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Wednesday, July 27, 2011

“Plus ca change Plus c'est la même chose"—"the more things change, the more they stay the same.”

 The More Things Change the more they stay the same 
The more things change the more they stay the same 

Ah, is it just me or does anybody see 
The new improved tomorrow isn't what it used to be 
Yesterday keeps comin' 'round, it's just reality 
It's the same damn song with a different melody 
The market keeps on crashin' 
The more things Change – Bon Jovi (partial lyrics)

"Plus ca change Plus c'est la même chose"—"the more things change, the more they stay the same."
This familiar proverb of French Origin is credited to the novelist Jean-Baptiste Alphonse Karr (1808-90). I am sure the phrase is familiar to you as it has appeared in many instances from George Bernard Shaw’s “Revolutionist’s Handbook” to an utterance by Kurt Russell as he depicted “Snake Pliskin in “Escape From LA” the movie sequel to “Escape From New York”. Perhaps watching those films might be in order as if things continue on the current trajectory society could end up imitating art. Now please understand dear reader I am not an alarmist by nature but I do believe in looking at things from many perspectives.

The current Kabuki Theater as I have called it for the past few weeks in my Tweets continues to drag on and on far longer than I had expected. It is obvious to me that there is a dearth of leadership, economic knowledge, reality and cooperation by all parties involved. There is much talk about “sharing the pain” but whether it is coming from congress or comments on articles posted on the net the message is clear we should share the pain as long as someone else is getting the pain. In other words cut that program or increase that tax but don’t cut my program or increase my tax. Instead of sharing the pain or fixing the problems we are all engaged in this twisted form of “class warfare”.  I am not interested in the politics of the situation just the reality. The reality is that we are now subject to the laws of large numbers.

It does not matter how we got here or who is to blame because we are all to blame. We are all to blame because we have all benefited from the excesses of Government in one way or another. Really, how many of you reading this bought a car under “cash for clunkers” or a new appliance using “dollars for Dishwashers” or even a home with the $8,000 first time buyer credit? Even if you did not participate in those deals there are so many other areas where the government has been subsidizing throughout the economy that virtually everyone has contributed some to this mess whether they realize it or not.

Alexis de Tocqueville’s quote describes the point at which we have arrived in our society. "A government that provides total security for its people, foresees and supplies their necessities, manages their principal concerns, directs their industry, regulates the descent of property and subdivides their inheritance-what remains but to spare them all the care of thinking, and all the trouble of living.”  Along the same lines in 1917 Vladimir Lenin looked around at what he saw at the time and made some predictions that: “Germany will militarize herself out of existence, England will expand herself out of existence, and America will spend herself out of existence." These two individuals had the foresight to connect the dots as to the probable future outcomes; while it is ironic that the father of communism would be one of the predictors, he obviously had a grasp of human nature and government.

As I watch what passes for Government leadership and compromise I am brought back to an article I read back in 2009 when things seemed pretty dire, but at least at that time the government appeared to be functional. Today the Debt Ceiling deadlock has exposed a raw nerve that is a crack in the republic. The Wall Street Journal featured an article regarding the predictions of one Prof. Igor Panarin. Panarin a 52 year old professor is a former KGB analyst, as well as the dean of the Russian Foreign Ministry's academy for future diplomats. Needless to say Panarin is an expert on US - Russian relations. His prediction at the time of the article was that the US will split in to 6 separate regions by 2010. The regions are depicted in a graphic contained in the article. Back in 2009 when I read this I dismissed the theory out of hand and felt that Professor Panarin may be an expert but he is not an American so he cannot fully understand our republic. With each day passing I can see the divisions and fractures that are growing in the republic. While I still believe that the good Professor is wrong I will say it does feel as if we are accelerating down the path toward his vision as the rhetoric, vitriol and lack of cooperation grows in Washington.

