Perhaps we label this as a wild, wild week but in truth it’s not going to be the last one we see and we’ll run out of adjectives soon. The prior Weekly Reader post split out the Markets & Investments section so here we’ll concentrate, largely, on the matters of real substance in the economy and business. With some nod at financial issues – let me draw your attention to the 4* column on re-discovering and re-evaluating Graham and Dodd’s work on valuation and the need to look at long-term trends which finds that, despite the wishful thinking, that the markets were over-valued (which is reflected in our analysis of long-term PE Ratios and their importance). Another really interesting article introduces JPMorgan’s interesting look at trying to deal with the complexities of exchange rates via the Economist. Excellent. There are also interesting articles on China, India, Europe and the overall World economies and the sudden discovery that they are likely to slow more than anticipated, as well as deeper structural problems, e.g. the millions of Chinese engineers whose qualifications don’t meet requirements. The really interesting article sets are two. First, given our primary emphasis in this blog is on understanding the deep structural factors that drive both the environment and enterprise performance, is a multi-part set on what managing by the numbers really mean, the neglect of management systems and the critical role of judgment and its’ overwhelming neglect.
Finally I’d also like to point you to the latest issue of Portfolio magazine which has made a major leap from pure glitz to serious substance. We’ve provided URL pointers to four interesting, key and critical articles to get you started. The ones on Citi’s breakdown as a viable organization and the one on Cereberus and the colossal challenges of the Chrysler deal (that is, making it actually work in terms of strategy, operations and especially product development) are well worth your time.
General & Special
Why is the market going crazy? Sure, the subprime mess is a big factor. But there's more to the stock market's stunning summer sell-off and wild daily swings than the real-estate bust.The stock market has been trading violently up and down every day recently. The Dow Jones Industrial Average ($INDU) has gained or lost more than 100 points on 13 days since the blue-chip index peaked at 14,000 on July 19. It dropped as much as 343 points by 1 p.m. Thursday -- and recovered nearly all of it by the close. Even so, stocks are off nearly 10% since July 19. Why? Here are some of the forces behind the sell-off, the wild gyrations and why it may be a while before the market finds a bottom.
(4*) Remembering a Classic Investing Theory More than 70 years ago, two Columbia professors named Benjamin Graham and David L. Dodd came up with a simple investing idea that remains more influential than perhaps any other. In the wake of the stock market crash in 1929, they urged investors to focus on hard facts — like a company’s past earnings and the value of its assets — rather than trying to guess what the future would bring. A company with strong profits and a relatively low stock price was probably undervalued, they said. Their classic 1934 textbook, “Security Analysis,” became the bible for what is now known as value investing. Warren E. Buffett took Mr. Graham’s course at Columbia Business School in the 1950s and, after working briefly for Mr. Graham’s investment firm, set out on his own to put the theories into practice. Mr. Buffett’s billions are just one part of the professors’ giant legacy. Yet somehow, one of their big ideas about how to analyze stock prices has been almost entirely forgotten. The idea essentially reminds investors to focus on long-term trends and not to get caught up in the moment. Unfortunately, when you apply it to today’s stock market, you get even more nervous about what’s going on.
Misleading misalignments Judging whether a currency is seriously undervalued is much harder than you think. This activity is based on the widespread assumption that the Chinese yuan is hugely undervalued against the dollar. Yet the awkward truth is that it is almost impossible to be sure when a currency is misaligned, let alone by how much. A recent Treasury research paper admitted that there was no fail-safe method to estimate the correct value of a currency. A study by two IMF economists, Steven Dunaway and Xiangming Li, examined eight different estimates of the yuan's supposed undervaluation: they ranged from zero to almost 50% depending on the methods and assumptions used. The yen might be anything between 18% overvalued and 29% undervalued, depending on which model you trust. But nine of the 13 models signal undervaluation, with the median value suggesting the yen is 15% too cheap—the weakest currency in the chart. What about the yuan? Morgan Stanley uses only four models to estimate the yuan's fair value, of which the median valuation suggests it is only 1% undervalued against the dollar—not the answer Congress wants. Another surprise is that most other emerging Asian currencies now look overvalued. None of these numbers should be taken as precise, but two conclusions follow. The first is that, in theory at least, there is a stronger case for declaring Japan's currency to be misaligned than China's. It is bizarre that the weakest currency is the yen, when Japan is the world's largest net creditor and had faster GDP growth than either America or the euro area in the first quarter. The problem, says Mr Jen, is that traditional models for estimating the fair value of currencies still focus mainly on the real economy, but increased cross-border investment flows (based partly on nominal interest-rate differentials) are now much more important. The second awkward conclusion is that the highly subjective nature of assessing currency misalignment will make it very hard for America or the IMF to agree on whether a currency is out of line.
