THE KELLY LETTER OR
To me it’s a truism, but one that few people grasp: Both major US political parties are the same. To watch excitement over the midterm elections as a chance to “throw the bums out” in favor of the other party, when the bums are Democrats and the saviors are Republicans, is to watch irrationality in full bloom.
Don’t get me wrong. I share the frustration of those who desperately want real leadership in Washington. I knew early on that President Obama’s hope and change shtick was a load of bull, and hardly original. That “change” continues working as a campaign theme shows mostly the unchanging landscape of politics. It always stinks, which is why we always want change. It would be great if things went well so the campaign slogans could become “keep it like this forever,” but instead we’re constantly desperate for change. Now that Obama’s performance in the White House has confirmed him to be like his predecessors — even down to continuing the same useless wars he once vociferously opposed — it would be nice to see people reassess their view of politics. A simple acknowledgment of the following would be encouraging:
No matter how interesting the new package, no matter how silver the talking tongue, no matter how different from the status quo the candidate appears to be, if he or she is backed by the same money bags that backed the previous politicians who made our current mess, we’ll be no better off.
Instead of placing that view front and center, we transformed in just 18 months from a nation of voters excited to end the awful Bush era with the fresh new hope of Obama, to a nation of voters excited to end the awful trends of the Obama era with the fresh new hope of the Tea Party Republicans.
Maybe stepping away from the emotion-packed labels of Democrat and Republican will help make the irrationality of this behavior more clear.
Pretend we’re remodeling our kitchen and have two carpenters at our disposal: Deemsel and Ruprit. We go with Deemsel for the first phase, and boy does he screw it up. The cabinets are crooked, the floor is sloped, and none of the outlets work.
We promptly fire Deemsel and put Ruprit on the job. A week later, the cabinets look worse, the floor now contains holes in addition to being sloped, and the outlets are visibly smoking. Ack! What to do?
If you’re the American electorate, you get excited about the chance to replace Ruprit with Deemsel — again. Deemsel gets back in there, rips the cabinets from the wall and starts filling the floor holes with toxic chemicals. You can scarcely believe your eyes, so you throw Deemsel out the front door and quickly whistle to Ruprit. He rushes back in and starts sledge hammering the outlets. Ack! Repeat.
Get it? Deemsel and Ruprit are our only choices. They both “trained” at the same school of crooked carpentry. In the case of politicians, both Democrats and Republicans get their funding from the same special interest groups that have leeched the US Treasury dry. Just as the solution to Deemsel screwing up the kitchen was not to hire Ruprit, nor is the solution to Democrats screwing up America’s finances to elect Republicans.
They’re both the same, and they both stink.
Blogger Jeff at All Financial Matters tackled this issue last weekend. He assembled an economic history of the United States for himself because he’s “tired of the rhetoric.” He identified himself as a Republican, but believes that if “Republicans are responsible for our current mess, then I think the American people have a right to know.”
In a two-page PDF, Jeff presented the economic results and S&P 500 performance for each administration from Roosevelt to the second Bush. Some highlights:
There you have it: Deemsel and Ruprit hard at work bankrupting your nation. Despite the trend going back as long as almost any of us have been eligible to vote, we still think the answer to Deemsel screwing it up is to send Ruprit back in, or vice versa. The following 1934 editorial cartoon from the Chicago Tribune shows that the troubles we face today are not new (click to enlarge):
The only real solution is to elect a third party that swears off financing from the same gang of special interests that control the purse and puppet strings of the two major parties. That won’t happen, because without that big funding no third party stands a chance of winning elections. That leaves only campaign finance reform as a possible solution, but that will never fly because the people who would plan and enact it are the ones who are in power because of the current system of campaign finance — and their backers aren’t eager to give up influence for the good of the people.
That’s why we’ll just keep screaming for change while choosing the same people to give us the same garbage that makes us scream for change again. Deemsel’s in the White House, and some people are excited to send Ruprit in his new Tea Party hat to Washington to shake things up.
Let’s see if we can get this more accurate than Bush got it: Fool me once, shame on you; fool me twice, shame on me. My fellow American voters, how many times will we get fooled before we feel a sense of shame and finally ask why we bother to choose between Deemsel and Ruprit every couple of years?
Perhaps abstaining from voting would send the clearest message that none of the usual suspects boasts a mandate.
I shared a month ago Arthur Laffer’s idea that a tax holiday would have cost less than the government’s budget-busting stimulus programs and would have already achieved an unemployment rate of 2.5%. Instead, the US faces bankruptcy thanks to a crescendo of mindless spending following decades of fiscal mismanagement in Washington, and still suffers an officially reported unemployment rate of 9.5% and an actual unemployment rate of 16.5%. See the July 12 article here.
