April 2014

In September of 2008 I had coffee with a group of executives from local manufacturers, it was just after the financial crash had started. One company president in the group - a particularly political sort - asked me how long the economic slowdown would last? I said "until the middle of the next decade sometime." He laughed at me.

Fast forward to today. What we know now is that the economy still has not recovered in real terms and that it will be a few more years until it does. The United States is just about in the middle of a demographic depression that can not be fixed with legislation or easy money. We must wait until household formation and spending by the very large millennial/ echo boom generation ramps up. Last year was the first year since 2008 that we saw an uptick in the birth rate, so that is a positive, however, it is only a baby step.

My 2011 annual letter was titled The Great Retrenching and its themes are continuing today. Let's touch briefly on a few before moving onto the investment climate:

Financial reforms slowly but surely have taken hold in the financial markets. While the reforms never did get the teeth that many envisioned as they reacted to the financial crisis, that is probably good. We already have a slew of laws in place, which if enforced, seem to have plenty of teeth.

The New York Attorney General has recently been focusing on insider trading (don't let anybody convince you that insider trading is okay) and the front running activities of the high frequency traders. The investigations into the high frequency traders, the subject of Michael Lewis' brand new book Flash Boys, will be interesting. Those investigations should lead to investigations of the dark pool trading platforms that are secretive and possibly probably manipulative. In short, the wheels of justice are slowly grinding away in the financial world. The only thing that could hold up the process is more politics and propaganda from the ignorant or paid-off. Hopefully we are too smart to fall for any of that.

Support for small business has been mediocre and that's too bad. Small business is the backbone of the American economy and politicians on both sides of the aisle continue to give in to the largest richest companies. Entrepreneurs will need to suck it up, focus on their businesses and find ways to overcome the impediments - which is often local government as well. People who establish small businesses with good models the balance of this decade could do very well in the next decade as the demographics become favorable again.

The playing field between small and big business will likely never be level, however, the Affordable Care Act has in fact been a help (avoid thinking like a partisan). Because of the healthcare exchanges, small businesses can now avoid one of the biggest hassles of hiring, which is healthcare benefits. They can simply pay what is appropriate for the job and people will get their own health insurance. I am doing that. It is a huge factor that will allow hiring to small businesses to thrive in time.

On healthcare, it is important to also realize that healthcare inflation is at its lowest level in six decades as reported by the Wall Street Journal. This fact will ultimately be good for the economy. In the short-term there is still doubt about the effectiveness of "Obamacare" however, from what I can see and measure, the benefits are outweighing the negatives (again, I implore you to avoid thinking politically). Presumably the Congress will fix the negatives over time, in which case, the 2020's are looking very bright indeed.

Debt issues do continue to plague us and other nations in the short-term. The rebalancing of finances from the household level to the national level will continue for years to come. In the United States, households are making some progress as debt service as a percentage of income has shrunk to levels last seen in over a decade. The drop however is mostly due to lower interest rates:

Household Debt

 

Absolute debt however is still at dangerous levels for households and in fact has ticked up this year:

Total Debt

 

All this points to one thing - the great retrenching of the American economy is still in process.

There is an economic factor which is still overlooked by many people that is enormously important to America's favorable position in the world. The technology that has led to an incredible upsurge in energy development is monumental. I have talked in depth about this on MarketWatch.com and made it the subject of a "Freedom" mid-year letter titled Freedom from OPEC a couple years ago.

I dubbed what is going on the "energy technolution" on MarketWatch. The term didn't catch on, but the idea is very important. The United States reserves of natural gas are massive. Our oil reserves too are large, likely exceeding one trillion barrels, which is about how much has been used by humanity to date.

The natural gas is most important as it is much cleaner than coal currently and can allow us to move towards a cleaner way to fuel our base energy power plants. With reasonably priced natural gas, we have regained our ability to be competitive with low wage nations in manufacturing. This should help slowly return the workforce to work and help expand the middle class again which has been shrinking since the 1980s.

Oil which is used primarily for transportation is also vital. The question we must ask however is how long can we go pumping carbon into the atmosphere beyond historical measures as we are now outside the range of naturally found pollutants in the air going back millions of years. In the short-term, the light sweet crude produced in America should allow our prices at the pump to remain range bound and somewhat insulated from goings on in the middle east.

On a larger scale, keep an eye on the developing energy bloc between the United States, Canada and Mexico. Ultimately, whether formalized or not, the North American Nations will become the key producer of natural gas and oil in the hemisphere, as well as, be an exporter to South America, Europe, Japan and possibly China. The United States refining industry, the largest and best in the world, is a key idea to be aware of as an investor.

The energy technolution doesn't stop with oil and gas however. The solar industry is booming, with the companies that survived the 2008-2012 collapse, coming out huge winners. Solar will eventually be about a third of our energy and if battery technology evolves could reach two-thirds over the next couple decades.

One thing to understand about solar, is that during daylight hours, it is very efficient to produce, costing little more than coal and natural gas. However, because it is intermittent, solar  can not produce all of the energy we need due to our 24 hour usage, particularly for industrial uses. We do use most of our energy during the day however, so, solar is going to have a huge growth phase that is just in the very early innings.

For investors, it is not too late to invest in solar. SunEdison, is one of our core holdings and has been since 2012 when I first discussed it (back when it was called MEMC) on MarketWatch and Motley Fool. I believe the company will reach its former high later this decade. Considering that it had over a 90% share price collapse, there is still a ways to go, despite being the top gaining midcap stock in 2013.

Ultimately, an age of cheap energy in America will merge with better demographics and we will see another boom. It will take several more years, however, it is coming. In the meantime there will be turbulence in the markets. Volatility when planned for is an investor's friend. For now, as our tactical models are still bullish, we will continue to take part in the uptick in the stock market while the Federal Reserve has our back, however, that day is coming to an end. More on that in July's Freedom letter.

Your forward looking adviser,

Kirk Spano

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