bizzXceleration: Performance, Value and Profit

For some time now it's been the intention to revisit prior dissections of HD - where we ran a nice little series but also with the intent of using HD as an example of we outsiders taking a look at company performance. It seems like it might be time to re-visit that and for several very good reasons. As the set of postings on profits and earnings show company performance is a critical factor in many things. And, the point in yesterday's post on the Weekly Reader, there's a lot of examples of folks who deserve poking at.

Just to review the bidding the last HD posting id'd six major factors in digging into HD's performance and then worked thru them in some detail. The six are: 1) Economic environment and whether or not it was going to be worse, 2) Employee Morale and it's linkages to HD performance (an anlysis thread we dug into in several postings, and here), 3) Customer Service - a major area of old competitive advantage, current major breakage and bad image and one requiring major investments but not too major, 4) Operations - major changes in procurement, logistics and store operations to improve service and lower long-term operating costs, 5) Product Development - continue and expand the development of new products with higher value propositions and new services to support them ala Target and 6) revisions and extensions of the historical Business Model because the US market is pretty well saturated and new market niches will need to be developed to restore growth.

So the key questions are how're they doing, what's likely to happen and what can we do about it ? Below we present a summary table of the six factors along with some discussion and some implications. But before doing that let's review the last few months of headlines:

• May/Jun - Q108 same store sales down approx. -8%, buying back $25B of stock (a 1/4 of capitalization at the time) using $10B in proceeds from the sale of Hughes Supply plus $12B of borrowings. [Earlier on MSN Money over 10K e-mails were recieved with detailed stories of customer woes and complaints]. BigPicture rants about poor service.
• Jul/Aug - EPS for FY07 -15-18%, down from expectations of -9% with a 1-2% reduction in shares btw. Buyback set at $39-44/share. (7/26) Moody's downgrades all ratings, buyback reset (8/9) at $37-42/share, (8/26) Hughes prices drops to $8.5B with a guarntee of $1B in debt plus retaining equity.
• Sep/Oct (9/5) Buyback 290Mil shares at $37/share for approx which would be 1/2 way uisng $8B in proceeds plus $2.7B in cash, about 12.5% of the stock. Seperately outlook was revised and pessimism increased for revenue, profits and earnings. (10/10) HD Design Center concept announced - warm & fuzzy hardware stores targeted at women (?). (10/16) Same store sales down -16% and (10/30) Buffett rumored to be interested.
  

While those are the sorts of headlines you'd expect in the financial press, especially in these times, notice that after a couple of quarters of "how-to-fixup-HD" articles the summer to date is primarily about buybacks, finacings and deteriorating sales with a little buyout thrown in to flavor the buyback. On the surface you'd have to ask yourself is this HD just being coy, preserving competitive information while it explores those options or is the lack of information a lack of action ?

Given a downtrending economy, increased financial pressures, and an imploding primary market then using scarce & expensive capital resources to buyback shares, especially when you're having to borrow and increase leverage to do it, doesn't make much sense. Even if you're a PE guy this outfit is going to spend the next couple of years fighting down pressures on EPS. Pressuring management to buyback shares makes sense if they're under-valued. Using scarce capital to hold back the tide and worsen performance is in nobody's interest. Or so it seems to me. 

And judging by the stock chart so it would seem to Mr. Market. Now if you're buying back stock at $37 that then is worth $32 you better hope Warren buys it for $35 or more and reduces your loss. It seems to me that now would be a good time to hunker down, explain what's going on, make some judicious investments and get set for an upturn that would/will hopefully follow what's likely to be another two tough years. And for gosh sakes - tell your people that too. Not use borrowed money to prop up your stock and paper over the deep challenges. 

Having set the table let's lay out the feast - which is captured in the accompanying table which lists  each of the major improvement factors, status and assessment/ comments plus grade where possible. The data's from late summer and/or early Sept.

1. Outlook - Blake admitted to a worsening outlook but it's been a bigger surprise. Outlooks will likely have to be revised down so a C/C+ may turn out to be optimistic. Watch out for excess cost cutting to maintain quarterly earnings. Bad..bad idea.

2. Morale - Blake's been more down to earth, eating in the cafeteria, etc. which helps but no programs of employee development and compensation have been announced - which also feeds forward to service. Again a B- may be optimistic.