Last week, a small business owner in New Jersey named Michael Fleischer provided further evidence of how government tax policies are killing job creation. He wrote in a Wall Street Journal opinion piece:
When you add it all up, it costs $74,000 to put $44,000 in [my employee] Sally’s pocket and to give her $12,000 in benefits. Bottom line: Governments impose a 33% surtax on Sally’s job each year. Because my company has been conscripted by the government and forced to serve as a tax collector, we have lost control of a big chunk of our cost structure. Tax increases, whether cloaked as changes in unemployment or disability insurance, Medicare increases or in any other form can dramatically alter our financial situation. With government spending and deficits growing as fast as they have been, you know that more tax increases are coming — for my company, and even for Sally too. Companies have also been pressed into serving as providers of health insurance. In a saner world, health insurance would be something that individuals buy for themselves and their families, just as they do with auto insurance. Now, adding to the insanity, there is ObamaCare. Every year, we negotiate a renewal to our health coverage. This year, our provider demanded a 28% increase in premiums — for a lesser plan. This is in part a tax increase that the federal government has co-opted insurance providers to collect. We had never faced an increase anywhere near this large; in each of the last two years, the increase was under 10%. To offset tax increases and steepening rises in health-insurance premiums, my company needs sustainably higher profits and sales — something unlikely in this “summer of recovery.” We can’t pass the additional costs onto our customers, because the market is too tight and we’d lose sales. Only governments can raise prices repeatedly and pretend there will be no consequences. And even if the economic outlook were more encouraging, increasing revenues is always uncertain and expensive. As much as I might want to hire new salespeople, engineers and marketing staff in an effort to grow, I would be increasing my company’s vulnerability to government decisions to raise taxes, to policies that make health insurance more expensive, and to the difficulties of this economic environment. A life in business is filled with uncertainties, but I can be quite sure that every time I hire someone my obligations to the government go up. From where I sit, the government’s message is unmistakable: Creating a new job carries a punishing price.
When you add it all up, it costs $74,000 to put $44,000 in [my employee] Sally’s pocket and to give her $12,000 in benefits. Bottom line: Governments impose a 33% surtax on Sally’s job each year.
Because my company has been conscripted by the government and forced to serve as a tax collector, we have lost control of a big chunk of our cost structure. Tax increases, whether cloaked as changes in unemployment or disability insurance, Medicare increases or in any other form can dramatically alter our financial situation. With government spending and deficits growing as fast as they have been, you know that more tax increases are coming — for my company, and even for Sally too.
Companies have also been pressed into serving as providers of health insurance. In a saner world, health insurance would be something that individuals buy for themselves and their families, just as they do with auto insurance. Now, adding to the insanity, there is ObamaCare.
Every year, we negotiate a renewal to our health coverage. This year, our provider demanded a 28% increase in premiums — for a lesser plan. This is in part a tax increase that the federal government has co-opted insurance providers to collect. We had never faced an increase anywhere near this large; in each of the last two years, the increase was under 10%.
To offset tax increases and steepening rises in health-insurance premiums, my company needs sustainably higher profits and sales — something unlikely in this “summer of recovery.” We can’t pass the additional costs onto our customers, because the market is too tight and we’d lose sales. Only governments can raise prices repeatedly and pretend there will be no consequences.
And even if the economic outlook were more encouraging, increasing revenues is always uncertain and expensive. As much as I might want to hire new salespeople, engineers and marketing staff in an effort to grow, I would be increasing my company’s vulnerability to government decisions to raise taxes, to policies that make health insurance more expensive, and to the difficulties of this economic environment.
A life in business is filled with uncertainties, but I can be quite sure that every time I hire someone my obligations to the government go up. From where I sit, the government’s message is unmistakable: Creating a new job carries a punishing price.
The Kelly Letter bought shares of Google (GOOG) in the midst of the subprime financial crisis at an average cost basis of $407. They rose to a high this year of $630 on January 4, fell to a low of $434 on July 6, and closed Friday at $500. I listed GOOG as one of the letter’s best buys from May 23 until now, a period that included share prices between the $434 low and Thursday’s $509 high. Now that GOOG is back over $500, I’ve removed it from the short list of best buys.
That’s due to valuation, however, not a lack of faith in Google’s future. I want to revisit the case for Google, having read and heard a great deal of skepticism about the company’s prospects as it competes with Apple (AAPL) and Microsoft (MSFT) in the hunt for online profits.