Economy
Do China and India Produce A Million Engineers? For years, pundits and the press have been warning that the millions of engineers and scientists India and China produce each year would soon challenge the United States' technical superiority. Just a few months ago, the London-based think tank Demos warned in a report that "the center of gravity of innovation has started moving from the West to the East," and that China could become a "scientific superpower" by 2050. Indeed, the raw numbers are impressive. China cranked out more than 600,000 engineers in 2005 alone, and India produces nearly 500,000 technical grads annually. But these stats only tell half the story. Many of the graduates can't find work, and corporate recruiters in both countries lament a dearth of qualified applicants. "Out of the huge number of engineering and science graduates that India produces, only 25 to 30 percent can be regarded as suitable," says Kiran Karnik, head of the National Association of Software and Services Companies. The reason? Underfunding and a range of other factors have produced serious educational crises in India and China. These problems could soon wreak havoc on their economies. To sustain their breakneck growth, the countries will need lots of high-quality engineers and scientists. Yet neither have enough reliable universities to produce them. M.A. Pai, who taught at the prestigious Indian Institute of Technology in Kanpur, warns that the "lack of highly trained people at the Ph.D. level in both sciences and engineering will be a serious setback to India becoming a knowledge economy."
- Investors Are Wary of China Politics Wrangling among China's political elite in the coming months, ahead of a pivotal Communist Party meeting, could leave some foreign investors scratching their heads about their China portfolios.
Blame Money, Not Pigs, for China's Price Scare: -- What makes China's worst inflation scare in a decade doubly dangerous is its deceptively harmless appearance. Many analysts are inclined to write it off as a temporary food shortage, when it actually stems from a serious money glut. The annual inflation rate zoomed to 5.6 percent last month, the highest in more than 10 years, the National Bureau of Statistics said yesterday. Food prices jumped 15 percent, driven by a 45 percent surge in meat and poultry. Non-food prices, by contrast, remained well contained, rising just 0.9 percent from a year earlier. It may be erroneous to make light of China's inflation challenge just because the gains are occurring in food, rather than ``core'' -- or non-food -- prices. It may be equally facile to view the surge in inflation as transient, caused by supply shocks such as floods and the ``Blue Ear,'' a respiratory illness that has killed thousands of pigs in China and curbed hog supply.
Europe's Economic Growth Slows More Than Forecast -- European economic growth slowed more than economists expected in the second quarter as a rebound in consumer spending failed to make up for weakness in manufacturing and construction. The economy of the 13 nations that share the euro expanded 0.3 percent from the first quarter, when it grew 0.7 percent, the European Union's statistics office in Luxembourg said today. The growth is the slowest since the fourth quarter 2004. From a year earlier, the economy expanded 2.5 percent. The euro's 7 percent gain against the dollar in the last year has eroded export competitiveness and higher oil prices increased costs for companies and consumers. While record-low unemployment may lead to more consumer spending, confidence may be hurt by further turmoil in financial markets. ``It confirms what we've thought, that from the spring onwards and into the second half, we see the economy losing some momentum,'' said Kenneth Wattret, an economist at BNP Paribas in London. ``Most business surveys still suggest growth, but the economy is slowly decelerating.'' The second-quarter growth was slower than the 0.5 percent median forecast of 32 economists surveyed by Bloomberg News. The statistics office, Eurostat, will publish a breakdown of the gross-domestic-product data on Sept. 3. The European Central Bank forecasts the economy will expand about 2.6 percent this year, close to the 2.7 percent recorded in 2006, which was the fastest in six years.
