21st Century Economics

This is not offset by anything else, happens mostly in January and is in the billions of dollars. The result is prices go up and the general market rises. This has happened all but 4 times in the past 25 years………one of those four is January 2008.

What a prudent investor would have noticed is that in January 2007 the price of gold was $610, in July it was $685, in December it was $835 and now, so far in January 2008 it is at $912. This is a clear indicator that people have been bailing out of the market for more than a year. And note that the rate of exit is increasing. In the first six months, it rose $75 but in the last six months it rose $227. That should have been a clear sign to prepare for the worse. It was for me.

Unfortunately, this is just the beginning. Remember that the boomers own more than $6 trillion in stocks in the market plus trillions more in real estate. In fact, while the underlying retail price inflation has only come to 14% over the past 5 years, the value of residential housing has climbed 78%. More than 40% of that total home value is in the hands of boomers that regard it as a pre-retirement investment. As I predicted and justify in The Dismal Science article (written in 2005) on this blog, the boomers will precipitate the largest and longest recession in US history beginning around 2015.

The “U” shaped graph has two peaks at the top of the “U”. The inner one - the one with the high Y or profit values corresponds to businesses that compete by selling an item at good profits. But this end of the curve is also low on the “X” axis values meaning that it has little market share.

This is the “niche” market. To a small but focused market, you can sell a service for a high profit. Let’s look at the drug companies as an example. They make a drug that addresses a disease that only 10,000 people in the whole US have a need for. They ask and get $5.00 per pill. A small market that has a narrow but high demand for a product can command a high price for that product.

The other end of the “U” is also a high profit point but with much improved market share. This is characterized by Japanese autos. The price is not the lowest on the market but they still command a large market share. Why? The answer is that at this end of the graph, businesses “differentiate” themselves in some manner from their competition in order to command a price that is not the lowest. In the case of Japanese cars, the differentiation is “quality”. Buyers will pay more for perceived or real quality because that is important to them. Japanese cars have invested in both the real and perceived sense of quality.

Volvos, on the other hand, differentiate themselves as the “safe” car. Mercedes Benz is the “rich man’s car”. Land Rover is the car of choice for safaris…and so on… All these cars are significantly more expensive than their competition but they still command a large share of the market because they differentiate themselves in the eyes of the buyer.

The bottom of the “U” is characterized by low profits and only a medium market share. A good example of this is McDonald’s hamburgers which are sold at nearly the cost to make them. There is very little profit because they are so cheap. (McDonald’s, as a company, makes their profits off drinks and fries). Their market share is a portion of the fast-food market in that they are appealing to those buyers that want that kind of food, fast and cheap. This means that they are very vulnerable to price fluctuations from their suppliers and from their competition.

Another aspect of the older business model is that any given marketplace can typically support up to three top competitors. Others can and will enter the market but they will play a distant second place to the top three.

Sears-Wards-Pennys…..
Ford-Chevy-Chrysler…..
McDonalds - Burger King - Wendy’s.

Many investors today are interested in the high flying, fast growing and most profitable investments possible. An inviolate law of economics is that high profit comes at high risk. So far, no one has been able to break that law, although many have tried or thought they had. In the long run, it has proved to be true in every case.

Unfortunately, the high risk, usually expressed as a high beta value, can be misleading because many people do not understand that in the area of investments, if you lose 10% and gain 10%, you are NOT back where you started. Let’s take an exaggerated case:

Suppose you invest $1000 in a volatile stock. As it is prone to do, it whips up and down and in the first year after you buy it, it suffers a total of a 25% loss. Being high risk, it also can go up so in the second year it ends with a 25% gain. How much money do you have? $1000? NO! You actually have $937.50. It is down more than 6%! Here’s why.

The first year’s loss of 25% of $1000 is $250 so you end the year down by that amount to $750. Now you start the second year with $750 and go up 25% or $187.50 to $937.50.

You would have to have about 34% gain in the second year to just get back to your original investment.

Now let’s take a much more conservative investment with a low beta. In this case you start with your $1,000 in a blue chip or balanced mutual fund that has a 10 year average return of 10%. At the end of the first year, at that rate, you will have $1100 and at the end of the second year you will have $1,210. That is $272.50 higher than the volatile, high risk, high return stock - or 27% better!