The bearish case against Google is well presented in the August 16 edition of Fortune magazine, which sports the unsubtle cover title, “Is Google Over?” with a picture of the letters in Google’s name melting into a puddle of their individual colors. The article by Michael V. Copeland and Seth Weintraub begins with the teaser, “Yes, the company is still growing at rates that would be the envy of the rest of the Fortune 500. But its core business is slowing, its stock is down, its Android mobil platform generates scant revenue, and competition (hello, Facebook) is fierce. Can Google find its footing in this brave new world?”
The article contends that a classic innovator’s dilemma confronts Google, and “the company seems unsure about how to move beyond the core search business that has brought it such massive success.” That success is to the tune of $23 billion per year in revenue, 91% of which comes from the AdWords and AdSense business model built around Google’s PageRank algorithm. “Even more telling,” the authors point out, “an estimated 99% of its profit does too.”
With 99% of its profit coming from search, Google looks vulnerable to an evolving internet that might not value search as much as it does other activities. The authors offer this example:
Say you want to buy running shoes to train for a marathon. Five years ago you would have simply Googled it, looked at the list of results, weighed your options, and made the purchase, perhaps by clicking on one of the sponsored links that accompanied your search. Today you might still do that, but increasingly you might pose the question “What running shoes should I buy?” to your friends on Facebook, or maybe write “Who knows about training for marathons?” on Twitter. By the time shopping service Groupon sends you (and 25 of your friends) an offer for the perfect shoes and registration for a race, you’ll probably just pounce on it.
They also tell the story of one James Buck, an American graduate student who was arrested in Egypt for taking photos of a protest near Cairo. He typed only the word “arrested” into his Twitter account via cell phone, and his network of people contacted officials at the University of California at Berkeley, who involved the US State Department and a local lawyer to get Buck out of jail within 24 hours. “Try that with a keyword search,” the authors quip, and contend, “This is the phenomenon Google is up against.”
Those two examples form the crux of the article’s argument that search isn’t what it used to be and, therefore, Google will need new business lines to grow. The growth of the internet itself is not enough to grow Google’s search business because search isn’t a core part of the new internet.
I disagree. The examples offered are fundamentally flawed.
In the first, we see a different way to gather information but not one that displaces initial search. While we may turn to our various online networks for personal advice on which shoes or other products to buy, where will the friends offering advice get their information? Somebody had to do initial research to whittle down the list of offerings in each category. They could always go to the source directly, such as a consumer website that specializes in product reviews, but a Google search remains the best way to get a list of such sources. Some people will have walked into physical stores to perform comparisons, but that option existed since long before Google took over the internet search industry.
So, research still needs to happen even when many people get their information via word-of-mouth, or word-of-fingertip (typing) as the case may be these days. When you merely utter the word “research” anymore, it’s tantamount to planning to Google something, be it shoes, or restaurants, or the history of space exploration. Moreover, somebody fishing for tips from friends rather than Googling their own information is assuming that those friends have already done worthwhile research which, as I just pointed out, probably included Googling as part of an in-depth effort.
In the second example involving the arrest of James Buck, we find a straw man. At no point in history was a Google keyword search the preferred way to get out of jail. Had Buck not found access to his Twitter account, he could just as easily have emailed a friend in California or called them. The State Department responds to phone calls as well and, by the way, automatically sends a consular to visit any American arrested abroad. They even provide a manual in English on how best to proceed in the arresting country’s legal system, and basic legal advice. I know this after an incident left me wiser and leaner at the end of an 11-day stay in a foreign hoosegow, and more familiar with a jail system than I thought I’d ever be.
For anybody who has not been through such a firsthand experience abroad, details await at the end of a Google search on “assistance to US citizens arrested abroad” and a click to the travel.state.gov page that comes up as the first result. Maybe James Buck could have saved his network of friends the trouble of “rescuing” him by running that lowly keyword search from his cell phone. He may have quickly noticed that Article 36(b) of the Vienna Convention on Consular Relations “provides that the foreign authorities shall inform the consular officer of the arrest of a national ‘without delay’ if the national requests such notification.” Most local authorities will ask the arrested subject if he or she would like them to submit such notification, which is why doing nothing would likely have produced the same result as James Buck’s now famous one-word tweet.
Thus, I reject entirely the argument that search is no longer a key part of the online experience. Social networking is great, but it did not supplant the need for somebody to research which running shoes are best for a marathon nor did it get James Buck out of an Egyptian prison. Google still plays a role in finding the right shoes, and the State Department needed neither Google nor Twitter to receive word that James Buck had been arrested and required a consular visit.
