Navigating the US's Politicized Economy

By Terry Coxon, Casey Research

Absent the state's involvement in the workings of the marketplace, an investor's central task would be to evaluate companies for their ability to efficiently produce and market what customers want. Shrewdness at that one task would lead to the profits investors are looking for. And there would be other consequences.

The stocks of companies that succeeded in convincing investors that they had the right stuff (primarily through good performance) would be bid up. Stocks of companies that failed to make their case to investors would tend to drift down, and any company whose stock drifted low enough would become a takeover target. A takeover would replace underperforming management with a new team of officers and directors – individuals picked by the people who laid out their own money to buy enough shares to control the company.

That's how things work when the government isn't a player in the process. It's a marvel of efficiency and impartiality. Managers who serve investors by serving customers are rewarded. Investors who identify such managers are rewarded. Unskilled managers eventually lose the corporate positions that enable them to make wasteful, money-losing decisions. And investors who are blind to management weakness or who forgive it too willingly lose their own money.

That's how it works when government is absent. But year by year, government has become less and less absent. In fact, it now has a sterling attendance record at occasions where economic decisions are being made. Through subsidies, tax breaks, regulation and spending, government has claimed a virtual seat in the boardroom of most companies. In some cases, government in effect holds a majority of the votes.

Government's involvement profoundly alters decision-making for investors. It no longer is enough for an investor to identify the companies that are doing a good job of serving shareholders by doing a good job of serving customers. Now an investor needs to consider how effective a company's management will be in getting favors from government and in avoiding getting punished by government. Even if you've made a cover-to-cover study of classics such as Benjamin Graham's The Intelligent Investor, you need to understand the appendix on political factors that Mr. Graham never wrote. Here's a quick outline.

Four Categories

At the big-picture, macro level, you undoubtedly are already familiar with the essentials. Unmanageable deficits and reckless money printing have made bonds dangerous and gold a necessity. That's simple enough. But drill down to the next level and things get messy.

Most of the government's involvement in business falls into four categories.

  1. Government as customer. No other customer's shopping cart comes close to the size of the wagon the government pushes through the aisles of the economy. For many companies, government is the number-one customer. For some of them, government is the only customer that matters.
  2. Government as regulator. In some industries, complying with regulations that customers care little about is a matter of life and death. The big payoff comes from getting new regulations written that help you and hurt the competition.
  3. Government subsidies. There are products and services that would be sold only at much higher prices and in much lower quantities if government weren't directly or indirectly absorbing part of the cost.
  4. Government detritus. Sometimes an industry grows almost accidentally, as an unforeseen or unintended result of government activity.

Examples and Rules

Government as customer. Government uses certain types of products. Military equipment is the biggest and the most characteristic example. The large, established companies devoted to this market are essentially public utilities. They produce things that government is sure it can't do without. To give one example, for the government to be assured of sources for developing and acquiring military aircraft, it needs Lockheed, Northrop Grumman and Raytheon to stay in business. So when any of them stumbles, you can expect government to help.

When you consider buying stock in a company that sells primarily to government, the rule of thumb is: Buy on bad news. Bad news knocks down a stock's price. But whatever the bad news – didn't get the contract, got caught handing out money that looks like a bribe – it likely will be old news soon, because government will find a way to help out.

Government as regulator. Most businesses must live with regulation of one kind or another. But in some industries, the need to conform to government regulations is at the center of all decisions. Banks and stockbrokerages, for example, are no longer run by financial analysts or operations managers. They are run by compliance officers.

It is a sad and stifling fact that regulation weighs the most heavily on small companies. A giant company may need a platoon of lawyers and regulatory specialists to stay out of trouble, but the cost is a minor matter, given the company's size. A small company in the same highly regulated industry, on the other hand, needs a similar platoon of lawyers and regulatory specialists. But for it, the cost is a serious handicap.

Big companies seldom complain about regulation. They like it because it handicaps the small-fry competition. It forces upstarts, startups and innovators to run the race with bags of sand on their backs.

When you consider buying the stock of a company in an industry that is highly regulated, the first rule of thumb is: Go with size. It may offend your sense of fairness, but the big guys have a built-in advantage that you generally should not bet against.

The second rule of thumb is to look for industry subversives with strong strategies. The more arbitrary, wrong-headed and harmful that regulation becomes, the greater the potential reward for a company that can provide what customers want in a way that falls outside the scope of the harmful regulations. Money market funds, for example, began as a product that side-stepped the regulatory limitations on the interest that banks were permitted to pay on checking and savings accounts. While those regulations continued in force, the money market fund industry grew rapidly, and the companies that sponsored and managed the funds profited accordingly. Today, manufacturers and marketers of food supplements operate largely free of regulation and provide (or at least claim to provide) customers with some of the benefits that come from the highly regulated pharmaceuticals industry.

Government subsidies. Some industries would be tiny and some companies wouldn't exist at all, but for the subsidies they receive from government. Without subsidies, fuel-grade ethanol would be a micro-industry. (Potable ethanol is another matter.) Without subsidies, Chrysler Corporation would be no more than a chapter in automotive history, like the Packard Motor Car Company.

For an investor, profiting from government subsidies is a matter of being a good judge of political fashion. Investors who saw early that ethanol promoters would succeed in convincing the (voting) public that burning crops is a good idea have profited nicely. Investors who are now holding stocks like BioFuel Energy and BlueFire Renewables will get hurt if they are still holding when the public eventually notices that burning food makes as much sense as eating coal.

