Views on 2013

I thought, like everyone else I would make some predictions, so I can look forward to reviewing just in what exact ways I was wrong about the happenings of 2013. So without further ado.

I think there is a continued rebalancing process going on where better growth rates in emerging and frontier economies and currency devaluations and easing by central banks in developed countries like the US, Japan, and Europe will decrease gaps in the economies and standards of living between rich countries and poor countries.

Education has been "democratized" and is available globally. The set of corporate laws, strategies, infrastructures and overall economic "setups" are becoming more similar and copied across business and countries internationally as well. We will all be playing by the same rules. I expect continued slow global growth overall and for countries to have increasingly similar profiles, pushing the small competitive edges that they can.

Individuals within countries will have more differentiated profiles. Software, robotics and technology overall continue to offer efficiency and productivity improvements. Employment tied to these areas will do extremely well, while cannibalizing work from other non-technology workers, now unnecessary. Unemployment leads to pockets of frustration, violence, crime, fundamentalism and overall discontent. Long term unemployed and discouraged workers are left behind or become difficult to bring back up to speed. Human talent decays quickly in disuse. Differential benefits from receiving more units of education and compounding benefits from ownership of productive assets (stocks, bonds, real estate, etc) will also magnify wealth gaps over time.

Competition for scarce resources will be another ongoing trend. Geopolitics will come more into focus from an investment standpoint, along with topics like state capitalism, resource nationalism, and currencies . We will continue to see extreme weather events, greenhouse effect impacts, environmental destruction, and basically, we won't do anything about it.

 

The rise of the "temporary worker" and "contract position" along with overall employment and economic uncertainty will be just another trend that holds back consumer spending in US economy.

US multinational corporations will continue to do well. Cheap, well educated, plentiful workers, global marketplaces to sell into, executives focused on high return on investment projects, and efficiency and productivity improvements from software, technology will all be beneficial for continued high profitability.

Over the longer term, I expect more cutthroat and explicit use of metric indicators like credit scores, genetic scores, intelligence scores permeating all areas of social life. Education and medicine last frontiers to finally begin to be disrupted by software in systemic ways. 

Wealth gaps stretch further. Cultural and political gaps stretch further. Do we find ways to form new equilibriums and compromises? A new more collaborative culture? What is it?


Overall, increasing similarity between the profiles of individual countries, and increasing differences between the profiles of people within those countries is the biggest trend I think shaping the world we are in today. I wouldn't be surprised with the s&p500 anywhere between 1200 and 1500. A little more downside than upside.

Low interest rates from the fed continue to punish savers, encourage financial risk taking, and make stocks a fair if uninspiring and slightly overvalued asset to currently purchase more of for long term investors. The strong version of the "efficient markets hypothesis" is sufficiently disbelieved and there is sufficient distrust in the general public of the stock market due to recent crashes, that it makes sense ironically, that the market would be perhaps more efficient than usual in tracking to the real value of underlying companies. No one is dogmatically buying anything regardless of price, except perhaps those buying gold. Lots of people holding cash and waiting for everyone to throw up their hands in a panic and dump assets at obvious firesale prices for some reason. The usual work by serious analysts, insiders, institutional investors, etc that the efficient market hypothesis talks about continues to take place, and perhaps, things will continue to muddle along at fair value in the usual, boring, business cycle type manner - Just a little slower, a little less powerfully than we've grown in past decades.
  

"Japanification"

Characteristics of a "Balance Sheet" Recession e.g. Japan 1990s:

Article: http://www.businessinsider.com/fiscal-cliff-understanding-the-significance-through-richard-koo-2012-11 

• Happens after an "asset price crash" which destroys health of corporate balance sheets
• Firms have a preference to minimize debt, rather than maximize profit
• Focus on repairing "balance sheets", improving financial strength
• Economy is unresponsive to Central Bank lowering interest rates because no demand for debt

PIMCO - Viewpoints
Article: http://www.pimco.com/EN/Insights/Pages/Japanification.aspx

From the Whitepaper:

Ballooning fiscal deficits, record low interest rates, depressing economic growth, private sector deleveraging, uncoordinated and ineffective governmental responses and monetary authorities increasingly exhausted and reluctant to act. Over the past two decades, people would have associated this characterization with Japan. However, more recently, they are accurate descriptions of the status quo in many other developed countries, raising the question: is the developed world becoming “Japanified?”


