Fedor Sannikov's  Instablog

During different stages in life, we question what we are, where we come from, where we are going, and why do we work or study. Just like Diogenes in the barrel. By the way, Alexander the Great supported this approach. When he was asked what he would like to be he answered: "If I was not Alexander, I would wish to be Diogenes".

There have been many philosophers in history for which philosophy had been their lives work. Intellectual labor is common for great minds. As a rule, these minds worked hard and efficiently. The following is for those who love and respect their own work as well as the work of others.

Our work is always creating something: ideas for the future, products or technologies, harmony in nature, future for ourselves, our family and children. A person's natural desire is to leave something after he has gone, through realizing his sense of value, to leave something that would live and shine through the ages. Cinema masterpieces, music hits, bestsellers in literature, records in the Guinness book are all realization of one's sense of value. For most of us, it becomes a priority after one is dressed and full.

Within the development of one's career, a man comprehends the wish to give a better start to his children and family. One starts pondering over something to pass on to his descendants. The most rational thing is to pass on knowledge or the possibility to gain it. Here the matter of creating savings comes in, that is, creating wealth. How to realize it? How to save? What is the best form to pass on the wealth?

Deposits are the cheapest source of financing for banks. Most deposits in international banks do not cover inflation in domestic currency. Meanwhile, inflation grows. Looking back into history, according to "This Time is Different" by Kenneth Rogoff and Carmen Reinhardt, the median inflation in the world between 1500 and 1799 was 0.5% per year, 0.71% between 1800 and 1913, 5% in the 20th century (1914 - 2006), the century of uncontrolled money printing. The gold standard was actually suspended some 40 years ago, which means that even though a 5% rate of inflation did not happen in a day, the beginning of the century was less inflationary than its end. The worst is yet to come…

Therefore, deposits do not create but destroy one's wealth. The main conclusion we may draw is that wealth should be kept in assets, not in cash. In the Forbes ratings, we see people whose wealth is regularly re-calculated. It is indeed calculated in money value though, in reality it is the cost of assets that changes.

Some may stand up for real estate. Prof. Jack Francis, Baruch College, and Roger Ibbotson, Yale University, show the numbers of latest generations: dwelling realty yielded 8.6% on average annually, commercial 9.5%, while investments into stock provided 13.4% annual income. The conclusion seems obvious.

Gold. What is its true price? Since the end of the 18th century until the end of the 20th when the gold standard was suspended, the price of gold had been floating within the range of $25 and $35 per ounce. During the 40 years following the suspension of the gold standard, the price varied between $35 and $1900 per ounce. That is, the price doubled in 200 years but increased 54 times in the last 40 years! Please note, that we do not eat gold, we are simply psychologically attached to it as it has always served as a guarantee for payments and as a protection against inflation. Today governments print money secured by the economy of a country and not by gold, even though anything can happen to the economy. Different estimates show that the fair price for an ounce of gold is between $800 and $1000, taking into account production costs and adding a reasonable profit margin. Depending on the volatility of the speculative sentiment which has risen 5000% over the past 40 years, the market price of gold can vary.

Art. Timeless treasures… The most influential index in this sphere is Mei-Moses Fine Art Index and it's been lagging behind the S&P 500 index for the last 25 years. The main disadvantage of investing into art is a wide range of unpredictable fluctuations of price and demand in combination with low liquidity. The famous "Irises" by Van Gogh was sold for $80 T in 1947 and re-sold for $53.9 M 40 years after. At the end of the 20th century prices for objects of art started to warm up and beat new records however, the world recession cooled it down. The objects d'art are unique and their price is a subjective evaluation of beauty and history by a narrow circle of credible connoisseurs. This causes huge price leaps during the economic recession and is not suitable for everyone.

What type of assets are the most secure for saving and multiplying one's wealth? Civilizations and technologies are rapidly developing people's preferences, habits and lifestyle changes. Tape-recorders were substituted by CD-players and MP-3 players in their turn during less than one generation. Nevertheless, today, as well as 500 years ago, the major of their peoples' earnings people are spent on 5 constituents: food, clothes, housing, medicine and education.