3. Customer Service - the heart and soul of the HD that was, the quickest path back to protecting business and growing it anew (a saving grace - a recent retail study found that HD's locations bought in the good times so far outweigh Lowe's better layout, service, ambience and quality. Since my local stores are across the parking lot from each other, well....). On the other hand Blake apologized extensively and good some good feedback. C+, at least in contrast to Nardelli. IF there's no follow-up and bunches of PO'd customers continue to swirl around this will boomerang - risks of D/D- very high.

• Putting serious efforts and funds into employee training, recruitment, compensation, store layout, cleanliness, purchasing and stocking as well as supporting marketing and sales efforts, e.g. more readily accessible experts which are still non-existent, are very high strategic priorities. Since everybody can see all this for themselves here's a major factor to judge how things are going.

4. Operations/Product Development - here we effect a timeframe shift. Whatever we're buying and putting into the stores in the next 18 months is most likely what we've agreed with the supplier base to sell us. Similarly how we run the warehouses, stores, transportation and buying operations is also pretty fixed. Yet these are major opportunities for huge performance improvements (the whys and wherefores are discussed in previous posts). Not being on the inside (fair disclosure) it's hard to tell what's in train. At the same time after all the supposed internal deep-dives on Six Sigma you'd think a) the analysts and the MSM types would have an interest and b) the analysts certainly would. Unfortuately it takes a certain level of understanding of how these operating functions actually work, and their critical role in the overall Retail enterprise, to know why you should be digging.

That said it's definitely in HD management and shareholder interest to at least let the world know these are serious issues for serious people - which are getting, or planned to get, serious resources. HD has NO better set of strategic opportunities once short-term fixes are funded, designed and underway. If I was one of the PE or Hedge folks poking at this company this is where I'd put some attention. Bottomline NG/NG since we have no observables. You have to wonder though if it shouldn't be an F.

These are the sorts of major strategic initiatives that when you start evaluating HD's recovery chances that you should be looking for, monitoring and, if possible, encouraging. 

5. Innovation -again a low to no-observable though the announcement in Oct. that there's trialing of some warm and fluffy versions of design centers is work a look. That's encouraging - so is it a NG, a D+/C- because it looks little and late and needs to be improved (what'd your teacher used to write - you've got talent but need to apply youself ?). Or an F because so far it's not much and way late ?

Certainly HD has the smarts, people and resources to be running some major innovation efforts. In fact when the old Business Model cratered at the end of the 90s and Nardelli was brought in this is the sort of combination, blended and balanced recovery agenda he should have applied. It's the sort of thing Kilts did at Gillette over 5-10 years, that Boeing has done over the last ten and Cisco as well. It is in fact what Nardelli needs to come up for Chrysler now that it's his watch again. 

But what we have here is an evaluation framework that looks at Business Model & Strategy, key operating functions, people and service issues and lays them out over immediate, tactical and strategic timeframes. And is a foundation for investing in HD should you care to apply it.

In that wise you've got a couple or three tacks to consider. As things begin to flatten and turn around with Housing HD is likely to improve. Spotting that a couple of quarters ahead of time makes you a worthy value investor. Of course without the other initiatives HD will crater again for the same reasons.

What makes us mini-Buffetts is if we spot the long-term turnaround taking hold, down the blueprint, and get in early enough. Or contrawise if we want to be speculative Buffetts (huh ?) it's realizing when the Street's recovery fantasies are going to be disappointed and getting out :) !

Good luck and let me know how it works. 

Posted by dblwyo at 02:58 PM | Permalink | Comments (0)

Here's the second set of readings, this time focused on companies and business in general. While it's always valuable and interesting to dig into company performance and outlook our little multi-part series on earnings puts another perspective on it (The Heart of the Matter: Profits vs Earnings ?,Have You Seen the Elephant ?: More on Earnings, Review the Bidding, Count the Cards: EPS Growth Rates). Or so we hope - the general economic and business environment matters enormously. As does the state of markets and credit which help determine outlooks and valuations. But at the end of the day the sine qua non, a Latin tag, meaning "that without which there is no other", is earnings. And trickery aside - and don't we have a lot of that is company performance. The sine qua non. Or to quote Harold Geneern:

"In business, words are words, explanations are explanations, promises are promises, but only performance is reality."

 A bunch of last week's news certainly brings that home, the primary example being Merrill's giant writedowns. The questions you have to ask yourself boils down to what were they thinking ? Not just about the continued efforts by all parties to avoid marking to market but where were the banks fundamental skills in risk management ? Where was the CEO ? And the Board ? So as you skim over this week's readings think of it as due diligence on company's - what are they thinking and what does that mean for where they're going ?