· WTO Warns of 2008 Slump Over Concerns About Credit -- Global economic and trade expansion could slump in 2008 because of increased risks in financial and property markets, the World Trade Organization said Tuesday, citing concern about credit problems that started in the market for subprime mortgages. The global commerce body said market uncertainty caused by defaults in U.S. subprime loans, combined with large trade imbalances in goods and services, is already hampering global economic growth, which it said would be around 3% for the year. Global goods trade growth for 2007 will slow to about 6% from 8% last year, the WTO said in a 119-page report.
US retailers warn of tough times Two US retailing giants, Wal-Mart and Home Depot, have warned about a poor year ahead after their latest results. Wal-Mart's profits hit $3.1bn (£1.54bn) between May and July, from $2.08bn last year, but missed forecasts. In contrast, Home Depot saw profits fall to $1.59bn from $1.86bn in the same period a year earlier, but beat expectations. But both firms expect earnings to fall in the months ahead, amid fears that the US economy will continue to cool.
Economists React: Inflation Isn’t the ‘Beast’ Economists weigh in on the July consumer-price data, which showed a modest increase in the headline number due to falling gas prices and a jump in core prices amid increases in costs for apparel and medical care.
Business
(***) Now, It's Business By Data, but Numbers Still Can't Tell Future We've had management by objective and total quality management. Now it's time for the latest trend in business methodology: management by data. The success of enterprises as diverse as Harrah's Entertainment, Google, Capital One Financial and the Oakland A's has inspired case studies, books and consultants promising to help executives outpace rivals by collecting more information and analyzing it better. There is much to be said for the approach. In many cases, analyzing data would be an improvement over prior management techniques, which Stanford business professor Robert Sutton derides as "faith, fear, superstition and mindless imitation." Mr. Sutton is co-author of "Hard Facts, Dangerous Half-Truths & Total Nonsense," one of several recent tributes to the data-driven enterprise. Running a complex enterprise can't be reduced to a spreadsheet, however. Even the most detailed statistical analysis has limitations, as Mr. Sutton acknowledges. For one, conditions may change, rendering the analysis misleading. Thomas H. Davenport, a management professor at Babson College and co-author of "Competing on Analytics: The New Science of Winning," says such change helps explain why so many sophisticated lenders and investors have gotten burned by the downturn in subprime mortgages. For years, default rates followed a predictable pattern based on the borrower's credit score. Last year, that pattern changed slightly and many lenders didn't adjust. Jeffrey Pfeffer, Mr. Sutton's colleague and co-author, offers a more insidious pitfall: Managers can be so focused on perfecting today's business that they lose sight of tomorrow's. The tension between the short term and the long term is familiar to managers. Other research suggests that quality-focused approaches may reduce defects, but hamper innovation. That helps explain why companies seem invulnerable one minute and aimless the next. For a decade, Dell captured an increasing share of sales and profits in the PC industry by mastering supply-chain logistics. But Dell couldn't diversify its business, making it vulnerable once Hewlett-Packard matched its expertise. The real trick, then, is to combine these skills, gaining advantage by analyzing today's problems while looking creatively for tomorrow's opportunities.
· Cog Or Co-worker? The organization man isn't extinct or even endangered—but the role has been refined over the past 100 years The 21st century is still young, and management gurus are sounding positively Aquarian. They proclaim that the future of work lies in creativity, flexibility, and individualism—broken molds and smashed time clocks. They say that organizations of the future will have to adapt to their employees, not the other way around.
· New CEOs May Spur Resistance If They Try to Alter Firm's Culture Employees who find themselves reporting to a new chief executive, especially an outsider who has bought their company or been recruited to turn it around, often face a roller coaster of changes. New leaders typically reshape their senior executive team and the company's growth strategies. The most wrenching adjustment occurs when a CEO changes the corporate culture -- the core values and ways of doing things that bind people to their jobs.
