Tuesday, March 22, 2011

Biggest threat to US economy

I recently wrote to a friend regarding the biggest threat to the US economy so I figured I better put something up so individual investors can protect themselves as well.  The question was regarding an investment in a company that receives a large portion of their revenue from local governments. 

One key to understanding a business is to know where the revenue comes from.  Problems can and do arise when revenue it is concentrated with a few customers or a special type of customer.  Many of the for profit education firms in the US have been hurt hard because a large portion of their revenues come in the form of subsidies and student loans backed by the US government.  The government is currently reviewing these practices and likely will cut some funding... I guess likely is a poor way to put it, they will cut funding for these programs. 

The single largest threat to the economy right now is the US government spending.  Obviously the government is trying to prop up the US economy by spending trillions more than take in.  I don't have the recent data beside me but something like 7.5% of US GDP is being fabricated by government due to overspending.  I would guess the situation isn't much different in Canada but I haven't looked at any data our side of the border.  This number is down from a couple years ago when it was closer to 10% of GDP.  To put this is plain English, if the government balanced it's books and only spent what it takes in, GDP would fall 7.5% from current levels.  Perhaps that is why many of the large defense companies appear cheap.

The government is walking a fine line because they know they can't sustain this overspending forever and they are counting on a strong recover by the public sector.  Now the data is showing strong improvement in the public sector, particularly manufacturing, but growth takes time.  Don't get me wrong I am a large bull on prospects the US and Canada over the long term.  I know how capitalism works, and everyday we work smarter, improve productivity, thus increasing our standard of living. 

My only problem is how the government thinks they can smooth out the economy by messing with natural market forces.  I would strongly recommend a review of all companies in your portfolio to see if the derive revenue from the government.  Any company that derives a large portion of revenue from the government may be in for a large 20%+ haircut, or the best case scenario would be flat revenue for decades. 

Canadian Federal Budget

In other news the Canadian government announced their budget today.  Nothing out of the ordinary and it looks like we will have an election fairly soon as none of the opposition parties want to support the Conservative government. 

I always find it amusing that the government constantly puts little things into the budget that have an large effect on natural supply and demand of certain product or services.  This then encourages Canadians to spend their income in such a way that they wouldn't otherwise because they get a tax break.  Why not just leave the taxes in the hands of the individuals (and companies) and allow them to decide how to spend it themselves?  This interference will create artificial demand for certain products and when the tax break is taken away that sector will incurring huge revenue losses.  I guess the construction lobbyists got their way this budget with the reinstatement of the eco-energy retrofit program.  Encourage more Canadians to spend even more money they do not have. 


In conclusion, I highly recommend investors read Vito Maida's latest newsletter to clients (Click here).  I have the utmost respect for him and he notes some important concerns in the market.  He is currently at high cash levels and recommends against being foolishly invested just because of the low interest rate environment.  Many investors are only interested in making a buck, not the preservation of capital. 

You don't need to have very high returns on your portfolio so long as you don't suffer any significant losses.  If you are constantly having to make up for losses on investments you will find yourself treading water.  That is a secret that makes the like of Prem Watsa and Vito Maida such great investors.  Do you only focus on the upside?  Good question to ask yourself, be honest.  The easiest person to fool is yourself. 

Best Regards,

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