Why the next 30 years will kind of suck.

At a dinner party a few days ago, I was trying to explain what the sovereign debt crisis meant to average people and why it kind of sucks to be someone who is just starting their working career today. I hadn't used this analogy before, but might be pretty appropriate.

Imagine you and a few friends are driving a car really far.  Not just across the country, but back and fourth across the country forever, until there is no more country.  This road trip has to last as long as there is still a country.  You have this magic kind of car that produces gasoline for itself, but it doesn't  produce quite enough gas on its own to go very fast.  Say it can typically support the car going 25 miles per hour.  

So, as long as you and everyone in the car decide that 25 miles per hour is fine then you will able to drive forever.  Of course, it would be way more fun to go 80 if you could, right?  Well, a few years ago the drivers of the car made a deal with a gas station that will give you a bunch of gas for free, if you agree to give all that gas back in the future with a little extra.  Of course, just like you, those drivers wanted to go fast, so they signed up for the deal.  They filled the tank to the brim and took off!  Zoom, zoom!  Now, it's 30 years later and everyone has gotten used to driving at 60 miles an hour.

Today, the folks that have enjoyed riding in the car for the last 30 years are retiring and handing the keys over to the next set of drivers.  But after decades of speed, the gas tank is now completely empty.  Thankfully, the magic car still produces enough gas to naturally let us cruise at 25, which would be fine.  But the gas station that lent us all that gas back when is demanding that we pay back the gas that was borrowed.  So, it siphons off 10 MPH worth of gas as we drive.  Now our car can only go 15 miles an hour.  Compared to 60, that kind of sucks.

The sovereign debt crisis is the collective set of all cars slowing down.  Everyone has run out of this extra, borrowed gasoline.  If you are 60 or older, you got the chance to spend most of your working career in a car zipping along at high speeds.  For younger workers, this new pace of 15 is going to feel really slow compared to years past.  If you are just starting your career here, welcome to a period of suck.  It may not be 15 miles an hour forever, but it's very unlikely that you'll get to see 60 MPH in your working years.

What is a Fair Share of Taxes?

There has been considerable debate over the last few years about what the "Top 1%" should be paying in taxes.  This of course has come to the forefront of the political debate because of the newly proposed "Buffet Rule." The rule is named as such because Warren Buffett, a fairly sensible billionaire, has publicly and repeatedly stated that he thinks it's absurd that he pays a lower marginal tax rate than this secretary.  The reason for this is because the majority of his income is taxed at the capital gains and dividends rate that is capped at 15%.  While his secretary has ordinary earned income that is taxed at the progressive and well understood "tax brackets."

It is worth noting that while Buffet's marginal tax rate is lower than this secretary's -- it should not be misunderstood:  He DEFINITELY does not pay fewer dollars in taxes than his secretary (in a typical year).  It probably also worth noting that he COULD. If he elected to not pay himself any dividends or paychecks, I expect Mr Buffet could pay $0 in income tax any given year if he chose to do so.

Anyway, let look at this more broadly than just one billionaire and his secretary.  The chart below shows the distribution of US tax payers by income percentiles, their share of income, and their share of taxes paid.

Chart: Heritage Foundation via Zero Hedge

We can see that the Top 10% of earners, earn 43% of the income and pay 71% of all of the individual income tax.  In contrast, the bottom 50% of earners collectively earn on 13% of the income and pay only 2% of all the income tax.

Some may see the tax burden of the Top 10% as unjust, others will see their disproportionate share of the income as even more severe sign of injustice.

Who is paying their "fair share"?  The chart above doesn't necessarily give us an answer to that question.  It's in part, a moral values question.  One possible place to look for answers would be to compare that distribution to other leading OECD countries, or perhaps compare it to past distributions in US history.  I think both of those are worth exploring.

Key to the policy debate is "What should the top marginal tax rate be?"  The chart below provides some context to the debate, as the top tax rate has fallen from 91% in 1960 to the mid-30% that we have today.  Of course, the top tax rate is a dynamic and vague question.

The top rate needs to be taken into consideration with the brackets, the rate applied to all other brackets, and what types of deductions, credits, and caps are allowed.

This is where the Warren Buffet issue comes into play.  He earns in the top tax bracket, but doesn't pay nearly 35% in taxes.  He has publicly stated that his effective rate is 15.4%.  So it appears that "Top Marginal Tax Rates" don't necessarily effect the top earners nearly as much as we expect.  Perhaps professional athletes and movie stars are affected, but all of the hedge fund millionaires and business owners (small and large) have much more control over when and how their income is applied.  Often their choices are how and when to realize their income will be driven by tax code.  However, I laugh-out-loud at the notion that people will stop trying to get rich if the tax rates on the Top 1% are raised.  John Paul Getty wasn't exactly deterred by high taxes -- and he made his billions when the top rate was 90%.



Chart: Heritage Foundation via Zero Hedge

The chart above shows that there is no visible correlation between the top marginal tax rate and the total amount of income tax paid.  Of course, as mentioned above, we have no idea what counter balancing factors were going on in the tax code from this chart.  All we can say for sure is that it looks like Uncle Sam collects around 8% of GDP each year as tax revenue.  So perhaps the answer for increasing revenues (and closing the deficit) is less related to the tax code and more related to raising GDP.