If the argument that search no longer matters falls flat, then the case against Google becomes unconvincing. It owns search, as the Fortune article points out: “Google sites lead the US market with 64% of all searches conducted.” If that can grow or even stay constant, then the growth of the internet should produce more search activity that turns into more revenue for Google.
As for it being a vulnerable one-trick pony, most great companies are exactly that. It’s di-worsification that usually causes problems. For instance, it doesn’t seem to bother anybody that Coca-Cola (KO) makes 100% of its profit selling drinks, that Exxon Mobil (XOM) makes 100% of its profit selling oil and gas, or that McDonald’s (MCD) makes 100% of its profit selling food. That’s what they do, and they do it better than most. Online search is what Google does, and it does it better than most.
All of Google’s other efforts are aimed at growing its search business, and that’s fine. The Fortune article mentions Google’s budding sub-businesses such as Android, DoubleClick for multimedia ads, Google Apps for Enterprise, Google Me (a planned social service to compete with Facebook), and YouTube. To downplay the impact that these and other non-core initiatives will have on Google’s bottom line, the article quotes Caris & Co. internet and software analyst Sandeep Aggarwal as predicting that they’ll total just $5 to $8 billion in 2013, which is peanuts compared to the $40 billion that Aggarwal estimates search will produce in three years.
While the Fortune writers see in that statement small numbers from the non-core businesses, I can’t help but notice the projected 74% growth in core search revenue on top of the new $5 to $8 billion from non-core business lines. Let’s take the middle of the non-core projected revenue range, $6.5 billion, and add it to the $40 billion in core search revenue to get total revenue in 2013 of $46.5 billion. Going from $23 billion now to $46.5 billion in three years doesn’t look like cause for concern, does it? I wish I could double my business revenue every three years.
Other sources show Google’s current revenue being $26 billion rather than the $23 billion used in the Fortune article, but the growth rate to $46.5 billion remains impressive from anywhere below $30 billion.
Finally, the article implies that Facebook advertising is going to prove more valuable to some advertisers than Google’s various forms of advertising. Real world results, however, give the nod to Google. As long as three years ago, advertising analysts found that Facebook’s way of advertising by targeting user interests was not as effective as Google’s way of targeting user behavior. The former relies on what people say while the latter relies on what people do. We should all know by now that actions speak louder than words.
The following is from a test run in October 2007 by AU Interactive writer Markus Urban:
Comparing every single metric, Google AdWords visitors were far more engaged, far more valuable, and far better targeted. The traffic was cheaper and more consistent. The volume was far higher. It’s not even close. Facebook ads just don’t work. And for all the hype that it’s gotten, it’s not even in the same ballpark as Google’s AdWords. Not even the same league. While targeting users by their listed interests may sound promising, it’s just not very effective.
Comparing every single metric, Google AdWords visitors were far more engaged, far more valuable, and far better targeted. The traffic was cheaper and more consistent. The volume was far higher.
It’s not even close. Facebook ads just don’t work.
And for all the hype that it’s gotten, it’s not even in the same ballpark as Google’s AdWords. Not even the same league. While targeting users by their listed interests may sound promising, it’s just not very effective.
More recent comparisons I’ve seen (by Googling the topic, incidentally) have shown Facebook narrowing the gap, but not closing it. It seems that knowing a person’s identity is less important than knowing what they’re looking for right now. For example, will my sister have better luck getting customers to Red Frog Coffee by targeting 30-year-old women within a 50-mile radius of the shop who identify “coffee shops” as an interest of theirs, or by targeting anybody searching on the phrase “coffee shop” within that same 50-mile radius? Probably the latter, because it allows flexibility for any demographic, for people who are traveling through the geographic zone instead of just those living there, and specifically people who are looking for coffee shops in the area. Advantage: Google.
I’m sure results from both advertising platforms vary based on a number of factors, so there’s no doubt that an increasingly popular Facebook and its ever-improving advertising platform are a challenge for Google, but they’re almost assuredly not a game ending development for the search giant.
Google has a history of surprising entrenched competitors with innovation. The search market itself was well established when Google came on the scene with its minimalist search box. I remember those days. I was one of the early users, and loved showing people stuck on Yahoo (YHOO) a new way to search. Since then, Google has managed to outflank installed software companies, such as Microsoft, with its excellent Google Docs system, and even browser makers with its unsurpassed Google Chrome browser that is both faster and more elegant than any other offering.