Our leaders and government are making it impossible to work toward repairing our republic. Now please understand dear reader I have made it clear that I feel that both parties are to blame for this mess so I am not looking to pin blame on either side. I believe that neither party is competent or has our best interests at heart.  We all know that George W. Bush was a big spender and swung the country from the miniscule surplus, but surplus none the less, to some pretty large deficits.Of course people also fail to comprehend that just because there was a surplus does not mean that we did not havea large national deficit, but it was much more managable at that time. Not that I am defending Bush but after he took over he did have to deal with the tech wreck, 9/11, Afghanistan, Iraq, prescription drug program then the Lehman\subprime debacle. Obama has the continuation of Bush’s problems, auto bailouts, omnibus stimulus bill, Obamacare and Libya to name a few items. Due to the combination of circumstances and his own ideology Obama has been a big spender as well, but unfortunately for him we are much closer to the endgame and the spending measures don’t have the same effect as in the past.  To papprhase John Maynard Keyenes, "in the long run we are all dead" and we have arrived at the long run. Many people misinterpret the meaning of what Keyenes said as a live for today mantra, but that is not what he meant. Keyenes knew that the policies that he put forth and have been adopted as a psuedo religion would eventually undo the economy, but he also knew that the leaders of his day including himself would not live to see theaftermath.

The current Debt Ceiling debate and “deficit reduction” are a giant sham. To truly take care of this situation would require enormous pain on all ends from rich to poor. No politician alive with the goal of getting reelected will do the right thing, so we are condemned to a crisis before this is repaired. Congress has not put forth a budget in 2 years since Obama took office because instead of addressing real problems they had to both deal with issues in the economy as well as create massive new legislation which we have yet to see the unintended consequences of.   On the other hand Obama to his credit presented a budget back in 2010 that would have had us on a course for $1T deficits basically as far as the eye could see. Obama’s rosy ,if you can call it that, budget made some assumptions to get to the $1T mark. The budget was predicated on the assumptions that we cannot have a recession, the unemployment rate needed to fall from 9.6% to 8% and lastly GDP would have to grow 3.2% in 2010, 4% in 2011 and 4.6% in 2012. The people who made these budget assumptions have all subsequently bailed on Obama, probably because they all knew that this scenario could never happen.

This brings us to the Current situation which has rocked the confidence of the nation as we are on track this year to run a deficit of $1.7Trillion.  Tax Receipts account for about 2.2 Trillion of our roughly $3.9 trillion in spending for the year. Obviously because the assumptions were incorrect the deficit is larger than the $1Trillion projected and will be larger again next year if the economy does not improve. It is possible that the current projections will be off yet again and the Debt Ceiling will need to be addressed earlier than Obama or congress believes. Without front loading of real cuts any deal is suspect at best and I don’t believe will fix anything. First off looking at both the Boehner and Reid plans the “cuts” all come in the latter portion of the 10 year plan, which the next congress will at best modify or at worst ignore rendering them ineffective. Furthermore, the Government is the only entity in the world that can increase baseline spending but still call them cuts. You see dear reader if the Government is slated to increase spending by 7% but they agree to spend only 6.5% more then it is considered a cut, don’t you wish you could do that! Additionally, many of the savings in both plans are fictitious as they count things that may not happen but it is still a cut and savings you see, like money for ending the War in Afghanistan but not counting the action in Libya.

Even if it is not publically admitted the Republicans and Tea Party members have scored a huge victory for their side. They stuck to their guns and changed the direction of the dialog. If you notice dear reader that the original discussions had the Democrats and Obama looking for a revenue rise (..IE Tax increases) and no cuts for social programs. The Republicans were seeking the opposite side of the coin. Both sides were at least paying lip service to deficit reduction but without any real way to get to that end. The problem is so large that you can’t cut your way out without causing real problems for individuals and the economy. 

You can’t tax your way out, in fact there is a great YouTube video that explains this better than I can. You can watch “Eat The Rich” by clicking here. Politicians always use linear thinking when it comes to Taxes as they think if 10% tax brings in $100 then raising it to 20% will automatically bring in $200. The problem is something known as Hauser’s law which was coined by Kurt Hauser, Former Chairman of the Hoover Institution, at Stanford University. Hauser studied Federal Revenue as a percentage of GDP since WWII. What Hauser found was that regardless of the tax rates federal revenues hovers around 19.5 percent of GDP. This is because the higher rates influence behavior and result in lower growth levels for GDP and consequently tax receipts suffer. Hauser’s law is kind of like the law in physics that states nothing can travel faster than the speed of light.

