The Debt Issue, Part 2

After last week’s wild and crazy market action, all of us at Cabot are looking forward to a return to relative calm … and then the new bull market.
And how do I know there will be a new bull market?
I know it because the century-plus chart on my wall tells me it has always been so.
I know it because last Thursday and Friday’s action revealed the presence of enormous pent-up buying power.
I know it because there are more than a dozen stocks acting very well today, stocks with rapid growth of sales and earnings, with strong price charts, and with powerful trends of institutional accumulation.  (Note: They’re not the stocks you came to know and love in the last bull market.)
And I know it because despite its problems, the U.S. remains an excellent place for an entrepreneur to start a company that serves a hungry market.  It’s an excellent place to take a company public, to tap the assets of institutional investors.  And it’s an excellent place for individual investors who want a piece of that action.
So at Cabot, our growth-oriented editors are researching, analyzing and waiting at the starting gate for the beginning of the next bull market, which could come soon.  I hope you’ll enjoy it with us; it’ll be fun.

Worried About Debt

In the meantime, I remain worried about debt.
Two weeks ago I wrote here about the massive buildup of both government and individual debt in last 70 years. I noted that this bubble of debt appeared to have popped in the past year.  And I speculated that a very long (decades-long) period of debt shrinkage and balance sheet improvement might be in the cards.  Then I asked for your opinions.
Since then, the chickens have come home to roost.  We’ve seen more than a few institutions laid low by imploding debt.  We’ve seen a massive transfer of debt (and assets) from the private sector to the public sector.  And now we’ve got tighter credit markets (not a bad thing).  We’ve got more unemployed mortgage bankers, credit analysts, debt-swap experts, and their ilk (also not bad, especially according to my first correspondent below).  And we’ve got some pretty scared Americans!  Read on.

Letters From Readers

Hello Timothy,
“With respect to Fannie/Freddie, I agree.  Ditto with respect to debt in USA.
“Here’s another chestnut to roast over an open fire (so what if it’s not December).  Bean counters and politicians tend to count all jobs as being equal.  In reality, some jobs have a positive impact on the economy, while others have a negative impact.

“At the negative end of the scale, we pay people “just in case.”  Fire and EMS personnel sit at the station house until the bell rings.  Then they go out and put their lives on the line.  Frankly, I consider the portion of my tax money that is spent on the local Fire Department to be a good investment.  Police Departments belong in a similar category.  Insurance is also a “just in case” situation.  If all of us put money into a pot, then one of us who has a disaster can be made whole.
“But the overhead associated with collecting money for the pot, and figuring out how to avoid paying policyholders with money from the pot is costly.
“I submit that lots of money spent by our governments (at all levels) for all sorts of activities also has a negative impact on the economy.  For example, I am hard pressed to figure out what our State and Federal Departments of Education do to justify their existence.  And why do our Federal tax laws have to be so complicated that not even the IRS can figure out what the tax laws really mean?  In 2006, some sage figured out that American taxpayers spent $160 BILLION to prepare our tax returns.  And how much does the IRS spend to process those tax returns?
“At the other end of the scale, those folks working in four special categories (my fab four) contribute far more to the economy than just by spending their [after tax] paychecks.  They are: (1) Manufacturing; (2) Farming; (3) Exploiting natural resources; and (4) Creating intellectual property.  Manufacturing jobs convert some kind of raw material into a product of value.  The kid who gets paid minimum wage to convert half a buck’s worth of beef ‘n’ bun into a $4 sandwich is doing more for the economy than the exec who draws $20 million per year to run an insurance company.  It’s about adding value.  We ought to glorify the kid, rather than excoriate him for taking a dead-end job that anyone can do.
“The rest of us fall somewhere in between.  The sad fact is that as our economy becomes increasingly service-oriented, those working in fab four jobs can’t increase the total amount of money in the pot if the rest of us are simply stirring the pot, or sucking money out of the pot.
“Think about these concepts for a while.  Then think about where current economic trends are leading us.   I’m frightened.”
Bruce Bardes

“Tim, Keep pounding on this issue! I’m amazed that more people in the investment business don’t realize the seriousness of this problem, which in my mind, is right up there with energy, as one of the most pressing confounding problems of our times.”

