Monday, January 12, 2009

March 2008: Tough Economy

Recession Cometh or Recession Here?: What is a recession? There is an official definition: two successive quarters of declines in the gross domestic product. We are not officially in a recession. But it sure seems like that if you watch the news, read the papers, or are trying to sell your house.

There is also humorous definition of recessions and depressions: If my neighbor loses his job it is a recession. If I lose my job, it is a depression.

Economists do not necessarily follow this rigid definition. On March 14th, the Wall Street Journal reported that in their survey of 51 economists, 71% said that the economy is now in a recession. So far in 2008, there was a net loss in jobs in January and February. This fact, in spite of the GDP still showing miniscule growth, led many of these economists to classify the slowdown as a recession.

How bad is the economy? I knew things were not that good. Gasoline prices are up. The dollar is worth less than it was a few years ago. The housing market is terrible due in large part to the crisis in the variable mortgage rates that got so many people in over their heads.

I was worrying about the softness in the office products business. Sales have been soft and while we are maintaining market share, we are selling less. I have asked myself if this is an aberration or a level change in demand. Hard to tell, but we mostly believe it is the economy.

Other than this there has not been much impact in my lifestyle. I still live about the same way I have been living. Sure it now costs $50 or more to gas up my car. It used to cost $25-30. It still kind of shocks me, but other than that, life goes on.

In late February, I was at our annual sales meeting. At the hotel, the USA Today was waiting every morning outside my door. I would peruse it with my first cup of coffee. My perusing focused on the business section for the most part. The stories depressed me. Everyday the week of February 23rd the Business Section of the USA Today had stories about the state of the economy. It really began me thinking.

First, it is way too easy for me to get caught up in the day to day and not pay enough attention to the news. Mostly, the only stories that I have been paying attention to or keeping an eye out for are
Colossal headlines of which, thankfully, we have not had many lately.

Stories about quality problems with imports from China – the recent story about the
tainted blood thinner heparin was quite disturbing

Whether Terrelle Pryor, the high school quarterbacking phenom, was going to choose to go to Michigan. He not only did not choose Michigan, but he decided to go to Ohio State!
Second, I realized that over the years as my career has progressed and my salary along with it, I am in a different economic bracket then I was in previous economic downturns. The increases in gasoline prices on those making $30 or 40,000 per year must be very tough. I am fortunate enough to be able to absorb this kind of price jump easier than most. This second thing bothered me a bit. This shows that I am not as in touch as I thought. I will have to work on that.

One of the USA Today stories stuck with me. On February 26, 2008, the lead article in the USA Today business section entitled “Consumers cut back on small pleasures.” Here are some examples of what was reported in the article:
A yacht salesman who used to by Power Bars at his health club for $1.59 now buys Tiger Milk bars from Trader Joe’s for $.59.

A VP of marketing and his wife for a theater company used to spend $40 a month for Evian water. Now they fill a water bottle with tap water. The same couple used to spend $8 a bar for soap The Body Shop. Now, they buy Irish Spring or Dial at Walgreen’s and only when it is on sale.

A legal secretary was spending $55 a month for Iced Mocha Lattes at Starbuck’s for $3.86 a pop. She now makes her own using Folgers and chocolate syrup for a fraction of the cost.

A college professor used to buy designer jeans costing $100. Now she buys jeans at
the Gap Outlet for $19.95.

A couple in Ohio were spending $170/month at MacDonald’s for lunch. They now make their own lunch and brown bag it.
The paper’s website offered readers to comment on their own savings initiatives and posted the responses. A majority of the responses talked about not so much saving pennies here and there on coffee or bottled water but eliminating credit card debt which could easily cost hundreds of dollars a month. They are absolutely correct when you consider the following:
The average American household with at least one credit card has nearly $9,200
in credit card debt, according to, and the average interest rate
runs in the mid- to high teens at any given time.

Doom & Gloom: The USA Today articles I read were certainly gloomy. Were they reporting on what was actually going on or are they adding to peoples fears and hastening a recession? One could argue the case either way.

One thing I have noticed is that at or near the onset of a recession or economic downturn, there is always a flurry of books that try to cash in on the fears of people. Over the years, I have seen books with bold titles like DEPRESSION 19XX (fill in the year) or The Coming Economic Disaster. I wonder who buys these kinds of books and how they use them.

For this letter, I went to and did a search on recession. The following books appeared:
Crash Proof: How to Profit from the Upcoming Economic Collapse - published in 2007

Financial Armageddon: Protecting Your Future from Four Impending Catastrophes – published in 2007

The Second Great Depression: Beginning 2007, Ending 2020 – published in 2005

America’s Bubble Economy: Profit when it Pops – published in 2006

America's Financial Apocalypse: How to Profit from the Next Great Depression – published in 2006
The doom and gloom books are certainly out there. I probably will not buy any of them and thus will not be able to profit from this recession. But, I will keep an eye out for them on the remainder table at Barnes and Noble in a few years.

Restaurants: I read another doom and gloom article in the March 4th USA Today. This one was about the $555B restaurant industry. This article focused mostly on chain restaurants in the casual dining category. Same store sales in this segment were down. The dinner hour was hurting the most being down 2% year over year.

Same store sales were actually up .3% at the largest restaurant chains. The article called this growth “paltry.” MacDonald’s actually had a very good 2007. They recovered from their lackluster performance of a few years ago. Their dollar menu was the right move for this market.