So it appears to me that we are not addressing our problems and whether we passed either plan currently in congress we are just papering over the problems. We as a nation have been papering over things for decades so the powers that be believe that they can do it again just like before. It is kind of like buying a fixer upper house that has lots of holes in the walls but instead of repairing them you just put wall paper over it to make it appear fixed.  The rating companies like S & P or Moody’s know what the deal is and this is going to result in a downgrade in addition to more debt both of which will devalue the Dollar further acting as a tax on the economy and citizens. In many respects we have now entered a visious feedback loop that is extremely tricky to extricate the country from. Even without a downgrade it should be apparent to the whole world that we are not addressing our issues and this will cause the Dollar to decline, because the day of reckoning has not been averted but only postponed.

The US won’t default as tax receipts come in on a monthly basis that are adequate to service the debt and pay prioritized bills. The Default notion was tossed out by Obama and backed by Turbo Timmy as a political tactic to light a fire under congress to act and I consider it fear mongering which is what Bush constantly accuesd of(and I think he was guilty of it too). The law of unintended consequences reared its ugly head at a most inopportune time resulting in congress linking the debt ceiling extension to deficit reduction, based upon Obama's insistence as part of his move from the political left to the center. So instead of dealing with the two problems separately and calmly a crisis has been manufactured that is having unpredictable results. Markets are all over the map because uncertainty is the theme of the day and each time one of our leaders gets on TV to report the chasm between the sides it is like pouring gasoline on the fires of political machinations.

So with uncertainty on the rise here the markets are becoming unglued as there is not much good news to focus on since earnings are essentially done and the economic reports are not coming in so strong.  So what is an investor to do? For starters you need to keep a close eye on your portfolio and protect gains. One can buy some inverse ETFs to profit from a down turn and if you are comfortable you can hedge your positions with puts on the S&P or NASDAQ. It makes no differnece if either of the plans passes or the US defaults(very unlikely) I believe that we will see a further decline in the dollar which will drive precious metals even higher. Ironically if we the US does default it is possible that the Dollar could have a bust of strength up for a short period as a result of asset realignments around the world creating demand for dollars before the dollar resumes its decline. The stocks of companies that have pricing power and exposure outside the US will recover and rise as well.  My current plan is the same I am continuing to average in to Precious metals funds outside the US like Central Fund Of Canada (NYSE : CEF), Sprott Physical Gold Trust (NYSE : PHYS), Central Gold Trust (NYSE :GTU) and certain intermediate and exploration precious metals stocks. If you are looking to buy CEF, GTU or PHYS I have updated a spread sheet that was originally created by Jesse From Jesse’s Café American(a Gold site). The spreadsheet calculates on a delay basis the gold silver ratio as well as the premium or discount on the various closed end precious metals funds. If you are looking to acquire precious metals then you want to buy when the premium is the same or better than what you would pay for physical, so this tool will help you identify that situation.

 I am also in the process of making a shopping list of stocks and price points especially in the more blue chip and international names as this impasse will probably drive prices further down creating some tremendous bargains. Of course if you believe Professor Panarin I would not be worrying about investing as much as acquiring stuff you will need to survive, I am not there yet so let’s hope that our leaders can get their act together before it comes to that.

All the same we take our chances
Laughed at by time
Tricked by circumstances
Plus ca change
Plus c'est la meme chose
The more that things change
The more they stay the same

                Circumstances (Chorus), Rush

Thursday, July 21, 2011

Debt Ceiling, Delusion and Gold...

First off dear reader I must apologize for the tardiness of this missive as I was delayed due to prior family engagements that ran much longer than expected.

The topic that is grabbing most of the headlines is the “Debt Ceiling” solution. If you haven’t heard about this bit of Kabuki theater then you must be the neighbor of the guy in the “GEICO” commercial, who lives under a rock by the road, unaware that he can save money on his car insurance. All kidding aside the debt ceiling debate is more political show than true substance although they make it seem like more. The level of fear mongering seems to be rising by the day and it reminds me of those dark days in 2008 when then Treasury Secretary Paulson was depicted to have gotten down on his hands and knees begging Nancy Pelosi for “TARP” money. We all know how well the TARP package worked out and it stands as an example of how making decisions in a panic mode is never a good idea.