· How a Company Made Everyone a Team PlayerAmerican corporations love teamwork. But few companies are as smitten as ICU Medical Inc. At the San Clemente, Calif., maker of medical devices, any worker can form a team to tackle any project. Team members set meetings, assign tasks and create deadlines themselves. Demand for the company's Clave product, used in connecting a patient's IV systems, was skyrocketing; Dr. Lopez needed to figure out how to ramp up production. ICU had fewer than 100 employees but was expanding rapidly. Handling the booming growth and demand "was an overwhelming task for one entrepreneur CEO," says Dr. Lopez, 59 years old. He was still making most decisions himself, often sleeping at the office. Then, he had an epiphany watching his son play hockey. The opposing team had a star, but his son's team ganged up on him and won. "The team was better than one player," says Dr. Lopez.
TXU to begin pushing buyout to shareholders - Texas power company TXU Corp. (TXU.N: Quote, Profile, Research), making a final push to win support for its $32 billion buyout, said on Monday it would probably split into three separate businesses if the proposed deal fails. The company has set a September 7 shareholder vote, where it needs two-thirds approval to go ahead with its proposed sale to a group led by private equity firms Kohlberg Kravis Roberts & Co. (KKR.UL: Quote, Profile, Research) and TPG (TPG.UL: Quote, Profile, Research), formerly known as Texas Pacific Group. TXU's management team, led by Chief Executive John Wilder, on Monday began a series of meetings with top investors on the merits of the buyout bid. The deal has encountered opposition from the company's largest shareholder, money manager Franklin Resources Inc. (BEN.N: Quote, Profile, Research), which said the offer price was too low. TXU said it was scheduled to meet with Franklin Resources as part of the final push. In a presentation to investors, TXU said the buyout's 25 percent premium was meaningful and superior to alternative options, including a stand-alone plan that would separate the company into three distinct businesses. TXU's three core units are transmission, generation and retail electricity.
Caterpillar: Big trucks, big sales, big attitude In the most recent quarter, weak construction activity in the U.S. sent profits down 21 percent. Even so, Cat has been on a great run over the past five years, revelling in a global moment - booming commodities, infrastructure-hungry markets and a weak dollar - precisely suited to its strengths. Double-digit growth overseas in both mining and construction equipment helped propel it to record exports ($10.5 billion), profits ($3.5 billion) and revenues ($41.5 billion) in 2006. Net profit margins have also improved, from 4 percent in 2002 to 8.5 percent in 2006. And shareholders have joined in the fun. Shares are up more than 20 percent in the past six months, and the stock has outpaced the S&P by 100 percent over the past two years. Overwhelmed by business, Cat cannot keep up with demand, taking orders into 2009 and beyond. Yet the boom obscures something more fundamental - and potentially threatening. Its factories, however, win few awards for efficiency and productivity. So Caterpillar is launching a major effort - its third since 1985 - to raise its manufacturing game. If the effort fails, the risk is that Caterpillar goes down the same disheartening road as General Motors (Charts, Fortune 500) - becoming another iconic American company with a dominant presence that failed to step up in terms of manufacturing innovation and performance, allowing other competitors to chew into its markets. Academics and consultants figure that Caterpillar's production system operates under the same philosophy used in Detroit in the 1970s - production is pushed by the availability of parts rather than pulled by the demands of customers - and we know how that story turned out. Here's another unhappy parallel. Embittered by three major labor disputes in the past three decades, many of Caterpillar's employees are leery of buying into the new overhaul, much as autoworkers resisted changing work patterns at GM in the 1970s and '80s. And just as in Detroit, which put off change because it made so much money for so long, instilling a sense of urgency is not easy.
Why Deere Is Weeding Out Dealers Even as Farms Boom. -- For more than a century, Deere & Co. has relied on dealers to sell its iconic John Deere tractors and other farm equipment. Deere dealers like to brag that they "bleed green," the company's trademark color. But even as the farm boom helps Deere harvest record profits, dozens of North American dealerships are getting sent out to pasture, including some that have passed through families for generations. Chief Executive Robert Lane says times have changed. In an age when tractors use satellites to track the location of every seed, he says, dealers must match the sophistication and size of agribusiness customers. "For years we talked about Deere as a family," says Mr. Lane, a former banker. "The fact is, we are not a family. What we are is a high-performance team....If someone is not pulling their weight, you're not on the high-performance team anymore." Deere's overhaul is one answer to a challenge faced by many large businesses that distribute their products through independent retailers. These retailers are supposed to know the local turf and market the product more effectively than a big corporation could. But if the retailers are too small-scale, their inefficiencies could outweigh the advantages.
