The World will not grow at a Long-term Sustained Pace until China Consumes

     For the last 30 years the western world has borrowed from its’ future.  As the west deindustrialized and grew more service and finance oriented they stopped investing for the future and started consuming.  The investing that the Western world did was in financial rent seeking assets leveraging the accumulated savings built up from the growth period between the 1940’s to the early 1970’s.  In the 1980’s Wall Street took over and leverage started to multiple.  

      At first this leverage sprinkled over a relatively unlevered base made things multiply as if some sort of magic was happening.  People were able to have the cake and eat it too.  No longer did they need to save a large portion of the income for the future.  All they had to do was go to the bank and borrow more money.  This combined with the large demographic change brought on by the baby boomer generation entering the job market, led to an inflationary increase in the price of most financial and hard assets.   At the same time there were more women entering the workforce creating two income households.  The demographic shift and additional income caused a spike in consumption.  This led to more employment and production.

     Whenever there was a downturn in the economy, a recession, Keynesian economists opened the spigot of cheap money and the recession soon ended.  Consumers saw lower interest rates and consumed even more.  The Western consumer was addicted to consumption and debt; the Western governments were addicted to easy money and the supercycle of Keynesian economics.  West could do no wrong.  This was a time bomb ticking.

     All this works until it reaches a critical point.  The point where consumers cannot take on any more debt, they have almost everything they need, and demographics have shifted to save and not consume because the average consumer is approaching retirement age.  This also goes for government too.  The only difference is that the government has to also cut back to be able to pay for the demographic shift towards retirement and greater demand for health care.    This happens at the most inopportune time when the demographic that votes the most, older people, are asking for the exact opposite.  Something has to give.  

      Starting in 2008 the bottom fell out of the US economy, putting the world in a worldwide recession.   Governments tried every Keynesian trick known to man in an effort to stave off a depression.   The Western governments did not understand that Keynesian economics only works on a giant growth supercycle and not on protracted long-term declines.  In the US it seems the politicians and central bank were able to kick the can down the road for a few years.  In Europe they have not been so lucky.  The European economy at first took to the loosing of money.  Their economies were able to avoid a deep recession initially.  They were able to delay their day of reckoning for almost 2 years before cracks started to appear on the edges of their foundations.  Today Europe, excluding Germany, is in a deep debt induced recession.  Interest rates and unemployment are spiking as consumers and governments try and make up for their past sins.  People are consuming less and eliminating debt (either on their own or through forced measures like foreclosure).  Governments are even trying austerity plans to rein in their spending.   

  

     The only country that seems to have escaped this downturn is Germany because they went through a similar period of extended downturn when Eastern and Western Germany unified to become one country again.  Upon unification Germany experienced a long period of protracted economic growth.  They spent nearly two decades cleaning up from the shock of unification.   Now that they are on the other side they are the strongest country in Europe.   There is a lesson to learn from this but does the West have the almost two decades it takes to master given their own demographic time bomb?   

 

      Austerity and deleveraging might work in the real long term, but is there a way where we can fixed this problem with less pain than what we are going through now?  Enter China.

     China has the largest population in the world.  For the most part China’s GDP has been growing at over 9% per year for almost 20 years.  They have repositioned themselves from a very low economic base with a communist government to now the second largest economy (assuming you do not treat the EU as one county) with a strong capitalist bent.

     China has experienced its’ meteoric growth due to high savings and infrastructure spending.  They went from nothing to superpower in less than three decades.  Arguably China is in the stage of mal investment where large useless projects are being built.  There are large examples of cities capable of having millions of residents that sit practically empty.  China can no longer continue to grow as it has in the past.  Its’ economic model needs to shift.  No longer can they produce for the West and invest the proceeds into more production back home.  The world is awash in production especially given the long-term downtrend in their largest markets in the West.  They have production capacity for a world that no longer exists.  If China does not change they too will experience what the West is currently going through.

     Once China realizes that they need new markets to replace the saturated Western markets they will naturally look inwards.  China has a long history of being inward focused.   As 1/6^th of the Worlds’ population starts to consume this will take up slack in production capacity in China for goods originally intended for Western consumers.   Eventually this growth will lead to demand for more goods and services from the West, just as the West is exiting their long period of decline.  Eventually the World will find equilibrium.   Then the world will grow together, until that time, expect a long slow and painful downturn in the West.

Full Disclosure

Nothing to report.

