Showing posts with label devils advocate. Show all posts
Showing posts with label devils advocate. Show all posts

Wednesday, April 22, 2009

The Hyperinflation Scam

There is a lot of skepticism about the plans of the Federal Government and the FED to defrost the credit markets through its many stimulus plans. One of the biggest fears for some investors is that pumping too much money in the system would lead to hyperinflation and a complete devaluation of the US dollar against hard assets such as gold, oil, land and others, which would eventually lead to everyone living in caves hunting for food. There are even several ETF tracking Gold (GLD, IAU) and Crude Oil (USO, OIL).

I disagree with those fears. First of all I do expect average inflation of 3% annually for the next 3-4 decades to continue. The best way to hedge against that is to buy common stocks, which are not just pieces of paper, but rights to ownership of real businesses which would be able to pass any price increases on to their consumers. At the same time these businesses would share a portion of their profits with shareholders, by paying out dividends. Over the past 80 years dividend growth in the Dow Jones Industrials Index has more than compensated for the eroding forces of inflation. Dividend Growth for the 1920-2005 period was 4.9%, which was almost 2% higher than the 3% average inflation rate. The best ETF to track Dow Jones Index is Dow Jones Diamonds (DIA).

Over the past few decades the wealth of US households has been primarily comprised of Real Estate, stocks and fixed income. The real estate has been the primary residence of families; stock ownership was through owning mutual funds or owning stocks directly, while the fixed income portion consisted of deposits, bonds and cash on hand. As the value of stocks and real estate rose steadily, consumers felt richer and spent more, which in turn stimulated the economy. The past 2 years however have brought low stock prices, and declining real estate values.

According to some estimates, the total amount of stock market losses is estimated at 8 trillion dollars. No wonder many investors simply throw away their quarterly brokerage statements these days – their passive investments have plunged significantly in value.
On the other hand, the housing bubble has eroded a total of 6 trillion in homeowners equity in the US.

To summarize:

Money lost in the stock market: $8 trillion dollars according to World Exchanges

Money lost in real Estate: 6 trillion dollars according to Safe Haven

Total: $14 trillion dollars

Government Bailouts: 8.5 billion according to this article


Source: Government bailout hits $8.5 trillion

At the end of 2008, Americans' net worth fell $11.2 trillion, or 18 percent from 2007, to $51.5 trillion according to the Federal Reserve; which makes people less secure about their net worth situation. Investors have most of their wealth invested in real estate and stocks. When stock and real estate markets are booming, people feel wealthier, and tend to spend more. If homeowners wanted to redecorate their house or take a cruise around the world, they could easily sell their appreciated stocks or take a HELOC against their home equity. If they lost billions of their networth however, on aggregate they would be less likely to spend it all since they would have less assets to post as collateral in order to get the credit to live the nice life.

Thus in order to make people feel wealthier again, the government is spending several trillion in bailouts in order to lessen the negative wealth effects on the economy. As fewer consumers take out loans in order to spend on anything from decorating your house to going to that cruise to the Bahamas, and the ripple effects of this is felt throughout the economy there is less money to be loaned. Someone has to step in to provide a buffer against further declines in spending, and the government’s recent plans are a decisive action to prevent the worst from happening.

Thus I disagree that the government bailout would lead to hyperinflation, such as the one we saw in Germany in the 1920s, Zimbabwe or in Eastern Europe in the early 1990s. If the private sector’s participation in the economy decreases, and the government’s participation increases and offsets the decline in the private sector, the net effect for the economy is zero. Another difference between US and the other hyperinflation situations is that the US dollar is a currency that virtually all countries in the world accept in their foreign trading. Not only that but the US dollar is the primary reserve currency for many large foreign central banks such as the Chinese, Russian and Japanese banks. These banks hold their US dollar reserves in US Treasury Securities. They don’t have another alternative for their reserves. If they sold all their dollars their currencies would be much more unstable and the countries would suffer a huge drop of confidence in their economies. Furthermore during economic crises most foreign individuals tend to purchase dollars. For example during the Asian financial crisis (1997-1998), Russians, Indonesians and others were converting their savings mostly into US dollars, not gold or silver.