Macy's earnings tumble M&A costs are said to have slammed the department-store chain's bottom line, but news of Carl Icahn stake bolsters the stock.
Overrated The subprime-mortgage meltdown could—finally—end the credit-ratings racket. Late last year, officials from Moody’s Investors Service gave a PowerPoint presentation to a group of mortgage lenders in Moscow. There were the usual arcana about what the ratings mean and how the agency creates them. Along with competitors Standard & Poor’s and Fitch Ratings, Moody’s serves as an unofficial umpire in major league finance, helping investors and underwriters gauge what to buy and what to avoid. Many big investors aren’t allowed to even touch bonds that don’t have the blessing of a good credit rating. But midway through the presentation, Moody’s revealed a significant, and ultimately more dangerous, role that the agencies play in financial markets. The slides detailed an “iterative process, giving feedback” to underwriters before bonds are even issued. They laid out how Moody’s and its peers help their clients put together complicated mortgage securities before they receive an official ratings stamp. But this give-and-take can go too far: Imagine if you wanted a B-plus on your term paper and your high-school teacher sat down with you and helped you write an essay to make that grade.
A Legend's Bloated Legacy Sandy Weill’s Citigroup is staggering under its own excessive weight. Tucked in the bowels of the Citigroup website is a family tree every bit as sprawling as the one belonging to the Hapsburgs, the continent-spanning family that once ruled Europe. Set against a Gustave Courbet painting of a mighty oak, the tree represents the different branches of the seminal financial conglomerate of the 1990s. The website kindly offers three different options for printing it out. I chose the shortest version, eight pages (no joke). But even then, I needed a magnifying glass. By my count, there are 271 entities, combinations, spin-offs, and name changes listed, ultimately filtering down through the decades to become the ungainly entity ridiculed as GroupCorp. Now Wall Street wants to take a chainsaw to those magnificent branches. Investors have come to believe that Citigroup needs to be whacked down. This spring, hedge fund manager Eddie Lampert bought $800 million worth of the stock. That’s only a small percentage of the $260 billion bank, but the purchase stirred the hearts of investors, who hope that the manager who liked Sears and Kmart so much he bought the companies might be able to spur change in another boardroom.
Driven to the Brink Bill Ford is scrambling to save the family legacy. But with Motor City in a tailspin and takeover firms hovering, can a new C.E.O. figure out how to keep the Fords in Ford? It’s a rainy Friday night in Detroit, and 
Bill Ford would much rather be on an ice rink playing pond hockey with his buddies or at home watching 24 with his wife, Lisa—anywhere but here, the Cobo Center, where he’s feeling hot and confined in his black tie, taking part in the kind of pomp and pageantry for which he has little patience. Tonight is Detroit’s Charity Preview gala, the biggest social event of the year and the triumphant finale of the opening week of the North American International Auto Show in January. Ladies in department-store ball gowns sweep past dazzling Maseratis and Mustangs, sipping champagne and trying to catch a glimpse of the glitterati—captains of industry like former Chrysler chair Lee Iacocca, G.M. vice chair Bob Lutz, and Bill Ford, the executive chair of Ford Motor. There is an aura of old Vienna. This is truly Detroit in denial, or maybe pretending that it is still the center of the universe. Never mind that Ford will soon post its biggest-ever annual loss, $12.7 billion, or that Chrysler will be put up for sale, or that before long the Big Three might become the Big Two and eventually, God forbid, the Only One. Toyota is the real star of this show, but for tonight at least, everybody acts blissfully unaware, and that’s driving Bill Ford crazy. He’s always been an iconoclast in macho Motor City. He shakes hands and makes pleasantries until beads of sweat break out on his forehead, and he tugs at his collar and says under his breath, “Can you believe this? My least favorite night of the year.”
