ZIRP guns

5 January 2016 By Rob Cox

As President Barack Obama heads into his final year in office, he has kicked off the third firearms bubble of his administration. Just a few hours before he unveiled on Tuesday an executive order requiring more gun dealers to perform background checks on customers buying firearms, Smith & Wesson had some very good news for its shareholders. On Monday night, the gunmaker said sales in the current quarter could be up to 20 percent better than it had originally expected.

Welcome to the inside-out world of the American arms trade, where news that should be bad for the purveyors of what are arguably the deadliest consumer products sold to man turns out to be very good. But as the previous booms demonstrate, bringing forward future demand can store up trouble down the road.

In the short run, though, business is very brisk indeed for Big Gun. Smith & Wesson, based in the historic arsenal town of Springfield, Massachusetts, is Exhibit A. In the statement gleefully released the night before the president convened at the White House survivors of mass shootings like former Representative Gabby Giffords and the relatives of many other victims, the company said fiscal third-quarter sales would range from $175 million to $180 million, up from a previously guided $150 million to $155 million. Investors in the company that advertises its 9mm handguns as “homeowner’s insurance” kicked up the share price by some 12 percent.

Just a little over a month ago, there wasn’t so much ebullience around Smith & Wesson. That is until the San Bernardino shootings of Dec. 2, in which 14 people were murdered by a radicalized married couple wielding AR-15s and semi-automatic pistols. The massacre offered a new spin to the traditional cycle of gun hysteria.

Smith and Wesson share price Nov. 5 2015 - Jan. 5 2016

Smith and Wesson share price Nov. 5 2015 – Jan. 5 2016

Source: REUTERS/Rob Cox, Benjamin Kellerman

The previous two Obama gun bumps were largely the result of rising concerns that he would persuade Congress to pass stringent new rules around the ownership of firearms in general, and some products in particular, like assault weapons, which the industry euphemistically calls modern sporting rifles.

The first occurred as Obama’s candidacy for the presidency gathered steam in 2007. As a proxy, Smith & Wesson shares doubled that year to a high of more than $21. When Obama was sworn in and failed to pursue any new gun laws, Smith & Wesson shares dropped to under $2 apiece.

It wasn’t until the Sandy Hook Elementary School shooting in December 2012 that the American gun business got back into boom times. After 20 first-graders and six teachers were murdered there at the barrel of a Bushmaster AR-15 made by a company controlled by private equity firm Cerberus, Obama called for laws to ensure all gun sales were accompanied by background checks.

Enough senators rejected that bill to ensure its failure. Gun sales, though, surged in anticipation that it would pass. Moreover, some states, including Connecticut, moved to ban sales of certain weapons, like the AR-15, sparking stockpiling by customers who were still allowed to own them.

San Bernardino, however, stoked fears not just about future regulation but terrorism: the assailants had pledged their allegiance to Islamic State. It sparked the greatest Christmas gun spree ever. Some 1.6 million guns were sold in December, according to a New York Times analysis of federal background checks. That compares to the record 2 million sold in January 2013, the month after Sandy Hook.

But here’s why the guns business is a crummy one. It’s not just the social stigma increasingly attached to the trade – which has led to boycotts by pension managers and the divestment of Remington Outdoor by Cerberus. These boom-and-bust cycles make it hard to plan for the future and appropriately allocate capital. In this respect, the periodic scares about new gun rules more closely echo the economic consequences of zero interest rates – they bring forward future demand in ways that can backfire.

It explains, for instance, the fate of Colt Defense, the Connecticut-based maker of the revolver that won the West. When times were good in 2009, it engorged on debt to pay dividends to its owners. As demand fell, Colt filed for bankruptcy last year. While Remington has managed to stay afloat, its equity accounted for less than a tenth of its enterprise value when Cerberus offloaded the firm last May.

In the United States, mass shootings have become tragically predictable. It won’t be any less difficult to foresee that today’s gun boom will lead to an industry bust in the not-so-distant future, too.

 

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