Monday, April 7, 2008

Risk Analysis Update – A Forward Looking View Of The U.S. Economy

U.S. Dollar Still Treading Bottom
Bloomberg reported today that currency futures traders have increased their bets against the dollar. Three major banks that control 40% of the global FX market, Citigroup Inc., Deutsche Bank AG and Royal Bank of Scotland Group Plc, are now projecting that the dollar may fall as low as $1.65 per Euro by October, from $1.57 on April 4.

“The dollar will continue to move lower in the next couple of months until the U.S. economy improves markedly,'' said Adam Boyton, senior currency strategist in New York at Deutsche Bank.”

As I have noted in my previous article, Now The Dollar Is The Carry Trade Vehicle, this may seem bad but there may be a silver lining in that the U.S. firms may be able to use the low dollar to increase their profit from exports. This may already be happening as the U.S. Import / Export Price Indexes for February 2008 noted that agricultural prices rose 4.4% in February, capping a 30.8% rise over a 12-month period ended in February, largest rise since September 1988. Nonagricultural prices increased 4.6% in 2007[i].

Risks To Consumers

  • With the weak dollar, price of imports, including imports from China, will go up. This will result in higher consumer prices. According to the U.S. Import / Export Price Indexes for February 2008, prices for foods, feeds, and beverages rose 11% in 2007[ii].
  • As the prices of exportable goods increase, businesses will raise prices across the board, resulting in even higher consumers prices, as they (U.S. consumers)will have to compete with demands from other nations.
  • As foreign demands for certain commodities increase, U.S. consumers may be facing sporadic shortage of certain goods as businesses begin chasing profit and ship more goods overseas.
  • Electricity price will rise as the prices of coal and natural gas used to generate electricity increase
Risks To Businesses
  • Increased potential for consumer backlash against rising prices
  • Risk of increased frequency and duration of truckers’ strikes affecting their supply and product chains
  • Increased risk of rising utility price affecting profit
  • Increased risk of brownouts from insufficient supply of electricity
Signs Of Above Stated Risks
  • There will be less discounts and coupons offered in grocery stores (clothing retailers, on the other hand will continue to invent new discount events to draw customers)
  • Bifurcation of retail – sale of extreme upscale products (ones one would typically see in Robb Report magazine) will still do well while sale of ‘upscale’ products geared to middle-class families will see sales declining
  • Some companies will reduce the portion on their products and offer it the consumers as being ‘new and improved’
  • Prices of generic and store brand products will also go up, reducing the discount spread between it and the brand name products
  • Increased frequency of advertisement aimed at informing consumers on energy shortage and the need to conserve
  • Increased frequency of protest against rising food and energy prices, worldwide
Areas That May Benefit
  • Carbon traders – Carbon trading market will increases as well as the price of metric ton of CO2 equivalents
  • Energy trading – With increased demand and periodic reduction in supply, it is only natural for speculating in this area
  • Alternative energy – It is only logical that as price of fuel increases, people will look for alternatives. Solar energy seems to be one area that will benefit
  • Energy storage – Again, as fuel price increases, the companies that make energy storage facilities, such as batteries or inertia storage (think large spinning cylinder), should do well
  • Oil Refineries – Demand for gas and oil is not decreasing as much as people would like. Higher prices will make for another record profit year
  • Water desalination – Demand of clean water from arid areas will increase, making desalination more feasible
  • Rail transport – Warren Buffett may be on to something. If there is a prolonged trucker strike or truck transportation disruption, companies will have to resort to using rails to transport more of their products and supplies (while trucks will still have to handle most of the final mile delivery, the bulk of longer transportation will go to rail if truckers strike)
  • Motorcycles & Scooters – Low fuel consumption and low cost will be the draw
  • Movie Theaters & rentals – As people cut back on vacations and long-distance travels, they will still want to be entertained. The logical choices will be local form of entertainment, such as movies and rentals
  • Family style restaurants – people will have to eat and will still want to go out from time to time, in lieu of going on vacation. Low cost family style restaurants will do well as people will step down from more expensive restaurants
  • Dry good shipping – U.S. will increase exports of dry goods, especially grain, to the rest of the world. This will keep those dry good shipping companies afloat. Also, as more companies switch from airfreight to ships, ships will see a solid year
