Agora Financial’s Rude Awakening

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Laguna Beach, California

• Markets take a breather after frantic start to the week,
• The weakening credit pulse and what it means for hopes of recovery,
• Soft porn to make comeback at the Happiest Place on Earth and more…

Eric Fry, reporting from Laguna Beach, California…

It’s true that economic contractions produce widespread hardships. But contractions also bestow benefits to those individuals who remain employed and/or possess sizable nest eggs. For example, during recessions, houses become cheaper to buy, 5-star resorts offer deep discounts and dinner reservations become a mere formality…certainly not a necessity.

These sorts of “benefits” are fairly obvious and expected. But who would have guessed that our current recession would put a $10 filet mignon on the menu of a pricey steakhouse or that the recession would invite an extra dose of youthful exuberance to the Happiest Place on Earth?

Well, dear investor, it’s true.

Last night, your California editor and a friend walked into an absolutely packed steakhouse. “How on earth could this restaurant be so full on a Tuesday night?” your editor asked himself, while simultaneously questioning his dire macroeconomic outlook. Finding no place to sit, your editor intermittently sipped his wine and scratched his head, as he tried to figure out what was wrong with this picture. Almost every restaurant in which he had dined during the preceding weeks had featured a noticeable paucity of clientele. Sure, the Saturday night crowds were still present in the very best restaurants, but Mondays and Tuesdays had become reliably free of patrons. This steakhouse was NOTHING like anything he had observed recently.

Forty-five minutes later, your editor got a table…and the explanation for the mysteriously large Tuesday night crowd. The menu’s upper right hand corner featured three “$10 Specials” – the high-end steakhouse version of McDonald’s $1 menu. For the price of one mere “Hamilton,” the frugal carnivore could enjoy an 8-ounce filet mignon. A half-pound of King Crab legs was also on offer for $10. Both items, in other words, were cheaper to order in this restaurant than to purchase in a supermarket.

“So how’s business?” we asked the waiter. “Is it always this packed?

“Yeah, we’ve been pretty busy,” the waiter replied unenthusiastically. “But that’s what happens when you sell stuff for less than it costs to prepare.”

“Do a lot of customers order from the $10 menu?” We asked.

“Yep,” he answered. “Why wouldn’t you?”

“What percentage of patrons order the $10 items?” we inquired.

“About 80%,” came the response. “Look around you. Is it any surprise?”

As your editor glanced around the dining room, he noticed a very large percentage of sixty-something patrons. He didn’t think much about that detail until 45 minutes later, when the clock hit 8:30. He took a bite from his filet mignon, and glanced around the dining room again, surprised to discover that it was now almost completely empty.

“So this is the recovering economy,” your editor thought to himself. “A two-hour crush of retirees seeking a $10 filet mignon.”

Mission accomplished: Dire economic scenario intact.

But what about those exuberant Disneyland visitors, you may be asking? What do they have to do with the slowing economy? Read on for details…

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Topless Mouseketeers
by Eric J. Fry

The toxic tentacles of recession seem to extend into every imaginable – and unimaginable – pocket of the economy. As these tentacles release their toxins, the resulting distress affects both individuals and industries alike, often in ways we might not have imagined in advance. But so too do recessions impart the occasional surprising benefit. Our advice: Enjoy the benefits when and where you can because this recession is likely to get much worse before it gets better.

“Call it an unexpected consequence of the bad economy,” the LA Times remarks. “A recent round of staff reductions at Disneyland could result in the return of embarrassing episodes of public nudity at the Happiest Place on Earth.

“Back in 1997, a front-page story in the Los Angeles Times chronicled a scintillating Internet phenomenon involving the Anaheim theme park’s Splash Mountain log ride: Photos of women flashing their breasts at an automatic camera that snapped souvenir photographs during the final 50-foot drop were ‘unzip-a-dee-doo-dahing’ their way around cyberspace, earning the ride the dubious nickname ‘Flash Mountain.’”

Disneyland officials quickly put a stop to this informal soft porn by hiring employees to examine each and every photo before posting them on the preview screens at the end of the ride.