The Most Dangerous Deal in America Inside the secretive world of Cerberus Capital—and why its plan to save Chrysler spooks Wall Street. Now the question is whether Feinberg can turn the battered auto manufacturer around or whether this might finally be the deal that gets the best of him. In an industry of damaged companies, Chrysler is almost a total wreck: It has sunk to fourth place in North America, the market on which—unlike its competitors—it is almost entirely dependent. Nearly 75 percent of its business comes from sales of increasingly less popular light trucks, such as the four-wheel-drive Jeep Grand Cherokee, which was ranked by the Environmental Protection Agency last year as the least-fuel-efficient S.U.V.—an impressive distinction. Chrysler controls less than 10 percent of the hot market for crossover utility vehicles. And it owes its retiree medical plan more than $17.5 billion. The day after Zetsche announced the sale, the company revealed that in the first quarter of 2007, Chrysler’s revenue had dropped 11 percent compared with the same period the previous year, and it had swung from an $857 million operating profit to a $2 billion loss. “There’s no economic justification for Chrysler Corp. to exist,” says Gerald Meyers, the former C.E.O. of American Motors and a professor at the University of Michigan’s Ross School of Business. “Whatever they can do, someone else can do better.”
Uncool or not, Nokia is soaring The world's biggest handset maker has cultivated brand loyalty with cell phones that are basic, reliable and cheap. Now Nokia is ready to take on the BlackBerry -- and it thinks it can win.A few years ago, Nokia found its stock stagnating and its market share declining. In an age when mobile phones had become fashion statements, multimedia tools and design benchmarks, Nokia remained unrelentingly uncool. The Finnish company missed design trends like clamshell phones and arrived late with so-called candy-bar phones, which slide open and closed. But though Nokia (NOK, news, msgs) was slow to take advantage of the developed world's move to ultrathin, blingy and multifunctional cell phones, it continued to build its business in critical developing markets such as China, India and Indonesia where consumers still demand basic, reliable hardware. That strategy has paid off and given Nokia time to retool its new-product pipeline and global marketing strategy. Nokia's global market share rebounded and is expected to top 40% this year. The company posted a 14% gain in brand value on the BusinessWeek/Interbrand Top 100 Global Brands ranking in 2005 and a 9% gain in 2006.
to try and interpret & interpolate. Several points to notice here. First off, as we noted a couple of weeks ago, the downturn hadn't really broken the l.t. trend (green) lines, though the credit-seizure caused a very s.t. breach. Which could have really...really turned bad except for the technically brilliant and practiced interventions of the Fed and other Central Banks (this is NOT a minor point - during the '20s and '30s a lack of understanding, tools and courage collapsed the world economy in very similar financial circumstances !). During that breach the talking heads were mentioning drops at least downto the 1380 (yellow) line or more likely the 1225 (red) line. In fact even if we "corrected" to 1300 or so we'd still be in the uptrend. Yet within the last four weeks everybody is all of a sudden talking about a weaker economy and screaming for rate cuts. Methinks they doth protest, to much, and too self-interestedly, forsooth. And just in passing let's also note a point we've discussed before (Markets, Earnings and PE) about the l.t. rationalities of the market because earnings have gone up tremendously but PE ratios have been very compressed. In other words investor's long-term outlook is for significantly slower growth and they don't think those good earnings are grounded in l.t. organic growth of the companies.
Shifting gears let's take a look at the YTD and last 10 day S&P and see if we think it'll tell us much. Interestingly enough this week's rather wild gyrations confirm my original musings. As of last Fri. it looked like the debate was whether we'd establish a new s.t. downtrend or struggle back up over 1490 and get a new uptrend going. Certainly it looked as if the psychology and sentiment favored that. Notice again btw that the s.t. downtrend almost got busted bigtime two weeks ago to the downside and then we'd have been off to the races. (for those of a certain age or inclination does the image of Slim Pickens riding his bomb come to mind ? )