The pointers start with three interesting more general articles. One on the rise in performance improvement consulting which is finally picking up and is yet another canary. The second on the level of effort most companies elicit from their employees - 1 in 5 will make an effort, the other 80% are just there to collect a paycheck for minimal effort (previous proposals are Aholes, Shirkers and Performance) where, to quote myself:

But, I'm more convinced than ever that good HR is a mandantory strategic performance requirement and excellent HR is a competitive differentiator.

The final general article is on the recovery of Scwab from it's post-bust near-death experience. Another case study in how deep revisions to the business model, innovation, customer value focus, painful cost controls and execution, along with good people policies, come together to re-vitalize a business.

All these themes, and questions, are illustrated in the sets of articles below. First is a set on the Finance and Banking Industry, starting with the admission that they knew the problems were coming but were too trapped in the "dance" to give up the greed. Which says a lot about strategic foresight and cojones doesn't it ?

Then there are some wonderful Greek Dramas, only in the real world, beginning to really play out:

1. WMT (aging, mature business model and lack of innovation) vs Tesco in the US (adaptive, innovative, customer-focused)
2. Detroit (ditto only compounded over decades of denial) vs emerging Asian markets and their need for small, affordable cars. Who'll figure out how to make those at a profit ? Whee !
3. GE in China - if there's an old-line company which is re-factored itself into  new lines of business and  other geographies it's GE. A strategic opportunity for long-term investing though you may want to see what happens during the next few months.
4. Apple vs MSFT - iPod, Leapord, etc. vs milking the mainstays. MSFT is still a big, decently run company. But stop to consider two things. First, none of it's new initiatives have taken off despite years of $B investments and in it's bread-n-butter operations it's still living off monopoly rents not excellent execution. Anybody who doubts that is invited to go back and compare Longhorn vs Vista. HINT: search on Microsoft and Code Red :) !

Business

Firms Seek Outside Guides For Help in Credit Crunch As credit markets tighten, U.S. companies are finding it increasingly difficult to ignore their operational weaknesses. And a growing number of them are turning to consultants that specialize in corporate restructuring. The Turnaround Management Association, which polled 190 turnaround, financial-advisory and consulting firms, says that six out of 10 respondents reported that inquiries, engagements and revenue have increased at least 10% in the past year. The surge marks the end of a years-long drought. The firms attribute the rise in inquiries to the difficulty companies have had obtaining money since the subprime-mortgage crisis hit. Most firms said clients were reporting increased difficulty getting refinancing or merger-and-acquisition financing. Turnaround firms say most of the inquiries they recently have received are from banks and lenders concerned about their borrowers. Bank-and-lender inquiries leapt to 70% this year from 57% in 2006, the TMA poll showed. The firms say they also are getting calls from attorneys, hedge funds and company managers. Lenders worried about their corporate borrowers turn to turnaround firms for a variety of services, such as developing strategies to improve operations of the distressed companies.

'Hey, boss, show me you care'
Only one in five workers worldwide is willing to expend extra effort on the job, according to a study that says the top reason for disengagement isn't money, but senior management's sincerity and caring. Only 21% of workers worldwide are "engaged" -- that's human-resource-speak for ready to expend some extra effort at work -- while 38% are either disenchanted or disengaged, according to a new survey. The survey found 21% of workers worldwide are engaged, and another 41% are "enrolled," which means they're on the road to engagement…More than 80% of the engaged employees say they contribute to the quality of company products, services and customer satisfaction, while only 40% of disengaged workers agree. Engagement helps retention too: About 50% of engaged employees say they have no plans to leave their company versus 15% of the disengaged. In a separate study, Towers Perrin assessed data on 40 global companies over a three-year period, measuring employee engagement at a certain point and then looking at the companies' financial results over the ensuing three years. Companies with highly motivated workers enjoyed a 3.7% increase in operating margins and a 2% rise in net profits, while companies with a lower level of worker commitment saw both measures decrease slightly.