Food for thought in this election year.

A Bottom for Natural Gas?

Earlier this week, the Market Monkey opened up a long position in Natural Gas.

I don't have any indicators that say "this is the bottom."  Mostly there is a lot of evidence that says, "this is cheap."  I happened to see natural gas stories popping up in a number of places this week, so it's possible that it will garner some buyer attention here.  It came up on my stochastic screens and also there have been a number headlines over the last two weeks about Aubrey McClendon's ongoing irresponsible money management at Chesapeake Energy (CHK).   Also, natural gas is on the cover of Fortune Magazine this week.

This chart shows how dramatically natural gas prices (in the US) have fallen in the last four years.  From $14 to $2.

It's helpful to put that fall in price in perspective.  Crude oil has retained it's value in that same period.  So we have seen a parabolic rise in the price ratio between natural gas and crude oil.

To me, this says one important thing:  Energy is not as fungible as they say it is on TV.

Certainly, it takes some time to convert infrastructure from using oil to natural gas.  Energy stored in one form is not easily transferable to another form.  (I am optimistic that battery and fuel cell technology will change this the future).   But there are lots of capital-rich and rational-acting trucking companies out there that probably see an economic incentive to start converting engines to natural gas vs diesel fuel.  That process is likely to start sooner if the price ratio is 50X.

I think the big beneficiaries of this change are households that use natural gas to heat their homes and steel companies that use natural gas to make steel.

There is another other piece of information that is interesting to about the decline in natural gas prices.  Its that the cheap price of natural gas is unique to North America.  Prices remain around $10 for natural gas delivery in Europe and Asia.  This has to be attributable to the recent productivity gains from shale.

One would think that the the price arbitrage pressures have got to become large enough to overcome the financial and energy costs of natural gas liquefaction.  ( I know almost nothing about this... does it need to stay compressed to stay liquid?  Does this mean you need to build gigantic compressed tankers to move it from one place to another?)  Is 5X a different enough price to get the ball rolling?

In any case -- below $2 seems very cheap for a commodity that was $14 in recent memory.  Of course there is not much of a floor here.  Natural gas could certainly keep falling, but it seems cheap enough to start thinking about.

MONKEY BUSINESS

Buying: BOIL @ $6.65

Holding: RENN ($5.30), AGQ ($79.85, $63.16, $54.10, $60.35),  UGL ($91.00), AVL($2.72), NFLX ($74.70), DAG ($11.00)

Apple's Huge Pile of Cash and a Mountain of Student Debt

It is difficult to find the right words to describe Apple's earnings announcement last week.  The largest (by market cap) and most profitable (by net income) company in the world managed to grow like a baby baboon drinking bovine growth hormone.

Year over years earnings growth was 91% higher, total revenue was up 59%.

That is just INCREDIBLE.  A company at that scale simply SHOULDN'T be able to grow that fast.  Frankly, the Market Monkey can't get his head around it.  In it's most recent quarter, Apple's market cap peer, Exxon Mobile (XOM) had earnings growth of 1.6%.

Really, Apple is growing like a teenager.  The world's biggest, smartest, and tallest teenager.

This chart was posted on Zero Hedge this week.  The scales are a little different with total US student loan debt at about $1 trillion and AAPL's cash hoard at around $109 B.  But it's a funny (ha ha) correlation.  Is $10 out of every student loan dollar going to pay for Apple products?

Chart: Bloomberg via Zero Hedge

Some back-of-the-credit-card-offer math:

Tuition at a mid-tier public university: $5000 / semester

x 2 Semesters = $10,000 / year

x 4 Years = $40,000

50% Borrowed: $20,000

--------------------------------

Total Student Debt Expense = $20,000

MacBook Pro: $1500

iPhone: $200

iPod Nano: $129

iPad: $400

----------------------------

Total Cash to Apple: $2,229

Cash to Apple : Student Debt Expense = 11%

Apple's Total Cash Hoard : Total Outstanding Student Debt: 11%

Sadly, the math works out.  Perhaps the US Department of Education should start negotiating a better bulk discount.

MONKEY BUSINESS

Holding: RENN, ($5.30), AGQ ($79.85, $63.16, $54.10, $60.35),  UGL ($91.00), AVL($2.72), NFLX ($74.70), DAG ($11.00)

RenRen as Alternative to Facebook (RENN vs FACE)

           

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With all the news about the upcoming Facebook IPO, many people are wondering if they should take the opportunity to buy Facebook once it starts trading.


My thought is that the underwriters know that this will be one of the most closely watched IPOs of the decade, so expect that the IPO will be under priced.  There will almost certainly be a meaningful pop of 25% or more on the first day.  So, if you are fortunate enough to get in on the IPO, then it's probably best that you do so.  Of course, under pricing the stock is bad for the company.  But they are selling $5 B worth of stock that day, so perhaps that will be enough cash.