“Regarding your statement:  “Fannie Mae was converted to a private corporation, and at that point all guarantees of government backing disappeared. Technically, the company was no more part of the government than Wal-Mart, Apple or Exxon are today.”
“I am surprised you failed to mention a fundamental difference that implied a strong government involvement in the company.
“Under its charter, Fannie Mae had 18 directors. Thirteen were elected annually by shareholders and five were appointed by the president.  Couple this with an obligation to, at the very least, “listen” to directives offered by the US Treasury, and one must realize there was a difference between FNMA and private corporations like WM, AAPL, and XOM.”
S. H.
Fairbanks, AK

“Tim, with your permission I have copied your four-page epistle and am going to mail it to my kids. They’ve heard from an old banker and stockbroker and it’s time they hear from someone younger.
“Well done!!!! Educational, simple and unbiased.”
S. C.
Roseville, MN

“And the Boomers are going to be shocked when they learn that their anticipated inheritance has been greatly diminished by the “reverse mortgage.”
“I have absolutely no debt, other than my share of what the government has created for me, and this letter has scared the hell out of me.  It needs to be a full page in all of the major daily papers.”
T. V.
San Antonio, TX

“Thanks for your usual thoughtful essay.  I think you might find the “Money As Debt” video interesting, if you haven’t already seen it.
“One of the inferences from it is that debt is a necessary part of the system (not necessarily in its current runaway form!), and the booms and busts, collapses and reconstructions that have characterized the human economic enterprise from the earliest days may be an inevitable characteristic, just as the inchworm moves by contracting and expanding its reach. There is the idea that we’ve cracked the code since 1929, so we can avoid depressions, busts, bank runs, personal pain and ruined dreams. Hope so.”
C. F.

“Dear Timothy Lutts,
“I read your mail of 12th Sept with great interest as I have been following the stories of Fannie Mae and Freddie Mac in the Indian media and CNN.
“As an Indian, I understand what globalisation means because the Indian equity market came down almost 35% since January this year. The Sensex now is range bound between 14,000 and 15,000 points and the brokers who lost huge money in January and February have taken recourse to short covering to reduce their losses.
“Inflation is running at 12%, food prices and edible oil prices have gone up by 40/45% in last 8/9 months. The coalition government in India is in trouble with general elections looming large in mid-2009. The only redeeming feature for the Indian economy is that popularity of credit cards is a recent phenomenon, so the default payment on that count is low.  But house loans are getting into default mode. The banks are reportedly (print media stories not mine) using tough guys to recover installments of car loans/ default payments etc. The malls are going empty and with the Central Bank resorting to hiking interest rates discouraging people to spend on credit cards/auto loans/even house loans and restricting money supply by hiking CRR, the relentless fight is on against inflation and rupee depreciation. The oil price is another great concern because in order to contain inflation, the Indian government is subsidising petrol/diesel and cooking gas leaving public sector oil companies bleeding. To compensate them, the government is issuing oil bonds. On the whole, the economy is under stress.
“Therefore, I am not surprised by the content of your mail. The solution suggested by you is the only one. We have to demand less, meaning spending less and spending within our means and there must be savings every month. Use credit cards but keep in mind the basic principle of “Ability to Pay.”
“There is no other way to recover and bring the USA economy to some form of stability unless people understand that they should only incur debts that are payable.
“Arnold Toynbee’s book on History of Civilisation tells us how great civilisations went into decline due to poor economic policy of the then ruling government. Privatisation is fine but it cannot be given that type of liberty that will ruin the economy of a giant nation, leading to its slow decline. Living good is fine but not beyond means. The age-old Proverb is good to repeat here: CUT YOUR COAT ACCORDING TO YOUR CLOTH. Thanks for giving me the opportunity to express my views. That’s a great virtue of Democracy.”
B. G.
Kolkata, India
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“I mostly agree, especially with reducing expenses.

“My plan would be to go to every government department and reduce their budget allocation by 10%. Then let the empire builders figure it out.