If you don't believe that you are an above-average judge of political fashion, avoid companies that live off government subsidies.

Detritus of government. The state's involvement in the economy produces little boomlets here and there that no one intended. They can be profitable for those who do their homework.

The "War On Drugs," for example, has become a high-volume recruitment program for another euphemistically named operation, the "criminal justice system." As a side effect, bail bonds have turned into a big industry. The subsidies, government guarantees, tax incentives, banking regulations and money printing that fueled the housing bubble had as a side effect a boom in the mortgage brokering industry. More recently, the bursting of the housing bubble has produced a lucrative cottage industry in buying and brokering tax liens.

Such detritus industries come and go. When they arrive, they generally do so with almost no one expecting them. So, typically, there are no stocks you can buy to profit from them. But you can profit, perhaps handsomely, by treating them as business opportunities. That means you can't profit just by putting your capital into them. Either approach them as a business to be managed or stay away.

The entire topic of navigating in a politicized economy is, for me at least, a dreary one. It too much resembles "How to Eat Well in a Prison Camp." It is, however, a necessary topic. Ignore it and you raise the odds that you may eventually be eating less well than you expected.

So what's an investor to put money in today? Given the political uncertainties in the US right now, reasonable individuals' ideas may differ. That's why Casey Research brought 28 seasoned, well-respected analysts in finance, the military, politics, and economics together for an eye-opening conference. You, too, can hear every word of their presentations, and get every piece of specific, actionable investment advice, in order to be well positioned for what's ahead. Learn more and order today.

6 thoughts on “Navigating the US's Politicized Economy

  1. I sympathize with the comment that advocates of free markets believe in a mythical world. But it is equally true that advocates of relying on the government to control the market and guarantee fairness also believe in their own mythical world. The truth is that there are always crooks and robbers, who always weasel their way into whatever segment of society offers the most concentrated power over other people. That is precisely why "Power corrupts and absolute power corrupts absolutely". The Founding Fathers understood this and for this precise reason crafted our Constitution with a "Balance of Power", "Checks and Balances" system to limit the fraction of power that any one entity can exercise over the society. The real evil is not capitalism or socialism (government power), but the real enemy is MONOPOLISM. And monopolies develop when the victims, the majority of the populace, are lax in their duty to combat centralization of power. It does not matter whether some robber baron in industry or finance has a monopoly, or whether corrupt politicians have the monopoly. It is the monopoly itself that is evil, and the only way we can prevent evil monopolies from developing is by decentralization, which means every citizen must awake and alert and diligent in the duty to fight against every accumulation of power in every segment of the society. If every citizen would accept personal responsibility for the consequences of their own decisions, educate themselves to be able to make wise decisions, and stop trusting the elites to do their thinking for them, we might be able to improve this society.

  2. When government is absent we see polluted rivers, toxic waste dumps, poisoned air, off shore bank account scams to avoid taxes, unscrupulous adulterated products, snake oil sales, false advertising, damaging products that kill babies, rip offs of consumers, poor workmanship foisted on the consumer masquerading as quality. Well we don't need less government, we need enforcement of the rules and regulations we already have. And a congress that works for the people not the special interests.

  3. The free market is constantly attacked today by people who mistake the robbery of '08 for capitalism. This is not a free market when the major banks lobby for key deregulation so they can pull off their massive scams and then have their own agents working for the govenment give out trillions in bailouts to companies that they used to work for. " Hello Tim Giethner." This was inside job of lobbying to neuter the SEC so that the banks could pull off the greatest robbery in the history of mankind. And don't get me started on the influence of Goldman Sachs, the company that Geithner came from and apparently now the only door whereby anyone can enter the Fed or the Treasury. Oh, don't tell anybody, but Goldman has eight people at the top of the European Union including Monti and Draghi.

    1. Don't worry my friend the whole system is doomed and it will collapse when the one world economic system is brought in. What the US has right now is some kind of a hybrid capitalistic system that is driven by big money, and power brokers. No one seems to be looking out for small business including government. When I think of capitalism I think of entrepreneurs working hard to develop a product then bringing it to the community to sell for a profit. Small business is defeated when they are taxed and regulated excessively. I say keep it simple and don't trust the phDs when the come to your door and say, "I'm from the government and I'm here to help you"!

  4. "That’s how things work when the government isn’t a player in the process. It’s a marvel of efficiency and impartiality. " In a mythical world where the market actually produces magic, that's how a certain breed of economists and other religious folks hope it would work. In the real world, the value of stocks and other securities are dependent on regulation to try to keep some connection to reality. Otherwise, the whole stock market would be a collection of ENRON scammers and would collapse from its own corruption on a cyclical basis. The problem with finance is that it is a, basically, worthless activity. The stock market does not add value to any part of society and, like all speculation, is parasitic.

    When the parasites become the drivers of society, we forget how to grow our own food, create our own products, develop new technologies, and are barely able to manage the pretense of being a 1st world nation. For the last 30 years, "performance" has not been a management criteria. Managers consistently receive promotions and bonuses for lousy performance and incompetent decisions. Hell, one of the current presidential candidates is a perfect example of that. His skill set consists of leveraging himself with borrowed money into semi-hostile takeovers, trashing companies through huge debt and poor decisions, and bailing with a fist full of cash while leaving a smoking hulk in his wake. This is "performance" in the financial sector, but a disaster for the culture and economy.

    As far as society is concerned, the characters who live off of the work done by others should be heavily taxed and regulated. It was called "unearned income" back when the country knew something about business and productivity.

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