Of course, you invest in the high risk stock because it has more positive net returns that used in this example. More likely is fluctuations of up and down 25% but with more ups than downs but even that can be misleading. Here’s why.

Suppose the stock, from July to January, goes down 25% and then back up 45% by June of the following year. If you were to read their ad or see one of those investment magazines, it would show you a “YTD Rtd” (Year To Date Return) of 45% in the first 6 months of the second year. So you put $1,000 into this stock in July. It goes down 25% by December and you end the year with a balance of $750. But you hang in there and watch it rise from January to June by a whopping 45% - wow! Hmmmmm wait a minute - what have you really got now.

$1,000 down 25% to $750 in 6 months and then up 45% for a second 6 months gain of $337.50 to $1,087.50 by July of the second year. You end the 12 months with $12.50 LESS than the buy that invested in the conservative stock at 10% annual return!

You can change the percentage numbers and shorten or lengthen the periods of time but you get the same result. If you have a volatile stock and it incurs a loss early on in your investment, you have to have a very hard working investment to make up for it later. For instance, if you invest in a stock with an expectation of getting 10% per year but in the first year you take a 10% loss, you now need to have an average annual return of 15.7% for the remaining 4 years to get the original expected 10% average return for the 5 year period. Look at the stock ans see if that is reasonable.

It is predicted that in the relatively near future, newspapers will have so much competition with other forms of news delivery that many, if not all, will go out of business. In perhaps 10-20 years, technology will be such that you can pick up a flat panel LCD screen, about the size of a notebook page and weighing about 10 ounces. It will be a wireless computer that has been programmed to receive news that interests you including hourly updates. It will be text, audio or video, whichever you prefer. Such technology exists today but the public is not ready for it yet, but it will be soon.

Visualize Information:

There are several researchers working on new ways to visualize information. The hypertext method of non-linear reading has lots of advantages and will be the basis for future capabilities. You will be able to quickly “bore down” thru a long list of topics to the exact bit of information that you want to see at that moment.

As the Internet’s bandwidth is expanded and the speed of computers - particularly graphics - is improved, the actual mechanism of how you move thru the information will become more and more graphic. Eventually, you will do it with virtual reality. A hood of 3-D viewers will allow you to move in a three dimensional world and “open” virtual files that contain the information you want.

Access

There are devices now that can broadcast selected news stories directly to your computer while you are asleep so that you can read topics that interest you in the morning. This is also happening using wireless technology into laptops and palmtop computers. The cost is high and the available sources of information of this nature is limited now but that is changing. If one of the major news networks like CNN were to offer a service, it would spark a major competitive race that would open a huge market. The end result will be that you will be able to access what you want, when you want it 24 hours a day, no matter where you are.

Social Complications:

Unfortunately, this is not all roses. We are developing into a nation of “haves” and “have nots” but instead of money or power, it is information access that is separating us. There will be a marked difference in the success of people that have access and the equipment to get this information and those that don’t have it. If you have it, you’ll be better informed of everything - including job and investment opportunities, social and economic trends and general information about the world we live in. If you are one that does not have this access, you will miss those job and investment opportunities, not be aware of the politics and societal issues of the day and will generally be less successful in your career and life.

Nearly all of the wars in the past 3,000 years can be traced to having a strong motivating factor of a disparate distribution of wealth within or between countries. When that has not been the direct cause, it has been a major contribution factor.

Now consider this:

The United Nations reported last month that the net worth of the three richest families in the world (the Gates family, the Sultan of Brunei and the Walton family) is greater than the gross domestic product of the 43 poorest nations on Earth — combined.

A recent issue of Nation contained an article noting that pharmaceutical companies spend far, far more money researching lifestyle drugs for the affluent than life-saving drugs for the hundreds of millions of the world’s poor people. Instead of trying to come up with treatments for life-threatening diseases, resources go into treatments for wrinkles, impotence, baldness and obesity.

Recent business surveys indicate that the ratio of the salary and perks of a firm’s CEO to that of the average employee of the firm is at an all-time high. Nowhere in the world is it higher than in the US.

Other studies indicate that although profits are rising, productivity is increasing and the stock market is advancing, employee compensation remains flat.