Marc Buehler, the CEO of Lone Star Restaurants which just closed 27 of 179 stores, said “In the lifespan of casual dining, we haven’t seen economic times like this.” The Ruby Tuesday chain has also been hit hard. They experienced a 10.5% fall in business just in the fourth quarter. They are mostly based in malls and probably rely on mall traffic and impulse. If people aren’t going to the malls, this would hurt them. People went to the mall to Christmas shop. They might have been spending their money in stores and passed on dining. Richard Johnson, SVP of Ruby Tuesday said, “Unlike paying the mortgage, going out to eat is discretionary and can be changed easily.”

Starbucks: Starbucks qualifies as part of the casual dining industry. It is an interesting harbinger of the economy for me. There are a few reasons for this. First, I am a pretty good customer. Second, I have always wondered way we pay so much for coffee especially in a downtown. Witness the lady mentioned earlier who gave up her Iced Mocha Lattes for home brew.

On May 5, 2006, Starbucks stock was $39.63. This was the highest ever for the coffee chain. On March 19, 2008, Starbucks stock was closed $18.24. To look at the graph, there has been a steady decline since the high. In the fourth quarter of 2007, their transactions were down 3% though same store sales for stores open over a year were up like 7% in both December and January. Part of the stock decline this year is attributed to this growth being below the 10% expected from analysts.

Starbucks has been expanding rapidly. They have, perhaps, 13,000 or so stores around the world. I have worried that the were trying to outdo the struggling clothing retailer The Gap whose goal some ten years ago was to have a store in every zip code. Starbucks wants to have multiple stores in each zip code. They seem to have one on every other block in Manhattan.
They just open two stores in my world. One is walking distance from my house and is placed in between two stores on the same street, Waukegan Road, about eight miles apart. There is another in downtown Lake Forest. One just opened on Butterfield Road less than a mile east of my office. This compliments the store less than one mile west of my office. All of these stores seem busy. It amazes me. But consumers are fickle and their tastes change. Competitors also do not take things passively.

Witness again The Gap. They led the surge of business casual with the dot com popularization of khakis and blue oxford shirts. Gap Khakis became all the rage. Gap, originally launched to sell Levi’s, rapidly expanded their stores focusing exclusively on their own brand. There seemed no end to their growth. Often when retail growth and power seem to have no limit or end, we are actually at the apex. In the end, Gap sold clothes. Others started offering the same and better, the same and cheaper, and segmenting the market. The Gap thought that any innovation would lead the market i.e. they had the Midas complex thinking anything they would do would turn to gold. They lost market share and ended up paring back their stores and men’s fashion. There is little buzz about The Gap these days.

The same could be happening to Starbucks. The may well have saturated the market in the US. Competitors like MacDonald’s and Dunkin Donuts are trying very hard to take some of the coffee store market share from them. I stop sometimes in the morning at a Circle K share for a 16 oz coffee that costs $1.25 versus the Starbucks equivalent that is $2. Plus, I have a card from Circle K that gives me every sixth cup free. A recent Consumers Reports rated MacDonald’s Premium Coffees as being the best… better than Starbucks.

Recently, as you might imagine in such a decline of share price, there have been management changes at Starbucks. Howard Schultz who grew the chain to a global icon took over again as CEO from Jim Donald. Schultz claims that he will restore luster and growth to the chain by focusing again on what Starbucks is all about: coffee. A few years ago they stopped grinding coffee beans at each store. They moved to pre-ground coffee probably to save time and money. The chain is now investing in new equipment that will grind and brew on a grander automated scale. Schultz said, “you will not be able to find a fresher cup of coffee on the planet.”

Schultz claims it is not the economy but more Starbucks losing focus providing both excellent coffee and coffee shop ambiance for their customers. He is eschewing suggestions that he lower prices or provide other discount like incentives. He may be right or a combination of over expansion, the economy, and intensified competition may have permanently changed the landscape. We shall see.

Housing & Mortgages: A large part of this downturn is the shambles that housing market is in. This is largely due to complete mess all these sub-prime variable rate mortgages caused. People and companies were in a feeding frenzy during the recent red hot housing bubble. People were buying and mortgaging themselves to the hilt. Others were flipping houses, buying, making a few repairs, and then selling the property for a profit a few months later. It was crazy and apparently could not last… it clearly did not.

I never ever felt variable rate mortgages were a good idea. They are not good for consumers and therefore are not good for lending institutions. The problem is that people and companies easily are wooed into believing that nothing negative will happen. The problem is also that bubbles are fragile. They burst. You can make money in kind of an arbitrage way as many did house flipping. But, a variable rate mortgage over many years can and, now clearly, has burned many. Consumers are in dire straits because of it as are companies such as Bear Stearns.

I am a puzzled that the government has not stepped in with money so that people can refinance at a reasonable fixed rate. After all, we are spending an ungodly amount on this war which has probably also contributed to our economic woes. A bit, and I am sure it is a bit, more national debt to stabilize the housing market and help citizens sounds like a good idea to me. Then, I think a lending practice regulation should be put in place to prevent this kind of craziness in the future.

OK… that is it for this month. I have to go, my little espresso maker full of economic yet tasty Costco Kirkland brand coffee is beckoning me.

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