Thus I believe that the best way to protect your wealth is to purchase shares in consumer staples companies, whose products we use on a daily basis. I am a fan of Procter and Gamble (PG), Clorox (CLX), Colgate Palmolive (CL) and Johnson & Johnson (JNJ), which have not only been able to pass inflationary pressures onto consumers but are relatively recession immune as well. For a larger list of the best dividend stocks for the long run, check out this post.

Procter & Gamble (PG) makes detergents, soaps, toiletries, foods, paper, & industrial products. Brands include: Always, Head & Shoulders, Olay, Pantene, Wella, Actonel,
Dawn, Downy, Tide, Bounty, Charmin, Pampers, Folgers, Iams, Pringles, Gillette, MACH3, Braun and Duracell. The Cincinnati, OH company has increased dividends for 52 consecutive years and currently yields 3.30%. Check out my analysis of P&G (PG).

Johnson & Johnson (JNJ) is the owner of some well knows brands such as SPLENDA, TYLENOL, SUDAFED, ZYRTEC, MOTRIN IB, and PEPCID AC. The New Brunswick, NJ company engages in the research and development, manufacture, and sale of various products in the health care field worldwide. If you are concerned about the US dollar depreciating, look no further – 49% of JNJ’s 2008 sales came from abroad. Johnson and Johnson (JNJ) has increased dividends for 46 consecutive years and currently yields 3.60%. Check out my analysis of JNJ.

Colgate Palmolive (CL) manufactures and markets consumer products worldwide. It operates in two segments, Oral, Personal, and Home Care; and Pet Nutrition. The New York, NY based company
has rewarded stockholders with a rising dividend income stream for 46 consecutive years. This dividend champion currently yields 2.90%. I am considering initiating a position in CL on dips below $53.

Clorox (CLX) manufactures and markets a range of consumer products such as Clorox, Formula 409, Glad, K C Masterpiece, Ever Clean. The Oakland, CA company has a 31 year uninterrupted streak of dividend increases. The stock currently yields 3.40. Check out my analysis of Clorox.

Full Disclosure: Long PG, JNJ and CLX.

Relevant Articles:

Tuesday, November 11, 2008

The future for US Auto Stocks

There have been some pretty negative news surrounding the big three US auto manufacturers this year. Recently GM and Ford reported continuing large losses, triggered by a decrease in the demand for cars nationwide. The demand for cars, which typically is highly cyclical in nature, is lower because of the low consumer confidence in the economy as well as the difficulty that car buyers have in obtaining credit financing to purchase new vehicles.

As a result of these events Detroit manufacturers’ stock prices have taken a large hit this year with GM losing 82% in 2008 while Ford stock lost only 70% during the same period of time. GM eliminated its dividend payment in July 2008 in order to boost its liquidity. The company has taken other measures to bolster its cash situation by selling off assets. Ford eliminated its dividend payments back in 2006. These two stocks should have been out of any dividend portfolio after the cuts, as every dividend investor knows that dividend cutters and eliminators have underperformed the stock market over the past 30 years on average.

The future of the US car companies is definitely getting bleaker every day. The executives of GM, Ford and Chrysler are in talks to get money from the US government in order to keep the industry afloat until the current downturn ends. This could be the only thing that could save several million jobs in the auto industry, since selling off assets might be difficult to achieve in the current tough credit environment.

With GM and Ford stocks trading at multi-decade lows, it seems that investors could potentially make large gains once GM and F overcome the crisis and return to profitability. I see three scenarios for the future of car companies:

1. Car companies receive a loan guarantee from the US government, similar to the one received by Chrysler in the early 1980s. Millions of jobs will be saved; new energy and cost efficient models will be unveiled and after the economy recovers the auto manufacturers will make advance loan repayments and start paying out distributions to their shareholders. Furthermore, as long as the stock base isn’t diluted, long term investors could easily see large capital gains from current levels. Back in the late 1970’s Chrysler stock was trading at under $2 a share before the government loan guarantees. After the company turned around, the stock traded as high as $50 before the 1987 crash. No dividends paid for several years after the bailout. If this scenario were to occur owning stock would be a very good strategy.


