MARCH 2003 Western Investment Club

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MARCH 2003Western Investment Club

• Ian Skaith

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Storm Cloudsover the US Economy

• Debt buildup
• Household credit card use equity loans at
  historical highs
• Corporations financing with debt instruments as
  the market is not receptive to equity issues
• 2003 Federal budget deficits estimated at a
  record 304B before a war and any further tax
  cuts.
• States also running record deficits
• External debt growing a 2B a day

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Storm Cloudsover the US Economy

• Declining consumer confidence
• Insecurity intensifies with every alert
• Travel down sharply
• Credit lines linked to inflated house values
• Rising unemployment
• Business failures up

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Business Confidence

• Shaky profit recovery
• Restatement of earnings
• New accounting for options
• Sales growth with no profit
• Runaway executive compensation
• Cut-throat competition
• Deflation in producer prices
• Weak investment spending
• Systems and equipment upgrading put off
• Credit squeeze raising business failures

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The Decline of the US

• Trade weighted value of the US is down 21
  against the Euro since February 2001
• US needs to attract 2B per day to finance the
  current account deficit
• US external deficit to reach 600B in 2003 nearly
  6 of the GDP
• 10 fall in trade weighted dollar to reduce
  external deficit by 1 so another 30 decline is
  needed to cut the deficit in half
• Resisted by Japan and China
• US Treasuries part of the bank assets and reserve
  base
• Exports become less competitive in US market

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Risks of a Weak Dollar

• Negative effect on Japan and the EU will outweigh
  positive effect on the US possibly leading to
  stronger deflationary pressures
• Correlation between dollar and stock/bond returns
  has been almost zero since 1973 when the dollar
  started to float
• US stock prices had median return of 6.1
  during 10 largest quarterly declines much larger
  than the 1.8 average between 1973 and 2002

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Bushs Tax Cuts

• Aimed at preventing flight out of equity shares
  capital by domestic and foreign investors spooked
  by dollar decline and weak recovery in profits
• Removing tax on dividends favors high income
  earners invested in dividend paying equity. Very
  negative to NASDAQ venture companies unable to
  pay dividends
• Meeting strong resistance in the congress but a
  scaled down version will still increase the red
  ink on the budget
• Shareholders will prefer profit distribution over
  investment expenditures

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Oil

• US domestic supply 7-10 years current use rate
• Ten or more years until significant ground
  transportation energy use contribution from
• Liquid Natural Gas
• Hydrogen
• What about jet fuel?
• No future prospects to reduce hydro-carbon
  dependency
• Alternative energy generation
• Electricity returned to the grid or stored as
  hydrogen

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Iraq

• Iraq is not as dangerous a threat to the world as
  North Korea and Pakistan with nuclear weapons
• Disarming Saddam is not enough for Bush
• Eliminate terrorist threat to Israel and safe
  haven for terrorists
• Provide an oil rich showcase for US democracy and
  energy investment
• Hopes for domino effect on tribal totalitarian
  theocratic governments in the region
• Wants to develop client states to reduce US
  energy vulnerability and influence future pricing

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Financial and Real Property Markets

• Longest bear market in last century
• March 2000 to March 2003
• Further declines likely unless uncertainty
  reduced
• Flows out of stock redirected to
• Gold
• Real Estate
• Bonds (including corporate bonds)
• Cash and Money Market
• Income trusts

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Delayed Market Recovery

• Resolution to Iraq and North Korea war threats
• Optimism on finding a solution to the
  Palestinian-Israeli conflict
• Reduced threat of terrorist attack
• Restore confidence in US economy
• Optimism on future energy costs and supply
• Restore confidence in corporate governance
• Recovery in Europe and Japan
• Clarify trend in the price level and interest
  rates

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Importance of a Stock Market Recovery

• Will help large corporations like GM deal with
  unfunded pension liabilities
• Start to reverse 7T negative wealth shock
• Reduce flight of capital from the US
• Higher tax revenues from capital gains
• Increase investment spending and equity finance
  opportunities
• Cash burn and credit squeeze lethal to venture
  companies prevented from selling equity

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Globalization in Reverse

• What are the economic costs of
• Reduced world migration of refugees and talented
  people looking for opportunity
• Higher overhead costs of security for government
  and business
• Slowing the flow of trade and investment
• Less investment in information and communication
  technology

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Geopolitics of Inequality

• Differential development success of nations can
  be traced to
• Ineffective and corrupt government
• Overspending on military
• Capital labour misallocation
• Tribal warfare
• Rejection of globalization
• Closing the gaps will require radical political
  changes and embracing the tenets of globalization

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