  • Executive & timeshare Jets – As airlines cut back on services and routes, more businesses will find it attractive and affordable to fly timeshare corporate jets, especially when several people are flying together
  • Auto repair shops – as more people opt to keep their existing cars instead of purchasing a new one, demand for repairs will increase
Areas That May Be Adversely Affected
  • Airlines – rising fuel costs will force more of them into history
  • Automobile manufacturers – with people opting to stay with their car for a few more years, car sales will suffer. Big cars and SUVs will be hit the most, even if they are touted as being a hybrid. The bottom line is the rising fuel price
  • Auto leasing – The combined effect of more cars come off their leases and less customers seeking to lease, auto leasing companies will be stuck with rising inventory. Expect to see ridiculous lease options on certain vehicles as these companies try to minimize their losses. Their loss is your gain
  • FedEx and UPS – Trucker strikes, rising fuel costs, and reduction in delivery, all contributes to lower revenue and challenging times
  • USPS – Consistent reduction in ‘snail mail’ with higher fuel costs, and disruption in long distance services (they rely on UPS, FedEx and major airline carriers to help in delivering the mail)
  • Internet shopping – again, rising cost of shipping and disruption in delivery will decrease sales as people opt to go back to their local stores for most items
  • Major department stores – why shop retail when you can buy outlet prices? Retailers will offer more and more discounts but they will never be able to compete with discount stores like Target that is closing the gap on quality and affordability
  • Specialty retail – stores that offer upscale version (not the ultra upscale of the wealthy but those geared toward the middle- an upper-middle class) of regular products that is widely available, such as bottled water, coffee, soap, lotion, shoes, etc., will see lower sales as people replace these with lower cost items
  • Recreational boats and wave riders – the yachts will weather this downturn but those selling smaller recreational boats will not. The combination of high fuel cost (marine fuel is far more expensive than regular fuel) and general cost of upkeep will reduce the demand for these items
  • Travel & Leisure industry – people will cut back on their dream vacations to Hawaii or other long distance locales; instead they will opt to go to local spots. Flow of Foreign visitors coming to the U.S. will also dry up as their economies also begin to slow down
  • Restaurants – people will be eating out less frequently and opting to go to a lower-cost ‘family style’ restaurants to cut costs
  • Winery – Wealthy will always buy expensive wines but those wines targeting the middle-class consumers may feel the pinch
  • Housing & RE Brokers – people who want to buy a house will still wait on the sideline, knowing that the housing prices will continue to fall
  • Lumber & Building Materials – Slowing housing and remodeling markets and reduced demand for cardboard and packaging papers will hurt
  • Home Material & Supplies – Home Depot, Lowe’s, and the likes will see slowdown in demand coupled with higher delivery cost and sporadic disruption in delivery from truckers' strikes
  • Lower quality commercial properties – commercial properties that were marginal or had small local tenants will see increased vacancies. Loans secured by these properties will experience haircuts
  • Timeshare Condos and hotels – less vacationing and traveling mean less need for timeshare condos and hotels. Expect to see some really great deals from these companies that have overbuilt. Caveat: expect reduced level of services, if you should go
  • Car rental companies – As travel slows down, so will the demand for rental cars. Also, due to rising fuel prices, expect vacationers to economize to smaller (read less profitable) cars
The above lists are just my views of where I think the various markets are headed. I didn’t list them all, as the list will be very long. However, I listed the major ones and ones that most readers are familiar with. Naturally, I strongly encourage you to do your own due diligence.

Given this, note that there are going to be common themes in 2008, revolving around limited resources, such as oil, grain, and water, uncertainty in the financial market, and U.S. Presidential race. These themes will be further modulated with sub-themes like Middle East, Summer Olympic, global climate changes, and regional unrest. All of these will make 2008 a very interesting year for businesses and investors alike. Commonsense approach with focus on fundamentals will work best. Those chasing fortune in commodities will need to have titanium stomachs, as the volatility in the commodities market will be nauseating.

May your Investing be profitable!

Ed Kim
Disclosure: Author holds long position in Berkshire Hathaway and Oil Refineries

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