A professor at New York University estimates that the richest 1 percent of Americans own half of all stocks, bonds and other assets.

These stories and many more like them indicate that there has a been a basic paradigm change in our basic moral sense of fairness and philanthropy. Greed, ego and self-preservation has taken over as the predominant factor in many social and business decisions. Although this is being observed all over the globe, it is by far the most egregious in America.

Other reports in this information service have also told you about the “information haves and have-nots” and the impact of that growing gap.
Combine this with the historical cause of revolutions, wars and social upheavals and you have the formula for some bad, sad times to come.

Of course, the object of this blog is to discuss Profit and that does certainly seem to demand that we limit our rock throwing while standing in our glass house but there are good reasons why we must examine even the worst of our most advantageous behavior.

The simple answer is that there is not a shred of evidence, analytical data or economic, historical or scientific justification to believe that the good times will continue for very much longer. In fact, by historical standards, we are way overdue. By social standards, we are stretching the rubber band of class tensions almost to the breaking point. By economic standards, we have surpassed conditions which have, in the past, precipitated great economic upheavals or social unrest. Standby, it will happen again.

As an investor, you should understand two very important factors that have been absolutely proven to be fact:

Timing Does Not Work - Study after study has shown that, in the long run (actually as short as 3 years)that investment timing does not work as compared to invest and hold strategies.

This does not, of course, apply to investments in known events that have an economic consequence. In fact, that is precisely the premise of 21st Century Economics - that the only way to make a timely investment is to either (1) plan for a long term investment or (2) invest in a known event that has economic consequence. The failure of the timing in the classic sense is that it applies to the chasing of money that is common in day trading and in the rapid and short sighted buy-sell mentality that has always pervaded Wall Street. See a separate report on this subject elsewhere on this service.

Good Times Don’t Last Forever - The extensive reporting contained elsewhere in this service on the concept of Regression to the Mean is not an investment philosophy. It is scientific and mathematic fact. The mean growth rate of the stock market since before 1900 has been under 7% - no matter how you figure it or what adjustments you make. We have had a 3 year growth rate in excess of 25%. It is a FACT and an absolute certainty that 50 years from now, we will again look back at the average growth of the stock market and it will not be appreciably higher than 7%.

Any finite period can show growth or loss depending on the time selected but over long periods of time, a gradual increase in the rate of growth is possible but nothing like 25% - more like 3% in 50 years. If the mean that the average growth of the market returns to is 10% in 50 years - then when do you suppose it will change from 25% growth back to less than 10% so that its mean will be 10% in 50 years?

What all this rambling is about is that the known event that has economic consequence is that our world society is headed for a major adjustment in the social order based on the distribution of wealth, information and influence. That “adjustment” will be of such large economic consequence that those that have money now will need to begin now to prepare for it.

How? Like this:

Diversify your portfolio - The tried and true investment strategy of spreading your money across a range of investments is an old one precisely because it works.

Pay off Debt - We are a debtor nation now, currently spending more than we earn and with a national savings that is negative. When the economic turnaround happens, you don’t want to be in debt for a lot of luxury items that you can’t afford to maintain. If you are wealthy now, use that wealth to pay off your debt. If you are spending beyond your means now, stop and begin to prepare for a time when those that do that will be on the streets, out of work or worse.

Save - I am not going to predict the nature of the economic turnaround that will happen, only to say with confidence that it will happen but there are certainly some powerful pointers that it will not be good.

The retiring baby boomers will cause the real estate collapse of the second decade of the new millennium will the worst in history.

The boomers will also create the worst stock market fall in history - mostly because of how high it has risen above the “norm”.

If we make it to 2010 without a major social upheaval that is economically motivated, then the one that is motivated by the aging world population, demands on the publicly funded infrastructure and the disproportionate power of the older generation will certainly cause problems.

Wealth:
A professor at New York University estimates that the richest 1 percent of Americans own half of all stocks, bonds and other assets.
Power: Largely as a result of the wealth and also due to the usual time in one’s life that you typically gain that wealth, the vast majority of the power in this country is in the hands of the “older” generation - that is, those age 43 to 65. This is the age that most people exercise the most influence on their environment because it is in their interest and ability to do so.