Should that innovation turn itself to social networking online, Google could open up a very profitable new business line. The Fortune article concedes that, too. In the concluding paragraph, we read that if Google added a “social layer to its core search business and to Android, and blew it out on YouTube, giving people a reason to hang out on Google sites for long periods,” advertisers “would come flocking” and Google would become “unstoppable.”
To that, I’d like to add that Google is up to something more with its Chromium project than just pumping out the world’s best internet browser. I’ve contended for some time now that all of Google’s endeavors seem to be heading toward a grand unified offering that could finally present a real challenge to the operating system duopoly of Microsoft and Apple. Those parts are essentially in place now, and Google is in the final stages of pulling them together when it rolls out the Chromium OS this fall. There’s a nice three-minute video on the OS at YouTube that shows how most of what we do on a computer involves the internet anyway, so we should reorient the OS to emphasize the internet.
Once that rolls out, it could be a compelling alternative to existing operating systems. Computer makers could bundle it for free, greatly helping their margins. Computer buyers would be able to get online within seconds of powering up their machines and access all of their online services, which comprise the bulk of what they’re doing with computers now anyway. What would they use? Anything they wanted, but probably a lot of what Google offers: Gmail, GDocs, Google Apps, Google Earth, YouTube, Google Buzz, Google Maps, Google Me social networking, and so on. What does Google hope to get out of this free giveaway? More people online to generate more ad revenue.
All in all, I don’t see much of a problem in Google’s future. Even if it maintains its current hold on search, the mere growth of the internet will see its revenue advance smartly. If it does a few things right to grow search, its revenue will improve all the faster. If it proves clever with its many new lines of business, they should add a decent chunk to overall revenue as well. If all of this adds up to a doubling of sales in the coming three years, current shareholders will be happy.
That’s why we’ll hold.
Disclosure: GOOG at $407
Many thanks to the fine folks at TheStreet.com for running an excerpt from Financially Stupid People Are Everywhere: Don’t Be One of Them as a summer reading recommendation this weekend. They even linked to the feature from their top page, one of the investing world’s most trafficked properties. See the excerpt at their site here.
Sometimes it’s best to just leave the market in its range, slip on the ol’ hiking boots, and take the dog on a long, lovely walk through the Colorado Rockies. So, that’s what I’m doing for the next couple of weeks. I hope you’re enjoying summer in your neck of the woods. Here’s my dog in mine:
We considered here back on July 2 some ways that this worsening recession could turn into a major war. If you’re going to read that article for background, be sure to read the many thoughtful comments as well.
One of my readers, Ron, sent along an article by Peter Schiff on the same subject but with a different angle. Schiff looked at the ways that World War II helped end the Great Depression, joked a little about staging a fake paintball war with Russia as a way to stimulate our way out of the current recession without killing anybody, then showed how, actually, the US can no longer afford a conflict on the scale of World War II anymore. Highlights from the article:
There is overwhelming agreement among economists that the Second World War was responsible for decisively ending the Great Depression. When asked why the wars in Iraq and Afghanistan are failing to make the same impact today, they often claim that the current conflicts are simply too small to be economically significant. Most economists believe that massive federal government spending on tanks, uniforms, bullets, and battleships used in World War II, as well the jobs created to actually wage the War, finally put to an end the paralyzing “deflationary trap” that had existed since the Crash of 1929. Many further argue that war spending succeeded where the much smaller New Deal programs of the 1930s had fallen short. The numbers were indeed staggering. From 1940 to 1944, federal spending shot up more than six times from just $9.5 billion to $72 billion. This increase led to a corresponding $75 billion expansion of US nominal GDP, from $101 billion in 1940 to $175 billion by 1944. In other words, the war effort caused US GDP to increase close to 75% in just four years! The War also wiped out the country’s chronic unemployment problems. In 1940, eleven years after the Crash, unemployment was still at a stubbornly high 8.1%. By 1944, the figure had dropped to less than 1%. But to repeat the impact of World War II today would require a truly massive effort. Replicating the six-fold increase in the federal budget that was seen in the early 1940s would result in a nearly $20 trillion budget today. That equates to $67,000 for every man, woman, and child in the country. Surely, the tremendous GDP growth created by such spending would make short work of the so-called Great Recession. The big question is how to pay for it. To a degree that will surprise many, the US funded its World War II effort largely by raising taxes and tapping into Americans’ personal savings. Both of those avenues are nowhere near as promising today as they were in 1941. Current tax burdens are now much higher than they were before the War, so raising taxes today would be much more difficult. That leaves savings, which was the War’s primary source of funding. During the War, Americans purchased approximately $186 billion worth of war bonds, accounting for nearly three quarters of total federal spending from 1941-1945. Today, we don’t have the savings to pay for our current spending, let alone any significant expansions. Even if we could convince the Chinese to loan us a large chunk of the $20 trillion (on top of the $1 trillion we already owe them), how could we ever pay them back? If all of this seems absurd, that’s because it is. War is a great way to destroy things, but it’s a terrible way to grow an economy. The truth is that we cannot spend our way out of our current crisis, no matter how great a spectacle we create. Even if we spent on infrastructure rather than war, we would still have no means to fund it, and there would still be no guarantee that the economy would grow as a result. What we need is more savings, more free enterprise, more production, and a return of American competitiveness in the global economy. Yes, we need Rosie the Riveter – but this time she has to work in the private sector making things that don’t explode. To do this, we need less government spending, not more.