Everyday there are more and more articles released about the minutia of the wrangling around the Debt Ceiling debate. As someone once said there are two things so disgusting that one is told never observe them being produced, the first is sausage and the second is legislation.  Of course since this is a topic that I need to keep on top of I read every article that I can reporting on the Debt negotiations. The thing that strikes me is not the reporting or the two sides being so far apart on the method by which to resolve the problem, but instead the comments on each article. The comments section gives one an idea of where the public thinking is on the subject. As far as I can see the public is heavily divided and the comments reflect it. These comment sections degenerate in to the blame game where people from one political bent try to cast the opposite in a negative light blaming all of our woes on one party’s leaders or another, all of which is pointless to me.  

It is obvious to me that the general public, at least those that read articles on line are no longer adults but instead petulant children hell bent upon proving each other wrong. I say to all these people grow up as this infighting does nothing to move the dialogue forward nor does it get us any closer to solving our problems, whether on a message board or in the halls of Congress. If these people were in a fox hole during war time they would end up dead as they would not be able to work together and the enemy would come up and just shoot them as they argued. It doesn’t matter who did or spent what to get the US to this point but it does matter that we are not galvanizing to come up with a solution. I know we as a nation can come up with a solution for our problems if we would all put aside the past and look to the future.  To paraphrase Winston Churchill’s famous quip, “Americans will try everything but the right solution first but will ultimately do the right thing.” The problem is that we are actually running out of time to do the right thing and I am not just talking about Turbo Timmy’s August 2nd ultimatum but instead the law of large numbers where the debts and other figures become mathematically insurmountable.

Needless to say the debt ceiling and all the debates has an impact on the financial markets at least to some degree. With all the wrangling taking place and the appearance that there is a possibility of not coming to an agreement the markets have remained extremely calm. The common perception is that the two sides will hammer out a hodge podge proposal and the Government will be given an upward bump on their credit card to keep things going. I guess the question I have is what if those in Washington don’t do what the markets are anticipating? I believe that as the saying goes the stock market would become a market of stocks and many issues would decline where others would be much less affected and possibly even go up.

If the US were to default you could see the stocks of those companies like Flir Systems  (NASDAQ :FLIR) that derive a substantial portion of their earnings from the government decline. Additionally, a default would probably raise interest rates because investors would demand more compensation for the new risk associated with the formerly “riskless trade”. As a result of the rate rise stock sensitive to such things could get hurt as either their borrowing costs escalate or they are unable to get funding. The rise in rates would also kick the housing market in the teeth. While it would benefit savers in the form of increased yields it would decimate the baby boomers who have exited the stock market in droves and piled in to bond funds.

Around the world US Treasuries are considered a safe haven and in past crises investors have run to the Dollar and treasuries. This time around when treasuries are the epicenter of the storm I don’t foresee the masses diving headlong into the very assets that are defaulting.

 Ironically the US Dollar would probably be a beneficiary of a debt default as there could be a demand for Dollars as other assets are sold. The synthetic spike in the Dollar would be short lived in my opinion as people would be looking for other areas to park their assets. When a country defaults on its debt its currency becomes suspect and people look to exit to greener pastures.

The US Dollar is currently the reserve currency which has afforded the Government and the FED exceptional privilege in the past and I believe that may not be the case if there is a default. Reserve currency or not the Dollar is backed by the full faith and credit of the US Government in other words it is an IOU. How much is an IOU worth when the “ower” is in financial straits? Think of the down on his luck gambler who has exhausted their money and used up his “credit” lines. Is the House going to lend the gambler more or cut him off and force a payment? The same is true of the Dollar once “faith” is lost in the Government’s ability to back the Dollar.

There are many that argue the Dollar cannot be supplanted because it is such a deep and liquid market and there is no single currency to replace it. I agree with that statement except in the circumstance where the Government has destroyed the confidence in its ability to deliver on monetary promises.  In a world of US default , trading internationally would become more difficult as exchanges would have to be worked out between trading partners. A loss of confidence in the Dollar would hurt world GDP as it would force a decrease in trade velocity until a system of exchange could be implemented.

I am pretty sure that the powers that be understand that a debt default would be inherently bad for both the US and the world and I have to believe that the Congress will pass something and at the very least raise the debt ceiling, albeit in the 11th hour.