“Then cut another 10% the next year.  History tells us raising taxes is counter-productive.
“Medical care is so expensive because of the lawyers, the pharmaceutical industry and the governmental regulations … also insurance companies. I promise you that doctors are NOT getting the money. I could go on for hours. Many, many paychecks in the medical field are directly related to insurance companies and complying with governmental regulations.  We as Americans need to stop empowering the bureaucrats in both these industries.”
F. B. MD
Rochester, MN

“This GREEDY GOVERNMENT needs to downsize, NOT take more taxes!!!!!!!!!!!!!!!”

“I think you have go down a level or two to get to the guts of the “debt problem” to really understand it better and therefore the solutions.
“First, a great number of people with credit cards don’t owe a penny; they pay their balances every month … which means a few owe a lot. Second, as the population gets older, many more mortgages are paid off; it’s the recent mortgagors, last five years or so that are “upside-down” hence the current problem with housing. Third, China owns trillions in U.S. Treasuries. They got this money as we bought their inexpensive products, which kept inflation down in the U.S. If they would start dumping the U.S. Treasuries, I’m sure our government would act to limit purchases of Chinese goods, which would require Chinese companies to lay off people, resulting in more riots in China, which the Chinese government does not want. It’s the typical “catch 22.” (The Chinese government is investing in U.S. hedge funds and other U.S. investments rather than dumping Treasuries.)
“Bottom line: we are not in dire straits.  And look at other countries’ debts relative to their economies and assets!  There’s no comparison. It would be those countries that would get hit first.  The U.S. dollar is still the strongest currency in the world.”
B. P.
Williamsville, N.Y.
“I’m not in favor of bailing out Chrysler, Fannie Mae, Sally Mae, Lehman, etc. The capitalist system is not perfect but the weak have to expire. Federal support leads to inefficient investment results.
“Just because we have so many social entitlement programs doesn’t mean corporate should follow that model. That model doesn’t work anyway. But that is another story by itself.
“The problem is the shareholders and employees get cleaned out but the managements get “golden parachutes.”  I understand there are no to little environmental laws in most other countries, no unions but dictators in many countries and laws limiting foreign suppliers (Japan), so the U.S. companies have their hands tied behind their back.
“In spite of this, we are winning in the world because we have the best-educated work force in the world, the best colleges around the world, the most creative and innovative (check the number of new patents each year around the world) people.
B. P. (again)

“Timothy, I enjoyed your advisory today.  It seems no one is concerned about government and personal indebtedness.  If China and Japan called in our debts, we would be history.  For several years I have described our country by one word, GREED.  It is our driving force.  A lot of people are borrowing money they don’t have to buy something they don’t need to impress people they don’t know.  THIS HAS TO STOP.  I think some of this has trickled down from Washington.  Our politicians, as you point out, seem to think all we have to do is print more money.  Our current presidential candidates don’t even address the issue.  I think most politicians talk the talk so they can get elected, but the American public has to take 90 % of the blame because they all want more entitlements.  The nation has become weaker as a result.  We are like a ship at sea without a rudder.  We have no direction or vision.  Too many people only have one interest, THEIR PLEASURE (HEDONISM).  Most are not the doers of our forefathers.   We need a Harry Truman to read us the riot act.  A well-written and researched article.  Enough of my rambling.
J. W.
Salem, Virginia

