If they say "This Time It's Different" take the other side...

You would think that with the number of people who have business degrees and experience corporate failures would be isolated events.  Sadly, many of these practitioners of management skipped their classes concerning capital financing, research and development, competition and human resource development.  They've managed to take good businesses and drive them into oblivion.

The remnants of Blockbuster have been absorbed by Dish Network.  Borders book store is closing its remaining stores and liquidating its inventory.  Both companies initially were successful in their respective niches.  But with a change of ownership and management operational success turned to failure.

There were several reasons for the collapses.   

• The acquisitions were financed with an inappropriate amount of that, calculated with projections that were overly optimistic.  Management apparently believed their own B.S.

• The markets that both companies were serving were evolving, but Blockbuster and Borders did not, or did so much too slowly to satisfy their customers can keep up with the competition.

• Management was unwilling to redesign their operational framework until it was too late

The drop in revenues and new customers reduced cash flow to the point both companies had difficulty making the interest payments on their debt, meeting payroll, and providing products to their stores.  As the deteriorating condition of Borders and Blockbuster became public knowledge, the lack of consumer confidence reinforced the negative downward spiral that carried them to the point of no recovery.

Borders is in the process of closing its remaining stores.  Blockbuster, which at one time had over 5000 stores, is struggling to retain the last 500 locations.

Trying to continuously expand using highly leveraged debt over the course of multiple economic cycles without adapting to new market conditions is business suicide. The result is catastrophic, a terrible waste of financial and human capital.  When senior management commits successive errors in vision, judgement, and execution you need to remove them from their positions of power in order to stop and repair the damage.

Our elected "professional" politicians are squabbling about how to reduce the bloated spending of the federal government, and holding our capacity for debt hostage so they can use the control of that debt as leverage with the voters.  They are reluctant to change the spending for 'fear' of upsetting their constituencies, even while acknowledging the system will collapse, and soon.   The majority of these politicians are concentrating their efforts to defend their political positions and spending , and have no clue as to what the effect of their current actions will have on the economy in the next three to six months.

The following is my personal opinion, but here goes:

• The housing market for sale of existing homes will contract by 5-8 % due to higher interest rates and lower demand.

• Food, clothing, a consumer product will increase by 5 to 10% due to inflation forces, further reducing personal disposable income.

• Businesses will be forced to raise prices to cover commodity cost, regulatory fees, new taxes, and personnel costs (if they can).  Profit margins will suffer, because of businesses maintain the same profit margins, their total business will contract due to less people been able to afford the purchases.

• Equity markets will reflect this action with lower prices, further shrinking federal and state tax receipts due to lack of capital gains.

• Interest rates will begin to rise substantially.  That debt markets will start to more accurately reflect the risk/reward profile of the cash flows from capital assets.

•  Our Gross National Product will struggle to stay positive due to lack of demand and increased costs.

A description of the above is something like "this will not be pretty".  The most disgusting part of the circus will be the stampede of politicians trying to avoid blame for their extravaganza with the help of the mainstream media sycophants.  The entire situation is so revolting it makes one want to throw up.

If there is any upside to the situation (based on the above scenario) is that this type of debacle results in the replacement of the sitting politicians with a new set of elected officials that are a bit more pragmatic when it comes to fiscal conservatism - or at least we can hope.

Until next time

The Instigator

P.S.

Dow Jones Industrial Avg. - 12, 304
S & P 500                       -    1,305
10 yr  Treasury Bond Yield  - 2.97%


Watch for the stock markets to rally before the unemployment report next week.  It's a recovery from the oversold condition.  Some people will attribute it to the action in Washington over the weekend, but in reality I believe its a setup for more seriously disappointing news in August and September.

"I'm going to call my brother..."

Snowstorms, Heat Waves, Bubbles and Crashes    It takes some effort to recall that just 5 and a half months ago the Chicago area was buried by a huge snowstorms so severe it closed Lake Shore Drive. Our current heat wave looks to last all this week and most of next. It's time to retreat from the heat, stay hydrated and wait for cooler times to work on the outdoor projects.

