Big Boys, Little Guys
Research for Online Investors

by John Dalt

6/25/10

What do we do when only the big boys are left?  This question cuts to the unintended consequence of the current attitude in Washington.  Whether health care, financial regulation or off-shore drilling, more regulation means less competition and higher prices for consumers.

The current political party in control of all things politic in Washington say they are the “champions of the little guy.”  The populism sweeping through the hallowed halls is palatable.  The president never misses a chance to demonize ‘big oil’, big insurance or big banks.  The dirty secret every one of the pols know?  More regulation means less competition for the ‘big boys.’

The financial regulation bill agreed to overnight is hailed as regulation that was overdue and will reign in the big banks.  That it may do, but provisions of the act will also be a millstone around the necks of every neighborhood bank in America.

This is known as the ‘cost of compliance.’  Every piece of paper, survey, or audit costs the small bank more as a percentage of assets or profits than it does the large bank with mega-assets.  The small bank must raise his interest spread, and user fees in order to maintain profitability.  What does the larger bank do?  Use the cost of compliance to squeeze the smaller bank into a merger, or sell him services through a correspondent banking relationship.  It seems like a win-win situation, the small bank lowers their cost of compliance, but becomes reliant on the larger bank to supply this service.  Over a period of years, the large bank erodes the smaller banks independence and gradually swallows it.

Who will be able to drill in the Gulf of Mexico after the BP disaster?  On June 3, Moody’s Investors Services said the cost of insurance for an off-shore well has increased by more than 50% since the BP disaster.  India’s largest exploration company, Oil and Natural Gas Corp., reported a threefold increase for insurance renewal.  John Lloyd, of Lloyds of London reports that available insurance coverage has been reduced by at least 30%.

The U.S. Congress is considering increasing the $100 million economic damages liability cap for off-shore drilling to $10 billion.  This amount is well below the expected cost to BP, but it should be added that BP appears to have been negligent.  Negligence negates the liability cap.

If the cost of insurance raises the bar so high that the little guy is removed from the market, who is left to drill off-shore?  According to energy consultant, PFC, only three companies have the balance sheet to self-insure; Royal Dutch Shell Plc, Exxon Mobil Corp., and BP.  We can probably mark BP off the list; they are going to be a much smaller company when the current accident is resolved!

What board of directors would sign off on risking the whole company for the right to drill a well?  Would you take your whole account and buy just one stock?  If so please read The Four Legs of Wealth.

We could look at a Venezuela style government owned enterprise, but who wants the postal service drilling for oil?  Do you really trust the government to do better than BP?  Remember, they inspected the Deepwater Horizon 10 days before it caught fire, and were slated to give BP a safety award.  This ceremony had to be canceled after the explosion, less the bureaucrats be embarrassed.

InsuranceRate.com has an interesting article on how price controls threaten the availability of health insurance.  Just like gasoline in the 1970's under Nixon, what difference is the cost if none is available?

The net result of all the populism and beating the drum against ‘big _________”, we end up with less competition and higher prices.

Our recommendation:  Buy Exxon Mobil (XOM), they completed their acquisition of XTO Energy today.  They are now the largest natural gas exploration company in the U.S. and the largest corporation in the U.S.  They pay a nice dividend of $1.76 and buy back shares of the company every year.  The stock looks to close today cheaper than in the last four years.

If you can’t beat the big boys, you might as well own them!

Today's chart illustrates rallies that followed massive bear markets. A 'massive' bear market is defined as a decline of greater than 50%. Since the Dow's inception in 1896, there have been only three bear markets that fit this description (early 1930s, late 1930s until early 1940s, and during the very recent financial crisis). We have also added the rally that followed the dot-com bust during which the NASDAQ declined 78%. The current Dow rally has followed a path that is fairly similar to that of the NASDAQ rally that began in late 2002 as well as the Dow rally that began in 1942. Notice that after 300 (plus or minus) trading days the market moved into a trading range/choppy phase that lasted for a year or more.

I hope we stay above the line from 1942!

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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