Business is the ideal tool to multiply one's wealth. We can create and develop our own business. As it matures, the assets will be diversified from the point of regional and industrial risks. Such diversification can be obtained either by having an international business base or through the acquisition of a company with international presence, thus generating profit from all around the world.

Having a global company in one's portfolio decreases exchange risks as well. After suspending the bond of currencies to gold, every country's money became a usual good on the market. The government of a country strives to develop trust for its currency. The higher the trust for the money the more real assets, deposits and resources one can buy for the paper. The reason that central banks advance money printing tempos over issuing real material values, is due to the fact that in the modern world currencies are overestimated. This causes further inflation and abrupt jumps of exchange rates. If the sales of a company are distributed around the world, the rise in exchange rates of one currency and the fall of another smoothes the business profit fluctuations in whole. Here, the perfect choice is to invest into companies capable of increasing their prices during inflation jumps on the resources market.

As a rule, companies with international presence have a long history and a high stability to competition and economic cycles. Just think how much technology, experience and information on customers Tiffany's business has had by producing jewelry for 170 years? It is more effective than other companies, coming onto the market and then disappearing soon after.

Considering that there are 7 billion people on the planet today and that the population is growing 0.7-1.0% annually while labor productivity grows 1.5-3% per year, the profit base of companies with global presence will continue to grow. Such assets, tested by time and economic cycles, protected against political collapses, interest and exchange rate fluctuation serve as the background for saving and multiplying wealth for the sake of coming generations.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article contains the opinions of the author. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service. Performance data shown represents past performance. Past performance is no guarantee of future results. No part of this article may be copied, distributed, transmitted or published without the prior written consent of the author.

By Fedor Sannikov

When times are tough, we start to question ourselves: why? Why do we deserve it? How long will it last? Will this be repeated in the future?

Let's try to get to the bottom of what underlies an economic crisis and draw conclusions.

When times are tough, we start to question ourselves: why? Why do we deserve it? How long will it last? Will this be repeated in the future?

The last crisis was not an exception. It has ended somewhere but not elsewhere. Yet the media keeps talking about it.

Fedor Sannikov, President of Oxenuk Management, LLC:

Someone blames the crisis on the government, somebody is simply waiting for better times to come, but everyone is curious: why have we started to live worse, we are not working more? During the economic recession the demand for books on crisis, research and on anything that could possibly assist in managing it, increased. An interesting fact: "The Capital" by Karl Marx reached the all-time record in sales exceeding its normal demand 4 fold in 2008.

Let's try to get to the bottom of what underlies an economic crisis and draw conclusions. There are numerous studies regarding the issue but we do not aim to cover them all. However, as we will see further on, there is something common in these studies. Let us first turn to theory.

Remembering Marx

The gross domestic product of a country (GDP) - is the cost of total goods and services produced in one year by all sectors of industry within a country for consumption, export or saving. Further on, we will discuss the economy of a country, referring to its GDP.

The modern business cycle goes through the following stages in development: expansion - prosperity - recession - bottom. Expansion follows bottom and the cycle starts over. What we are interested in is how often do the stages follow one another? It is not quite clear. It happens frequently as well as seldom...

Expansions and recessions in economy have existed since the beginning of structured economy. They were fist paid attention to in the 19th century. In 1874 a British scientist, H. Clark noticed that 54 years passed between the two world "economic catastrophes" of 1793 and 1847, assuming such intervals were not accidental.

Another English scientist, V. Jevons pointed out recurring long-lasting periods of increase and decrease in a number of prices he was analyzing. However, he could not find the explanation for this phenomenon.

In the 1860's Marx developed a theory of cyclic crisises. This theory gave a push towards researching the long economic wave phenomenon by the Marxist scientists.