Learning new tricks The old business model of attracting new customers through cheaper transactions over the Internet didn't completely disappear. But the firm's management did shift gears in a rather dramatic fashion. The result was a much leaner and diversified company. For example, at its peak in early 2003, Schwab had a payroll of around 27,000 employees and operated about 400 branch offices. Today, that's down to around 300 branches and a payroll of 13,000. Besides retail investors, the company's focuses on roughly three million 401(k) plan participants it serves in one way or another. At the same time, Schwab's management team has built what it believes is the largest network of independent advisers. The firm services accounts and refers more sophisticated planning work to its roster of 5,500-plus outside financial advisers. Schwab's revenue from investment management-related fees at third quarter's end was 47% of the total, almost double what they were just a few years ago. In the late '90s, about 60% of the firm's revenue came from transaction-based business. Through the third quarter, such trading-related revenue was down to some 17% of the total.

Companies

Bankers: We saw credit crisis coming The world's biggest bankers said Sunday their greed made them powerless to prevent the train wreck in credit markets, even though they recognized that markets weren't pricing the risk of subprime default appropriately. Despite their warnings, Deutsche Bank and Citibank have been forced to write off billions as the value of their portfolios of complex structured securities tied to subprime loans have plunged. The banks knew the dangers of buying and selling securities that were untethered to reality, but had to keep buying and selling them because of the pressure to keep profits growing, the bankers said.

Bankers' Ranks to Be Thinned By Bloodletting to Come Some day over the next few weeks, Wall Street executives are going to meet to make some bad decisions. They are going to decide to batten down the hatches, trim away the dead wood, button up for the battle ahead -- use whatever tired cliche you want. They sure will. Some people at these meetings are going to be asked to ``pursue other opportunities.'' The people who report to them are simply going to be fired. As you probably have heard, the financial industry has had a pretty nice few years. This isn't shaping up to be one of them. This is the year of subprime mortgages and structured investment vehicles and, at least for some firms, such as Bank of America, big losses on certain kinds of investments. Some firms have already made cutbacks, but so far, they have been pretty minor. What happens next is that the top brass meets and decides which businesses have been profitable and which businesses have not, and decide where they are going to spend their money. Then they cut jobs, and in some cases, entire departments. Entire departments? Whole lines of business? Those are the bad decisions.

Merrill Reports First Loss Since 2001 After $7.9 Billion Subprime Charge Merrill Lynch & Co. reported its first quarterly loss in six years after a larger-than-forecast $7.9 billion of writedowns for subprime mortgages and asset- backed bonds, the most by any Wall Street firm. Merrill's failure to meet its own projection shows how Chief Executive Officer Stanley O'Neal misjudged the severity of the decline in the credit markets since July, after late mortgage payments from borrowers with poor credit histories surged. The charge is the biggest in the firm's 93-year history and the first major setback in O'Neal's five-year tenure. Stan's still the man, but for how long? Merrill board will show chairman-CEO O'Neal the door, predicts David Weidner. Merrill's O'Neal losing appeal Hard-hitting management style made Merrill Lynch Chief Executive Stan O'Neal  a lot of enemies.

o        Merrill Lynch CEO Stan O'Neal Under Pressure to Resign After Record Loss Stan O'Neal is facing pressure to abandon his post as chairman and chief executive officer of Merrill Lynch & Co. after misjudging the contraction in credit markets and posting the firm's biggest-ever quarterly loss. Merrill's directors met yesterday to discuss his potential departure and may make a decision this weekend, the Wall Street Journal reported, citing people familiar with the matter. The New York Times said O'Neal discussed a possible merger with Wachovia Corp., angering his board. CNBC reported that he told friends he'll probably be out of a job this weekend. Merrill surged the most in five years in New York trading yesterday on speculation O'Neal, 56, will be ousted and the world's largest brokerage will become a takeover target.

AIG may take $9.8 billion subprime hit American International Group could take a $9.8 billion hit from its exposure to subprime mortgages, Friedman, Billings, Ramsey analyst Bijan Moazami estimated on Thursday. The write-downs will be big, but manageable for one of the world's largest insurers with $104 billion in shareholders equity and the ability to generate third-quarter earnings of $4.4 billion, the analyst wrote in a note to clients. Merrill Lynch's surprise $8 billion, subprime-related write-down this week has sparked fresh concerns about the impact of this summer's credit crisis on financial-services companies. AIG has the largest subprime exposure of any insurers he covers, Moazami noted. Shares of the company fell 3.2% to $61.79 on Thursday amid speculation it could be hit by big write-downs. Spokesman Chris Winans said the company doesn't comment on market rumors.