“Tim, I disagree with much of what you suggest in this piece.
“First, I think it is important to bear in mind that one man’s debt is another man’s investment. Consequently, it is a zero sum game in that what is recorded on one balance sheet as an asset is recorded on another balance sheet as a liability. Thus, GDP itself is a somewhat misleading statistic as it means totaling all transactions (i.e., both the liabilities and the assets) of an economy.
“Second, some of the growth companies that–to my knowledge–Cabot either has or is recommending as “buys” depend upon many of the factors that you seem to be aghast about: FSLR goes up when energy costs go up. Thoratec would have little to no business unless subsidized life expectancy went up. Toll would not exist if people chose to live in modest homes. MasterCard would not be a good investment unless people had a penchant for pulling out the plastic regardless of their cash position. Consequently, unless your point is that there is some immorality in making money in the stock market (and I certainly do not believe that to be your philosophy), some of the downside factors that you identify should perhaps be seen as indicators of where future prosperity awaits, rather than as something that is inherently bad.
“Third, surely the high P/E multiples of companies that are not at present paying dividends–and again FSLR comes to mind–reflect optimism about future earnings rather than anything else. Thoratec would not be worth buying if there were not huge future contingent liabilities for Social Security or Medicare.
“Fourth, the market is a great equalizer. Everything, in a free market, should balance out. One of the problems with the current environment is that the global market is not entirely free. Specifically, for example, the Chinese currency is not appreciating as it would be expected to appreciate in view of the large balance of payments surplus enjoyed by China. China is consequently building on the cheap, and selling its products abroad for an unjustified premium. Were the Renminbi free floating, its value would appreciate vis a vis the dollar, and all of a sudden, consumers’ spending habits, and their appetites for high value consumer goods, would change.
“Fifth, it is interesting that you started your analysis with 1938. I would have gone about twenty years further back. The U.S. came out of WWI rather well, from a financial point of view. It had notably taken over the UK’s position as the world’s leading economy, and it was in a large surplus position. Most of Western Europe was heavily in debt to the U.S. Germany was a ruin, and was unfortunately forced to pay massive reparations to the WWI victors in defiance of any common sense–reparations payments were a bit like forcing trauma victims to give (rather than receive) blood. The U.S., however had to keep lending in order to keep its creditors in Europe afloat. It was when the U.S. stopped lending that the whole deck of cards collapsed.
“All the best, in wisdom and (I hope) future wealth.”
M. M.
Washington, D.C.

A Great Biotech Stock

OK; enough about debt.
Turning to the market, we saw a huge relief rally on Thursday and Friday of last week, followed by a proportional counter-move today.  That the bottom has been seen in many stocks is a very high probability.
So what do I like?
I like medical stocks, especially those involved in biotech and genetic technology.  There are some impressive charts today, and the long-term fundamentals are bright thanks to growing demand from aging baby-boomers.  Who’s going to pay for all this care is yet to be determined, though recent events provide a clue.  Also, I have some “radical” ideas about the potential of health care to enhance productivity that I’ll share in a future issue.
But today I want to tell you about Sequenom (SQNM), a little company that earned a spot in Cabot Top Ten Report several times in recent months as it bucked the broad market’s downtrend.
Here’s a composite of what editor Michael Cintolo has written.
“Sequenom is a small California-based manufacturer of genetic analysis products for use in biomedical, agricultural and molecular medicine research. The company has never had a profitable quarter, but every quarter it sells more of its MassARRAY platform, a flexible and scalable platform that allows researchers to examine DNA sequences and variations with extreme accuracy.  The company itself has done groundbreaking work analyzing fetal gene and chromosome abnormalities such as RhD, and Trisomy. Trisomy 21, in fact, is Down Syndrome, and it’s the prospect that Sequenom could tap into this huge market that’s caused the stock’s strength since the results were released on June 4. The company’s non-invasive test (performed much earlier than amniocentesis) has a 99% detection rate, with zero false positives. The company’s first test group numbered 201 patients, and the company’s test correctly identified all 10 cases of Down Syndrome, while recording zero false positives. It’s now starting the process of testing 10,000 patients, and management is optimistic the results will show greater than 99% accuracy, with less than 1% false positives or false negatives. If all goes well, Sequenom is looking to commercialize the product in the middle of next year, and it by some estimates, the company could see revenues (for this one test!) of $165 million in 2010 and $2 billion in 2012.”
The stock has been acting extremely well in the last three months, hovering in the low 20s as the market fell apart.  It’s a very promising pattern.  Short-term, however, the biggest factor is tomorrow’s analyst and investor briefing, in which the company might release information that moves the stock. 

Editor’s Note: Sequenom may not appear here again but it will be mentioned in every issue of Cabot Top Ten Report until Editor Michael Cintolo recommends selling.  If you’re looking for the leaders of the next bull market, I suggest you try a trial subscription to Cabot Top Ten Report.  It brought subscribers Hansen Natural, Crocs, First Solar and many more leaders, and it’s guaranteed to bring you the leaders of the next bull market as well.  To get started with your no-risk trial subscription, simply click the link below.
Yours in pursuit of wisdom and wealth,
Timothy Lutts
Cabot Wealth Advisory


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