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7/25/2019 Goehausen 2016 Q1 Investment Outlook
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February 4, 2016 GOEHAUSEN INVESTMENT OUTLOOK
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"The best thing a human being can do is to help another human being know more" Charlie Munger
When I landed my first job out of college, trading physical commodities, I thought I hit the jackpot. Iget to spend the rest of my career sitting in a Laz-Y-Boy, clicking on a computer mouse, betting on
commodity prices with other peoples money. As a recreationalsports gambler, there was no bettercareer.
Once I got into the thick of commodity trading, I realized it was not all akin to sports gambling, but more
of a glorified logistics job. Physical commodity trading is about finding the most efficientways to move a
barrel of oil or bushel of corn from one market to another cheaperthan the next guy. The goal is to
undercut the market price and capture an arbitrage (riskless) profit. The sports gambling of the
commodity trade has very much resorted to the computers. Damn.
All was not lost though, because what the worlds oldest form of commerce did teach me was the only
the thing that matters: markets. They say good commodity traders have the capacity to analyze a
market thoroughly and recognize trends quicker than the competition.
What makes a market?
In its most simple form the global economy is the sum of price times quantity; or GWP= P(X)*Q(X);
where price is the value of every good and service produced in the world in a given time, and quantity is
the amount of goods and services produced in the world in a given time. In 2014, the most recent data
available, the world produced $77.8 trillion worth of goods and services. Put another way, there was
$77.8 trillion worth of revenuegenerated by individuals, businesses and governments.
Over the last 15 years, real GDP grew by 30%. It grew by 65% in the 15 years prior to that.
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Read more. It allows you to borrow someone elses brain. Anonymous
Auto Market:The US economy accounted for roughly $18 of the $77 trillion global economy in 2014.
The US auto market accounted for $1.1 of the $18 trillion US economy. Ford Motors generated $135
billion of $1.1 trillion in the US auto market. The only way Ford can generate more revenue is if the price
(P) or quantity (Q) of automobiles produced in the US grows or theyre able to steal market share from acompetitor. You get the picture; there is a finite level of revenue to be earned in any market, with the
ultimate ceiling being the $77 trillion global economy. So despite their lofty valuations, Google and
Amazon together cannot technically be worth more than $77 trillion.
As investors the goal is to invest in assets that will produce goods and services that generate enough
revenue to create positive capital return. To determine how much an asset is worth, we need to first
determine the shape of the market and then figure out the assets share of the market. (I.e. Ford has
12% of the US auto market). From there, the goal is to buy undervalued assets. Or as legendary investor
Howard Marks puts it, We want to buy things whose price underestimates the value of the assets
earnings (value investing) or the future potential (growth).. Were looking for instances where the
market is wrong.
THE Ps and Qs
Now that we have an idea of the scope of the global market, what causes it to move? Specifically, what
drives P and Q higher or lower?
P-Three things directly affect price:
Supply- If the supply of a good or service increases, the price goes down. If the supply decreases,
the price goes up.
Demand- If the demand for a good or service increases, the price goes up (Uber Surge). If the
demand decreases, the price goes down.
Productivity- Productivity is a fancy word for cost efficiency. If a company can produce a good or
service cheaper and still make above average returns they will increase supply or lower price to
win market share. If the production of the good or services becomes more efficient, the price
decreases. If the production becomes less efficient, the price increases.
While the supply and demand elements of price are learned in elementary economics; productivity
is often overlooked. Today, productivity, or efficiency, is becoming the most important element of
price with the rapid advent of technology.
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Where are prices inflating? Over the last 15 years, inflation has been most profound in three areas:
Energy, Health Care, and College Tuition. The energy (and commodity) inflation was largely due to
growth of China and other Emerging markets. Energy prices have likely peaked. Health care prices have
increased because of growing demand from an aging population (more later) and a certain government
act, ironically named Affordable. College tuition has gone up exponentially in price with the increased
availability to federally funded student loans (bottom chart).Student debt will be a long term headwind
to economic growth, as these debtors have less disposable income to spend.
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Q-The quantity of goods and services produced can also be thought of as Demand + Inventory.Everything sold during the time period plus everything that will be stockpiled into inventory falls under
quantity. The Q is driven simply by human need and desire. What do we need to survive in this world?
What do we want that will make our lives better? In large part, the Q is driven by three things:
Demographics- How many people in the world are buying these goods and services. If the
population of the market increases, the market needs to increase production. If the population
of the market decreases, production needs to be slowed or more of the goods and services will
be converted to inventory which will likely lower future prices.
