Friday, December 19, 2008

The Rosenberg case (Click here)

Thanks to my smart friend Larry, who forwarded a report by David A. Rosenberg, an economist with Merrill Lynch. He shares a historical perspective of today's recession, followed by my thoughts on how this affects an investment perspective in the software/internet arena. His case:

1. Unlike each of the past 32 US recessions since the Civil War, this one is a 'balance sheet' variety, where households are rapidly reducing debt($29b in Q3)

2. Past recessions were influenced by the Fed tightening credit, inflation, and excess inventories. Leading up to this recession, each of these metrics were behaving in an anti-recessionary way

3. We are seeing a fundamental demographic shift with the average baby boomer nearing 50 years and in the natural life mode to delever liabilities. Therefore, it is not realistic to expect the consumer spending to cushion any downfall

4. The repeal of Glass-Steagall in the mid-80's fueled great competition by financial institutions to gain market share in the consumer sector. With the household debt/income ratio at 140%, and with the demographics noted above, we should expect deflationary times as consumers focus on debt reduction and not spending. Deflation is his major theme driven by (demographics, excess inventory, excess labor (unemployment), and reduced credit affecting CAPEX).

5. Expect the Federal government to jump in and try to fill the gap, to avoid deflation, with at least $600b of incremental spending. Especially in light of the Q3 numbers where household net worth contracted by an astounding $2.8 TRILLION! This far exceeds the $1.9 trillion loss seen during the break of the Internet bubble in Q3 '01.

What does this mean for Internet/software venture investing?

If the case he makes about deflation and reduced consumer spending is true, then the sector of investments that are advertising supported will suffer for the duration as the customers for these services will be balanced sheet constrained.

It seems to me that a more promising arena would be one where vendors offer product/services that EXACERBATE a deflationary outlook by enabling net short-term spending reductions, or a longer-term strategic cost saving shift gained by a shift in basic infrastructure that addresses labor or operating costs.

In the Enterprise and SMB environment, the combination of tight credit, and deflation should accelerate the move to SaaS and open source based solutions. For the consumer, where more $ is spent fixing PC's than purchasing them, look for outsourced support (iYogi or Reimage (I am on the board)), as well as a a shift away from premium priced brands....the premium for cool is moving away from the average Joe. Speaking of Joe, Frappacino's ain't so cool no more.

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