Companies Avoiding Commitment Due to Uncertainty
Article: http://www.bloomberg.com/news/2012-07-18/temporary-work-demand-rises-as-companies-avoid-commitments-jobs.html

Jobs With High Uncertainty and Low Wages Driving Employment Growth
Article: http://www.ritholtz.com/blog/2012/12/low-wage-sectors-drive-employment-growth/

US Consumer - Attitudes and Personal Finances Shifting:

Article: http://www.theatlantic.com/magazine/archive/2012/09/the-cheapest-generation/309060/
Why aren't US "millenials" buying houses and cars in the same numbers as previous generations?

Responses from Reddit.com discussion forums:

"You can't expect us to have a mortgage worth of student loans, then take on a mortgage. You can't expect to not have any jobs with benefits available so that a small injury can turn catastrophic, and expect us to have babies to make a new generation to pay the bills from yours. You can't expect us to buy new cars when our wages are shrinking and food prices are going up."

"Maybe its that no one has any fucking money."

"One thing nobody has mentioned is how the lack of careers is affecting this. Not many people have a career where they know that they will earn x dollars a month for the next thirty years. Instead the most common state of affairs is temporary jobs where you can be fired on a whim. This situation doesn't lend itself to committing to mortgage or car payments over a long period of time."

"Yeah, I'll buy a house and a new car... right after I finish paying off this student loan debt. Somewhere along the way to squeezing every last penny out of the middle class corporate America forgot that they need consumers to actually buy their crap."

"What is so hard to understand that our generation is broke. Its not that I don't want a brand new fiesta, but I'm in grad school because my 50k bachelor's degree isn't good enough in today's competitive jab market. I don't have any money. When I told a family friend that I was moving to Victoria BC for grad school he said to me, 'but real estate is so expensive there!' Well, that's fine, its not like I can afford to buy a house on $300/week stipend!"

"Student loans. The recession is one thing, but the Millennials are getting way more in debt to pay for their education than the Baby Boomers ever did. We simply can't afford cars."

"Information and jobs move so fast today that you really expect to eventually move for work, so why buy a house? We are also much more informed about the environment and our toll on it. Instead of reading about it once a month in national geographic we read about it everyday. I think more people are walking, biking, carpooling."

"I'm a millennial and this is my message to car manufacturers: I want a car that's smarter than my phone, that isn't destroying the earth through CO2 emissions and that doesn't cost me more than a full year's salary before taxes. Then I'll buy a car."

"Even if it hasn't been altered by choice, having to pay college loans and dealing with a difficult job market would make many people wary of taking on debt in a vehicle."

"Why won't the most educated group of people who ever lived buy an overpriced depreciating asset like a car, or anchor themselves to a plot of overpriced land with a poorly constructed house that they will have to sell in 2 yrs when they get a better job 500 miles away."

"You mean the generation that paid three times as much for college to enter a job market with triple the unemployment isn't interested in purchasing the assets of the generation who just blew an enormous housing bubble and kept it from popping through quantitative easing and out-and-out federal support? Curious."  

" I don't find this surprising at all. Today's college graduates start off with a huge mountain of debt. If they find a job, it rarely comes with job stability. It's either a crap McJob with no benefits or a full-time gig they could lose at any time. Temp work and contract work are the norm. Few people get traditional salaried jobs with benefits anymore.