There is overwhelming agreement among economists that the Second World War was responsible for decisively ending the Great Depression. When asked why the wars in Iraq and Afghanistan are failing to make the same impact today, they often claim that the current conflicts are simply too small to be economically significant.
Most economists believe that massive federal government spending on tanks, uniforms, bullets, and battleships used in World War II, as well the jobs created to actually wage the War, finally put to an end the paralyzing “deflationary trap” that had existed since the Crash of 1929. Many further argue that war spending succeeded where the much smaller New Deal programs of the 1930s had fallen short.
The numbers were indeed staggering. From 1940 to 1944, federal spending shot up more than six times from just $9.5 billion to $72 billion. This increase led to a corresponding $75 billion expansion of US nominal GDP, from $101 billion in 1940 to $175 billion by 1944. In other words, the war effort caused US GDP to increase close to 75% in just four years!
The War also wiped out the country’s chronic unemployment problems. In 1940, eleven years after the Crash, unemployment was still at a stubbornly high 8.1%. By 1944, the figure had dropped to less than 1%.
But to repeat the impact of World War II today would require a truly massive effort. Replicating the six-fold increase in the federal budget that was seen in the early 1940s would result in a nearly $20 trillion budget today. That equates to $67,000 for every man, woman, and child in the country. Surely, the tremendous GDP growth created by such spending would make short work of the so-called Great Recession.
The big question is how to pay for it. To a degree that will surprise many, the US funded its World War II effort largely by raising taxes and tapping into Americans’ personal savings. Both of those avenues are nowhere near as promising today as they were in 1941.
Current tax burdens are now much higher than they were before the War, so raising taxes today would be much more difficult.
That leaves savings, which was the War’s primary source of funding. During the War, Americans purchased approximately $186 billion worth of war bonds, accounting for nearly three quarters of total federal spending from 1941-1945. Today, we don’t have the savings to pay for our current spending, let alone any significant expansions. Even if we could convince the Chinese to loan us a large chunk of the $20 trillion (on top of the $1 trillion we already owe them), how could we ever pay them back?
If all of this seems absurd, that’s because it is. War is a great way to destroy things, but it’s a terrible way to grow an economy.
The truth is that we cannot spend our way out of our current crisis, no matter how great a spectacle we create. Even if we spent on infrastructure rather than war, we would still have no means to fund it, and there would still be no guarantee that the economy would grow as a result.
What we need is more savings, more free enterprise, more production, and a return of American competitiveness in the global economy. Yes, we need Rosie the Riveter – but this time she has to work in the private sector making things that don’t explode. To do this, we need less government spending, not more.
One of the great dangers of bank stimulus that makes its way into securities markets is that it distorts the apparent health of the economy. The high-level, crony-replete financial system with its ties to government is far removed from economic factors that affect typical citizens in the US economy. It’s well understood by now that the tax dollars given to banks for the purpose of restarting lending and goosing business activity has instead gone largely into asset markets to pump them up and improve bank balance sheets. Anybody doubting that will become a believer after attempting to get a loan.
When asset markets jump, their wealth effect can help earnings dramatically even in non-financial companies. We’ve seen that over the past five quarters or so as stimulus seemed only to stimulate earnings reports. Now, we have those on the books. Some analysts look at those and project them ahead, as if the conditions of the stimulus will be sustained far into the future. That’s a sketchy assumption, though, considering that real economic numbers such as consumer confidence, retail sales, housing data, and other sets show that any stimulation achieved is already fading.
Another problem with projecting stimulus boosts into the future is that they can make current stock prices look cheap when they are not. They essentially are saying, “If the fake growth created by stimulus over the past year continues into future years even though the stimulus will be gone, stock prices are cheap today.” Couching the statement in official terms masks its absurdity.
