Making new highs
July 29, 2005
As I expected, the token revaluation of the renminbi has
had no material impact on any markets thus far. Nevertheless, China and
the renminbi remain key to the future of the US economy. In the meantime,
the US economy is chugging along nicely with many stock indices making
new highs this week on the back of better-than-expected corporate earnings.
Strong corporate earnings are making the case that the economy
is on solid footing, according to the Wall Street Journal. For some time
now I have been making the case that the economy is not on solid footing
based on the automotive sector. Americans love cars and they are not afraid
to go into debt to buy newer and more expensive cars. So when the auto
industry suffers it tells me that consumers are tapped out.
This week General Motors announced that its North American
automotive division lost $1.2 billion during the second quarter. The company
recently shook up the industry when it started selling its cars to consumers
for the same price it offers its employees, forcing other car manufactures
to do the same. Both Ford and Daimler-Chrysler entered the price war by
offering their cars at employee prices as well.
While Ford Motor Company made a profit in the second quarter,
it was 19% less than last year because of a $907 million loss at its (you
guessed it) North American operations. Both Ford and GM are suffering
because higher gasoline prices have reduced demand for their high-margin
sport utility gas-guzzlers. As a result, Ford is considering deeper cuts
to its workforce: a third of its white collar workers could lose their
jobs. That would mean an additional 10,000 unemployed.
Meanwhile General Motors said it would end its “employee
discounts for everyone” promotion and cash rebates, and instead
just reduce sticker prices permanently. I don’t recall how many
times in the past eighteen months I have said that prices for durable
goods and luxury items will go down (as the economy falters) while the
prices of essential consumables such as energy and food could increase.
It is busy happening.
Were we not still riding on the tail end of one of the largest
economic expansions in history it might almost be tempting to buy the
downtrodden automotive stocks. Had we been in the trough of a business
cycle I would certainly have looked at it seriously. But we are at the
top of a mega-cycle that was created during the Nineties, and that has
not yet been corrected.
During the Nineties there was a lot of talk about the wealth
effect and its impact on stock speculation. While the rhetoric has died
down, the wealth effect has not diminished. Both the real estate market
and the stock market are still rife with speculation. The major stock
market indices (excluding NASDAQ) are almost at their all time highs again
and I have commented in the past on real estate speculation.
Every business cycle expansion is followed by a contraction
during which assets change ownership and excessive speculation is eliminated.
We have not gone through that yet and, until we do, a lot of risk remains
in the stock, bond, commodity and real estate markets.
Paul van Eeden
Paul van Eeden works primarily to find investments for his
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