Why would you not expect this to affect people's purchasing habits? When faced with high debt and a very uncertain employment environment, the rational person:
-Lives more frugally
-Avoids long-term payment obligations
-Saves up a large emergency fund.
We've all seen friends go a year or two unemployed. If you lose your job, you won't just instantly be able to walk out the door and find another. You could easily be out of work for a year or two.
I ride a motorcycle around. If I didn't have that, I would just take the bus. It would take me 1/2 hour instead of ten minutes to get to work, but oh well. At an hour a day that's 52x5 = 260 hours per year. If not having a car saves me $4000 a year in fuel, maintenance, insurance, car payments, etc, then that comes to a savings of $15 an hour for every hour I ride the bus. I'm effectively getting paid $15 an hour to take the bus.
What about groceries? Well I can get those on my motorcycle. It would be harder if I had kids, but for a singleton it works out fine.
What about going out? Most of my time I'll be hanging out at my or someone else's house watching a movie, gaming, etc. I either don't need a ride or can carpool with a friend and chip in gas. If I'm going to a bar, a car is useless as I would want to take a cab anyway.
Traveling? I don't have family in nearby cities. My friends are in the same town and my family is 900 miles away. If I see them, I fly. A car is completely unneeded" 

"What I find vastly amusing is that automakers honestly believe that the key to breaking through the wall of no money, no need for a car and no desire to add to global warming is "hipping up" the names of your paint colors. Because if I'm a broke hippy living in a town with bus service and bike lanes, none of that will matter anymore once I realize that I can get the latest smog-wagon in 'pink lemonade'."

"5 year career as an engineer. Been laid off once, facing it again. I really hate the uncertainty of this economy. I'm driving a car with 140k miles with engine problems to save money because I don't know when I'll have a job. I have 6 months of pay in savings. If I had job security you bet your ass I would drive a better car, possibly the new Hyundai hatchback. "

"My dad covered an entire year's tuition, the cost of his (new) car, insurance, and gas back in the 70s with a summer job at the meat packing plant. My summer job in college didn't even cover tuition." 

Why I Like Consumer Staples

1) Population growth slowing and that stability and lower growth means COMPETITION. High focus on ROI and necessities
2) Inflation risk from QE means it is good to have pricing power, sell necessities
3) Good exposure to current emerging market consumers
4) Simple business models, no technology risk, benefit from technology
5) Psychology of habit, trust

The "new normal" is eventually going to be a global growth environment where the rate of natural demographic expansion has slowed down over time, until its reached zero. Every ecosystem matures. Mathematically with many kinds of growth you often see the same sigmoidal curve type pattern. I think it’s important to look for places where there may already be highly successful companies at being simple, consistent and profitable in a mature environment, "low/no growth" environment. So, at some point the human population on earth is going to be "some stable range", rather than adding millions of people every year.

I also think you want to own companies that sell necessities. If things are stable and growth is low, budgets are constrained, resources get conserved rather than consumed, ROI is a high focus, and people are looking to optimize their spend - it is better to own companies that sell things people need, not things they just want. Consumer staples are by definition, products people need. The industry is also one such space where there has been that kind of lower growth, boring stability for many years with big name companies like P&G, Phillip Morris,  Pepsi, etc all the while churning out regular, consistent cash flow.

Consumer staples companies also have good exposure to more positive population growth rates in the developing world. With population expected to trend towards 9 billion globally and then level off in the upcoming decades, they can also position to capitalize on these positive demographic and economic trends in emerging markets.

Consumer staples companies are in industries that are slow & simple. Despite the tumultuousness and "black swan" risks of the modern world, their business models are hard to invalidate. There isn't a lot of technology change that can make them irrelevant or displace them. In fact, they benefit from leveraging those technologies to run their operations more efficiently. There are strong industrial era economies of scale they can take advantage of in production of their goods. And people are people with certain daily needs… food, drink, painkillers, first aid, soap, sanitation, etc.

Info Overload: Who is the modern consumer?

Two huge seeming problems people have in the modern world today are that there is an overwhelming amount of complexity and information to deal with to make a decision, and equally a lack of time to deal with it in. Doesn't matter if its a young adult in the process of picking their college major, or trying to decide what restaurant you want to go for dinner at. If I truly want to evaluate all my options and make the 100% optimized decision, it’s practically impossible to do. So complexity would seem like a big problem, information overload would seem like a big problem, so how are people still able to go about their days effectively?