Income- How many of these goods and services can the market buy with their income? If the
market has more disposable income to spend, they are likely to buy more. Ones income is
largely made up of their salary+ investment gains+ credit.
o Credit- Credit is a way of bringing forward tomorrows income. Most of us cannot afford
to pay for a $350k house up front so we take out a loan that will be paid for by the
income we generate over 30 years. Psychology- Psychology effects demand in two distinct way:
o
Herd- What is the herd of society nudging us to spend our income on? Water, food,
shelter- check. What is everyone else spending their incremental income on? This
changes by generations and cultures, but the psychology of the herd is a great
influencer on demand. If everyone else in my high school has an iPhone, than I need
one too. We have finite time and information to make purchasing decisions so we often
follow the herd.
o Confidence- How confident are we that our future income will be there tomorrow? If
the economy is growing, consumers are more optimistic and inclined to take out more
debt to buy their new house or car.
The P and Q are self-reinforcing. If the population of the market goes up (Q), then demand goes up(P)
and price goes up; if inventory (Q) goes up, then supply goes up (P) and price goes down. The only thing
that matters for economic growth is the sum of the equation; so if demand DOUBLES but price is cut in
half, there is technically ZERO economic growth, and that is a big problem we are facing today.
Lets get out of the black hole of economic theory and figure out what is really going on in the world and
how that might affect global markets.
Right now there are four major forces exerting pressure on price and quantity. 1) Rising Wages, 2) Aging
population, 3) Technological Innovation, 4) Oversupply.
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"It is not the employer who pays wages. It is the customer who pays the wages." - Henry Ford
Rising wages= Increased Demand and Higher Prices
While our trusted politicians are spending their time in DC fighting over minimum wage
increases, the free market is doing their job for them. In the latest poll of independent
businesses 20% said they will increase wages this year, the highest since 2007. As the population
of high income economies gets older, companies are left with a smaller supply of working age
labor, which will force them to increase wages to attract and retain workers. In the US alone
there are currently 5.4 million job postings, the highest in two decades. Under our P/Q model
this will give consumers more discretionary income to boost demand, but will also decrease
productivity. Increasing wages will drive up the cost of production which will force companies to
increase their sales price to capture the same return on their invested capital.
Labor Pool (red) vs. Wages(blue): As the average age of the US population increases, and retires,
the pool of labor decreases which forces employers to pay higher wages to keep and retain
employees.
Wages and Profit:While employees and consumers enjoy the higher wages, corporations
struggle as more of their REVENUE is devoted toward salaries. Expenses per worker -- so called
unit labor costs -- increased 2.4 percent last year, the most since 2007. This chart shows that as
wages increase(Red), the S&P 500(INVERTED blue line) tends to move lower.
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Where is the income going?The US economy was in a golden age of growth from 1977 through
2008, primarily fueled by a debt binge. This culture can best be described by the chart below,
which shows that from 1977 until 2008, consumer spending outgrew income nearly the entire
time. This trend flipped following the Great Financial Crisis as economic uncertainty has led
people to save more of their income. This new, responsibleconsumer will be a drag on
consumer spending, which makes up 67% of US GDP.
Goods or Services?Another trend unfolding is consumers spending more money on services
then goods. In December, spending on durable and non-durable goods fell by $34.6 billion, but
was offset by a $33.9 billion jump in spending on services. I blame this on an aging populationand technology allowing us to do more with less goods. (KKR)
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Aging Population= Less Demand and Lower Prices
In 1980 the English band The Vapors released their one hit wonder Turning Japanese. The
song is supposedly about someone who was slowly going crazy and Turning Japanese was the
clich of their angst. Although Japan was at the forefront of the global economy in the 80s, the
irony of the song and its meaning cannot be lost on anyone following the global economy, asmost economistsgreatest fear is the economy Turning Japanese.
Since Japans financial bubble burst in 1990, they have gone through two lost decades of zero
economic growth, due in large part to their aging population peaking around the same time.
The Japanese prime population (ages 15-64) has fallen off by about 10 million people since the
mid-90s and consequently their economy has stagnated, falling below their early 90s peak.
Japans stock market the Nikkei 225 also peaked in 1989 at 38,916; sitting at 17,044 today, it is
56% below the all-time highs. The prime population in Japan is expected to fall by another 15%,
or 20 million people, by 2050 while the percent of population over 70 is expected to increase by
60%, making up nearly 30% of the population.
To the dismay of economist across the developed world, this problem will not be constrained to
Japan. According to the OECD, the size of the working population of the developed world
peaked in 2011 and will fall from 833 million to 799 million by 2025. Not only is the population
aging, fertility rates across the world are slowing; going from nearly five children per woman in
1950 to about 2.4 children per woman today.
This is the first time since the dawn of capitalism that lead economies are entering an era of an
aging and shrinking workforce- and nobody knows whether an economy whose population is
falling can actually grow, either in total or in per capita termseconomist Diane Coyle.
While I have nothing against the Silver Generation, the impact on economic growth is going to
be vast. As humans age, we typically spend less. Without an income, retirees are forced to save
more to fund future expenditures and at the same need less to live.