But alas, declining revenues at Disney’s theme parks have forced a variety of cost-cutting measures. The photo screeners at Splash Mountain, Tower of Terror, and California Screamin’ have been redeployed to other positions. “Actual inappropriate behaviors [sic] by guests are rare,” a Disney spokesperson explained.

Correction: “Inappropriate behaviors” by guests WERE rare.

Now that the breast police have been re-assigned, “inappropriate behaviors” are likely to increase. But this serendipitous recessionary “benefit” is probably not sufficient to boost Disney’s ticket sales. A family of four must spend at least $356 for a one-day visit to Disneyland here in Southern California, and that’s before paying for parking, food, Mickey Mouse ears, or a souvenir photo of mom riding Splash Mountain.

That’s a large chunk of change, even for those folks who still have a job and a little bit of money in the bank.

Therefore, the fact that unemployment is rising – in a populace with meager savings and plummeting home values – is a fact that provides little hope the economy is genuinely improving. Furthermore, the theoretically recovering banking sector is engineering its “recovery” by shrinking the asset side of its balance sheet. The banking sector is rapidly withdrawing credit from almost every sector of the economy – especially the consumer sector. That’s an ominous development for an economy that is as dependant upon credit as the American economy.

To validate the contention that sources of credit are disappearing, we offer both anecdote and hard data. First the anecdote…

“I talked to my 22-year old son last night,” a friend of your editor’s related recently. “Wells Fargo was his company’s only high-quality finance company for people buying air conditioning systems for their homes. Last week, Wells cancelled their vendor lending program for all of Texas. Credit rejections used to run at 20% of applications for my son’s company. Now they are running at 40%-plus. Bottom line – one of our TARP recipients has stopped lending to real people with jobs and ‘good credit’ who want to buy domestically manufactured and installed assets to improve their homes.”

Now, the hard data…

At the recent Value Investing Congress in Pasadena, California, hedge fund manager Igor Lotsvin, offered the following observations:

“The results of this banking crisis – and we do think very much that the worst is ahead of us – is that the banks are not lending. We see this almost everywhere and in every way… the banks have cut their unused lines of credit commitments by $1 trillion in the last six months of last year. That basically means lines of credit and credit cards. In the fourth quarter of 2008 alone, banks have cut more than half a trillion dollars of consumer lines of credit.

“So think about the American consumers; they are basically in the situation where their 401(k) got cut in half, where their house is worth 30% less than it was three years ago… and now their only source of liquidity is their credit card. And that’s being cut off very rapidly…

“The de-leveraging that’s taking place in the world is continuing a very massive scale. The world is really on the margin call right now and it will not cure itself in the next couple of quarters. There is plenty of more pain to come.”

In order to see the beginning of a recovery, says Lotsvin, we would have to see the beginning of banks’ willingness to lend. But that’s not happening.

“The banks have been pumped with hundreds of billions of dollars of liquidity and trillions of dollars worth of guarantees,” says Lotsvin. “We don’t see any lending. Lending is not happening, so the government can’t force banks to lend without taking ownership in them… you don’t see JP Morgan lending, you don’t see Citigroup lending, you don’t see it Wells Fargo lending…So that is not happening. Our premise is the economy will not work until you restore the credit pulse.”

Hmmmmm…Seems like a plausible premise.

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[Rude Endnote: Global stock markets calmed down a little after a somewhat frantic start to the week. The Dow edged slightly lower by yesterday after a promising start to finish 0.34% in the red. The story was similarly underwhelming throughout much of Europe and Asia.

After a record-shattering 17% rally in India’s BSE Sensex on Monday, traders gave back roughly 1.5%. China’s CSI 300 and Hong Kong’s Hang Seng fell 1 and 0.4% respectively while Japan’s Nikkei 225 managed to climb about 0.6%.

Over in the Eurozone, markets Germany and France edged somewhat higher in early morning trading. Last we checked the DAX and CAC 40 were up 0.9% and 0.6% respectively. London’s FTSE was relatively unchanged.

In the commodity pits, crude continues in stride, cracking the $60 mark overnight. Gold too is back on the radar, up four bucks overnight and closing in on $930.

We hope that gets you off to a decent start today. Shoot us an email if you’ve got questions, comments and/or complaints.

Until next time…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com