Tuesday, May 13, 2008

running out of gas

everyone knows gasoline prices are moving higher. but how much of a problem is it really? to quantify the question, I did some calculations and found some interesting results. at current prices, I estimate the average american can afford to buy about 10,677 gallons of gasoline a year. that does sound like a lot of gasoline, but it's down 47% from the 20,379 gallons that we could afford in 1994.



(to arrive at these numbers, I used gasoline prices from the Energy Informaiton Administration. Because the last per-capita income data was from 2006, I estimated the numbers for 2007 and 2008, assuming it rose about 4.3% each year... that was the average annual increase in the 1994-2006 period.)


anyway, this is a sobering thought. essentially, the average american can now afford to drive about half as much as was the case in the 1990s. and, in the 1990s, that same consumer was carrying many fewer unpaid liabilities... in 1994, consumer debt represented about 75% of personal income, versus 116% in Q3 of 2007.

this news hit bank of america said yesterday:

May 13 (Bloomberg) -- Bank of America Corp., the nation's biggest consumer bank, said losses on home-equity loans will be even worse than predicted three weeks ago, adding to evidence that more consumers are falling behind on debts.
More customers are under financial stress and using credit cards to pay for necessities, said
Liam McGee, president of the consumer and small business division, at an investor conference today in New York. Losses on the bank's $118 billion in loans linked to home values may top 2.5 percent, higher than the 2 percent to 2.5 percent projected last month. He didn't specify a time frame.

one more thing I would like to add: most people on Wall Street have long known that B of A is a lousy company. they tended to have much less profitable investment-banking operations than other securities firms. they essentially made all their money from high-fee consumer banking... when they announced plans to buy Countrywide, I knew their future would be even worse. they are marrying themselves to a collapsing market and an increasingly impoverished customer base. most daytime TV pundits praised the move, but I predict it will be a millstone around ken lewis's neck for the next several years. it might have been cheap -- but that doesn't mean it was a good value.

getting back to the broader economy, some very strange news came out today: the government is claiming that fuel prices declined last month -- at least according to how they calculate inflation. this is downright bizarre, given the obvious fact that energy prices are, in fact, rising. this year alone, the average price of gasoline rose 22%. the anomaly actually results from the fact that gasoline prices didn't go up as much as they're supposed to go up this time of year, based on the normal driving patterns. why didn't they go up more? because americans are already feeling squeezed and driving less. I don't consider that good news.

that didn't stop the stock market from charging higher... I have stayed bearish through this entire market bounce, and remain so today. many technical conditions make it hard for stocks to fall now.. basically, so few people actually own stocks at present .. one strategist told me recently that the amount of cash in money market accounts is at the highest level since the last bull market began in 2003. these strong cash positions, plus relatively cheap stocks, make big losses more difficult -- at least for now.

anyway, my basic point is that it's hard for stocks to decline because of this technical condition. I am a technician at heart. if there is anything we learned in 1999-2000, it is that people will buy assets completely devoid of fundamental value, such as shares in pets.com, if they have the money and the will. I don't believe in sitting around, arguing about what should be: "investors shouldn't pay 100x earnings." there is no "should." there's just the market, and what it will bear at any point in time.

still, the fundamentals cannot be ignored. when stocks rally on what is essentially bad news, like today's inflation report, you have to question the durability of such a rally. it worries me when stocks are strong despite inflation and a collapsing consumer.

let's consider what happened in 1999: after the asian crisis hit, billions of capital flooded into the US market, which had already been enjoying a strong rally. that made US stocks the logical destination for this "hot money." the key thing to remember isn't just that the hot money was available... but people it tends to gavitate to the sector that's already established as the leader.

now, a little bit of that hot money, the swing money, is returning to stocks. much of it remains in treasuries. in my view, that kind of money tends to follow the sector enjoying the most momentum. right now, that's not stocks, it's oil and other commodities. they have done far better than stocks over the past few years... but they have not yet formed a bubble. as a result, I fear that commodities might attract this fast money, allowing another surge of prices. so far, the fundamentals have supported commodity prices. it hasn't yet gotten to bubble status. the normal market behavior patterns would suggest that commodities have yet to enjoy that final lunatic surge higher we saw in stocks in 1999-2000, in credit we saw in 2006-7, and tulip bulbs in 1636-37.

the underlying fundamentals for stocks are bad and getting worse. for instance, many daytime pundits applaud the rally in the US dollar. it's hard to see the benefit of that after people were taking solace in the weak dollar as a way for US companies to boost their earnings... for example, IBM.

right now, we seem to have at least three separate crises hitting our economy simultaneously:

1- the death of the consumer. after years of borrowing to keep spending, people are at the end of their ropes, especially as home prices decline
2- a generalized credit crunch / banking contraction. it's not as bad as we faced in the S&L crisis, but it still means less credit is available in the system. lending standards are tightening.
3- inflation: despite the government's fantastictical report today, it's a problem.

briefly back to inflation: the main reason it declined was this bizarre estimation that gasoline prices fell 2% and a 0.4% drop in public transport costs. these numbers don't seem real or sustainable to me... I think they are poor reasons for stocks to rally.

on the other hand, I can see the other side of the argument. it's possible the global economy will go into a recession, causing commodity prices and inflation to fall. this could flood money back into U.S. stocks. it has happened before. but given the bad economy and bad momentum in US stocks, I don't think it's likely. instead, the chief danger at this point is for the hot money to chase commodities, causing another world of pain.

one thing to close on that could fit into that. oil prices are up on demand and speculative buying by people like me. political instability has not yet been priced in. when people talk about the notion of the US simply withdrawing from Iraq, I wonder how serious they can be. if we leave iraq, how long will it take before Iran, Saudi Arabia and Turkey are fighting over it? iraq already has some of the best and cheapest oil fields in the world. it seems likely some kind of conflict will result. after all, if you threw $10mln into a room occupied by 10 normally peaceful people, how long would the tranquility last? I hope I am wrong, but human nature doesn't change.

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