    

Letting the Knife Fall

     Over the weekend one of Carnival Cruise Lines Italian subsidiary ships struck a reef and sunk off the coast of Italy.  The disaster has been classified as human error.  As of this morning there are 6 people dead and 29 still missing.  The boat sits dangerously on its side with a 160 foot gash in it.  To make matters worse there appears to be over 500,000 gallons of heavy shipping fuel on board.  If the ship breaks up, or leaks the fuel, you are looking at a serious localized ecological nightmare.  All of this is obviously impacting Carnival’s stock.

     Carnival (symbol CCL) is indicating an opening decline of 16.7% ($28.55 down from Friday close of $34.28).   Today Carnival pays an annual dividend of $1.00.  As the charges for the cost of the disaster come in greater focus, expect that dividend to be cut to between $.20 and $.40 annually.   Expect the stock to be under increased selling pressure for at least 1 week past the removal of the ship from the reef.  You have time to wait to jump into the stock.    I would wait until the stock is $18 and below before starting a position.

Expectations:

     Wall St will more than likely sell this stock first instead of holding it through the disaster.  The stock will probably have a 2 to 3 month period where the price is heading lower.  Then you can expect a quick 10% rise.  After that the stock will do nothing for 6 to 12 months.   

     The way I plan on playing this one is to open a position below $18 over a period of weeks.  I will slowly add to that position until it is 10% of my portfolio.  Once I have the position in place I will plan on holding it 36 to 48 months for a price near $45 per share.  I anticipate a return of 150% over 4 years, or 37.5% annually plus dividends.

     This stock is purely speculative.   I would advise to only play this with money you can lose.  This situation is what is classified as a “special situation stock”.  That means a large company changing event has happened and that you are speculating that the company can make it through the rough period.  Sometime they do and sometimes they do not.  Previous special situations were like Apple computer when Steve Jobs rejoined, or McDonald’s when they reported their first quarterly loss, Starbucks when they shut a number of locations because of over expansion, or BP during the gulf oil spill.  All these situations rewarded investors that took a risk when things looked their bleakest.  There are also stocks like Enron and GM where investors lost everything.

     I think Carnival has the makings to be one of the winners.  They currently have over 50% market share in the cruise market.  The disaster hit in a foreign area that most of their largest demographic, US citizens, will quickly forget about.  Think of it this way.  If you are freezing your butt off in Buffalo in the middle of winter do you really care that some captain made a mistake in Italy causing the ship to sink?  You are just going to book the best deal in the Caribbean that you can find.  With over 50% market share in the Caribbean that means you will more than likely book Carnival.   

    Time will heal these wounds.  Carnival is looking at some serious law suits in the coming year.  A chunk of that will be paid for by their insurance companies, but there will be a hit to their earnings to cover their portion.   They ultimately will be responsible because it is clear that the captain made a navigation mistake and the evacuation drills were not performed.  That means there will be a large settlement to the passengers and crew members at some point.   The class action lawyers know it is better to keep the company alive so that they can collect rather than kill it off and get less money.   

Full Disclosure:

     I currently do not own or control any CCL stock.  As stated previously I plan to purchase between 500 and 1000 shares once the stock trades below $18 per share.   

Forecast for 2012

     I wanted to put out my first forecast on the blog as a way to measure the success of my opinions.  I plan to relook at these predictions in December 2012 and grade myself on well I have done.  I was always a B+ student so more than likely I will meet with similar success (at least I hope).  Warning my crystal ball could use some Windex occasionally.

·         US to enter mild recession in 2012 I am predicting that the US economy will stall out for a brief mild recession in 2012.  It will more than likely be brought on by an external event (i.e. major bank failure or sovereign failure in Europe, natural disaster in US, etc.).  This event will cause people to pause as they watch it unfold on TV and over the internet.

·         Housing Recovery in US This is an easy prediction.  We are starting to see a housing recovery in the US, albeit at a slow pace, as investors are using cash to buy properties at once in a generation pricing.  The cash flow that these properties are putting off is incredible especially given that these are typically investments for small investors.

·         US Stock Markets to drop 25% I predict the stock market will end up slightly (less than 10%) from Jan 2^nd levels but during the year experience a 25% correction.  The 25% correction will probably be tied to the first prediction.  We typically experience a bear market every 3 years.  We are overdue.  The reason for the upbeat end of year forecast is because the US economy is actually getting better and the cause of the recession will be external, not internal.  Traditionally the US ignores the rest of the world after two months of an event being thrust upon the American people.  Let’s face it, the average American really does not care what happens outside of their little world.

