I Know, Everybody Funny, Now You Funny Too

I come home one particular evening

The landlady said, you got the rent money yet?
I said no, can't find no job
Therefore I ain't got no money to pay the rent
She said I don't believe you're tryin' to find no job
Said I seen you today you was standin' on a corner
Leaning up against a post
I said but I'm tired,

one bourbon one scotch one beer  by George Thorogood and The Destroyers

Not your fathers (nor grandfathers) recession:

So this is it, this is all we get after $800 billion in stimulus and $2 trillion in dollar printing, a measly 36,000 net jobs last month, not enough to keep up with births. In December American companies hired 4,184,000 workers, while another 4,162,000 either quit or were fired. See if you can guess whether those fired made more than those hired? No, this isn't a typical cyclical recession, something much bigger than lost housing bubble jobs is at work here. Companies have come to realize that employing people is very expensive; regulations, taxes, health care costs, etc. Some of them have decided to hire people outside the US, but more and more have realized that increases in computing power have significantly decreased the need for flesh & blood.

This week IBM's supercomputer Watson has successfully held its own against the smartest Jeopardy champions of all time. Watson utilizes 90 servers to mimic the lightning fast intuition of humans, scary good. The interesting thing about Watson's power is that it will probably be available on your laptop/smart phone in the next five years. The beauty of cloud computing is that it allows users to tap into the vast knowledge of mankind in milliseconds. Our local library here in Mt Lebanon has cut its staff from 50 to 36 (-28%) and is still struggling to keep its doors open. No librarian can compete with a Google search that gives you thousands of results in 0.14 seconds. My daughters do 100% of their research on the internet, the only times they use the library is when a teacher clinging to the past makes them. 

Forget blue-collar and white-collar to define jobs, the present and future are about "creators" and "servers". As author of "Eat People" Andy Kessler explains; "creators" are the ones driving productivity, writing codes, creating drugs, running search engines...creating. "Servers" are the ones who service the creators; building homes, providing food, financial service, and legal advice. Many "servers" are being replaced by computer enhanced machines, and this trend is in its infancy. The world needs less servers and more creators.

As my oldest daughter enters high school later this year we are already trying to figure out what to do about college. Colleges are "servers", yes they have pockets of creativity, but by and large they are there to serve, and frankly they've done a horrible job. During the thirty years that I've been out of college the cost of living (inflation) has gone up by 106%, health care costs have risen 251%, but college expenses have ballooned by 439%! Yes, the college graduate makes more than the high school graduate, but no where near enough to cover the astronomical increase in cost. As a parent there is a bright spot to this hyper growth in computing power, online education. Many believe that the shakeout that has happened in corporate America is just starting to happen in academia, and that big college campuses will soon be relics. Over 30% of all college students currently take at least one class online. An online self-paced calculus class costs $70, while a similar class on the campus of a private school runs about $3,000. Certainly the social aspects of a college education are extremely valuable, but probably not $50,000 per year valuable. We as consumers will have choices for advanced education, and unemployment among college employees will grow.

The creative destruction caused by e-commerce continues to move through our society. As more and more people shop online we need fewer and fewer stores, just look at this weeks Boarders bankruptcy, those jobs are not coming back. As research firm ISI puts it, we are not overstored, we are underdemolished. By saying overstored you are hoping that someday those stores will be occupied, that just isn't going to happen. 33% of households have made purchases on their smartphone or iPad, and that number is growing at a 20% clip, while brick and mortar retail store sales are growing at a sub 1% clip. 

Obviously the biggest group of servers in the country are government employees, (contrary to what you may have heard the government does not create jobs). Even here, with their strong unions and political clout we are finally seeing some serious cut backs. Some are happening because the government is broke, but a large number are happening because of technology. Here in Pittsburgh our local branch of the Federal Reserve bank announced last week that the 200 employees that worked in the savings bond department would all lose their jobs as the Fed goes to paperless savings bonds (I couldn't believe that they had 200 employees in that department to begin with). 

Unfortunately for those unemployed, they will not see these jobs come back. They are gone forever. This is the difference between cyclical unemployment and structural unemployment. 

Technology marches on, and we lowly humans have to march with it or get left behind. Just look at the wonderful changes taking place as oligarchs lose power to the internet enabled masses. Literacy and access to information spread around the globe lifting millions out of poverty. Knowledge is power. Creative destruction is a wonderful thing, as long as you can move fast enough to stay on the winning side of that destructive process. Focus your energies on being a creator and you should survive.

Nope, No Inflation Here. Move Along.

Recent headlines below (courtesy of Sovereign Man):

“World Bank: Global food prices are rising to dangerous levels”

“Sysco declares force majeure, raises grocery prices”

“The J. M. Smucker Company Announces Coffee Price Increases”

“Kraft warns on price increases”

“Kellogg says it will raise prices”

“Sara Lee to raise prices again on higher commodity costs”

“Bridgestone To Raise Prices”

“Goodyear will raise tire prices up to 6%”

“Allstate rates rise; patience with execs runs thin”

“State Farm wants 28 percent rate increase in Fla.”

“Blue Shield to delay Calif. health rate hikes [for only 60 days]”

“Wellmark [Midwest division of Blue Cross] Rate Hike Approved”

“Abercrombie & Fitch CEO says retailer will have to raise prices”

“Sprint bumps up its smart-phone data plans $10 a month”

And then there’s this quote to tie it all together:

“Overall inflation is still quite low and longer-term inflation expectations have remained stable.” — Ben Bernanke, February 9, 2011

Overall, if you live in a warm weather nudist colony, grow your own food, and walk everywhere you need to, then Bernanke is correct. Core CPI, ex-food, and energy, has only risen 1.0% in the last twelve months. Nope, no inflation here. This is why I own TIPS (Treasury Inflation Protected Securities) with trepidation. In theory TIPS should protect you from increases in inflation. The problem, and hence the trepidation, is that the guys calculating the official CPI are the same guys issuing the securities. You might say that they have a vested interest in keeping the published official CPI a tad understated. Oh well, they should still outperform regular treasuries in an inflationary environment, just don't expect them to be a real money maker. 

"I know, everybody funny, now you funny too"

This market is certainly funny, not ha-ha funny or clown funny, but funny in a head scratching way. The S&P 500 is up 6.5% in the first 39 trading days of this year, if it continues at this pace we'll be up 42% for the year. You can almost taste the animal spirits, the warm spring air, the caution to the wind attitude of traders everywhere. Bad news is shrugged off on a daily basis; uprisings in the Middle East, Iranian war ships on the move, inflation bubbling up, and union protests in the US, none of it means anything as the market continues to melt-up. Week after week, the market has been moving up without any major setbacks. The S&P 500 is up 30% from July 2 to Feb. 15, and has only fallen 1% or more 13 times during that period. Based on that measure of volatility, stocks haven't risen this much with such narrow price swings since 1971.

One simple explanation is the Feds super-easy monetary policy, that has instilled a sense of confidence/arrogance among market participants. Don't get me wrong here, I'm not bearish. All of my equity and commodity indicators are decidedly bullish and we are at maximum weight in those assets, but I am increasingly nervous. I've lived through several episodes of animal spirits running amok, and while its fun on the upside, it can be pretty painful on the downside. 

Tread carefully, and as George Thorogood so eloquently said, "I want one bourbon, one scotch and one beer." 

Be careful out there, and keep the light's on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.