Buybacks, dividends in store for Wal-Mart Wal-Mart Stores Inc., facing slowing U.S. sales, may benefit from further trimming its U.S. store and square footage growth, and using the saved capital to buy back shares or pay dividends, analysts said. Ahead of its two-day analyst meeting that begins Tuesday, analysts and investors said the world's largest retailer, which already scaled back its supercenter store growth plan, can use some additional cutbacks. Wal-Mart in June said it will increase U.S. square footage growth by about 4% to 5% for fiscal years 2008 and 2009 and lowered its capital spending forecast to $15.5 billion from $17 billion. Same-store sales at U.S. Wal-Mart stores in the first 35 weeks of the year rose 0.8% this year, compared with 2.5% last year after the retailer failed to lure higher-income shoppers with more upscale apparel and home furnishing products, analysts said. The retailer last week cut prices on 15,000 additional items, 20% more than last year, as it said it plans to be more aggressive with price cuts heading into the holidays, many retailers' biggest sales and profit period.

·         Wal-Mart's woeful sales tale With its U.S. sales growth expected to slow further over the next three years, Wal-Mart executives told analysts Tuesday that the retailer will open fewer stores at home and instead boost its expansion overseas. Wal-Mart's chief financial officer Tom Schoewe said the world's largest retailer expects overall sales to grow about 9 percent this year, slower than last year's increase of 11.7 percent. More important, Schoewe said Wal-Mart's sales growth will further slow, to between 5 and 8 percent growth over the next two years.

Tesco Takes On U.S. Shoppers The British retail giant is bringing its concept of midsize, urban grocery stores to the Southwest. After all the research, can it succeed stateside? It's a big gamble, even for Tesco, which books $86 billion a year in revenue. The company, the largest retailer in Britain and among the largest supermarket chains in the world, already has announced 122 planned store locations in Phoenix, Las Vegas, and Southern California. It has committed to invest $2 billion over the next five years on the venture. Here's what Tesco has let out so far. Fresh & Easy stores will each be 10,000 square feet—roughly four times the size of a typical convenience store and one-third as large as a traditional supermarket. This mimics the format of the chain's highly successful Tesco Metro outlets in Britain, which dot the country in urban locations too small to support a full-size supermarket. Taking cues from consumers who said they were overwhelmed by choices, Fresh & Easy will offer an edited assortment of items—everything from freshly bottled fruit juices to detergent—at prices lower than convenience stores. At the center of each outlet will be a space called Kitchen Table, where customers can sample products. The company hopes to keep prices low by selling big volumes of those few chosen items and relying on trusted suppliers, some of which it brought from Britain to the U.S. To lower distribution costs, Tesco is clustering its stores in urban markets that it can supply quickly from a giant new distribution center it has built in Riverside, Calif., about an hour's drive east of Los Angeles.

Small Cars, Big Potential for Asian Makers Small, low-cost cars have abruptly become the next frontier for the global auto industry, after almost 20 years in which major car makers dismissed such vehicles as a low-profit afterthought. As gas prices keep rising, consumer tastes around the world are shifting toward smaller, more fuel-efficient cars. In the U.S., drivers are trading in gas-guzzling SUVs like the Nissan Armada for smaller models like the subcompact Honda Fit. In developing markets, where sales are exploding, first-time drivers are starting out with the smallest, cheapest cars. Global demand for small cars is expected to grow by 30% to 27 million vehicles by 2013, with the growth coming mostly from developing markets, according to auto research firm CSM Worldwide Inc. Demand for big SUVs during that time is expected to drop 4%, to 10 million vehicles.

General Motors Takes Sales Lead Over Toyota on Growth Outside of the U.S. General Motors Corp. outsold Toyota Motor Corp. in the first nine months of the year, buoyed by sales outside the U.S., in the battle to extend its 76-year reign as the world's largest carmaker. GM sold 7.06 million vehicles through September, taking a lead of 10,000 units over Toyota's 7.05 million, the two companies said in separate statements. At the end of the first half, Toyota led by 39,000 vehicles. Toyota's sales in the U.S., its largest overseas market, dropped each month of the third quarter, the longest stretch of declines since 1995. Detroit-based GM won customers in Brazil, Russia and China, boosting sales by 4 percent in the quarter.

Crash of Frontline, Overseas Shipholding, Teekay Nears on Freight-Oil Gap The record increase in oil prices and the unprecedented number of new tankers transporting crude is a stock market crash waiting to happen. That, at least, is the growing consensus among analysts who say the widening gap between West Texas Intermediate crude and the rate for supertankers shipping Middle East oil to Asia means industry titans Frontline Ltd., Overseas Shipholding Group Inc. and Teekay Corp. have unsustainable valuations. The Bloomberg Tanker Index has risen 19 percent in the past two years, even as freight rates sank 38 percent. The price of marine fuel, the biggest cost for shipowners, has advanced 73 percent to a peak of $446.50 a metric ton and the number of ships available is near a record.