Since we have no idea where the stock will trade after it floats, it's difficult to make an opinion based on valuation.  The next reports are suggesting something in the range of $75 to $100.  So for the sake of thought, let's assume it prices the night before at $80 B and then has an immediate 25% pop and starts trading at $100 B.

Obviously FB is behemoth of a company.  $100 B given it's market power today seems reasonable.  Currently Google is worth $198 B, but unlike FB they have massive amounts of revenue and profit to back that up that valuation.  They trade at about 5X revenue and 20X earnings.  At a valuation of $100B, Facebook would be trading around 60X revenue is which is VERY steep.  10X revenue was considered "rich" even in the dotcom bubble.  What is attractive about FB is that is have undeniable stickiness, and it currently is the #1 most visited site in the US.  Importantly, it also has a very long average visit time compared to the other top sites. The network effect of Facebook's market share is very compelling -- and it's hard to construct a scenario where users start leaving Facebook in mass.  So from that point of view, the is the moat around the business is VERY wide -- and in that way it is much more like Microsoft or Google than Groupon or Netscape. 


In the end, it's just that fact that the valuation is so high already that it difficult to get really excited about it.  At $100B, it doesn't have a lot of room to grow -- it would be around the 25th most valuable company in America. It's peer companies (in terms of market cap) would be Cisco, Pepsi, McDonald's.  If you are looking to double your money, then FB would have to grow to the 7th (or so) largest company, surpassing the likes of Proctor & Gamble, AT&T, and GE to get there.  

So, I went searching for a cheaper alternative.  I've decided to play the Facebook IPO through Renren (RENN). The "Chinese Facebook" it doesn't have the same market dominance that FB has.  Even in China, it is only the 2nd or 3rd most popular social networking site.  But with 120 million users (and growing) it has a real opportunity to truly become the "Facebook of China."  It is clearly copying them in many ways.  At $2B (23X revenue), the valuation is still high, but much easier to swallow.   As a follower of FB, is has the luxury of just replicating the way Facebook creates user experiences and generates revenue.  The reports that I read suggest that RENN is making excellent gains in Chinese market share.  However, I don't know how reliable any of that data is.

In addition to being a cheaper stock with more potential for growth, RENN might be an acquisition target for Facebook.  Facebook has a tiny, tiny, tiny share of market in China.  A few billion to jump to the top of the list -- buying a site that has essentially a Chinese knock-off of the Facebook user interface might be an easy decision for a CFO that has $100 B of FB equity to trade with. 

Also, RENN has performed terribly since it's IPO, so the hype has already faded from that star and is ripe for some attention.  The Facebook IPO might be the catalyst to bring that to the front of mind for both retail and institutional investors.

As a closing thought, for Facebook to be worth the same as Google ($190 B), it needs to double from the IPO.  That means it needs to create $100 B worth of value, which is not easy.  For RenRen (RENN) to double, it only needs to create $2 B of value.  That seems a lot easier to do when you have a $100 B big brother to follow and a powerful Chinese government that would rather have you succeed than your big brother.

MONKEY BUSINESS

Buying: RENN @ $5.30

Holding: AGQ ($79.85, $63.16, $54.10, $60.35),  UGL ($91.00), AVL($2.72), NFLX ($74.70), DAG ($11.00)

The Year of the Dragon (of Inflation)

So, this Chinese New Year rings in the year of the Dragon.  It is supposed to be a good year for business and families.  Let's hope so.

Earlier in the week Fed Chairman Bernake said that the Fed intends to keep interest rates low (near zero) until the later part of 2014.  This is great for anyone who is interested in borrowing money, because it suggests that the price of short-term money is going to be cheap for at least another two years.


There is a fun and educational game on the Federal Reserve website that is called the "Fed Chairman Game."  Your job in the game is to use interest rates to manage unemployment and inflation in a way that helps to stabilize the US economy.


http://www.frbsf.org/education/activities/chairman/

What is entertaining here is that in the game, after 8 quarters of 0% interest rates, you have a 12% rate of inflation.  Admittedly, the model in the game is probably simpler than the real economy, and the game does not start off with 10% unemployment.  But the expected effect should be clear.  There will be inflation.

It's unclear where the inflation will manifest itself.  There has been meaningful inflation in commodity prices since the zero-interest-rate policy (ZIRP) began.  But we have not seen inflation in the cost of services, labor, or real estate.  I expect that we won't see wage inflation until unemployment is a little lower... but there is something to think about here.  The demand for "stuff" is still high and supply is flat.  Demand for people is down, and supply is _____.

The price of labor has been flat - to falling over the last 4 years.  The interest rate is essentially the price of money.  That is near zero and will remain low until 2014.  Inflation is likely to keep flowing to the price of goods until the unemployment market tightens.  So, if interest rates stay low and unemployment remains high, I would expect that inflation is will continue to be focused on the commodities and goods sectors.

MONKEY BUSINESS

Buying: AGQ @ $60.35, DAG @ $11.00

Holding: AGQ ($79.85, $63.16, $54.10),  UGL ($91.00), AVL($2.72), NFLX ($74.70)