John Hussman touched on this in his weekly comment yesterday, titled “Don’t Take the Bait,” from which the following:
I continue to urge investors to have wide skepticism for valuation metrics built on forward operating earnings and other measures that implicitly require US profit margins to sustain levels about 50% above their historical norms indefinitely. Forward operating earnings are Wall Street’s estimates of next year’s earnings, omitting a whole range of actual charges such as loan losses, bad investments, restructuring charges, and the like. The ratio of forward operating earnings to S&P 500 revenues is now higher than it has ever been. Based on historical data, the profit margin assumptions built into forward operating earnings are well beyond two standard deviations above the long-run norm. This is largely because, as Bill Hester noted in his research article last week, forward operating earnings are heavily determined by extrapolating the most recent year-over-year growth rate for earnings. In the current instance, this is likely to overshoot reality, and in any event, has little to do with the long-term cash flows that investors can actually expect to receive over time. I can’t emphasize enough that when you hear an analyst say “stocks are cheap based on forward operating earnings” it would be best to replace that phrase in your head with “stocks are cheap based on Wall Street’s extrapolative estimates of a misleading number.”
I continue to urge investors to have wide skepticism for valuation metrics built on forward operating earnings and other measures that implicitly require US profit margins to sustain levels about 50% above their historical norms indefinitely. Forward operating earnings are Wall Street’s estimates of next year’s earnings, omitting a whole range of actual charges such as loan losses, bad investments, restructuring charges, and the like.
The ratio of forward operating earnings to S&P 500 revenues is now higher than it has ever been. Based on historical data, the profit margin assumptions built into forward operating earnings are well beyond two standard deviations above the long-run norm. This is largely because, as Bill Hester noted in his research article last week, forward operating earnings are heavily determined by extrapolating the most recent year-over-year growth rate for earnings. In the current instance, this is likely to overshoot reality, and in any event, has little to do with the long-term cash flows that investors can actually expect to receive over time.
I can’t emphasize enough that when you hear an analyst say “stocks are cheap based on forward operating earnings” it would be best to replace that phrase in your head with “stocks are cheap based on Wall Street’s extrapolative estimates of a misleading number.”
I joined a nice conversation with Michelle Maltais at the Los Angeles Times over the weekend, regarding the benefits of e-book publishing, specifically as it applies to Amazon’s Kindle program. From my comments:
You can hear the conversation here, with my segment beginning at 2:38.
I received yesterday a certified letter from the IRS informing me that I need to send money to the Treasury for the third time in three months. On the one hand, I’m fortunate to make enough money to need to pay so much so often. On the other hand, I have to wonder what I’m getting in return for such a privilege. More bombs and bailouts? I wish it weren’t so, but history suggests that that’s precisely what my taxes will buy.
And I do mean my taxes. Not mine as in just mine, but mine mixed with taxes paid by fewer other citizens. Corporations have whittled their share of the federal income responsibility to just 12%. Now I find, courtesy of longtime reader Richard and material he found from the Gartman Letter, that the percentage of US households paying tax is on the decline. Witness the following excerpt from Gartman:
While on the topic of taxes this morning, we thought the following information gathered by the Tax Policy Center was hugely important as nearly half of the US households paid no federal income tax last year because their incomes were too low or because they qualified for enough income tax credits, income tax deductions and/or income tax exemptions to avoid any tax at all. The problem is the trend is for ever greater numbers of people to avoid income taxes and to thus have “no skin in the game” of governance: In 2006, 37.3% of the households in the US paid no income taxes: In 2007, 37.9% did not pay taxes; In 2008, 48.5% did not, and In 2009, 46.9% did not. This is a shocking trend indeed, for it was only five years ago that nearly 2/3rds of the public paid in income taxes to Washington. Five years ago 2/3rds of Americans had “skin in the game” of government. Last year, that was down to just a very little bit more than 1/2, and if the trend has continued, when the data for 2010 is gathered we may find that we’ve crossed the 50% threshold. When the majority of the people find that they can elect representatives to government that will willingly raise the taxes on the minority, the minority… the productive citizens of the nation… are doomed; the Republic is doomed; the great experiment in free markets, property rights and sanctity of contract shall be on its way to swift and certain failure. Of all the statistics we’ve seen lately that give us reason to be disconcerted about the future this is the one. It is a trend in full; it is a trend we fear… greatly.
