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| NOVEMBER 2007 NEWSLETTER There is much to discuss this month. Where to begin? I have just returned from Demographics School and the H.S. Dent Advisors Network semiannual conference. It was a great refresher and wake-up call. The biggest news is that the continuing research being done today is even more compelling as to how demographics can give a peek into the future of our economy. What worries me the most is how few of our “leaders” use this vision. The timeline of major change and action may begin as early as the summer or fall of 2008. For example, the astounding growth in stock valuations in emerging market countries like China and India run the risk of collapsing in a speculative bubble. Bubbles have a typical cycle of doubling in their last 12-18 months. The collapse historically brings the relative price level back to the beginning of that doubling point or lower. We will probably reach a peak in general stock market valuations at this time. Another likely scenario is that residential real estate values will stabilize or continue to decline until the real economic malaise takes it down by as much as 40% beginning as early as 2010. What evidence leads to these conclusions? The US consumer is continuing to spend at an increasing rate. In fact, that is the key factor we need to watch. The key is to note where those dollars are being spent. It is not, for example, on the next bigger home. The largest block of our population, the Baby Boomers, is past that point in their lives. (Click here to see the attached chart and graph provided by the H.S. Dent Advisers Network.*) Where are they going to spend their money? As you can see from the listing of key ages in the consumer lifecycle, the next area of consumption is typically vacation homes, resorts, travel and leisure. In this stage of life, retirement is looming. So, lots of money goes into debt repayment and saving. These activities are not consumer activities. Saving does not drive the profits of companies like Toll Brothers or GM. The US and much of the developed world, like Japan in 1990, is on the verge of a consumer spending slowdown. This is normal. What is not normal is that there are 100 million (immigration-adjusted) Baby Boomers. This group is four times larger than the Greatest Generation that preceded it and makes up one third of the US population! The US economy has benefited for the last 25 years as this generation has grown our economy at a 5% annual rate. Five percent doesn’t sound like much until you compare it to the historic norm of 3%. That is a 66% increase! What happens when the businesses have to adapt to gradually slowing consumer spending? What happens when revenue and, more importantly, profits decline. Let me explain my understanding of the stock market. Stocks historically sell for 12-15 times last year’s earnings or profits. That is the P/E (price/earnings) ratio. Some companies sell for more; some for less. Right now, the Dow and S&P sell at 17, GM has a P/E ratio of 11, Microsoft is at 27. Does that mean investors are willing to wait 17 to 27 years to just get their money back? No return on the money, just the return of the money? I don’t think so. What is built into this game is the assumption that profits will grow and the investment typically will be returned in six years or so. That is a rate of return of 10-12%. Now, let’s look at the attached graph of consumer spending. It grows steadily over the last 17 years. Notice that you can’t even see a “blip on the radar” for the Tech Wreck of 2000, or 9/11, or the worst bear market in the last 75 years, or the War in Iraq, or the sub-prime debacle, or even the monthly travails of Paris Hilton and Britney Spears. This means that 300 million people are going about their lives relatively oblivious to anything other than what is important to them and their family at that point in time. Demographics do not change. Demographics are a force of nature. These cycles are written stone for the most part. The life insurance industry figured it out a long time ago. The actuaries don’t know who will die, but they do know how many and when. This enables them to set the appropriate rates. OK, let’s go back to consumers and profits and stock prices. What do you think will happen when the part of the US population that is four times larger than its predecessor, and had its peak years of birth in 1957 and 1961, naturally moves its attention to saving? Here is what I think will happen. Revenues at the companies will begin to decline. Lower profits will be reported and the media and analysts will scratch their heads and wonder why. They will write it off as a random occurrence and say it is because the consumer was worried about bird flu or some other news item of the day, such as higher prices at the gas pump. Profits will continue to decline and the estimates of the future will be lowered because that gives two dots to connect, and two dots make a line. It worked on the way up. Why not use it on the way down? By the time the companies get around to downsizing, the stock market downturn will be in full swing. We may eventually have 10-15% unemployment. How much spending do unemployed people do? By the time this potentially comes to pass, we will have been out of stocks, our money in CDs waiting until the market is panicked to begin buying high quality corporate or US Treasury bonds. (I will address the reasoning for not buying solely US Treasury bonds in a later newsletter.) This letter has been relatively long. I thank you for staying with me. The point to take away from all of this is that we have a plan. We are looking out into the future, rather than using the rearview mirror to guide you on the road to financial security. Your plan will be monitored and adjusted as necessary. Thank you for confidence. We appreciate the trust you have in us. Best from Dominion Wealth,  | |
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Defensive Portfolio Measures
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The Lagging Healthcare Sector
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Investing in India
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Consistency
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The path Ahead
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Key Demographic Statistics
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Closed-End Funds
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Revising Dent's Expectations
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Service Integrations
IRA ADVISOR NEWSLETTER 2006
Trow profiled in the April Newsletter
MATTHEWS ASIA NOW
NEWSLETTER 2006
The Demographics Issue
BNET BUSINESS NETWORK 2001
Ready to Retire