China buys GE's 'green' push In China, GE (Charts, Fortune 500) appears to be making headway: The country is now one of the company's largest foreign markets, with $5.4 billion in revenues last year, a nearly fourfold increase since 2001. GE has 12,000 employees in China, including about 1,200 who work in a research and development center in Shanghai. It has 23 joint ventures with Chinese firms; last year, just to pick one example, the company opened its first wind turbine assembly plant, in the city of Shenyang. GE has been especially successful at selling Ecomagination jet engines, locomotives and wind turbines, said Bertamini.

Apple's wireless land grabThe iPhone maker's most audacious move is a possible end-run around wireless operators, including partner AT&T. The touch (yes, it is a lowercase "t") and other devices like it could spell trouble for big wireless operators, including Apple's exclusive iPhone partner in the U.S, AT&T (Charts, Fortune 500). In the short term, the touch provides consumers with what I would argue are the best parts of the iPhone (the touch screen, the music player and the Web browser) without requiring the consumer to sign up for a two-year service contract with AT&T. AT&T, of course, makes its money from such contracts. The iPod touch lacks the ability to make and receive phone calls, but plenty of people are content to carry a separate cell phone for voice calls. Indeed, the touch would certainly appeal to wireless customers who aren't inclined to get an iPhone because they have service contracts with AT&T competitors. The Wi-Fi capabilities built into the touch - and other devices such as Nokia's N95 and Samsung's T409 - in the long run could end up bypassing wireless phone networks altogether. How? If a user downloads ringtones or searches the web on a Wi-Fi network, he or she is not consuming minutes on the carriers' data networks, which phone companies are spending billions to build. Sure, the Wi-Fi connection usually is "fixed," which means the consumer isn't able to connect to the 'Net while walking around. But a lot of iPhone customers, for example, have expressed frustration with AT&T's data network, and prefer to surf their iPhones on Wi-Fi anyway.

·         Apple Shares Advance After Jobs Reports Record Mac Sales, Holiday Forecast Apple Inc. shares rose after Chief Executive Officer Steve Jobs delivered a 67 percent jump in fourth-quarter profit, topping analysts' estimates, on record Macintosh computer sales and growing iPod and iPhone demand.

 Leopard: Faster, Easier Than Vista The Mac is on a roll. Apple Inc.'s perennially praised but slow-selling Macintosh computers have surged in popularity in the past few years, with sales growing much faster than the overall PC market, especially in the U.S. By some measures, Mac laptops are now approaching a 20% share of U.S. noncorporate sales, up from the low single digits where they once seemed stuck. There are several reasons for this, including the security problems in the dominant Windows platform from Microsoft; spillover from Apple's blistering success with its iPod music players; the fact that Macs can now run Windows programs; and Apple's highly successful chain of company-owned retail stores. But another key factor has been the Mac operating system, called OS X, which came out in 2001. It has proved to be as powerful and versatile for mainstream consumers as Windows, yet easier to use and more secure. And Apple has upgraded OS X far more rapidly than Microsoft Inc. has upgraded Windows, bringing out major new releases roughly every 18 months, while Microsoft struggled for more than five years to produce the latest Windows iteration, Vista, which came out in January.

Microsoft's mainstays pay the bills Video games and Facebook aside, the real meat in higher earnings from the company are in the stalwart Windows and Office products. Microsoft on Thursday reported results that included a 24% increase in quarterly revenue to $4.1 billion for its client unit, which includes Vista, the latest iteration of its Widows operating system software. It also reported 21% growth to $4.1 billion in revenue for its business division, which includes its Office suite of software applications for things such as word processing and spreadsheets. Such impressive growth from relatively staid products came amid a flurry of headlines about the company's newer, edgier businesses. Microsoft's entertainment and devices unit, which includes its Xbox video games, did post a 91% increase in sales, though its total still came in at $1.9 billion. Microsoft also made big news by winning a partnership to sell advertising for Facebook Inc. earlier this week, though the company's online services unit continued to report a quarterly loss, with losses expected through the end of the fiscal year. And while games and online services certainly figure heavily in Microsoft's future, Windows and Office also seem poised to continue to post their own strong growth, analysts say.

