We may be at another economic crossroad today, though only time will tell. But before we get into exploring that idea, I can’t help but share with you a few memories of August 2007 that included my own search for a crossroad.
I was participating in a motorcycle endurance competition that required a minimum of traveling 900 to 1100 miles a day to visit a few points of interest throughout the continental United States. I had just left the great city of New Orleans, with my sights set on obtaining a couple of bonus points by going to the intersection of US Highway 61 and Mississippi State Highway 49 in Clarksdale. It is at this crossroad that Clarksdale claims Robert Johnson, the great American blues singer and musician, sold his soul.
Being the farm boy that I was, I had to take a side trip and head north on the great river road through the farm country known as the Mississippi Delta, as one of my former clients, now gone from this earth, owned a farm and grain storage facility that I wanted to visit. So off I went riding along the great Mississippi river.
In the town of Greenville, Mississippi, I rode down Nelson Street where a number of night clubs specializing in the Delta Blues became famous during the years following World War II. On Nelson Street, I saw a little run down place with an old painted sign hanging out front proudly claiming the name “Doe’s Eat Place.” Little did I know this little shack of a restaurant would serve me with one of the greatest steaks I had ever had in my life.
When I walked into the place, directly to my left was a huge six-foot tall rotisserie grill that looked as if someone had made it out of old combine chains and sprockets along with some steel grating which could have been borrowed from a road construction site. It was just full of sixteen ounce steaks. They sent me to the back of the place, and thinking back I realize why. Having been on the road for nine days in August with 100 degree temperatures being the norm, I can only assume that the smell of motorcycles and manhood was in competition with the great smell of the steaks. After a half-gallon of sweet tea and that wonderful steak, I was ready to hit the road again. If you happen to be near Greenville, Mississippi, drive down to Nelson Street and see if the old place is still there. If it is, don’t pass it by!
I may have been heading towards the intersection of 61 and 49 to claim some points, but all good blues fans know the true crossroad was not the one claimed by the city of Clarksdale. I wanted to visit the real site, Rosedale at the intersection of Mississippi Highways 1 and 8.
It is Rosedale that Robert Johnson mentions in his song, “Travelling Riverside Blues,” with these lyrics: “Going up to Rosedale, got my rider by my side.” Of course no one really knows the true location of the crossroad other than Robert or the devil himself, but I place my bets on Rosedale, and the story surrounding this myth is a bit more entertaining.
According to the Rosedale story, Robert Johnson wasn’t looking to trade his soul to the devil. He just happened to be walking along on his way from Beulah to Helena, Arkansas, and the devil and his dog were waiting for him. As Robert entered the crossroad, the devil’s dog attacked, grabbing on to poor Robert, and shook him so hard that the strings of his guitar vibrated and the blues emerged from the sounds. That’s when the devil offered Johnson a trade. He said “the dog is not for sale, but you can buy that sound.” Thus the legend began.
The story of Robert Johnson may not seem to have a place in the discussion of your financial wellbeing. Yet when you think about it, you can see that each of us are forced to make decisions that can give us instant gratification for a price. Our Federal Reserve creates trillions of dollars, and keeps interest rates artificially low at the price of possibly creating bubbles and long-term inflation. Our politicians give rewards to a few at the expense of others to seek reelection. On Wall Street individuals use illegal insider information, outright theft, or misrepresentation for personal gain. People spend their money now instead of saving it to maintain their lifestyle in retirement.
Since the great recession began, stories emphasizing the negatives have dominated our discussions. Personally I believe this constant bombardment of the negatives in our society has kept our economy in a state of little to no growth. It takes confidence in the future to take risk, and risk taking is what we need to firmly place our economy on a path of sustained growth. But instead of investing for the future, and looking towards long-term rewards, individuals have placed their savings in the bank. This behavior is simply a quick fix for their fear that all investments fail and they will lose everything. Businesses, fearful of zero growth, unemployment, and the end of consumer spending have done the same; cutting costs and reducing payroll instead of paying for expansion and future growth.
But I am seeing now more signs that people are willing to take on financial risk. Housing starts and building permits both exceeded one million annualized units in April. Granted, the majority were for multi-unit construction which some say is not as beneficial as single family homes, but I look at it in a different light. New construction would never take place without someone taking the risk that, over the lifetime of the project, financial rewards will exceed the cost of construction. In addition, most multi-family construction projects include the use of borrowed money. These funds come from someone who also agrees that greater wealth will come to them over time, and choose to take the risk rather than leaving their money in the bank. Multi-unit construction has a long-term payoff with minimal, if any, short-term rewards.
The National Federation of Independent Business optimism index is at the highest level since before the great recession began. Because the vast majority of small businesses have 100% of their family’s wealth tied up in the day to day operation of their business, their optimism assures us that they will continue to keep the doors open. With the doors open, their employees will feel secure enough to take on risk that will benefit their own long-term future. And we know that it will take optimism in the future for a small business owner to hire new employees, something that we desperately need in this country.
We are seeing some changes take place in the board rooms of the world’s largest corporations as well. Since 2008 we have seen corporations massively cut expenses, including their largest cost, employees. We have seen them take their excess cash and use the majority of these funds to payout dividends and buy back shares instead of reinvesting those funds into the business for long-term growth. Board rooms are now full of discussion concerning growth of revenues. They can approach this in a couple of ways, both of which take cash to implement.
The easiest way to increase revenues is through acquisitions. Although the few large mergers will always dominate the news, the acquisitions of small companies with special expertise has been on a rapid growth path for some time. This is the type of activity that does not result in massive layoffs, but instead has the potential to create new revenues and jobs, as the cash and marketing capabilities of these large companies maximize the potential of the small company’s capabilities.
The second approach is organic growth. Spending on organic growth has a longer term payoff, but in most cases, produces a greater net profit. The current level of spending on organic growth is accelerating. We are seeing research and development budgets increasing in corporations even while the amount spent by our government has decreased. Research and development is absolutely important for all of us. Without it, there could be little advancement in the way we live.
Marketing spending is also accelerating. We know that businesses are quick to cut marketing spending with any hint of a downturn. When we see an increase in spending on marketing, we know that confidence in the future is growing.
Economics is and always will be a social science. Although the majority of economic news you hear or read will contain numbers, all these numbers are simply an attempt to explain what people have done or will do to benefit themselves financially in the future, given the circumstances they live in. Just as Robert Johnson entered the crossroad and made a choice that ruled his life, each of us make choices that will have an impact on our own future.
As we build and maintain your portfolio, we too have to make some decisions that may not be supported by the underlying numbers. Since the value of every business we own will change with the future profits the company creates, we must make a judgment as to the company’s ability to grow these profits. The rate and timing of profit growth will depend greatly on whether our central banks, politicians, and people decide they want short-term gratification or instead take the steps necessary to build a secure long-term future for the world.
Until the path is chosen, we will be a bit more cautious. We will continue to maintain a higher than normal level of cash. We will make new investments when we are confident the price is low relative to both present and future profits, or the interest we can earn is enough to maintain purchasing power.
Until next time,
Kendall J. Anderson, CFA