While on the topic of taxes this morning, we thought the following information gathered by the Tax Policy Center was hugely important as nearly half of the US households paid no federal income tax last year because their incomes were too low or because they qualified for enough income tax credits, income tax deductions and/or income tax exemptions to avoid any tax at all. The problem is the trend is for ever greater numbers of people to avoid income taxes and to thus have “no skin in the game” of governance:
In 2006, 37.3% of the households in the US paid no income taxes: In 2007, 37.9% did not pay taxes; In 2008, 48.5% did not, and In 2009, 46.9% did not.
This is a shocking trend indeed, for it was only five years ago that nearly 2/3rds of the public paid in income taxes to Washington. Five years ago 2/3rds of Americans had “skin in the game” of government. Last year, that was down to just a very little bit more than 1/2, and if the trend has continued, when the data for 2010 is gathered we may find that we’ve crossed the 50% threshold. When the majority of the people find that they can elect representatives to government that will willingly raise the taxes on the minority, the minority… the productive citizens of the nation… are doomed; the Republic is doomed; the great experiment in free markets, property rights and sanctity of contract shall be on its way to swift and certain failure. Of all the statistics we’ve seen lately that give us reason to be disconcerted about the future this is the one. It is a trend in full; it is a trend we fear… greatly.
I fear it greatly, too, and my personal feeling shows why this trend will kill the nation if allowed to continue. Frankly, I get too little in return for the income taxes I pay, and I pay too much. Here’s what I’ve had to pay on my own on top of what I’ve had to pay to Uncle Sam over the years:
When I add up all the taxes I’ve paid, they total far more than the cost of all the above services I’ve had to fund on my own. Why don’t I get any of those services provided by my taxes? Instead, here’s what I’ve received in return for the exorbitant taxes I’ve paid:
If my taxes go even higher to fund all of the above while I continue needing to pay the higher education, insurance, and retirement costs for my family, why in hell would I want to work harder? Suddenly, ambition becomes idiocy. What was once considered a successful man turns into a sucker who foots the bill for all the deadbeats who don’t pay a dime into the system.
About the only good things I get in return for my taxes are roads and 911 services. Even the roads, though, I fund mostly via gasoline taxes. As a foreigner living in Japan, I’m better taken care of by that government than I am by my own. I don’t actually want government care, but if I have to choose between getting nothing in return for the taxes I pay and getting some useful services, I’ll take the services.
Now, here’s the really scary part. To be one of the “rich” who pay most of America’s taxes, your household needs to earn just $60,000 per year. Two people making $20 per hour and working 40-hour weeks will get there. We’re not talking about doctors, lawyers, and hedge fund managers. We’re talking about plumbers, electricians, and restaurant managers. If that group of mainstream Americans are footing the nation’s welfare spending, and the ranks of deadbeats are growing, we’re on course for catastrophe.
Cato Institute senior fellow Richard Rahn wrote in the Washington Times:
Assume you own stock in a company whose market share has fallen from approximately one-third of the industry 15 years ago to only one-quarter today, the company was racking up record losses and debt, and the management has proposed increasing the prices of its products while many competitors are cutting their prices. Would you vote to fire the management? Rather than a company, the entity I have just described is the United States. The US has been losing market share as a percentage of global gross domestic product, in part, because many competitors, particularly in Asia, have been leading with pro-growth economic policies while the US is piling more taxes and regulations on the productive sectors of its economy. . . . If those managing a company had acted as recklessly and irresponsibly as has Congress with the US economy, they rightly would be fired. Congress by its actions is driving away foreign capital, new and existing companies and jobs; burdening the people with excessive debt — and even providing an incentive for murder. Voters, who act as the shareholders of the US economy, have the responsibility to fire the “managers” (i.e., Congress) for their dereliction of duty. For the sake of the country, let’s hope they do so in November.
Assume you own stock in a company whose market share has fallen from approximately one-third of the industry 15 years ago to only one-quarter today, the company was racking up record losses and debt, and the management has proposed increasing the prices of its products while many competitors are cutting their prices. Would you vote to fire the management?
Rather than a company, the entity I have just described is the United States. The US has been losing market share as a percentage of global gross domestic product, in part, because many competitors, particularly in Asia, have been leading with pro-growth economic policies while the US is piling more taxes and regulations on the productive sectors of its economy. . . .
If those managing a company had acted as recklessly and irresponsibly as has Congress with the US economy, they rightly would be fired. Congress by its actions is driving away foreign capital, new and existing companies and jobs; burdening the people with excessive debt — and even providing an incentive for murder. Voters, who act as the shareholders of the US economy, have the responsibility to fire the “managers” (i.e., Congress) for their dereliction of duty. For the sake of the country, let’s hope they do so in November.