There is really no debate about the point that unemployment levels lag the stock market. The data is clear on this. Even if one wants to challenge the accuracy of the level of unemployment, the trend is the same. This past Friday saw the passing of the level of 10% unemployment in America.  This level was thought to have been a severe psychological barrier to market participants and the market had sold off the two weeks previous in anticipation of that result.  The number was announced on Friday morning, and….nothing.  The market barely reacted.  And for good reason.

All good things must come to an end.  In the case of my ownership of General Growth Properties stock (GGP was its ticker before bankruptcy filing), the end is near.  Why? Anyone following GGP will already know this, but just in case you don’t, the price per share moved from $4 to $7 in a matter of a couple weeks.  This move, and the reasons for it, mean it is now time to part ways with a very good stock pick (originally bought in April at $0.63 / share).

Three good things happened for GGP the past two weeks:

1. GGP released its 3rd Quarter financials on Monday, November 9.  They were better than expected.  Year over Year (YOY) results were down, naturally, given the near depression we have experienced since Q3 2008.  But they were down much less than had been expected by analysts still following the company.  Cash Flow (FFO) was actually positive by $671M ($2/share) when $700M of one-time, non-cash expeneses are added back while revenue and operating earnings were down only marginally (less than 5%).  The ”comprehensive” earnings were down substantially because of the large non-cash impairment charge to reserve for future unknown expenses attributable to the very weak economy.  But all in all, the Q3 report was very encouraging.

2. The second big news event happened early last week (November 17) when  Simon Properties (SPG), the other really big mall REIT other than GGP, did a SEC filing that it had retained a law firm (Wachtel, et al) and investment firm Lazard to explore acquiring some or all of GGP’s assets.  This creates a market for the malls owned by GGP, which will definitely help its valuation.  Part of the problem for GGP and other CRE companies the past 18 months has been an increasingly dreary commercial real esatate market as financing disappeared.  Just as with the derivatives market, when buyers disappear, the market value of the assets get marked down dramatically.   Now that there is a buyer on the horizon, I expect the GGP Board of Directors to work towards a sale of the properties at a price near the current market value.  Bill Ackman and Pershing Square Capital have a large equity stake in GGP and sit on the board.  It is Ackman’s job to realize value for his fund investors and will therefore likely work towards an exit strategy.   He needs a large buyer to absorb his 23% share and SPG looks like just that buyer.

3. And third, on Thursday this past week, mortgage holders / lenders on (170) of the mall properties that were in bankruptcy, agreed “in principle” to refinance $8.9B of the mortgages for GGP properties by extending maturities.  This agreement eliminates the pressure to liquidate those properties which were in technical default when many mortgages came due at a time late last year and earlier this year 2009) when there was no ability to refinance in a frozen credit market. 

All these are very positive situations and increased the value of GGP in some ways that are admittedly hard to measure at this point in time.  How much are GGP’s assets worth to Simon Properties?  Are they willing to pay a fair price based on cash flow (FFO) or do they think they can get a steal based on the depressed CRE market?  And how fast does the economy recover? 

For the reasons that the stock now seems fully valued with the balance sheet owners equity at $5 per share and a small premium now available due to the brighter  future prospects, I have liquidated all my position in GGP as of Monday, November 23.  Sure, the stock could even go higher.  It was near $60 in early 2007 and could be worth north of $20 if everything goes perfectly from here.  But best not to get greedy.  It was a very good ride while it lasted.

In the Land of the Rising Sun, the financial sun is apparently setting. I have zero investments today in Japan for the reasons outlined in the story linked below. Credit Default Swaps (CDS) are showing the Japanese banks are under great stress. Those bank debt insurance policies are at levels close to where American banks were in September 2008 before the big crash and bank implosion.

I have business associates in Japan, and the economy has been in virtual depression for many years. They have a homeless problem like you would not believe with tent villages on public grounds in the cities, especially around the old castles (but being Japanese, they are very tidy tent villages).

From my take on the Japanese people, the problem is mostly to do with their domestic reluctance to consume. They have a domestic consumption economy much too small for the size of the country (by population). The older generation that came of age post WW2, was reluctant to spend on anything, understandably so given what they went through in the years after 1945. Even the business leaders who make a very nice income by American standards, are very frugal in how they live. The wages for the workers among the younger generations are very modest. I was able to determine that a sales person selling the same products as me, with the same skill set and experience, was making half the wage. The Japanese I know can’t believe how well we live here in America and some consider us wasteful and decadent (though they enjoy participating in the decadence when they visit).