· 

· 

· 

Motorola's Zander May Buy Time With Return to Profit Motorola Inc. Chief Executive Officer Ed Zander may have bought more time for a turnaround after firing 10 percent of his workforce and introducing a successor to the Razr handset. Motorola, the biggest mobile-phone maker in the U.S., probably will report its first profit in three quarters tomorrow after losing $209 million in the first half. The Schaumburg, Illinois-based company earned $49.9 million, or 3 cents a share, in the third quarter, down 95 percent from a year earlier, according to a Bloomberg survey of analysts. A return to profitability may give Zander another nine months to show he can produce a successful handset line to go with the cost cuts, said Tony Carbone, an analyst at RCM Capital Management in San Francisco. Investor Carl Icahn wants Zander's resignation if the phone unit doesn't recover by year's end. ``They're putting a tourniquet on the wound by cutting expenses,'' said Carbone, whose firm oversees $100 billion including Motorola shares. ``The longer-lasting solution of new products takes hold by the middle of next year.'' Motorola Reports First Profit in Three Quarters, Forecasts Higher Earnings

Verizon's FiOS Challenges Cable's Clout After years of promises, Verizon Communications Inc. is making significant headway with its $18 billion effort to roll out television and faster Internet service, posing a difficult new competitive threat for the cable industry. Two years after launching its FiOS service, Verizon has signed up half a million TV subscribers and, as of the second quarter, was adding 2,600 customers per business day, the company says. In the parts of the Dallas area where FiOS service is offered, a quarter of households are taking it, Verizon estimates. FiOS uses fiber optics to deliver television, faster Internet services and phone. Like similar cable packages it typically costs a little under $100 a month for all three services. Cable systems use fiber-optics in their networks as well but depend on coaxial cables to get the service into homes. The FiOS network has far more capacity for high definition TV channels, online games and downloading and uploading files. It also offers a few premium features that cable companies don't offer, like digital video recorders that can pipe recordings to different TVs in the house. On a national level, FiOS promises to change the balance of power among cable, telephone and satellite TV companies over which one can offer consumers the most attractive combinations of the latest TV, phone and high-speed Internet services. Until recently, cable companies were winning. They have about a 54% share of the high-speed Internet market and were much faster in breaking into phone service than phone companies were in offering TV. About 12 million of the roughly 90 million households that can get phone service from their cable operators subscribe to that service.

Qualcomm Has Plan to Widen Web Access Qualcomm Inc. today is announcing new chips to let laptop computers use multiple cellular data services, hoping to outflank a high-profile alternative called WiMAX. The cellular services are proving popular among laptop users who want to stay connected wherever they go. But there is a hitch. Many carriers built their networks on a technology called GSM, or global system for mobile communications. They typically use a technology for delivering data that is known by yet another acronym -- HSPA, for high-speed packet access. Another camp of carriers use code division multiple access, or CDMA, a technology pushed by Qualcomm, and favor an associated data network dubbed EV-DO, for evolution, data-only. The two kinds of networks aren't compatible. So laptop-computer makers hoping to offer long-range Internet access now have to buy two kinds of chips to support each service. Consumers typically choose one technology and one service provider and have to stick with them. Qualcomm, of San Diego, says its new Gobi chips can use either EV-DO or HSPA and their variants. That means PC makers can build laptops that can tap into the Internet virtually anywhere, says Sanjay Jha, Qualcomm's chief operating officer and president of its chip division.

Posted by dblwyo at 12:18 PM | Permalink | Comments (0)

Time to put up and review last week's interesting news and postings - split into two entries. First on Markets and the Economy and the second on Business and Companies. The news on all fronts continues to be interesting.

Basically the markets recovered last week what they lost the week before - which means of course that everything's going to be allright, right ? We put up what we'd like to think are a couple of major and interesting posts last week (Models, Metaphors, Musical Chairs and Market Outlook,Market, Market, Nice Market, Here Market.... ) that provide our views on market trends and ways/weighs to think about things. In the first pass a framework borrowed and adapted from BigPicture and Minynaville was presented that looks at four factors: Structure, Fundamentals, Technicals and Outlook (Psychology) and in the latter used it to examine current market trends. Despite the uptick last week we still argue that none of the first three factors is favorable but is being outweighed by the fourth.