In the meantime there are at least 4 plans floating around  1) the Republican (cut, cap and balance), 2) The Coburn (Back in Black), 3) The Gang of Six plan and 4) Just get us to 2012(the kick the can plan or the McConnell/Reid plan). All the plans have inherent problems but I do believe that either a combination of elements or the “Gang of six” plan will make it through. While the “Gang of Six” plan is what appears to be in the lead it has issues and I don’t believe after reading the points that it will achieve anywhere near what is being touted. I believe that there are holes in the ideas big enough to drive a truck through, for example there is no real plan to come up with the initial $500 billion but it is up to each entity to review and propose cuts, I am sure dear reader that you can remember how well that worked when President Obama tired to get his own cabinet to find $100 million to cut. Additionally without any kind of amendment to force compliance in the future do you really believe that a future congress is going to be held hostage to today’s budget negotiations, I don’t.

As many of you have read my articles here and on my own site I advocate ownership of precious metals along with stocks as assets you need to protect yourself in the financial landscape of today. The $64,000 question is what impact does debt and the debt ceiling debate has on stocks and precious metals.  When congress passes the raise to the debt ceiling I believe you will see a rise in the general equities market as Wall Street will interpret the action as business as usual. Meanwhile I believe that the passage of the Debt Ceiling will cause a sell off initially in the precious metals markets and conversely a great buying opportunity.

Regardless of what is passed I think ultimately it will be perceived as kicking the can down the road. The deficits will continue to grow even as the economy grows just not at a fast enough clip to meet the assumptions laid out in any of the deals.  I also can foresee that as the deficit does not really get fixed but instead expands that gold and silver will continue to perform very well. Gold and silver are really the anti-debt and during periods of uncertainty and debt inflation especially coupled with negative real interest rates the metals perform very well. I am attaching a chart below that shows the rise in the deficit has fostered the rise in gold. As the events unfold and shake confidence in the FIAT regime the precious metals will grow stronger and tugged higher by the even larger debt.

It really is the “the best laid plans of mice and men”. What I mean is that until something forces the US to deal with its issues and prioritize what is really needed we will not get our house in order. Just look at all the plans proposed they all make rosy assumptions that will reduce the debt by large amounts but are they based in reality. Think back dear reader to when Mr. Obama proposed a budget that would have had the deficits falling during his term. His budget predictions were predicated on high GDP growth, lower unemployment and reduced borrowing none of which came to pass so consequently neither did the reduction in the annual deficit.  As Yogi Berra once said “predictions especially about the future are really difficult” and that is why I believe that regardless of what plan is adopted their assumptions are too rosy and they need to take a scalpel (or a chainsaw) to the budget or we will be having this conversation again in a few short months. The difference is in the future the conversation might be with a gun to congress’ temple.  Until I see the move toward positive real interest rates and a credible plan to reduce the deficit not a delusion I will continue to hold my precious metals.

Wednesday, July 13, 2011

Of Broken TVs And Netflix..

Just yesterday I drove 55 minutes through heavy rush hour traffic to retrieve my HD TV . You see dear reader, one night I was watching a show and the TV with no warning at all went black. As far as I can tell the set did not fall victim to a power surge, but instead had a “freak” situation occur internally. This started an odyssey in to the world of TV repair that I hope none of you ever have to face. I searched around to find someone to come to my home to repair the set and there were a couple of repair men that I spoke with. Well after a few calls I got one who was willing to come out and fix the set.

To describe the repair guy , Vlad, would be to say he was a nice Russian immigrant,  what I would call “hustler”. I don't mean hustler in a bad way but instead in the sense that he talked fast and moved fast but you felt a little uneasy with what he was saying. Dear reader, I am not picking on Russians as my wife has some in her background and I only mention it for color commentary purposes.  
You see I am pretty mechanically adept and have built computers and know how to repair many things mechanical and electrical, but I had never opened and HDTV. Once Vlad opened up the set  I recognized immediately that at least my Toshiba was essentially a large screen computer. I know how to check circuits but I deferred to Vlad as I was going to be paying him to fix the set. He quickly identified that the issue was the power supply board which I had suspected. So he told me  that he was going to order a replacement and we would pop it in solving the issue with the set.

