who, while now in their 60s, still bopped
like rock stars.
We enjoyed performances from the following artists:
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Christopher Cross (Arthur's Theme, Ride Like The Wind, Sailing)
Orleans (Dance With Me, Still The One, Love Takes Time)
Gary Wright (Dream Weaver)
John Ford Coley (I'd Really Like to See You Tonight)
Robbie Dupree (Steal Away)
Player (Baby Come Back, This Time I'm In It For Love)
Mark Volman & Howard Kaylan (The Turtles: Happy Together, It Ain't Me Babe, You Baby)
Gary Puckett (Gary Puckett & The Union Gap: Lady Willpower, Young Girl)
Chuck Negron (Three Dog Night: One, Joy To the World, Easy To Be Hard, Eli's Coming)
Mark Lindsay (Paul Revere and The Raiders: Kicks, Hungry, I'm Not Your Stepping Stone)
Gary Lewis (Gary Lewis and the Playboys: This Diamond Ring, Green Grass, Sealed With A Kiss)
As we listened to these classics from the rock and roll era, the words of Howard Kaylan
resonated when he asked between songs, “What have they done to our music?” You aging
music lovers from the 60s and 70s will know exactly what he meant. Look no further than the
raunchy lyrics and choreography displayed at the recent MTV Awards to fully understand his
lament.
The answer to the MIA question on the previous page is 90,000. I presume this is since we
fought for our independence, but the number is still notable…90,000 Americans who were not
brought home. This has left hundreds of thousands of friends and family to always wonder and
move on without closure. We offer a special thanks to those missing and their families for the
sacrifices made on our behalf.
Have a great month.
Respectfully, Bruce
Bruce Anderson, Managing Partner
South Georgia Capital, LLC
2135 City Gate Lane, SUITE 460
Naperville, IL 60563
630-447-2760
bruce@southgeorgiacapital.com
www.southgeorgiacapital.com
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