The Election is Finally Over. Now Wake Up- We Got Problems (LRG Capital Report)

Last week, after over a year and a half of campaigning, the United States of America elected its 44^th President, the junior Senator from Illinois, Barack Obama. Once again, the economy took center stage with most voters. In a pre-election survey by CNN/ Opinion Research Corporation Poll, 57% of the likely voters polled in the nationwide survey said that the economy was the most important issue to them in deciding on whom to vote for President. In the end, President elect Obama’s campaign theme that a vote for his opponent would be a vote for a continuation of the failed policies of the current administration was too much of a headwind for his Republican counterpart. With some of the lowest approval ratings for an outgoing President in history, President Bush didn’t leave much of a chance for whomever his party chose to run for the high office. Thankfully, the election is finally over, with a clear cut winner who will have to deal with once in a generation issues both economically and politically.

It’s important to understand that although a new face in the White House can certainly change the mood and social climate of the nation, it will take a long time for the economy to heal from years of financial mismanagement and readily available credit. Although some may look to the S&P 500’s 10% drop since last week as a sign that President Elect Obama is somehow doing something that the market does not like, the truth of the matter is that most market participants had factored in the Obama victory and its effects on the economy a long time ago. What is more important to look at is that the overall market, as measured by the S&P 500 is down close to 40% since it peaked out in October 2007 at a high of 1576.09, a clear trend of either a new bear market, or what many have argued as a continuation of the secular bear market that begin in the year 2000. Indeed, over a ten year span the S&P 500 is actually down by just about 10% (on October 12, 1998 the S&P 500 closed at 997.71 vs. October 12 close of 852.3). Certainly though, the health of an economy is not measured by stock market returns, but rather it is measured by the plight of the everyday worker (we’ll call him Tim the Teacher for the purpose of this exercise) who is now struggling with debt, rising costs, and a deteriorating job outlook.

A simple view of this past quarter’s earnings reports shows just where Tim the Teacher is spending or not spending his money. Last week, Seattle based Starbucks reported that profits plunged more than 96% in the last quarter as the company closed stores in the US, where same store sales were down 8%. So certainly, Tim has replaced his morning lattes with something more cost effective. Along those lines, if Tim the Teacher could no longer afford his morning coffee, his spending habits on other items, especially his favorite electronic gadgets would also have to change. Just last week, Circuit City, the best performing stock of the 1980’s, filed for bankruptcy citing “increased competition”. And yesterday, Best Buy cut its own forecast for the year saying that this is “the most difficult climate” ever. Additionally, the auto industry has been in decline for over a year now, with even the better run companies like Toyota and Honda decreasing their forecasts. Of course, as we know, the economic pain is stemming from the deteriorating housing market which is still showing steep declines, with the S&P Case- Shiller index posting record year over year declines of 16.6%. Declines of this magnitude do not turn on a dime, or from a new President, rather they will usually take months, if not years to find, a price where the necessary buyers can meet the selling pressure. So where is Tim the Teacher spending his money these days? One needs to look no further than the golden arches. Just last week, McDonalds reported that sales at its fast food restaurants open at least 13 months rose 8.2% in October, topping analysts’ targets and sending shares up more than 2 %. Same- store sales, a key gauge of retail health, rose 5.3% in the US. After years of zero savings, and spending borrowed money, frugality is now coming back into fashion.

The new administration is going to have to make some extremely difficult decisions over the next few months that will impact hundreds of thousands of people. Unfortunately, the Federal Reserve and the folks in Washington have shown that their preferred option of fixing the problems is to throw money at it. Whether it be low interest rates, increased money supply, or bailouts that reward failure, policy makers are now faced with an increasing problem of just what industry is critical enough to the nations economy that it justifies receiving taxpayers funds. This month, General Motors said that it will need some form of a bailout over the next 100 days as the company is facing a cash shortage. Already the talk out of Washington is that “allowing” a company such as GM, Ford or Chrysler to fail would be irresponsible and cause major disruptions throughout the economy. An analysis of GM, in particular, shows that the current veteran UAW member has an average base wage of $28.12 an hour, but the cost of benefits, including pension and future retiree health care costs, nearly triples the cost to GM to $78.21, according to the Center for Automotive Research. $78 an hour would be an excellent wage in high priced areas such as San Francisco or New York, but is there really a reason someone in Detroit, for example, where the cost of living is much lower than those areas should be receiving such a high hourly wage? Is it the taxpayer’s problem that GM negotiated contracts with its Unions that are unsustainable? For us, the answer is clearly that it is not, especially seeing that Toyota and Honda are now also producing cars in the US and are doing so profitably.

We are going down that slippery slope that the founders of this country warned us about at its inception. In a letter to the Secretary of the Treasury Albert Gallatin (1802), Thomas Jefferson wrote,

“I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

Bailouts do nothing more than reward failure and cause a misallocation of capital from profitable to incompetent industries and people. We have entered a time where there is essentially no shame in failure and asking for handouts from the government. By using public funds to prop up failing companies the government is basically robbing Peter to pay Paul. Unfortunately, Congress opened the Pandora’s Box and now companies are lining up saying that their industry is critical to the health of the nation. The effect of all this bailout spending and increased money supply will eventually result in higher interest rates, a devalued currency, and higher commodity prices. All factors which will result in more pain and hardship for the consumer. It’s simple economics that a nation cannot devalue itself into prosperity. Unfortunately, elected officials only see the economy in 4 year terms, or their own personal re- elections. If debasing the currency, through propping up failing companies and the jobs at those companies, will allow the politician to keep their job, than that’s what he or she will do. Hopefully, the new administration will put a stop to some or all of this madness and not give us the same kind of spin that we have become accustomed to. The Fed and banks can pump enough money into the economy to put the Dow to 100,000, but in real terms, or against gold for example, it will not feel like much of an accomplishment when it will cost $10 for a gallon of gas.