SPENCE Asset Management

The New Normal August 2009

Market mavens such as Mohamed El-Erian (author - When Markets Collide) of Pimco have began using the phrase “the new normal” since the onslaught of the global financial crisis. The “new normal” will incorporate the realities that have resulted from the meltdown of many of the world’s money center banks, insurance companies, and investment firms. But as the clean-up of such implosions continues, figuring out as precisely as possible what the new normal will entail is not easy, but it is crucial.

The “new normal” will vary for different countries, different industries, and even for different households. As everyone does their sweeping up, some households will trade down to a compact hybrid from their gas guzzling S.U.V. Some households will even go so far as to sell a car in exchange for a 60 mile-per-gallon moped. As they scrub away the proverbial soot, some industries will outsource more, some will be forced to reinvent themselves, and some will cease to exist. The “new normal” for some countries will be to face up to the threat of famine, severe political unrest, and/or bankrupt leadership. Other countries will merely encounter an almost unnoticeable downshift in break-neck growth.

The “new normal” at Spence Asset Management involves noticeable change. As a business, our “new normal” actually began shortly after the tech bubble burst in 2000. While dot-coms were becoming dot-gones, we did our best to remind our clients to keep their return expectations in-line with historical truths. The amazing returns of the late 90s were unrealistic and unsustainable. Cost cutting became not so much an initiative, as a part of daily life.

As an asset management firm, applying the “new normal” was merely part of our ongoing reality in 2009. The twelve business tenets that we have tried to rigorously apply to business analysis remain. However, now there are four new significant considerations that cannot be ignored as the post global financial meltdown’s “new normal” emerges.

1. Elected officials are applying stricter standards to the environmental footprint of every company. This factor must be weighed carefully. The ramifications of the changes in global consumption patterns cannot be ignored. Being “green” will be almost as important as being profitable. The “new normal” demands that a business cater not only to its customer, but to factors associated with climate change as well. Ever gaining in the importance of a business’s fundamentals are manufacturing methods, development of “green” products, and possible future environmental regulations.
2. The long standing “pricing power” attribute, which is essentially the ability of a company (to a reasonable extent) to raise prices and yet retain their customers is now more complex. In the “new normal,” this power/ability is more likely to raise a red flag with regulators. TOO MUCH pricing power is likely to lead to anti-trust issues and frequent visits from the U.S. Department of Justice.
3. With massive liquidity being pumped into the system by the Federal Reserve in order to avert financial catastrophe, inflation has become a real possibility. Because history is inflationary our primary business tenet has steered us away from capital intensive companies. Maintenance and replacement costs on equipment are more likely to increase at a faster rate than customer bases in an inflationary environment. The “new normal” is likely to exacerbate this phenomenon. We must be more keenly aware of how rising costs and rising prices will impact each of our business models.
4. Heavily leveraged businesses or businesses with poor balance sheets have always raised red flags. Depending on the types of leverage employed and the growth that the leverage generates, we have often times been comfortable with some degree of leverage. The “new normal” will require us to look even more closely at a company’s leverage, interest coverage ratios, and lines of credit as well as the company’s investments, their ratings and off-balance sheet vehicles/liabilities.

To be considered successful, investments must endure all realities: whether gas is $0.99/gallon or $4.00/ gallon, whether Democrats or Republicans control the White House and Congress, whether Michael Jackson is alive or in pop-icon heaven, we must accept and embrace reality rather than get bogged down in “what oughta be” thought processes. We could long for the days of buy now, consume now, and entitle ourselves now, then figure out how the system will pay for everything later. However, as we brush away the ashes of the financial wildfires we know we have to work more diligently than ever to define and to adapt to the “new normal.”

—Jim Spence, Registered Principal, Spence Asset Management

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Investment Advisory Services offered through Spence Asset Management, Inc., a Registered Investment Adviser Cambridge Investment Research and Spence Asset Management are not affiliated The views expressed here are those of Spence Asset Management and are subject to change with market conditions. The information contained in this newsletter is derived from sources believed to be accurate. You should discuss any legal, tax, or financial matters with the appropriate professional. Neither the information presented nor any opinion expressed constitutes investment advice or a solicitation for the purchase or sale of any security. Market forecasts cannot be guaranteed. Past performance does not guarantee future results.