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"There is only one success..to be able to spend your life in your own way." Christopher Morley
This also taxes the working population as more tax dollars will be funneled towards Social
Security, Medicare, and Medicaid; which will reduce more productive demand elsewhere.
Demographics are one of the most underrated drivers of economic growth in the world. While I
dont foresee the US demographics trending as poorly as Japan, due to a more favorable
immigration policy; slowing population growth is something for which every investor needs to
prepare. It will likely slow down the pace of demand, inflation, interest rates, valuations and
equity multiples to name a few.
The best cure for a downtrending population is an appropriate pro-immigration policy,
something the xenophobic Japanese population has struggled to accomplish. Unfortunately
that is also trending in the wrong direction for us, as the net migration of Mexicans to the US
has declined and recently turned negative. From 1995-2000 2.3 million Mexicans immigrated to
the US, in the most recent five years period (2009-2014) the net migration was a negative
140,000 people. Meaning more Mexicans are leaving the US than coming here. Thats right, Mr.
Trump, you might need to build a wall to keep them here!
INCOME AND SPENDING BY AGE:US citizens usually reach their peak income and spending
levels around the ages of 45-50. This is when most reach the height of their career. As baby
boomers advance later into their 50s they often have to start spending less and saving for
retirement.
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Population Portfolio:If the trend line of peak spending continues to occur between the age of
45-55, we could be looking at a particularly slow period of growth over the next 10 years as the
population of late 30/early 40 year olds today drops off significantly. The trend will hopefully be
temporary as the population of the millennial generation spikes from there; assuming they are
not still paying off student loans by then.
From almost every angle, the population of the world is growing slower by the day. In reality, that
might not be such a bad thing for the well-being of the world albeit it will hamper economic growth.
As investors we need to figure out where the population, and DEMAND, will continue to grow over
the next 25 or so years. India and Nigeria might not be bad places to start if you can mitigate the
political instability.
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Demographics and Infaltion: As more baby boomers drop out of the labor force, expect inflation
to remain subdued. Low inflation will also keep a ceiling on interest rates. Japans interest rates
most recently peaked in 1990 at 6%, and slowly moved towards zero by 2001, where they
remain today. (KKR)
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Equity Valuations:The San Fransico branch of the Federal Reserve recently published a report
analyzing how an aging population affects company valuations. The P/E ratio, which is the price
of a stock divided by its earnings, is in part driven by the age of the investment community. With
nearly 10,000 baby boomers turning 65 in the US every day, investment funds will be faced with
increasing demands to pull capital out of the stock market, which could reduce equity multiples.
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Technological Innovation= Increased Productivity & Lower Prices
Technology does not have any value now unless its deflationary. John Burbank, Passport
Capital.
Technology has no value unless its deflationary. Lets think about what that means.
In my opinion, Mr. Burbank is saying that technology will not be adapted by the masses unless it
makes our lives easier, or more efficient. As we have discussed, efficiency is about increasing
utilization, reducing time, and lowering costs. Efficiency is a deflationary force.
-Wal-Mart recently announced plans to close 269 stores because Amazon can sell goods
cheaper.
-New York City taxi medallions are down 60% in the last 18 months because Uber can transport
people around the city cheaper.
-Nearly 2 million Americans cancelled their cable subscription in 2015 because Netflix can
deliver media content cheaper.
- In 1990, the top three automakers in Detroit had combined revenues of $250 billion, a market
capitalization of $36 billion, and 1.2 million employees. The top three companies in Silicon Valley
in 2014 had nominal revenues of $247 billion, a market capitalization of over $1 trillion, and only
137,000 employees.
The list goes on; but you get the point. Technology has made our lives easier and more efficient
in more ways than we can count.
The crazy thing about technological deflation is how young and early in the cycle we are. In
1967, the internet was a set of cables that connected four cities on the West Coast. If you are
over the age of 49, you are older than the internet. More broadly, the internet did not become
mainstream until the mid to late 90s; meaning that over 65% of our population is older than the
internet. If the internet were a human, it would still be in college and unable to drink. In that
sense, no one has any idea of how far technology can take us. In the last five years alone the
number of people across the world with internet access jumped from 361 million in 2010 to 3.27
billion people today, good for a growth rate of 180% per year.
Going a step further, we need to realize that until 2-3 years ago, technology or the internet, hadno real effect on our physical life, it was only INFORMATION TECHNOLOGY. The first 20 years of
internet adoption was geared around the free exchange of information and connectivity.
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"The best minds of my generation are thinking about how to make people click ads... That
sucks." Jeff Hammerbacher, early Facebook engineer
This all changed in 2009 when a drunk technology entrepreneur wanted to ride around the
streets of Paris in style and stumbled upon the idea for Uber; bringing the internet into the real
world for the first time. Since then we have seen AirBnb, Tesla, Space X and numerous othertechnology companies bring the internet to the real world, or Infrastructure Technology as Elon
Musk calls it.
