US economy in Perpetual Recession; short US dollars!!

US economy in Perpetual Recession; short US dollars!!

The word “recession” definitely is nothing alarming when we talk about the current state of the world’ largest economy. Indeed many well known economists predict that the US economy may likely fall into a deeper recession and into a great –er depression in the years to come. However, a consensus, as it appears, is that the US economy would revive following this down turn. Well, this is precisely where I differ in my opinion and introduce what I call is a “Perpetual Recession”. (PR). Yes, US economy is entering a mode of perpetual recession.

Well I know that petty bold to make a statement like that and it would be quite unfair without stating the reasons as to why I believe that the US economy is in Perpetual recession. Well the rule of globalization has made tectonic shifts in which the world operates. Lets us go back to our economic textbooks. Economic foundation of any state is build upon two factors – Labor and Capital. This good old concept of “engines” of economic progress indeed took a new direction off late – thanks to US again when a new dimension was added – technology. The US strived and stood in the forefront of making innovative technology that saw businesses change the consumer livelihood. Innovation and technology progress swept through the 50’s through 80’s. With Computers in place fast penetrating the global economy, the US successfully drove the “engine” across end consumer markets. However, there was this widening gap being created - between the pace of development of new technology and the pace of transfer of existing technologies. Now I am calling this the “T – Factor”. While global firms continue to operate in oligopolistic environment, making sweeping changes in trade practices, absence of protectionist strategies and government focus on complying with global trade, the rule of the game is slowly shifting back to the roots of economic success– Labor and Capital.

This is where the competitive advantage of an economy exists, unfortunately pushing behind the world’s largest economy. The model of consumerism has failed, capitalistic philosophies are faltering, and access to capital (bank inability to lend, capital markets) is drying and technology progress ailing. Now what else is left in US if not what the consumerism model and technology! For if I can get a Chinese product at 1/5 th cost of what I pay for in USD, or perhaps make one at ½ the cost, Why then should I look into a market where there is no Capital and no consumer and of course the “T – Factor”. Add to that the worsening demographic situation in US (labor), what this essentially means is that the US economy is slowly losing out its competitive advantage to other economies like China and India. The US economy is slowly set to enter a perpetual economic recession of a de-growth path.

Now, the way out from this indeed should boil down to the exchange rate. Yes the USD has to weaken to that extent that the competitive advantage is realigned. This would mean the producing the goods and services in US should be profitable for global companies! A scenario which will return only if the currency gets revalued. This surely will create economic imbalances in the near term, but if US economy has any route left to its former glory – the USD should be revalued, making a short candidate – the US dollar.

Gold - The next bubble

Gold – The next bubble!

It took me long a while to pin down on the next investment bubble. We have seen the currency, the dot.com, the housing and now what’s next. If identified significantly early, every bubble provides twin opportunities to make money - long on up-cycle, and short the down cycle. It gets better, if the next bubble is a “Quasi” commodity!! – Yes I am referring to the one which many believe is the “Safest investment asset class in trouble times” – Gold.

In the current economic situation of global recession and depleting asset values across the much hyped structured and contra asset classes, Gold continues to remain an asset which is all set to be the next bubble. Symptoms that make a typical bubble. I may surely odd here. A global consensus on Gold being the safest and best yielding asset class, with a myth that its value never erodes. I will tell why it’s a myth later, but nevertheless when the whole world cries a common language it’s time to reassess some of the fundamentals. Inflation concerns, dollar weakening and the search for a new asset class are pointing towards an “emotional” asset – Gold.

For all those who believe its “precious” commodity – I ask so what. For all those who believe its safe investment – I ask with a price volatility as high as an equity asset class. How is it safe? For those who say it’s a hedge against inflation – I ask where is inflation. Say since last five decades or say since 1900’s, gold price has gone from less than 5$ to current 850$ over 100 years. Now, all of us know from our economic textbooks that long interest rates typically follow the inflation rates. Let us assume that long term interest rates over the last century stood in the range 5-6%, the $5 in cash should be worth more than 1500$ in a simple savings account. Tell me how it’s “hedging” inflation.

Are we not forgetting that it’s a commodity? I mean commodities move in cycles. Its been long since the Breton woods agreement, now that’s four decades back!, central banks across globe considered Gold a reserve currency. For average cost of producing a unit of gold still hovers at less than $300, why should a commodity price be as high at nearly 3x. Now does this not defy rules of a competitive market? With China replacing South Africa as the largest Gold exporter and Jewelry demand in India growing at low single digits why should the price of any underlying reflect such a huge mis-pricing?

What ahead is anybody’s guess? The asset has the potential to make it the next bubble only to fold at least by 3x. Now that would mean a price crossing well above 1000$ an ounce only to fold to less than 350$. What is left now is to time these long and short trades!! Well making money out of bubbles could be twice as exciting!!

Shareholder Value Creators - 2008

Itron Inc. (ITRI)
- Strong business momentum, untapped market opportunity beyond US, Sustainable competitive advantage.

Health Care Services Group ( HCSG)
- widening economic moat

Amgen (AMGN)
- Compelling R&D Pipeline, Competitor issues.

Economic Value Added (EVA) - Concepts

Economic Value Added is the financial performance measure that comes closer than any other to capturing the true economic profit of an enterprise. EVA (concept was developed by Stern Stewart & Co.) is the performance measure most directly linked to the creation of shareholder wealth over time.
EVA is net operating profit minus an appropriate charge for the opportunity cost of total capital invested in an enterprise. As such, EVA is an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenderscould get by investing in other securities of comparable risk.

EVA = Net Operating Profit After Taxes (NOPAT) - Capital * Cost of Equity

The capital charge is the most distinctive and important aspect of EVA. Under the EVA concept a business is profitable only once its profit is greater than its cost of equity. Until that moment it does not create wealth, it destroys it. By taking all equity costs into account, including the cost of equity, EVA shows the amount of wealth a business has created or destroyed in each reporting period.

The primary financial objective of any company should be to maximise the wealth of its shareholders; the value of a company depends on the extent to which investors expect future profits to exceed or fall short of the cost of equity.

Defining EVA and its components

Adjustments in net income and book capital
NOPAT represent the after-tax operating profit before financing costs and non-cash expenses of a company.

NOPAT
= Net Income to Common Shareholders
+ Goodwill Amortization+ Extraordinary Losses (minus gains) After Taxes+ Loan Loss Provision- Charge-Offs+(-) Deferred income tax created by increasing/reducing deferred tax asset

Invested capital
Invested capital can be defined as the total cash payments invested in the company without regard to form of financing or accounting adjustments. This represents the economic base on which capital investors require a minimum return based on the risk profile of the assets and operating characteristics of the company. Invested Capital is calculated by adding the following components: the book value of common equity, cumulative goodwill amortization, cumulative extraordinary gains/ losses, the after tax loan loss reserve.Invested Capital = Book Value of Common Equity
+ Cumulative Goodwill Amortization+ Cumulative Extraordinary Losses (gain)+ After-Tax Loan Loss Reserve- Cumulative Chare-Offs+(-) Deferred income tax created by increas-ing/reducing deferred tax asset

Cost of equity
The cost of equity (CoE) represents the minimum return an investor should require from an investment of similar risk. As part of EVA the cost of equity represents the benchmark by which to judge the adequacy of the rate of return earned on Invested Capital.