June 1, 2009
Good morning. A powerful advance last week in the market, with the S&P running Friday on the close to finish up 3.9% on the week, moving from 89.02 to 92.53. Continual upward moves in oil and other commodities are fueling the rally, as evidenced by the XLE being up 6.3% for the four-day week. Depending on your point of view, the increase in oil prices is an indication of a start to the recovery or an amazing example of the power of OPEC and the oil companies to hoard and store oil for the purpose of driving up prices. The third point of view is that oil is just following the dollar, which has been in sharp decline. So far this morning the futures look strong, as the serious expansionary policies being followed by China mean more orders for manufacturers in China, Japan, and other countries. The question remains, are those orders just short run or are they enough to sustain a recovery in Japan, which has had a severe manufacturing contraction.
Obviously the big story of the day is the GM bankruptcy, and maybe the story of the year (I refuse to be one of those who describes 7 or 8 fights, or games, or stories of the century by the year 2010). It has been impossible to dodge the endless opining on the problems of GM and what the so-called “experts” would do to fix it, complete with barely disguised shots at blue collar workers, unions, you name it. It reached a new low last Friday when a pair of popular journalists (?) on a national TV station joked about how much Viagra was being purchased by GM retirees, as an example of what a waste it was to give “those” people medical benefits until Medicare takes over, with supplementary benefits thereafter. It all goes with coining new words, like legacy costs, whatever that means. I assume it means that those benefits legitimately bargained for (in return presumably for other concessions) that for whatever reason were not funded on an ongoing basis.
I have two real issues with the GM problem and proposed solutions (including bankruptcy), one being the newfound ability of people to unilaterally break contracts, seemingly by popular acclaim, and the other being the lack of understanding of how powerless even powerful companies are in the face of a changing economic landscape. But first, I think a few words about GM and what it and other companies like it have meant to America is appropriate. The first significant change in the social landscape brought about by auto companies (before which automobiles were fairly custom made toys for the wealthy) was the famous Henry Ford proclamation that he needed to produce a car that his workers could afford. That was a tremendous leap forward in thinking. It said two things, one that blue-collar workers were deserving of some of the good life benefits previously reserved for the rich. The second was even more important, that instead of looking at workers as people to be taken advantage of, look at them as potential customers, if they do not make much they couldn’t buy much.
In the seventies the automakers were among the first to reach the middle class pay level of near $20 per hour for blue-collar employees (following the steel companies). To a large extent a relatively highly paid middle class provided for all the industries that went with it, be it restaurants, leisure time activities, fishing boats, second houses, you name it. Maybe it was too much to pay, maybe these people who paid that number were foolishly unaware of people in totalitarian states, like China and others, that were “willing” to work for a small percentage of that. The thing that bothers me, however, is that to hear these “people” tell it, to be competitive in today’s world you can’t pay people even as much as they made in 1978, yet cars now cost $30,000, not $6,000. Where does the money go if you can’t give it to the worker? Maybe he should work for nothing. How many direct labor hours does it take to produce the average car? The number is around 35 hours per car, not a whole lot, how many people opining on the problem even know that?
Is anyone other than me concerned about how easily contracts are being tossed out, seemingly by popular vote, in a very ad hoc fashion? Everyone knows that for the government to put money in GM (19.4 B so far) you had to get rid of these “legacy costs” that those people do not deserve. No one gets paid for not working at a closed plant; no one is guaranteed medical benefits, no one is entitled to a large pension, etc. Wait a minute; didn’t the government give an awful lot more to banks? Are we to assume (foolishly) that none of the people at banks have retirement plans, or that none of those that have recently left the banks have benefits that went with the “package”? Let me just say that whatever their benefits are in my opinion they are excessive. Before the government gave Citigroup or BAC huge amounts of money some cynic like me should have been allowed to go in and unilaterally cut Bob Rubins retirement package, along with the 50,000 other overpaid and over-pensioned (legacy costs) hacks. I would have cut the money the government needed to give by at least 10%. Better yet, I will buy CNBC from NBC and unilaterally decide everyone is making too much, walk into bankruptcy court and “surgically” cut everyone’s pay and benefits by 30%. The problem is that people in this country with contracts used to have rights. Obviously a company (or government) with no money can’t pay, but these people at GM purposely bargained away current income in several negotiations for these benefits, and now they are tossed aside out of hand with no concern for the precedent being set. Once we go down that road, be mindful of the words of the poet John Donne, “Therefore, send not to know for whom the bell tolls, it tolls for thee.”
The second concern I have regarding GM is the lack of appreciation for taking risk and making assumptions in the normal course of business (or even life). Most of us can think of risks we took, based on assumptions about the economy and the future, and how they played out. To a large extent the assumptions made in this country have been positive, and risk taking has been rewarded (until recently). Think of our parents (or grandparents) buying a home in the 50’s or 60’s. They saved for a down payment, put it down on a house, making the assumption that the economy would remain strong enough for them to stay employed at least at their current level. For a relatively long period of time they were right, the economy grew, income increases exceeded price increases, and all was good. GM (and I am not giving kudos at all to their management) traded away current pay increases at one point for health benefits down the road, or for paying people at a closed plant. Should they have assumed health benefit increases of over 10% per year for multiple years? Should they have assumed that some states would fall over themselves to put Toyota plants in their states with huge cost savings, causing (in part) decreases in market share and subsequent plant closings? Probably. Should they have assumed that banks would almost break the country and cause a 45% decline in auto production across the board? That’s a tough one. How about having Tim Geithner, in charge of regulating banks that cost us billions, taking you into bankruptcy as an expert on the auto industry? Wow! My point here is that most people, individuals and executives, generally make assumptions with somewhat of a positive lean. You would not take a job in the auto industry if you thought sales would decrease 45%, nor would you buy a house if you thought that in six months you would be out of work and the price would be down 20%. If all of a sudden everyone has to assume a disaster or general declines it puts assumption making and risk taking in a whole new light for what we know as America. Again, GM execs could have done a whole lot better.
A lot to learn, and a lot to consider. What about the market? The rally looks strong, and everyone is doing his or her best to describe it as the start of another bull market. I think the market might be a little ahead of itself but I surely would not short it aggressively. We (or they) are doing their best to describe the end of the recession as when the decline loses steam, but really we need to see some growth. Losing 500-550 K jobs per month for a while instead if 600 or more is an improvement per se, but it is not sustainable in an improving pattern. Six months of that means another 3+ million jobs, in itself enough to keep us dragging down. I was brought up to believe that the market knew and could see all, and in that vain we should see that the market is advancing and maybe predicting good things down the road. I don’t know about the all seeing part, the market was seriously behind the curve during the entire banking crisis, now I am not so sure it is discounting every bump in the road now. We will see. I surely question whether the store oil to raise prices strategy will work long term.