We are still very early in this new stage of technology, but I expect it to impact our lives a lot
more than the first wave of information technology. Imagine some of the possibilities: driverless
Uber rides, delivery Amazon drones, robot secretaries, talking refrigerators, and free renewable
energy that we can store. Technology is just starting to impact our lives in a meaningful way.
UBER Deflation:The easiest example of technological deflation is the Uber case study.
There are roughly 253 million cars in the US and on average each one of these cars are parked95% of the time, according to UCLA economist Donald Shoup. So the second most expensive
asset most Americans own only gets utilized 5% of its life. Talk about inefficient. Talk about
waste.
If every car is only utilized 5% out of the day (72 minutes/day), and
there are 253 million cars across the country, it means America
spends about 18.2 billion minutes per day in the car driving 8.715
billion miles.
In comes Uber. Think if Uber could offer us a cheaper per mile
travel option that increases utilization of cars from 5% to 10%.
Now every car in America spends 144 minutes per day on the roadinstead of 72, while the overall minutes we spend in the car
remains the same. We could now spend those 18.2 billion minutes
in 126 million cars rather than 253 million. A 5% increase in vehicle
efficiency could reduce the automobile fleet by 50%!
If we could reduce the fleet by 50%, maybe we could also cut the
800 million parking spots across the country in half, which would
free up roughly 2700 square miles across the country, or the
equivalent of 5 New York Cities.
Going full circle to the example of Ford Motors, a 5% increase in
efficiency, could reduce the US auto market from 17.5 million
vehicles per year to 8.75 million per year. If the auto market, which
amounts to 6% of US GDP, were cut in half; the US economy would
lose 3% of its value. While this extreme scenario is unlikely to play
out in the next decade, it is a real possibility at some point in our
lives. And that, my friend, is how technology is a deflationary force.
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Rising Supply= Lower Prices
Following the Great Financial Crisis (GFC), Central Banks around the world artificially lowered
interest rates in the hope that consumers would take out more debt and increase spending. In
theory the idea was fine. More consumer spending would mean economic growth. The only
problem was that the GFC was caused by consumers having too much debt in the first place,which forced them to de-lever. The only group that could get access to this free credit was
corporations around the world. These low rates incentivized them to increase their leverage to
12 year highs.
With companies able to finance new production of goods and services at nearly zero percent
interest, they maxed out capacity beyond demand. Oversupply in one time period carries overto inventory in the next which will ultimately put downward pressure on price. The ratio of
inventory/sales is at the highest level since the GFC. Oversupply and too much inventory is a
deflationary force.
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No one took advantage of the low rates and once booming Chinese economy as much as
commodity producers. In particular, my friends in the oil patch who nearly doubled the supply
of US oil from 2008 to 2015. The commodity oversupply goes well beyond oil, with every major
commodity aside from cocoa being down over the last year. Zinc, oil, nickel and natural gas are
leading the way lower, all down by about 50% or more over the last twelve months.
Another issue that drove the oversupply of commodities and decline in prices was the slowdown
of economic growth in China. Last year, China reported the smallest annual economic growth
since 1990. So just as China and other Emerging Markets inflated the commodity bubble in
2000, it looks like they will also pop it. Over the past 15 years China consumed the lions share of
the worlds commodities despite only make up 20% of the worlds population and less than 13%of the global economy.
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Summary:All of these trends make me cautious about the equity markets as I have been since the
inception of this newsletter. I recommend adjusting your investment expectations to meet this era of
slowing global growth. The deflationary nature of these forces will be particularly painful for highly
indebted companies and countries as declining revenues make it more difficult to pay down debt. As
Italian portfolio manager Fernando del Pino puts it, Debt becomes dangerous because our assetschange in value, as does our income, but debt remains mercilessly constant.
The economy of the 20th century was defined by scarcity. A growing population with more income and
greater access to debt always wanted more goods and services. Multinational companies and stocks
markets around the world reaped the benefits. The 21 stcentury economy will be defined by slowing
population growth and technological innovation that allows us to do more with less. The age of scarcity
is transforming into an age of abundance that focuses on utilization. This trend will continue to benefit
Main Street over Wall Street.
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Additional disclosure:Information in this newsletter represents the opinion of
the analyst. All statements are represented as opinions, rather than facts, and
should not be construed as advice to buy or sell a security. Ratings of
outperform and underperform reflect the analysts estimation of a divergence
between the market value for a security and the price that would be appropriategiven the potential for risks and returns relative to other securities. The analyst
does not know your particular objectives for returns or constraints upon
investing. All investors are encouraged to do their own research before making
any investment decision.