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From the pen of Gary Booysen

Dear Investment Academy Reader,

Today, I’m faced with another reader question. I feel compelled to answer these queries, because if one of you is asking it, there’s a good chance the rest of you could use a little more information too. The question: Is the problem with the US economy mostly to do with their share prices collapsing or failing company health?

When you read about a company’s share price tanking, in the perfect world of theory, that share price should reflect the actual real value of the company. Companies with high share prices are supposed to be fundamentally solid. The lower the share price, the less solid the company. We see this in the high prices of blue chips like Anglo (R202.26) and BHP (R191.99).

When is a share price a fair price?

This is based on two fundamental economic assumptions that underpin most economic theory. Firstly, that people are rational and secondly, that they have “complete knowledge” when making decisions. If these hold true, then the share price is directly related to the health of the company. And while most economic theories are built on these two assumptions, when you get down to the nitty-gritty real world, they’re basically untrue.

In the real world, the price is driven directly by “sentiment”. A share is worth exactly how much someone else will pay for it – no more, no less. It’s driven by how badly people want the shares. This can then be divided into its supply and demand components, namely, how badly people want to get hold of the share (demand) and how badly people want to keep the share (supply). Even if a company’s rotten to the core, if there are enough idiots willing to buy it, the share price will improve. Normally, we must assume that the majority of people make the right decision and dump a company that isn’t performing and this, broadly speaking, allows the share price to reflect the actual value of the company and its value to society. So, to answer your question: The company’s health and the share price are delicately intertwined.

The problem in the US has been that government hasn’t had the courage to allow unhealthy companies to die. General Motors, for example, is struggling to move with the times and continues to produce giant gas guzzling cars that no longer meet society’s needs. The H2 Hummer, one of their great examples, has a fuel consumption of around 24l/100km and isn’t allowed on certain streets because it weighs close to three tons!

Creative destruction can’t become creative creation... there’s just no space...

Mr Market is desperately trying to wipe out this social inefficiency. He’s attempting to free up the “labour resources” and allow them to actively pursue a better use of their time. But, unfortunately, when we have conglomerates of GM’s size, “freeing up labour resources” equates to millions of people losing their jobs. Though society no longer needs these workers to produce the cars that chug down Arabian oil, it still expects them to contribute.

Ay, there’s the rub, if they don’t find new, meaningful employment for their skills, they’re no longer welcome as part of our market society. Since they produce nothing for the world, the world doesn’t pay them and no resources – such as food, shelter and clothing – are distributed their way.

Governments, who’s mandate is to look out for the electorate, try desperately to protect these people, from the pain of losing there jobs and, at the moment, bailouts are the order of the day. But where is all this money going?  Unfortunately, where the governments around the world had the opportunity to do something spectacular, they opted to increase protectionism and prop up failing companies. Their efforts involve removing resources/money/potential, whatever you want to call it, from successful companies (providing efficient valuable services) and handing it over to weak companies providing things that the world doesn’t need.

One idea touted by the governments responsible (the need to be seen acting aside) is that if these people are “removed from our market society”, then they no longer have spending power. They argue that other successful companies will lose revenue because their markets will shrink. They feel it’s better to have people continue producing things we don’t need, so that people who provide us with the things we do need, can continue making things for the people that only make things we don’t need. Now that’s just crazy.

Unemployment is always structural

Now, I have to admit there’s a problem with millions of people losing their jobs and I won’t criticise without proposing a solution. I’m not going to say it’s time to make Soylent Green. But why not pour that bailout money down the throats of the unemployed in the form of training? That at least allows them to work in a sector that’s efficient. Only then can I see the transference of funds from people who make a difference to those that don’t as acceptable.

For any of you who’ve started to believe the recent gains on the JSE All Share Index are the beginnings of a turnaround, don’t. The bear market rally is running out of steam. Obama’s 100 days are up. He’s boosted moral and the crew is singing, but trust me, the ship’s still going down. The fundamentals are all wrong. My predication this week: We’ll see gold going over $1,000 very, very soon. I recommend you find out all you need to know about investing in gold with this report before it’s too late.