What the amount of information available in the modern age makes truly obvious, is that we aren't perfectly rational human calculators. The simple answer for what we do with all that information available? We ignore it. We try not to get overwhelmed by it. We come up with simple systems like checklists to avoid complexity. We go off of habits, personal recommendations, gut feelings, trust. We tend to make decisions with quick rule of thumb calculations that won't always leave us with the 100% optimal choice, but will get us from point A to point B without doing 10 hours of charts and research to pick a brand of Peanut Butter.

Products that help me simplify things, match well with "quick rules" or heuristics I use, and help me deal with all that complexity will be successful. And that’s where brands come in and why I like consumer staples.

Brands and Habits: How do I deal with the complexity? 

One quick rule of thumb you can use to evaluate a product, "Have I heard of them before?". If you haven't, that's going to need to be subject to more scrutiny. Brand name recognition is similar to the "social proof" phenomenon that is evolutionarily wired into us, and helps us with an indication a product is a safe option. By going with the name you know or a brand you trust, you can save the psychic cost and time of making a decision - which actually as the decisions pile up can be surprisingly taxing, and worthwhile saving on.

Every company has a brand. The key factor in the appeal of consumer staples companies are their ability to create and own trusted brands for products people need in their daily lives. 

In general for any kind of buyer, people will pay more for assurance of quality, and avoidance of risk. They'll pay up for certainty. So going with a trusted brand name product helps me to do that as well. Where a product might be something that they regularly eat, brush their teeth with, & include intimately in daily life that effect may be magnified in favor of consumer staples companies. People buy the comfort and perceived safety of going with the brand they recognize, or on the other side of the coin, the fear of going with the product that they don’t recognize. If you are buying consulting services or hiring a new employee, its easy to go with the guy who has a personal recommendation from a friend or colleague, versus a similar candidate lacking that social proof. If you are buying personal health products its similarly easy to pick the Advil or Tylenol off the shelf rather than going with some weird store brand option that you have less assurance with to save a few cents.

That brings me to habits, and another reason why I think consumer staples companies are interesting. Maybe its been on a trip, or moving to a new neighborhood, but everyone's had the experience at one point or another of going into a new grocery store that they haven't been in before. Suddenly, there's a million choices and you better have a list to follow or you'll be wandering around for what feels like years trying to figure out what exactly it is you need and where it might be located in this particular new store. 

If I am buying a computer, I do research and find the best option, once. If I am buying shampoo at a grocery store, there is a huge amount of value in having a routine, a habit, and a set practices that I employ each and every trip I make in order to save me time. Just imagine the new grocery store and how much longer than usual that might take before you get familiar with it, how much more searching you would do. Again, this is where brands and habits come in. I just kind of pick one off a name I know and like, and then if it works, I keep buying it. It’s a much less analytical decision, more gut level and value in repeating the same choice.

A benefit for consumer staples companies is that with small expenses its much easier to spend more to make a decision on loyalty for a brand. Paying up for that brand you know "feels" a lot cheaper for a consumer when you are paying for laundry detergent versus say a BMW or something. With frequently repeated purchases there is also a higher cost to being analytical and more value to forming a habit just because of the fact that if you don't, you will have to spend time conducting this analysis very often. Frequency magnifies the reasons why we use our quick decision making tools like habits, loyalty and brand recognition.

Consumer Staples

So, these factors all tie together very favorably in my view for big consumer staples companies. They have enduring pricing power because of the brand factor & trust, which are deeply tied in with social psychology, perception, and how people have made decisions all the way back to the proverbial Savannah. In a "boring" low growth environment, which these companies have already been in for a while, they continue to churn out free cash flow, and given the dynamics that create their pricing power I have a hard time imagining a scenario where basic human nature about trust changes, or technology somehow invalidates people’s needs for food, drink, basic health and sanitation, tobacco, etc.

One risk would be that people become more comfortable with off-brand products or become more solely price focused. Another downfall could be that they can't figure out how to succeed with emerging market consumers.

Other means of pricing power:

Individual staples companies like a Phillip Morris or Coca Cola have additional pricing power aside from the brand recognition & loyalty in that their products are highly and/or somewhat addictive, respectively… just another way of having the demand for their products be strongly in-elastic and unresponsive to different changes in the environment.