Influence:
A recent study revealed that 80% of the domestic news stories on television network news concern only 4% of people; most of the remaining 20 percent of domestic stories on the evening news cover the other 260 million of us.

Demographics:
The aging population of the US and the rest of the world means that the wealth, power and influence will continue to shift more and more into the hands of an older and older population.

Impact

Politics:
We know that the older generation is largely conservative and mostly Democrats. They favor the continued high levels of spending on the federal level to fund programs that they benefit from such as Social Security, Medicare and tax benefits for the elderly.

This will not only continue but it will rise to levels never seen before - Rise to levels that will make the other age groups and generations into minority citizens with no control over their own lives and futures.

Investments:
For the most part, the finances of the era of retiring boomers will be a shambles.

(1) 71 million baby boomers will be trying to sell their stock portfolios at the same time - dropping the market to its lowest level in 75 years;

(2) 71 million baby boomers will be trying to sell their expensive homes in order to move into more modest sized retirement condos. This will create the greatest drop in real estate prices in history. One bedroom Florida condos will cost $200,000 while the 30 room brick colonial in upstate New York will remain on the market for 3-4 years while the price drops to below its current mortgage balance and sells for under $150,000;

(3) When 71 million baby boomers reach retirement, we will see the effects of three decades of excess at the expense of no savings. Social Security and Medicare will be overwhelmed while millions of boomers that did not save discover they cannot maintain their previous lifestyles on their $900/mo. social security stipend. They will vote, in mass to increase Social Secuity taxes to the loss of millions of younger workers.

Society:
The conservative nature of society will pervade everything. Care designs, books, movies, music, religion and news. The majority of the audience for the mass media will be old people with money. Who do you think they will cater to?

Wealth, Power and Influence is about to undergo a major adjustment in the next two decades, it will change everything - especially investment opportunities - or lack thereof.

The market demand from the buyers controls the market supply from the sellers. In other words, the seller sells what the buyer is buying. If the demand increases, the supply will expand to meet that demand. There is often a small delay between rapid rises in demand before the supply catches up but this is not of particular importance to large slow swings of market demand as a result of demographic changes. (It can be a factor in fad or impulse marketing, however.)

It is an established fact that people in certain ages of life and career will, on average, buy certain things that are often in common with others in that same age of life or career. For instance, we know that, on average, people buy their first homes between the ages of 25 and 34. Most of this is common sense - you don’t market hearing aids to teenagers or toy dolls to senior citizens. In fact, nearly the entire market of a capitalist economy is based on this concept.

Having established this short list of facts that most of us will agree are intuitively obvious, let’s now look at some additional facts. These are FACTS that can be verified from a number of sources but perhaps the best is the US Census Bureau.

There are 71 million households (76 million people) that can be called part of the Baby Boomers - those born between 1946 and 1964.
An Echo Boom of 64 million people (currently making up 41 million households and growing) are the children of the Baby Boomers - are those born from 1977 to 1993.

Between 1964 and 1977, there was a relatively slow birth rate of 41 million babies.

In the next 50 years (1999 to 2050), the share of the US population age 65 or older will go from 12.5% today to 21% - a 68% rise.
The number of people 85 and older will grow to 19 million from just over 3 million today - a 533% rise.

In 1940, 7% of those 65 are expected to survive to age 90. Today, the figure is 25%. By 2050, 42% of the 65 year olds will survive to age 90. (Believed to be a conservative estimate)

These and other similar statistics make up what we call the demographic economics of the boomers and their effects on our economy. Because so many of us are actually a part of this group, we have not visualized it as an historical or unique event but simply the way life is. If you can step back and see this in perspective to what has happened to world economies in the past and how it will affects us in the future, you begin to see this a much more powerful and predicable series of events. And as you know by now, If you can predict an event, you can profit from it!

Imagine if you had been aware of this situation in the 1950’s - what would have been a good investment? How about everything related to schools? As the bulge in boomers moved from kindergartens, to elementary to high school, the demand for books, clothes, food and schoolteachers expanded to historic highs. Gerber foods, for example, doubled its sales in just two years from 1948 to 1950.

In the 70’s and 80’s, the real estate boom was entirely predicable. You had 76 million people competing for the existing housing and the demand exceed the supply for a long time.

If you had invested in industries that supplied this massive but evolving demand, you could have made a fortune - as many did.