At the beginning of the 20th century, Joseph Kitchin, a British economist, discovered short-term economic cycles, which recur every 3-4 years. Today, the reason for such cycles is considered the change of people's preferences and the renewal of durable goods. This causes the necessity of economic changes, when some sectors become more important than others and the loads of productive capacities change. These are the cycles we most often deal with and will examine them below basing examples on cellular networks.

Clement Jouglair, a French economist, discovered mid-term economic cycles, recurring every 7-11 years. The cycles appear due to change in demand for new technology. Love new technology? - wait for a crisis. Here the reason is not the change in technology's capacity, but its replacement. For instance, in our fast-paced era of information we exchanged the abacus for electronic data processing machines and then replace those for computers. Such situation requires investments from business, causing people to be fired, trained, hired, as well as accommodating new staff, which in its turn requires time…

There also are longer cycles, which we encounter less frequently. An American economist with a Russian background, Simon Kuznets, discovered 15-25-year economic cycles in the 30's of the 20th century. Finally, Nicolay Kondratyev, a Russian scientist, discovered 40-60-year-long periodic economic cycles.

Therefore, even now we are at some stage of an economic cycle. Depending on the point of view, we might at one and the same time be at the expansion stage in a short-term cycle or recession in a long-term one. This is how it goes.

Who is to Blame?

Let's examine the reasons for expansion and recession in modern theories

The so-called "prevailing theory of business cycles" suggests the following reason for expansion and recession: the potential GDP of a country grows at a constant speed while the demand - at a variable. What does it mean? Potential GDP is the GDP that a country is able to produce at full employment. We will not dig into the definition of "full employment". Here is the more important thing to understand: what is the kind of production in the country and what is the level of consumption. If we produce more than we can purchase, the recession appears: no one needs the product, so the amounts in stocks will increase, staff will be fired. If we produce less than we can consume, inflation appears: not enough goods but everyone wants to buy. The ideal situation is to produce as much as can be consumed. But in reality no one knows how much. So, we keep guessing, is it more or less?

Keynesian theory states that the change in demand is caused by the change of investments in the country. For example, if the entrepreneurial spirit is low, business ceases to invest, which leads to firing people, decrease of income and drop in demand.

Therefore, the "prevailing business cycles theory" explains the short-term business cycles though having a disadvantage: it concentrates on the demand omitting the supply. While the supply of a product may as well cause recession. For instance, a natural disaster may cut the supply of a product, closing down enterprises, which in turn will cause recession.

The so-called "real business cycle theory" defines the main reason of economic cycles as the change in labor productivity, where the productivity is defined by the level of technology. For example, such connection was seen in research defining the connection between the USA GDP growth and labor productivity during 1960 and 2005.

The question we might ask is why does the labor productivity decrease while technologies develop? The theory states that the appearance of new technology at first causes the decrease in production, as time is required for the technology to get established. For instance, coaches were not needed anymore with the appearance of cars, but hiring and training new drivers requires time, so productivity decreased. This in turn, is followed by the productivity boom. And so it goes until a new technology has been developed. Therefore, "the real business cycle theory" explains mid-term falls and rises, which were mentioned above.

Crisis within "Mobile Technology"

We most often encounter short-term rises and falls caused by the changes of demand for an existing or new product. Let's study the example with the appearance of cellular connections.

Let's suppose that prior to the discovery of cellular connections people used to spend 40% of their income on food, 30% on non-foods and 30% on other services. Now companies offering cellular connections appear. The offer of goods and services in the country increases, the Government prints money (to avoid inflation, it should print roughly the amount to cover the cellular network services consumption). This money will be paid as salary to the cellular companies' employees and equipment purchases with part of the money becoming profit of the companies.