·         Obama wins.  In what appears to be an Obama vs. Romney presidential race, it looks like an easy victory for Obama.  I personally think Obama is tied for the 2^nd worst president ever with George W. Bush.  Problem is that Romney is the typical plastic politician.  He is only in it for his own ego not to actually improve the country.  Massachusetts was a mess when he took over and nothing changed during his tenure.  All he seems to do is a bunch of negative campaigns whenever a candidate jumps out ahead of him.  If Ron Paul or Chris Christie were running for President it would be different.  Independents would get out the vote for them.  Obama will win because the low voter turnout.

Full Disclosure

     I am an independent voter that really thinks we need a third party that is moderate in nature, fiscally conservative, and puts the country first.  This is influencing my predictions for the presidential race.  More than likely I will have to write in Ron Paul again this year.   

Could BP Shareholders be in Line for a Much Larger Dividend?

     On April 20, 2010 BP’s Deepwater Horizon’s oil well in the Gulf of Mexico exploded sending the oil rig to the bottom and releasing crude oil from an uncapped hole on the seabed.  The oil well continued to leak for 87 days.   During the 87 days BP made mistake after mistake trying to cap the gushing well.  The news media had a field day vilifying BP.  They continually broadcast report after report claiming that the Gulf of Mexico is now a wasteland and that it may never be repaired.  

     The media way overhyped the situation.  There was barely any oil that contaminated any beaches.   They kept showing this one stretch of beach in Louisiana that got hit.  It was so comical to see people in hazmat suits on beaches next to sunbathers enjoying the late spring weather.  These people in the suits had literally almost nothing to do- they did not care because BP was footing the bill and they need work during the recession.  

     The disaster stayed mostly offshore.  Nature and some key chemicals helped disperse the floating crude once the gusher was capped.    This seemly ended the issue overnight.

     To try and help their case in the public’s eyes, BP agreed to set up a $20 billion trust fund to help people, businesses, and governments effected by the disaster.   They felt that if they made the money available sooner and to more people that the ultimate cost would be less to shareholders.  They were right.  As of December 1^st, 2011 only $7.710 billion of the $20 billion fund has been spoken for.  Almost 90% of all claims that have been made have been paid out.  BP has also settled a number of potential law suits outside of the courts.  Now that the accident is a distant memory it is hard to see any new claimants coming forward.  This is where the increased dividend comes in.

     The $20 billion trust fund was set up to payout to people impacted by the spill and any fines or lawsuits that may arise.   As of September 30, 2011 BP has paid a total of $9.9 billion into the trust fund.  They are required to contribute $1.25 billion quarterly.  Now that a large majority of claims are settled, does BP still need to make their quarterly payment?  The trust fund allows for its expiration.  In the trust fund document it mentions that the fund has a life until April 30, 2016 OR when all claims have been paid (whichever comes first).  It also has a provision that the trusties can dissolve the trust fund once almost all claims have been paid AND they have 110% of the potential claims covered.    

  

     Let’s assume that future US Government fines and lawsuits amount to $2 billion and the remaining claimants another $1 billion (numbers picked out of the air as what might be reasonable).  With payments made to date there would be no need to add more to the fund after the coming up quarterly payment.

     What should BP do with the extra $1.25 billion per quarter if they no longer need to make the payment?    Should they pay down their debt?  They are currently shrinking it slightly over the last few quarters even when making payments to the trust fund.  If they are able to do this now there really is no need to spend the money there.   In addition they already have a very strong balance sheet.  Should they use the money for additional exploratory expenses to enhance future earnings?  There is a solid argument there but they are already spending close to $30 billion per year there.  Would an additional $5 billion make that much of a difference especially now that crude prices are near peak cycle prices?

     I think spending the money on a larger dividend makes the most sense.   Last quarter they paid out $1.227 billion to shareholders @ $.42 per share (US depository shares- annually $1.68).  At the closing rate per share on the NYSE on December 23^rd, 2011 of $43.28 the stock was yielding 3.88%.  If they doubled the dividend to pay out approximately $2.5 billion quarterly (current payout plus the fund payment) the stock will be paying out $3.36 giving it a yield of 7.76%.    To add credence to this payout amount, BP was paying out $.84 per US share per quarter before the accident.   Back then the shares were trading between $35 and $80.  A move like this would definitely have an impact on the price per share.

     Now the question of when.  I would think you would see a move to dissolve the fund late in the summer 2012.  By then almost everything should be settled and BP will have a solid argument to end funding the fund.  Shortly after that you can expect to see a dividend hike.

Full Disclosure

I own or control between 600 and 1000 shares as of December 27^th, 2011.  I have a vested interest in see the dividend increase.