In retrospect, you can see lots of missed opportunities but the nice thing about demographics of this kind is that the opportunities are not over yet. The boomers and echo boomers are still there and still affecting the economy in a very big way.

The massive bull market we have been experiencing is no accident and it surely is not the results of actions by our President or Congress - despite the fact that they try repeatedly to take credit for it. It is because 76 million baby boomers (roughly 27% of the entire US population) have moved into their peak earning and their peak spending years.

Sales of new accounts in mutual funds exceeded $1 billion in a 30 day period in January 1998 for the first time in history. In 1960, there was a total of $640 billion in all mutual funds. Now there is more than $7 trillion. Almost all of that was invested by the boomers during their peak earning years. The early boomers are already moving into the age of retirement. This is why there is now more money in mutual funds and other investments than ever before in history.

But it’s not a totally rosy picture. The boomers will move on to the next stage in life starting in 2007 when the oldest ones begin to reach retirement age. The related changes in their buying and saving habits will have a marked and profound affect on our economy and the world. In fact, it is predicted to be the worse economic period in our history and perhaps for the entire world will follow the boomers into retirement.

21st Century Economics will show you the what’s, why’s and how’s to survive this megatrend and how to profit from it. In fact, if you don’t profit from it, you will be caught in it and suffer significant financial losses and personal hardships. This is not a prediction, it is simply a fact that has not yet happened.

We will be updating this service on a regular basis with new information of what the latest active trends are so that you can get in on the earliest part of the upward turn or get out on the earliest downward turn of a number of specific markets.

Background:

Robotics can be defined as any mechanical device that reduces manual labor by humans. This is obviously a simplistic perspective but it suits the purposes of this discussion. You either have cheap labor or you have expensive labor. If you have cheap labor, you have little incentive to seek out and invest in labor saving devices.

If you have expensive labor, you will seek ways to reduce the costs of the labor. That works fine until all your competitors are do the same thing to reduce labor costs.

You might also find that competition has found a way to reduce its labor costs while maintaining a very high degree of productivity, efficiency and quality. Japan did that in the early 80’s.

In the late 70’s and early 80’s, Japan was faced with a labor shortage, increased competition but a potentially large demand for its cars. To reduce costs, it invested heavily in the development of robotics for many of its auto plants. There are now plants that turn out auto parts hours a day and the entire plant employs 15 or 20 people - to watch the robots.

Japan did the same in the electronics industry. Their products dominate the markets in electronics and have challenged the American auto manufacturers in their own country by keeping quality high and costs low.

When Japan was experiencing their high labor costs, America was in the peak years of the baby boomers moving through their most productive labor years - 16 to 34 years old. All 76 million of them reached that age in the same time. This flood of the labor market held down prices for more than two decades with the effects only just now beginning to subside.

While the labor was cheap in this county, there was no incentive to seek labor saving devices. Even after Japan reduced its labor costs, the US industries did not respond until they began to lose large amounts of market share to Japanese products. Then they sought ways to reduce costs. One of those ways was to begin to move their assembly plants to other locations where labor was very cheap. The thinking was that this was cheaper than what Japan did and it avoided the problems of pollution controls and labor unions.

Unfortunately, a robot that can work 20 hours a day, 7 days a week for little more than a can of oil for pay will never be able to compete with a human worker. US auto makers underestimated the degree of efficiency and quality that a robotic force could apply to the complex assembly of cars and electronics. Despite moving 1000’s of jobs to other countries to reduce labor costs, the US businesses have never been able to compete with the quality and productivity of the Japanese robotic assembly plants.

New Motivator Coming:

American business, on average, has never been particularly smart when it comes to long range strategic planning. They are more driven by the quarterly stockholders reports and the annual fiscal balance sheets to worry about three to ten years away. As a result they almost never invest in the long term strategic development of their industry unless and until motivated by loss of profits.

Despite the massive bull market and the long running market expansion that has been flooding billions of dollars into US business, we are about to head into a much different market that will increase the pressure on many American manufacturers to invest in robotics.

Following the baby boom years of 1946 to 1964, when 76 million babies were born, there was about 13 years of reduced birth rates. In this 13 years, 41 million births occurred or about 45% of the baby boom years.