And with the WW2 generation being very conservative about their own future, they had small families with birth rates below the “replacement rate” of about 2.2 children per family. This, along with virtually no immigration, leads to the well known problem of Japan’s gentrification. Who is going to take care of all the older people on government pension and healthcare?

And now Japan has lost the one thing that kept it going and growing the past 40-50 years: a leading global position in manufacture and export of consumer goods. China and its siblings (Taiwan, Singapore, Thailand, Vietnam, etc) are taking over this role on the world stage. Japan is left to try and export capital goods and engineering know-how to China and siblings, much like America. But America has a population that always expands from immigration (a reason I am VERY pro-immigration) and an established consumer psychology that will recover within the next few years, Bill Gross’ proclamations to the contrary. Our desire to consume is genetic. It is the source of the proverbial “American Dream”.

A second significant problem for Japan is that Japan has no natural resources to export. So, they have lost their consumables export leadership and have nothing left to sell the rest of the world to drive their economy. Japan does not consume enough as a nation to fully utilize its own productive capacity for domestic demand and to keep its younger workers employed to pay for the retirements of the older workers. This is the source of Japanese deflation.

I think Japan will either evolve out of necessity into a consumer nation over the next 20 years as the younger generations with Western ideals take over management of the country, or Japan’s financial system will go into default. In October last year, the world financial system came to the rescue of America with its heavy importation of manufactured products and its reserve currency. The world had to save American banks in order to save itself. But for Japan, there will be no such salvation. Its banks will be allowed to fail and the Japanese people will have to build the country all over.

If Japan defaults, it will be VERY ugly (Iceland times 100). So, I expect global financial interests to push the Japanese to avoid that fate before it happens. Ironically, the Japanese need to spend their savings (those infamous Postal accounts). That is their one chance to save themselves and the rest of the planet a lot of pain. Strange as it seems for Americans with our low national savings rate, it is possible for a nation to be too thrifty (called “The Paradox of Thrift”). There is a need for balance in a sustainable economy: not too little savings, but not too much; not too little social security, but not too much (Obamacare for example); not too little immigration, and not too much. And so on.

Just be glad this is happening now and not in 1990. The Japanese economy (including real estate and stock market) has already deflated by 80%. The crash if it happens, will not be as precipitous from these levels as it could have been. But it is shocking to contemplate. I think the weakness of Japan’s economic system, its lack of domestic consumption and its long term social liabilitites, is the reason the Yen will never become the world reserve currency. The dollar remains safe in that role for some time to come.

Here is a link to the article that inspired this post published in the UK Telegraph on Sunday (bottom of post). It is somewhat frightening reading. But as mentioned, I don’t think the Japanese economy has a great deal of direct influence on the Rest of the World. Besides, as Warren Buffet says (quoting someone Ben Graham I believe), “Buy when everyone is Fearful and Sell when everyone is Greedy”. He did that today when he acquired ALL of Burlington Northern Santa Fe rail (BNI) for $44B.

“It is Japan We Should Be Worrying About, not America”

There are many doomsayers on the economy and markets. They all say roughly the same thing: we have been profligate as a nation and as a world, and there is a big price to pay. This price will be paid in the form of a very long period of economic stagnation and declining markets. The doomsayers give many seemingly sound reasons for their outlook, that to some may seem irrefutable evidence of a coming economic armageddon.

Unfortunately, history does not support their thesis. If anything, what economic history proves is that there is a wired-in persistence of growth in the economy. When we look at our financial surroundings on a day to day basis, we get confused by the noise. Daily, monthly, even quarterly data might seem to indicate some watershed change in the economic future. But the facts show us that year after year, decade after decade, the economy continues to grow very evenly and consistently. The markets will mirror this growth in the long term, and once all the daily noise is removed.

Here is a chart I prepared showing this persistence. It dates from the earliest Gross National Product data available on the government economic data website. It shows that even the 1930s disaster looks relatively benign in an 80 year perspective.

The conclusion: invest for the future, not the next day. And you will be richly rewarded for your patience.