Here is what happens next: people in other sectors keep earning as much as they used to before the invention of cellular networks and they want to use this connection as well. Therefore, they have to choose what to deny in favor of purchasing cellular connection services. For example, if a person used to buy 5 shirts a year before the launch of cellular connection, he may now be either satisfied with 3 shirts a year or start buying cheaper shirts. The result is the so-called "structural change" in the economy. The cellular network industry starts to grow with more and more people desiring to buy a mobile phone. In such case, the production of shirts is in dire straits: the demand drops, people are being fired. That is, shirt production has a smaller market share in the country's economy while the cellular network has a larger one.

This is the way changes occur in every sector. Every day a man makes a choice changing the demand within industries. These changes do not take place evenly causing rises and falls not only within sectors but within whole economies. It is a continuous process: with the development of mankind technologies develop, the diversity of goods increase, new industries appear, certain industries decay and disappear (tape-recorders are history now, replaced by digital appliances).

At times it leads to so-called "bubbles" - when a huge amount of money is directed to a certain industry. This was the case observed in 17th century Holland during the "Tulip-mania". People were wishing to purchase tulips that certain bulbs were sold at a price compared to that of a good house. In the end, this caused the crash in tulip prices (by the end of 1637 tulip prices dropped 100 times), thousands of Dutch went broke overnight and the economy faced a crisis.

Let's ask a question: why and when should the expansion after the recession start? Today, the governments of different countries tend to "make" the economy grow. The state may, for instance, launch road-construction projects (the sectors attracting a maximum number of people are usually supported), make purchases, demand in certain sectors is stimulated, taxes are reduced, money is printed. That is, the state may do anything for the people and the business to earn more money and actively spend it thus promoting the economic growth. As we have already mentioned, as a rule, the amount of money during a crisis does not decrease, so the state aims to keep existing money out of banks (excluding reasonable savings) but to work for the growth of the economy.

As we have already mentioned, all the reasons for crisis have something in common. This common thing is the psychological component. The choice of a product, a company's decision on what to invest, to spend or to save - all these are decisions made by people. Therefore, the issue of recovery from a crisis is in many respects a matter of confidence of business and of its consumers. The support of government is necessary because people cannot gather to decide on buying and investing. The task of the government is to revive people's confidence with its actions. However, this process may flow more or less successfully and the rise or expansion depends on it in many ways.

As a conclusion let's refer to the words of Robert Zoellick, Chairman of the World Bank, who considers that international economy has a number of issues, the main being the absence of confidence.

Robert Zoellick, Chairman of the World Bank, Nov 2010 issue:

"We are struggling for it in the USA and some other countries, nevertheless, due to some regulations, rules, fear of protectionism and other issues, we lack confidence".

By Fedor Sannikov, President of Oxenuk Management, LLC. Las Vegas, NV. December 2011.

This article contains the opinions of the author but not necessarily the opinions of Oxenuk Management, LLC. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.

By Fedor Sannikov

The US Census Bureau conducts 2 monthly surveys. The first is a household survey which collects data from 60,000 households regarding age, employment status and other indexes of employment with the most famous index being the Unemployment rate. The second survey conducted is the establishment survey with Nonfarm payrolls being its most known index. This index reports the number of non-agricultural business employees on the payroll of a company. The result of these surveys and the collected data is called the Employment Report and is issued by the Bureau of Labor Statistics (BLS) on the first Friday after the end of the month.

To estimate the Unemployment rate, the population is initially divided into two groups: people of productive age (16 years and older, who are not kept in "specialized" institutions) and those of unemployable age.

In turn, the population of productive age is divided into two groups: Labor force and Non-labor force. The number of people constituting the labor force is the indicator of the desire to work of the people of the productive age.

The Labor force population is divided into employed and unemployed and serves as basis for estimating the unemployment rate.

A discouraged worker is a person of productive age, able to work but not hasn't been looking for a job during the previous 4 weeks. Such people are often temporarily not accounted for as part of the labor force during recessions, though formally are not considered unemployed and returning during expansion actively looking for a job.

Below are the three main indicators, as estimated by the US Census Bureau:

· Unemployment rate = the number of the unemployed according to the above described method / Labor force

· Labor force participation rate = Labor force / number of productive age people

· The share of the employed among the total of economically active population is not widely used in the macroeconomic analysis.

