No More in 2004: (part II) The Wal-Mart Economy

By Paul Petillo - Blue Money Report

Patt Morrison of the Los Angeles Times outlined the circular logic of Wal-Mart's success. It fits comfortably in the logic that this administration has been offering the American people thus creating a Wal-Mart economy. When the next year unfolds, the cost of this thinking as she succinctly offered will be "Wal-Mart sucks them all up" as we hunger for cheaper goods we literally drive our own jobs away to countries where wages can be more proportionate to the end price on the goods. In other words, Wal-Mart keeps the poor poor and helps the new poor cope, which helps them spend what little they have keeping them effectively customers for life.

The economy has taken on this logic over the last year and I expect it will come to fruition in the upcoming year. Let's look at equities first. Or better, lets look at what many call the anti-stock, gold. This safe haven for skittish investors has gradually crept upward in the shadow of the equity markets. Stocks, historical reasoning would have, always do better when investors feel good. Gold does the opposite because the reasons to own gold are basically a belief in bad times not a positive outlook for the future. So when gold does well as equities do, that can be worrisome.

And gold has no reason not to outperform. There is only so much of it around. The inelasticity of the supply means that if the stock market tumbles in the first or second quarter of this year because there is deflationary pressures, gold will rise to previous levels of the early eighties.

Mutual funds are finding themselves much the same predicament as the cattle industry, hoping beyond hope that the average Dick and Jane is too busy trying to get by, avoiding layoffs, making ends meet to notice that they have been suffering from a few "downer" funds with diseased managers. Now normally you would expect the American public, whose equity ownership number now comfortably exceeds 60% of the households in America to be up in arms. Not so.

Many of the people I have spoken to, mutual fund owners one and all have little knowledge of how this is effecting them. Blind investing in index funds keeps us safe from the dangers of losing money, they think. Needless to say, the last "mad-cow" mutual fund has yet to be uncovered. The sad part of this story is that we won't change a thing because many of us are limited to the choice that would allow us to change the industry. The recent settlement with Janus at a penny a share elicited a yawn from investors and drove home the point that stealing pennies from everyone is far more lucrative that stealing dollars from rich guys.

So where does that leave us as we look at the equity markets in the near term. Small cap growth companies will struggle under a deflationary change in the economy. This group has had a significant run over the last year or so and the downward pressure of their larger customers to succumb to continued lower prices will have a demonstrative effect on what Wal-Mart thinking will do to these Main Street stores.

Mid-cap growth will find their business impacted as well but will survive nicely because of economy of scale. It will be far easier for them to compensate in this years head-on winds but they will not escape a downward shift in momentum. They will just suffer less. Large cap growth companies will do just fine. They have figured out the equation and it is not good for the economy but ironically, it will be good for business.

As long as this administration supports pro-corporate policies that undermine the growing legions of under and unemployed and turns a blind eye to the subtle shift of jobs overseas, large caps will do well. Workers will lose ground in organizing under these policies and those that have organized will be forced to make harsh choices that help their companies instead of the workforce.

This will be most evident when the Fed chairman deems the current unemployment rate as acceptable to a reinflationary scenario. That last statement I hope is not prophetic but it is looking inevitable. So growth will happen at companies who can improve productivity without adding labor, taking advantage of lower overseas labor and consumer markets, and do so because of favorable money and debt ratings.

Value companies will begin to outperform on every level. In many instances, these companies rely on "inelasticity" to charge higher prices. Many of those whom are stalwarts in their sectors will shine the brightest as they investors scurry for the doors out and in the process will leave many of the these funds overlooked and undervalued.

REITs may have seen their day in the sun slip away as well. Even as the housing market has continued to sizzle in parts of the country, the economy will falter under the weight of those mortgage backed securities held by Fannie Mae and Freddie Mac. If that happens, foreclosures will begin to mount followed by a fall in high end rentals which will force rents down slowing construction. Compared to the '04 result of the stock market, REITs will still fair better but the margin will be slimmer than in year's past.

We already mentioned gold and the same goes for any commodity based stock. There is value in owning something tangible.

I mentioned yesterday that the Fed had made a move in the last decade with an eye towards the world economy. That move it turned out brought a bubble to the stock market and like all good bubble economies, burst in due time. This past year's rally in equities has been particularly hard on bonds. But there is some hope that will change in the upcoming year. For two reasons: One, we are not a nation of overseas travelers. The trading value of the dollar has little to do with our day-to-day living and as a result of that thinking, reason number two: the Fed has made us a nation of homeowners.

As a nation of homeowners, we were able to tap into our credit further when the interest rates made it accommodative to do so. But in order for that to continue, something has to give and that something is the 10 year bond. With the yield on these bonds above four percent, refinancing is not as attractive slowing spending and putting pressure on the economy. This bond might even see yields as high as 5% by year end. This would effectively push investors away from Treasuries. With no where to move from an interest rate perspective, what looked to be accommodative for the country is now the tightened noose around the recovery.

The Fed it is believed will begin to tighten money supply and raise rates toward the summer with some folks suggesting that '05 will be the year the thumb drops on the recovery. But the recovery in based on inflationary pricing and Wal-Mart just doesn't operate that way.

Nothing is so indicative of this economic argument than the one made by Thomas G. Donlan of Barron's in a column dated 12.29. In it he pointed out that economic benefits that Wal-Mart provides a community are far greater than the benefits it could provide to unionized workers, who tend to do far better than the world's largest retailer's current workforce. Using the grocery strike in southern California as an example of the few seeking benefits outweighing the good of the many, a strike whose causes cover a wide range of issues among them the future competition of Wal-Mart grocery stores, he suggested that replacing the workforce of unionized employees with Wal-Mart workers would lower prices for more people than the current (on strike) workforce would return to the community in the form of spending.

What Mr. Donlan fails to observe is the difference in the quality of goods at the different retailers. Prepackaged meats for instance, the cornerstone of a successful grocery operation are created by low skilled entry level workers and sold to the chain as shelf ready. The true end weight of the package contains additional profitable moisture often up to 12% of the total weight. This illusion of savings due to the modified atmosphere that is required to keep these box to shelf meats fresh has allowed them to discount the product, one that many of us would find inferior in all aspects, except price. Mr. Donlan seems enamored by the company but makes no mention of whether he is also a regular customer. He does point out that this retailer should be revered because of its sheer size, whose worth is in excess of all but 30 other world economies.

Bow if you must to what they may call a bargain, but when it comes to adopting the business model of Wal-Mart as the way to run this country we will face the same outcome as investors: buying less and being told it is cheap.

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