Agora Financial’s Rude Awakening

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Baltimore, Maryland

• Houses go down while food and energy go up – what to do?
• When size does matter…but bigger isn’t better,
• The new craze of austerity (all the cool kids are doing it) and more…

Joel Bowman, reporting from Dubai in the Persian Gulf…

“Holy big building!” exclaimed our mate yesterday as we past the Burj Dubai – the world’s tallest manmade structure.

“Well, it’s not what they call a holy building per se…but yes, it is certainly big,” we replied. 

“Man, this is a total spinout after coming from Nepal,” our friend observed. “Everything is just so…so big!”

It’s true, there are lots of big things here in the City of Gold; big buildings, big cars, big shopping malls, big inflation figures. But even small towns have big things. In Pokhara, Nepal, for example, they have big mountains and people with big smiles. Across in China they have big GDP figures, big problems with pollution and big holdings of American debt. And, back in the capital of the Empire, they have big statues of the Founding Fathers who warned against big debt, big wars and big government.

Bigger, you see, is not always better.

“The future in a single word: downsizing,” Bill Bonner recently remarked in the Daily Reckoning. “Downsizing is going to be popular, hip, cool, fashionable and sensible. People are going to be proud of their small houses…their small cars…their low-impact vacations…and their modest spending.”

Chris Hancock takes a look at the downsizing trend in today’s column. Read on below and send any remarks to us here at aussiejoel@the-rude-awakening.com

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The Next Big Thing
By Christopher Hancock

The “next big thing” our friends at The Daily Reckoning recently predicted, “will be downsizing, cutting back, making do. Barely on the radar screen now, thrift is coming into focus more clearly day by day. So far, people are a bit embarrassed about it…a bit ashamed that they have had to cut back. But soon, it will be popular…fashionable…and, finally, almost obligatory.”

This new austerity craze – if/as/when it arrives – will impose hardships on manyAmerican companies. But a select few might actually benefit.

The cause(s) of downsizing are pretty clear. Home values are falling so sharply that very few homeowners can still pull equity out of their houses. Stock prices are also drifting lower, more or less. Meanwhile, inflation is ramping up.

Prices are rising in Europe as in America. Bread is up 12% in Germany over the last 12 months. Butter has gone up 45%. Milk, 25%.

Higher prices often stem from printing more dollars. “Force-feeding the rest of the world $2 billion per day (more consumption),” Warren Buffett reminded us last week, “is inconsistent with a stable dollar (more inflation).”

We share Mr. Buffett’s concern. Bernanke keeps printing. Politicians keep promising. Bridges keep crumbling. Wars keep spending.

With regret, we read last week that the projected total cost of medical care for U.S. veterans of the Iraq and Afghanistan wars will top $500 billion, a figure on par with the total military spending to wage these wars to date.And speaking of military might, Defense Secretary Robert Gates estimated in testimony before the Senate Armed Services Committee that the Pentagon will spend upward of $685 billion next year alone. That’s $170 billion more than the $515 billion the president proposed in his first-ever $3 trillion budget.

If that weren’t enough, Gates doesn’t even expect that number to stick. “I have no confidence in that figure,” he admitted. You can expect the estimate to rise in the near future.

A hundred billion here…a hundred billion there. Who’s counting?

Apparently, no one.

But that’s not to say the S&P can’t weather the storm. The companies representing the Standard & Poor’s 500 index now derive 49% of revenue from foreign markets, up from 30% in 2001. Meaning, those with money to burn (Southeast Asian consumers) should keep earnings reports strong. Stronger repatriated currencies should only bolster this trend.

Unfortunately, many Americans believe a strong S&P equals a strong American economy. We tend to see another American economy. We see an economy riddled with debt, more debt and even more debt. We see the American consumer eerily close to tapping out. Thirty-four percent of Americans now believe they are among the “have-nots.”

It serves to reason. More than 405,000 homeowners lost their homes to foreclosure last year.

Most middle-income Americans, the ones driving our buy-now, pay-later economy, have spent well beyond their means. Americans currently perpetuate a negative savings rate. That can’t last forever.

Cheap oil and cheap credit have fueled this era of consumption…this gilded age of instant gratification.

But the days of ultra-cheap oil are firmly behind us. The U.S. government began pricing oil at $225 per barrel in the not-too-distant future, says ouroilman Byron King. The U.S. Navy, for example, is currently designing future ships using $225 per barrel as a baseline for the price of fossil fuel. The days of ultra-cheap credit look to be waning, as well.

The endgame: Americans will be forced to consume less and less. It seems to us that cutbacks are the only option.

So investors should be very cautious on stocks reliant on American consumers. We suggest you take special note to exercise caution regarding companies like Apple Computer, Starbucks or P.F. Chang’s China.

We have no particular prejudice against any particular one of those companies. In fact, we could have easily picked three different businesses.

Simply put, if John Q. Public lost his house and credit card, we imagine he’d use his last $20 to buy toilet paper, Folgers and a pack of smokeswell before he made another dinner reservation on his 2008 iMac while sipping a $3 cup of joe. Furthermore, these companies aren’t cheap.

As for what to buy, ask yourself: Can a company raise prices?

Think of things you need. Beer and cigarettes come to mind. Well, you may not need these items, but I’ll use them to illustrate a point.

When’s the last time you actually looked at the price of one beer versus another? I’m not talking Heineken versus Pabst Blue Ribbon, mind you. I’m talking about Heineken versus Corona…or Bud Light versus Miller Lite. Customers in this sector buy on preference. And they buy a few more cases when the price is cheap.

One could make the same case for shampoo and bandages. The point: When times are tight, we’ll still continue (hopefully) washing our hair and staunching our wounds.

You also want to ask yourself: Can a business control its basic costs? When 1.2 billion Chinese start demanding a protein diet, can P.F. Chang’s easily pass on its input costs (higher meat prices) to a cash-strapped consumer? Will margins suffer?

You get the idea. So for those readers obdurately loyal to the American economy, we believe the best American equities right now are top-quality blue chip stocks that provide staples to the American and foreign consumer. Stocks like Exxon, Johnson & Johnson and the Altria Group come to mind.

We’re not recommending these businesses. We’re only using their names to make a point: Downsizing is the next big thing.

[Joel's Note: If you’re concerned that your eroding dollars are not the best vehicle to store your savings, perhaps you ought to be looking to other free markets to invest in. Chris Hancock has just enlightened readers of his Free Market Investor to a $2.5 trillion “wealth recovery fund” he reckons can help save your retirement. Interested? Read on here. 

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[Joel's Note: In the interest of keeping up with the new fashion of downsizing, we’ll cut today’s rude off here.

Until tomorrow…

Cheers,

Joel Bowman
Rude Awakening