This baby lull period is now coming into the labor force as the boomers leave. In 1999, they are 22 to 35 years old while the boomers are 35 to 53 years old and beginning to move out of the labor force. By 2007, the boomers had started retiring. The net effect is that the labor force is decreasing by more than 30 million people.

There has also been a shift in attitudes and work ethics of these post-boomer babies. Many of them grew up in schools with computers and many more of them went to college than the boomers did. This effectively reduces the blue collar labor force even more. As with any limited supply, and constant or increasing demand, the cost goes up. Labor rates, as a share of real business costs have risen 45% in the last decade and will continue to rise sharply for the next 7 to 10 years - until the echo boomers (the children of the boomers) enter they work force.

The response to this gradual rise over the past decade has been a gradual rise in capital investment in plants and equipment resulting in a 1997 record high post-WWII investment of 16% of their total economic activity. That percentage will be seen as low by comparison in the next few years.

Robotics to the Rescue

Predictions of what will happen in the future is understandably an inexact science and must be based on a number of inputs from leading industry analyst, current trends and the activities of similar industries and leading edge industry competitors. There are, in fact, often some very predictable results from such studies and an image of the future environment can take on a reasonable form. However, this analysis must be seen as an on-going task since what the industry will become is evolving constantly.

Michael Dertouzos, Director of the Computer Laboratory at the Massachusetts Institute of Technology (MIT), Cambridge offer the following observations as to his expectations of where the IT industry is going in the next twenty to twenty-five years. The statements in italics reflect comments that 21st Century Economics has added based on more recent studies and our own perspective of the world. Our comments have an emphasis on energy and electricity markets because of the importance they play in the overall economy.

Technoprophecy

* Manufacturing will be reborn, as customization replaces the assembly line and local high-tech workshops supplant centralized factories. In fact, “Mass Customization” is a term recently coined to describe the way that manufacturing is doing this now. The centralized factories will survive but with significant computer automation to control the customization processes.

* Business alliances will proliferate, creating hundreds of virtual corporations that may be spread all over the globe. ExtraNets (virtual networks) connecting suppliers to producers and then directly to their customers will evolve in nearly every industry. This will support the growing Internet economy

* Office productivity will increase 200%, yet people will work longer hours with less job security. This prediction is likely now but may prove to be less true after the bulge of the baby boomers mover out of their prime working years. Every job, regardless of the activity, will require computer literacy as a core competency.

* Electronic commerce will greatly reduce the need for any cash transactions. Smart cards, EDI and other on-line transactions will almost eliminate coins and paper currency and make it easier for the government to tax you.

* Your health-care costs will plummet and your health will improve, as computers monitor your vital signs and doctors bid online to care for you. Corporate health care costs will go down while worker health will go up. Preventive care will become a hallmark of both business and the health care industry. Unfortunately, the aging population will probably drive costs to the government to the breaking point and the large excess will be passed to the population as reduced coverage and higher co-payments and premiums.

* Virtual Reality will become the new primary form of entertainment and edutainment. Virtual Reality will also invade routine business communications and advertisements. Look for it to make its first market debut in video games, then in the military and then in marketing. Entertainment will be last because of the changes needed in standards and the costs of the equipment.

“Today we do our office work with just about the same inefficiencies [as] when we dug our streets with our hands. Looming ahead of us in the next century is an incredible opportunity to improve office work, not by 10%, but by a factor of 60 in many instances. Productivity will rise in the Information Age as it did in the Industrial Age and for the same reasons it did before: the application of new tools to relieve human work — more results from less work.”

But he warns of more missteps along the way where ill-advised IT innovations and poor implementations will under-deliver or have a negative effect on productivity. The man-machine interface is on his list as a fundamental challenge that affects the overall impact that IT will have.

The net effect will be that software developers must be much more in tune with the needs of the eventual users. This means that more than just the processing formulas have to be built into the software designs. Usability in the form of intuitive man-machine interfaces, easy to understand instructions and a true customer-oriented approach to the entire development concept must be adopted by every developer - both internal and external to the organization.

Among the effects of these design requirements is that internal IT or IS support departments must add skilled staff that are familiar with requirements analysis, user interface design and creating help or tutorial screens of complex ideas in easy to understand forms.