Well Vlad disappeared and would not return phone calls so my set sat idle on our large living room coffee table. After a few days giving Vlad the benefit of the doubt I decided I could remove the board and get a new one myself. So I hopped on to Google and began querying for the part using the Toshiba part numbers. I discovered some interesting things in my search. First, there was a lack of any new boards from Toshiba and one supplier told me it was as a result of the earthquake, while another supplier informed me that Toshiba was no longer supplying those boards. Second, the supply cycle for replacement parts used to be quite long, I hate to date myself but I have a CRT based TV that I acquired new in college and was able to get replacement parts for 20 years after manufacture. My current HDTV I had to have in 2006 and 5 years after manufacture parts are barely available, is the part of planned obsolescence?
 I was not ready to give up on the set after all it cost a pretty penny and I do not want to go out and buy yet another set even though that is what Benny and Turbo Timmy would like me to do. Initially I tried EBAY to see if anyone was selling one of the boards from a parted out set they were unable to repair after putting a Wii remote or some such object through the LCD screen which carries an exorbitantly expensive replacement cost. No luck on EBAY and it seemed all the TV parts suppliers were out of stock. Not ready to give up just yet I stumbled upon a site that showed me the capitalist spirit is alive and well. The site tvparts4less.com offered a service that seems to be the only one out there (at least that I could find). In the true American entrepreneurial spirit seeing that there was a need the company rebuilds the power supply boards.  You send them your board and they send you out a replacement when they have the tracking number of your board.  In the ture spirit of American business the service and product were outstanding.

The board arrived via another outstanding American business United Parcel Service (NYSE :UPS) in a couple days. I popped the board in and thought I was home free. Of course on my Toshiba the way it relays a problem to you is what I refer to as the triple Blink red light of Death or TBRLOD. As soon as the set went to power up the TBRLOD appeared, so I was back to square one.

Trying to find someone who was willing to take the time to figure what else could be the issue was a task on to itself. After many calls and convoluted searches though Craig’s List I located a retired TV repairman, Rico, who works out of his basement for what he calls smoking money (what is it with TV repair guys and chain smoking?). So I hauled the set over to Rico's house several towns away. Within a couple minutes Rico had the set apart and had diagnosed another board buried inside had craped out as well. Once again the challenge was going to be getting the part. Fortunately, one of the suppliers that Rico uses had one board of the kind I needed so the story has a happy ending.

Living without a TV for several weeks allows one to do other things with their time, but I have this habit of watching documentaries on a variety of topics before I go to bed. Needless to say without a TV one has to use other methods to get their fix. My choice was to utilize my laptop and stream Netflix (NASDAQ : NFLX).  Honestly I am fortunate that I enjoy the documentary genre as Netflix streaming options are shall we say not up to snuff in other areas.  
Today Netflix announced its plans to separate its streaming and DVD monthly plans which for some customers will result in a 60% price increase to maintain their current level of service. This announcement comes on top of a price increase just 8 months ago.  So now you have the “choice” to get unlimited streaming for $7.99 or unlimited 1 DVD out at a time for an additional $7.95. Netflix then sent out an email announcing the changes and the manner in which it has transpired has left a bitter taste in many consumers’ mouths including mine. Apparently I am not alone as the Netflix blog has some 8600 + comments at the time I am writing this and the count on their Facebook page stands north of 42,000 comments. On both sites the comments are overwhelmingly negative with members indicating that they were unhappy and either had cancelled or intend to cancel their service.

It seems that people myself included don’t see the value for the consumer in separating the services. In essence Netflix is requesting that you pay an additional $7.99 without any additional improvement in service. Netflix blog site explains the pricing structure and states  We hope one, or both, of these plans makes sense for our members and their entertainment needs.” Clearly judging by the reaction Netflix missed the mark in customer satisfaction. In the next paragraph they glibly write, “As always, our members can easily choose to change or cancel their unlimited streaming plan, unlimited DVD plan, or both by visiting Your Account.” It appears like many members are following their advice by canceling.  To put things in perspective Netflix has 23 million subscribers and so far only about 50,000 have voiced their opinions on the available outlets, but one should also not forget that this is still day since the announcement.

