One of the keys to the great success of America is that we let companies fail. On average, 10% of all companies (public and private) will fail in any given year. Business failures are difficult for those employees and investors who had an interest in the failed company, but this normal ebb and flow is why we have the strongest economy in the world. Even the largest companies fail. According to the book “Why Most Things Fail”, of the largest 100 US companies in 1912 only 19 were still in the top 100 in 1995. The figures below indicate what happened to those companies: 

# of Companies
Bankrupt 29
Survived 52
Remained in top 100 19

Living in Cincinnati, we have witnessed the decades-long growth of one of the few firms that is still part of the remaining 19 – Procter & Gamble. So it’s not unusual for even large companies to fail. Even at the start of the automobile revolution, many companies did not survive. From 1900 to 1920, there were almost 2,000 firms producing automobiles. Over 99% of those companies have disappeared. The creation and destruction of firms is the norm, not the exception. Competition allows the strongest, best managed firms that provide the best products and services to grow and prosper. The least productive and poorest run firms fail.

Companies going bankrupt are not a new phenomenon (US Steel, United Airlines, MCI, etc.). This has been going on for years. What is different this time is the level of government intervention both in terms of decisions and ownership. Since the die has been cast, the question is “where do we go from here?” We take President Obama at his word in that he has no interest in running an automobile company – or any company for that matter. So what should the government do with the ownership stakes it has in various companies (GM, AIG, etc.)? One idea that has been floated is to give this ownership directly to the taxpayers. We think that would be difficult to administer and, in the end, most individuals would get only a few shares. A second idea would be to have the government sell their ownership stakes in the market as any other investor would. Not a bad idea, but this strategy would be difficult to execute given the large number of shares that would need to be divested.

A third idea we have heard mentioned is transferring ownership of the shares to state pension plans. Many state pension plans are dramatically underfunded at this time due to the recent market downturn. Additionally, the federal government is already subsidizing state governments via the stimulus plan. Potentially, this is a good solution because 1) it would help the states fund their pensions, 2) it would compensate those funds for the losses they took on those investments, and 3) it would allow the professional managers of those plans to decide on selling or holding the positions based on the merit of the investment itself. This would also be stimulative to the economy as the states could use money equal to the dollar amount of the shares they received to fund other state programs.

In the end, we believe these companies will have a better chance of surviving if they are not controlled by the federal government. One final point – there are recent surveys that suggest even some long-time buyers of GM and Chrysler cars will not buy a GM or Chrysler car as long as the federal government is a stakeholder. So, the sooner the federal government divests its position in these companies, the better chance they have of surviving.

THOR Team

So we finally swallowed the bitter GM bankruptcy pill. The fact that the US government now owns greater than 70% of the means of production for this company presents a new set of challenges which will have political and financial implications for years to come. Hopefully workers and resources will move to more productive areas of the economy. Despite this long awaited news, the markets continue to show signs of recovery. As of this first day of June, we are flirting with new S&P highs for 2009.

One of the bright signs indicating a turn towards economic recovery is that inventory is now at an all time low. Industry has gone from a “just in case” inventory system, having enough excess inventory available just in case demand spikes, to a “just in time” inventory system, where inventories are kept as low as possible. The chart below indicates that industries may be preparing to ramp up production (minus the auto industry), which will ultimately create more jobs. In order to add capacity, companies will need to hire more people. Many THOR clients have reported to us that they are seeing record low inventories in their own various industries, which confirms the information in the chart from Charles Schwab Investment Research below.

Another bright sign for the road ahead is that lending standards are beginning to improve. And as you can see in the chart from Charles Schwab Investment Research below, equipment and software spending has historically followed. When capital expenditures increase, jobs and wealth are created.

In summary, record low inventories and improving lending standards are faint glimmers of economic recovery. This is not to say that we are not paying attention to the bumps along the way. Bankruptcies, inflation fears and decreased consumer spending are stifling factors to be considered. Knowledge and expertise can make the difference between sitting on the sidelines and watching the recovery pass you by or jumping in the race and profiting from the upswing.

THOR Team