As mentioned above, during recessions, many jobless people stop looking for a job therefore they fall into the category of productive age people but are no longer part of the labor force accounted for in the Unemployment rate estimation. Formally such people are not considered unemployed, this is why the published unemployment rate is understated and biased. During the economic extension these people return to searching for work and become part of the Labor force once again, i.e. the Unemployment rate may actually continue to increase during the extension period.

An employed person is considered the one having full or part-time employment. To be considered unemployed, a person should be available for work and fall into one of the following categories:

· Waiting to start a new job within 30 days;

· Waiting to be restored at the job he had been fired from; or

· Not working but making efforts to find a new job during the previous 4 weeks.

Speaking of long-term trends: from the 1960's to the 2000's the Labor force Participation rate enjoyed an uprising trend, primarily due to a high percentage of women involved into the work process (the index grew 38% to 60% for women). The Labor force Participation rate for men has had a downward trend (83% to 75%). The average Unemployment rate is 5.9%.

The first graph shows the Unemployment rate and the Labor Force Participation rate since 2001. The Labor Participation rate has changed to a downward trend - the main reasons being aging of the population and the economic crises of 2001 and 2008. The Labor Force Participation rate decreased from 66% to 64% since July 2008. The November 2011 results showed that the Unemployment Rate decreased to 8.6% compared to 9% in October. But this as well as the general Unemployment Rate decreased overall from 10% in 2009 is due not only to employment growth but also due to the Labor Force Participation rate fall. If a person is not looking for a job for the previous 4 weeks he is not part of the Labor force anymore and thus is not accounted for as an unemployed for the Unemployment Rate estimation. Prolonging the terms of unemployment benefits does not stimulate active job search among the population.

In the second graph we see the actual number of people representing the Labor force, which accounts for 155M people and decreases after 2008. However, the population continues to grow in the US. During the expansion periods, a monthly increase of 150,000 persons in non-agricultural work places is acceptable. During early stages of recovery after recession the necessary monthly increase should have been 250,000 non-agricultural work places. Today, such numbers cannot be observed.

From the Weeks Unemployed graph it is clear that the number of the unemployed actively looking for a job for over 27 weeks exceeds the pre-crisis level of 5M people, while the number of the unemployed looking for a job for over 15 weeks exceeds the pre-crisis level of 6M people, i.e. the job situation is still tough. At the same time, the median number of weeks spent for job hunting suggests stabilization of some sort which proven by the weekly breakdown graphs.

Private companies publish their unemployment data prior to the official Unemployment Report. Many market participants consider this data as a basis to predict the official Unemployment Report results. The Automatic Data Processing (ADP) report may be regarded as a starting point for prediction of the number of employed in the non-agricultural sector. The Challenger Job-Cut Report is the leading indicator for the number of unemployment benefits applications and is a recurring index published weekly on Thursdays. 400,000 first-time unemployment benefits applications are considered a threshold number. If the number is lower than the mentioned number, combined with other unemployment data, may stand for the fact that the Economy is generating sufficient work places for a post-recession growth. Today, this index is at its threshold. Monster Employment Index published online shows the dynamics of the Labor force demand from companies.

The employment indexes can be useful for the analysis of an Industries' condition. The employment dynamics in a certain industries may stand as a leading indicator of future sales. Businesses start to hire when there is confidence in the future. At the same time, one should allow a correction due to the development of automation process. The graphs below shows employment dynamics in some US industries, the growth dynamics in construction is especially important.

The US Unemployment Rate is one of the most important indexes to consider while analyzing current and future consumption in a country where 70% of the economy is formed due to private consumption, which we will discuss later. Currently, we consider that unemployment in the US will not have reached its pre-crisis level before the second half of 2014.

This article contains the opinions of the author but not necessarily the opinions of Oxenuk Management, LLC. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.

Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.