Many analysts are dismissing this outcry by saying things like once people sit down and think about the dollar value they will not leave Netflix. I beg to differ with the analysts in this case. In an economy where it has been reported that at dollar store revenues are down because the people who used to come in with $12 dollars to do their purchases have cut back to $8; people could jettison a service that they perceive is no longer a value for the buck. The same analysts argue that customers won’t leave the Netflix ranch because there is no competition, once again I disagree. There are alternatives to Netflix like Vudu and Hulu which both stream recent movies and TV.  Hulu Plus is around the same price of Netflix streaming and has a somewhat different content mix, but people might just opt to switch in protest. Vudu provides a wide selection of first run movies in 1080P HD which Netflix doesn’t offer, however, the cost is $2 rental for 2 days. Unless one is a DVD power watcher more than 4 dvds a month then the cost is the same for the privilege. In my own situation there are times where we watch more movies than others but it would be cheaper to go with VUDU on average. Additionally you have no monthly fee for the privilege of using VUDU. There are other services like Cinema Now and one for Amazon (NASDAQ :AMZN) so one can investigate those as well. For the DVD diehards there is Redbox which is a DVD vending machine that is a division of Coinstar (NASDAQ :CSTR).

Essentially the analysts and Netflix itself live in a static world where they don’t see that the barriers to entry are not that high. This move by Netflix is being lauded by the sell side analysts but it from my perspective it appears that the brand loyalty is what they are banking on keeping customers, which I don’t think will be enough. Given the alternatives and with Netflix raising the price it provides ample incentive for an Amazon or other competitor that has the capability of Netflix to come in and undercut them.  Once a company reaches a certain level of hubris they end up losing customers just like broadcast TV lost out to cable and in turn cable has lost to satellite. It doesn’t always have to be this way, for example look at Apple (NASDAQ :APPL), who competes by gong to extreme measures for customer service , quality and design. Apple essentially creates both brand loyalty and a barrier to entry against multitudes of competitors.

 Does this mean that Netflix will crash immediately, well the answer to that is no. But Neflix sports a pretty lofty valuation of 85 times earnings and the future stock price gains are based upon some fairly strong estimates of growth and earnings. The backlash developing over this perceived highway robbery could cause a stumble in Netflix and given the high valuation the fall could be spectacular.

At the moment most are very optimistic about Netfix as investors continue to see more and more dollar signs, and price the stock to perfection. As of this point in time I think Netflix will run higher because it can. If I were a shareholder in Netfix I would keep one eye on the stock and my finger on the sell trigger to protect profits.  As for me I am leaning toward canceling my own account and moving to other services. You see it is not that I can’t afford the extra $7.99 but it is the principal of it. I don’t like it when I am asked to pay an excessive amount for no new or improved service or product. It would seem that there are somewhere in the neighborhood of 50,000 members that agree with me.

Wednesday, July 6, 2011

The Beef Stops Here...

Taking time off for the July 4th weekend was probably one of the best decisions I made all year. It is incredible how one can get caught up in the day to day minutia of the markets and you don’t even realize how cluttered your mind becomes with information. The longer you go without taking a break to recharge the old batteries the more you become like those Bing! search engine ads with the people spouting off useless information when asked a question. So for me and the family it was off to one of the best summer places I can think of in New England, which would be Narragansett, RI.

 I won’t go in to much detail about Narragansett except to tell you that it is a wonderful town to vacation in during the summer and the town beach is perhaps one of the best family friendly beaches I have ever been to. The beach itself is a wonder of nature with a long stretch of white sand bordered on one end by the old Seawall and the Narrow River on the other end.  There really is something for everyone there from surfing, building sand castles, floating in the river to just sitting with your beach chair in the water as the tide goes out.

Well to make a long story short while down in the Isle of Rhode we were searching for a place to get a roast beef sandwich quickly as in fast food.  Initially we were told that we should try Walt’s roast beef a local “mini” chain but the nearest one was too far. At this point we decided to check and see if there were any Arby’s located nearby as they have been affiliated with Wendy’s for a while and I would have thought there would have been more locations nearby. So after doing a little searching I found out two things first that the nearest Arby’s is located in Massachusetts and that Wendy’s was also miles away.

Now I have followed Wendy’s stock for a while as I have long felt that in this down economy fast food places would benefit as a result of their ability to provide larger portions of food at less cost than healthy alternatives. It is sad but true that there are many among us who are either filling in meals or forced to essentially live off “the dollar menu.”.  The trend is what it is and it has and continues to enrich the shareholders and owners of companies like McDonalds (NYSE :MCD) and Yum Brands (NYSE :YUM).  I am not looking to get in to the negative health aspects for those that do utilize fast food as a staple as there are many issues , like obesity or excess sodium. Fast food is just that a meal on the go and I don’t believe that it was ever intended to be a lifestyle choice but unfortunately economics sometimes trumps good decision making.