2. The other scenario assumes that the US government entities does provide a bailout similar to FNM, FRE and AIG, where common and preferred stock ownership is diluted as the government takes majority stakes in the auto companies. This could lead to more losses for Ford and GM shareholders. The best strategy for this scenario would be to purchase GM and F debt at current levels.

3. A third scenario could occur if the government lets Ford and GM file for Chapter 11 reorganization. Shareholders will be completely wiped out, while bond holders would end up owning the companies after their interests are converted into equity into a newly formed corporate entity.

There could definitely be more scenarios involving a potential purchase of US assets by foreign auto manufacturers. The main point is that at this point owning GM or F stock is highly speculative, and should not be looked upon as an investment. In the meantime we could see short squeezes as short positions amount to 13% and 16% respectively of Ford and General Motors share float.
That being said if investors want to speculate on the auto industry, I believe that GM or Ford bonds could be the best vehicle for such operations. There are several retail bonds issued by GM, whose nominal value is $25. These bonds and notes are traded on the NYSE just like any other instrument. You could find more information in the table below (Source: GM Investor Relations Website):


Each of those bonds is trading currently at about 25% of face value.

Full Disclosure: None

Tuesday, February 26, 2008

The next bubble in the making.

Over the past 10 years the US economy has experienced the bursting of two major bubbles – the dot com bubble and the real-estate bubble. The Federal Reserve has been blamed for both failures – the first one happened supposedly because the US central bank hesitated to increase its interest rates too much until tech stocks started jumping like kangaroos in the Australian deserts in late 1999. The second bubble was formed just as the dot com bubble imploded and the FED tried stimulating the economy with lowering interest rates to multi-decade lows. Rates on fixed income instruments had fallen to multi-decade lows, and stocks were in a major bear market. Investors had nowhere to go for income. This situation stimulated speculation in the housing market and helped the US economy regain its power and achieve six years of prosperity.


Currently the US and Foreign stock and property markets are weak, ever since the subprime problems started making huge headlines in July 2007. Interest rates are declining again, which leads very few options for investors to invest and grow their savings right now. Somewhere down the road real-estate would pick up again, but it is still too early for that to happen in my opinion. One of the reasons for today’s real-estate bubble is that properties were sold to people who cannot afford them at all. If you are making $20,000 per year and you purchased a property for $500,000, which you were able to afford only with an ARM, with the intent of flipping it out for a huge profit, even if you refinanced your loan to a 0% interest per year, you would still be unable to keep up with the monthly payments. Most of those investors are holding such properties which they cannot afford, but which would lead to huge losses if they sold them right now. Those investors are trying to rent their properties in order to decrease their losses. This creates a very competitive market for landlords right now. Pundits are claiming that now is the time to buy into real estate. I believe that the next one or two years will also be considered “the time” to buy real estate. When no one believes in the real estate market, that’s when it will bottom out and start going up.

One of the few alternatives for investments is stocks that pay a relatively stable dividend, and which have maintained or increased their dividends over the years. There are several dividend based ETF’s out there some of which launched recently. This shows to me that the investment community is anticipating a demand for stable income producing securities in this unstable time. There are several major stock lists out there which contain dividend achievers, dividend aristocrats and high-yielding aristocrats and achievers. With very few reliable sources of dependable income from stocks, investors have few other choices but to invest in the dividend stocks of our times. I think that the dividend aristocrats would be the next bubble that will be formed from the current low interest rates. Investors, burned from the rest of the market, would flock into one-decision large cap stocks with good liquidity, which could be bought and held forever regardless of price. Something similar happened in the late 1960’s until the 1974 bear market with the so-called “Nifty Fifty” stocks.

I am already seeing big increase in interest in dividend paying stocks especially the above mentioned lists. If a bubble in dividend aristocrats/achievers does occur, that would enable me to reach my goals of $200,000 in net worth earlier than expected. If it doesn’t happen, then I would probably expect normal average rates of return of around 10%-11% annually. Very Boring.

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