Since the financial “storm" that froze our financial system it's now been a little over three years. Domestic equity indexes have doubled in valuation. Commodities have increased much more. Gold, silver, copper, cotton, the grain complex - nearly all are 2, 3 or more times their price of just a few years ago. We have a commodity asset bubble, and it’s huge. The price patterns and volatility illustrate an overheated situation, and these never end well.

Our political officials and advisers are so busy defending their actions and protecting their turf they are failing to see the cliff at the horizon that we are approaching with increasing speed. The Federal Reserve, with help from the European and Chinese central banks have flooded the world with paper money and artificially low interest rates. The fuel to overheat commodity prices is already in the system. What's going to happen is kind of like this story about the apprentice yardmaster.

Once upon a time an apprentice was taking his final exam to become the yardmaster for a major railroad. The examiner described the final scenario: two trains were entering the rail yard from opposite directions at a high rate of speed. What do you do?

"I'd throw the switches in the control station and route them to two side tracks."

"Good answer" said the examiner. "But what would you do if the switches were stuck?"

"I grab the red flags, run down to the tracks and try to wave off the trains."

"That's the right thing to do, but what if they don't see you?"

"Then I'd call my brother" said the apprentice.

"Call your brother? What could he do?" asked the examiner.

"Nothing, but he loves to watch train wrecks!"

It's a lot safer to watch a train wreck from the sidelines than to be in one.  Commodity prices as an asset class are going to correct-and sooner rather than later. Bubbles never end well. Here are some steps to take between now and mid-September.

Don't be greedy-if you own commodities now, scale out of your positions. If you must stay in, liquidate 80 percent of your position, and get back and after the prices break down, and at least 30 days after you close on your positions. But remember Jesse Livermore was right about the market going down but got back in too early and lost a fortune.

Stay liquid-don't take new positions. Put your money in short-term money market instruments that are safe and insured if possible.

Price inflation bad, price deflation good.  For those that guard their capital, the reduction of commodity prices will produce investment opportunities for the prudent. Exercise patience and you will find the right investment for you.

Stay away from long term bonds. As long as real interest rates are below the rate of inflation bonds yield a negative return.

August, September and October look to be a time when most commodity assets will be drastically repriced- be careful when you hear people saying this time it's different-it never is. If I'm wrong you will have sacrificed a percent or two in exchange for the peace of mind that comes from protecting yourself from the price contraction of a burst asset bubble. You will be able to re-establish long-term investment positions with a better identified base. If I'm right you're looking good!


Until next time

The Instigator

Where was I? Oh yeah, look out below...

It's been a while: recoveries take longer than most people think.  I finally feel good enough to start writing about my observations with (hopefully) some clarity.

The inflation machine is in second gear worldwide, and maybe shifting into third gear.  National governments, led by the U.S., have flooded financial systems with paper money.  The results can be seen in the rise in commodity prices (gold, silver, food, metals) and the reduction of disposable income because households and businesses must pay more for essential needs.

The next stage involves shortages.  As world supply chains have converted to just-in-time practices to reduce invested capital, inventories (read cushions) have been reduced to minimal levels.  Any disruption in supply due to shortages will result in delivery interruptions.  Lack of essential goods causes the prices of existing goods to rise as users offer more money to secure those goods.

This stage's effect on prices is more severe and price moves are faster and more dramatic.  The prior attitude of complacency and control is replaced with concern, anxiety, and eventually panic.

Having to pay a lot more for essential household goods will eliminate what disposable income most families have.  The general economy shrinks, causing a contraction in the GNP (Gross National Product) and tax receipts, further weakening the U.S.'s ability to service its debt and fund its programs.

The above situation is clearly global.  Our country has the capability to counteract this phenomenon, but while our President and Congress entertain us with their version of a Punch and Judy show don't expect conditions to change.

We'll get into prescriptions, cures, preventions and opportunities in the next missives.

Until next time

The Instigator

P.S. The general markets (D.J.I.A., S&P, Russell 2000) are headed lower for now (based on weekly measurements).  Don't expect a changing direction for the time being.