Back to Wendy’s which has been in existance since I was a kid. In keeping with the spirit of July 4th the story of Wendy’s depicts a true American success story. The founder Dave Thomas started Wendy’s in 1969 in Ohio and became a household name just a few years later.  Thomas focused on quality and presented himself in many of the ads. Wendy’s first giant leap in popularity came in 1984 with the unbelievably popular and very humorous “Where’s the beef?” campaign. For those of you too young to remember the commercial featured a then elderly lady, think it could be your grandmother, looking at a very skimpy burger asking the now famous question. As a result of the commercials the Wendy’s franchise grew nationwide. 

Later on by the 1990’s Thomas was out in front of the cameras doing his own commercials and his folksy style connected with people and Wendy’s continued to grow.  By the time Thomas died in 2002 he had appeared in some 800 commercials and 9 out of 10 Americans knew who he was and his restaurant chain.

Triarc a holding company, run by Nelson Peltz, was attempting to change itself from a holding company in to a true food company.  Over the years building the food empire Triarc acquired Snapple, Royal Crown Cola, Mistic Brands and Cable Car Beverage Company.  In 2008 Wendy’s International was acquired by Triarc in an attempt to become a full service food and beverage company. The acquisition of Wendy’s added about 5,200 restaurants to the Arby’s Group’s holdings of 3,700 locations.

 Triarc brought together the Wendy’s and Arby’s brands, but the latter has been a drag on earnings for a long time. Then on June 13, 2011 it was announced that Wendy’s\Arby’s group was selling the majority of its Arby’s chain to Roark Capital Group, although they will retain an 18.5% stake in Arby’s. Retaining the stake allows them to participate in some of the upside should Roark engineer a turnaround.  Roark is spending $130 million in cash and assuming $190 million in debt to acquire the Arby’s business. In the meantime Wendy’s appears to be the value trading essentially at book.

The problem for Wendy’s is both that Arby’s was underperforming and they had lost their focus. The latest ad campaign “You know it’s real” is an improvement over some of the prior ones. If Wendy’s can get back to focusing on the core business and the “mop bucket” mentality that Dave Thomas brought to the fore then a turnaround is in the making. Wendy’s will have to look at its menu and offer the old classics and introduce some new items to draw in new customers. Over the years Wendy’s has stressed the idea of fresh and better quality and in this author’s opinion the management needs to raise the stakes to compete.  Wendy’s has fallen from the third largest fast food chain just a few years ago  to number 7 at present so there is room to grow.

So what this all boils down to is two things. First, the question is whether management will stay focused and make the right decisions to bring Wendy’s out of its funk. They have to execute as management no longer will have the crutch of Arby’s lackluster earnings and sales to hide behind.  Second, Wendy’s will have to evaluate their business model to see what is working and revamp that which is not in order to improve margins .

With the off loading of Arby’s I believe Wendy’s is in a competitive position and will have reduced its debt load as well as gained an infusion of cash. The market apparently agreed as the shares surged today almost 5% on more than double normal volume. Looking at the weekly chart for Wendy’s the stock has been in a chop with a slight upward bias above its 40 week moving average. The daily chart is no work of art and one can clearly see the choppiness and the near term bottom established with the June 13th announcement of the Arby’s divestiture.

 Today’s breakout on heavy volume looks good and if one is so inclined to speculate on a turnaround story then you could take a flier on Wendy’s.  I would keep the position on a tight leash and pay no more than $5.75 using a 15% trailing stop. If management has learned from the 3 year union that has ended in divorce then the growth potential is there. Wendy’s has many obstacles to overcome but the potential is huge. Maybe we will not be asking “Where’s the beef?” but instead “The Beef Stops Here!”
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Wendy's Weekly chart - Click to enlarge

Pictures of Narragansett Beach if anyone is interested

The Famous Narragansett Towers and the old Sea wall in front..
Beach with the Narrow River in the backround

Some surf too
Looking from the Narrow River back to the beach