Structural Deflation- GI Joe with the Kung Fu Grip
November 1st 2010
The GDP numbers that were reported this week were not as bad as most think. Sure, at 2% GDP growth for Q3 (initial) we are not going to quickly put more people back to work. However, on a rolling 12 month basis the 2% added to the prior 3 quarters puts us at around 3.1% growth for the last 12 months.
Looking further into these GDP numbers we see a nice increase in consumption. Consumer spending added 1.8 percentage points to GDP this quarter, an improvement over last quarter. (http://bit.ly/aDecXC)
In fact, when you look at the last 3 recessions and recoveries, GDP growth coming out of this recession is similar to GDP growth coming out of the last three recessions. (Via University of Michigan Economist Mark J. Perry at http://mjperry.blogspot.com/)
All of these wonderful statistics aside, GDP is a clear look in the rear view mirror, while investing is about the future. As a wise investor once said (although I can’t remember his name), "you can't eat past performance."
So how does the future look from my perspective?
I see structural deflation continuing to put pressure on GDP growth.
When I can walk into a toy store and buy a G.I. Joe with the Kung Fu Grip at a 40% discount, and through efficient supply chain management another one will appear tomorrow on the shelf at the same or lower discount; you have a supply chain driven deflationary holding pattern.
When a business person walks away from his hotel he owns because of too much debt and the new buyer gets the property cheaper with less debt; they can lower prices and hope to increase demand. This is another structural deflationary challenge.
It’s everywhere, as it’s been built into our free market system. This structural deflation is not just a demand problem either; it's also a supply problem. Things are still too expensive and consumers are still too cheap. The consumer will win this battle at the expense of GDP growth and perhaps income growth, employment growth and real estate appreciation.
By the way, we have been living with this battle for over 10 years so it's not the recession it's the reality.
Structural deflation aside I also see tremendous gridlock in Washington DC. Unfortunately, I follow politics very carefully. My view is there will be little political compromise on tax policy and perhaps everyone will get stuck paying higher taxes with the expiration of the Bush Tax Cuts.
I do see some type of Equipment and Capital Purchases Tax Credit making its way through the political silly season. Encouraging more planned investment by business is another way to fix the GDP model.
I also see congress going along with a ‘roads and rails’ infrastructure allocation. It’s an easy example of how even though we hear all about the moralizations of no federal spending, congressmen are always looking to be reelected. To do this, they have to deliver something to their district. And as distasteful as this is, every politician is playing the game of "political chicken" and it's not hard to imagine our leaders going for more pork early in spite of what they say to our faces.
The Fed is going to jump in this week with their solution to the obvious policy gaps that are about to occur. They will offer up more asset purchase programs to attempt to ease the pain of the consumer and force more cash off the sidelines into riskier assets (BBB corporate bonds, equities and emerging markets). This will have a temporary and limited impact from my perspective. It's not really the supply of money, there is plenty of that. As I said earlier, it's the supply of goods and services and the demand from the consumer that is distorted.
However, I do see this distortion being corrected in Q4 and improving throughout next year. In fact, I can see GDP growth bettering the 2% we experienced in Q3, driven up by more consumption, better trade balances with a weaker dollar and depletion on corporate budgets for capital purchases. We might even reach 2.5% to 3% GDP growth if we get a quick win on the capital purchases tax credit.
While all of this occurs in the real economy there is plenty of opportunity in the capital markets economy.
My investment themes continue to be:
- Weak dollar opportunities-exporters
- Select technology - specifically business processing
- Media (Print that is adapting to on-line)
- Rare Earths (again see our Tweets on this)
- Emerging Markets Debt and Equity that is driven by US dollars finding better investment environments
- Mega Cap US companies that are finding great margins with little top line growth, especially exporters.
It may be a bit early but another theme would be around the roads and rails infrastructure opportunity.
Finally, my team spent some time at a meeting with noted investor billionaire Wilbur Ross. I have attached my staff's notes from that meeting (http://bit.ly/coDjT6). They are indeed interesting and not too far off from what I see.
Again follow us on Twitter as you will see me post my favorite research sources, comments from meetings with opinion leaders and other self declared interesting things.