One of the reasons is that none of last week's, or other recent, high-frequency economic data is particually positive. And the news on the Housing and Credit Markets can hardly be called favorable.  Which hopefully you can see in the accompanying chart which looks to harbbingers of future demand, from both Investment and Consumption. Investment is driven by (composed of) business capex spending plus housing investment. Last week's release of Durable Goods Orders, x-Aircraft, was down -3% YOY. A figure that's definitely one of the worst we've seen in a while, though not the worst this year. Meanwhile housing continues to deteriorate with New Home Sales down -30% YoY ! There's much more in the readings - most of it from our favorite source CalculatedRisk who continues to lead the analysis community.

On the consumption side real wages are "holding" up, though not improving, due to relatively benign inflation readings (more on those and interepretation thereof here: Inflation Re-visited: Uncle Alan & Prof. Jim Chime In). We'll see but the outlook there isn't particularly good either given rising oil prices and a falling dollar. Much more importantly employment continued to deteriorate with with YOY% gains falling from 1.19% from 1.27% the prior month. The average new jobs created in the first six months were 126K/month and fell significantly to 97K/month in the last three. Much more importantly, if you believe the working figure of merit is 150K/month to breakeven, then we're falling further behind and possibly at an accelerating pace. In the first six months the deficit was about -24K/month and has fallen recently to '53K/month. Really...really not good.

I'd say happy reading but it doesn't seem warranted. In any case you'll find all these themes dug into, reinforced and explored.

General & Special

Where was the Bubble: Houses, Rates or Credit? We can define a bubble as a “trade in high volumes at prices that are considerably at variance from intrinsic values." By that definition, I'm not so sure Housing was a true bubble -- the run up in prices, a doubling over the course of about 7 years, was actually a rational market response to interest rates being dropped to generational (46 year) lows. Trading volumes moved up, but proportionately so. Compare that with the Nasdaq, which doubled from October 1999 to March 2000 on a dynamic of a new paradigm. Trading volumes skyrocketed. When it was over, the Nazz had plummeted 78%. That example has the home price appreciating ~67%, but the monthly mortgage payments up only 14% But this only explains some of the pricing run up from 2001-04. It does not explain the next phase of price increases. To do that, we have to understand how everyone in the lending community got so drunk on securitization they simply abandoned their traditional risk metrics and repayment concerns. The assumption appeared to be that lenders could simply sell the mortgages to Wall Street to be securitized, without worries about delinquencies, defaults and foreclosures. You can see the decrease in lending standards over time: With each subsequent year of mortgage issuance, more and more homes began defaulting earlier in their ownership/repayment cycle. Have a look at the nearby chart -- it shows the delinquencies in the non-sub-prime loans. These were supposed to be higher quality loans. Apparently, these loans also succumbed to a lack of traditional lending metrics. The results speak volumes to where the bubble was.

Merrill's big mess up  What is the balance sheet of Merrill Lynch really worth? Depends to a large extent on who's in charge of valuing the company's large holdings of risky securities. Wednesday, Merrill (Charts, Fortune 500) reported third quarter earnings that contained $7.9 billion of losses on collateralized debt obligations (CDOs), which are complex debt securities, and junk mortgages. What shocked the market was that only three weeks ago Merrill estimated losses of $4.5 billion on these sorts of assets. What on earth happened that caused the brokerage to suddenly find another $3.4 billion of losses? One cause was that Merrill gave the job of valuing these securities to a group of people who turned out to have a much more conservative view on these assets' true worth. Compared with 10 years ago, Wall Street firms hold far more securities and financial instruments that don't trade regularly, which means they are valued according to in-house estimates and not so much by market prices. The extra $3.4 billion of losses at Merrill will only deepen fears that brokerages and banks have been overvaluing their assets to avoid taking the correct amount of losses at the appropriate time. This is big. It shows that executives had enough leeway under Merrill's approach to choose a very different end result. Different to the tune of $3.4 billion.

Markets & Investing

Mortgage Security Bondholders Facing a Cutoff of Interest Payments For all the pain in the mortgage market, investors who hold bonds backed by risky home loans have continued to receive their monthly interest payments — until now. Collateralized debt obligations — made up of bonds backed by thousands of subprime home loans — are starting to shut off cash payments to investors in lower-rated bonds as credit-rating agencies downgrade the securities they own, according to analysts and industry executives. Cutting off the cash flow, which is governed by rules and mathematical formulas that vary by security, is expected to accelerate in the months ahead. With such a re-evaluation, owners of collateralized debt obligations — investment banks, hedge funds, insurance companies and public pension funds — may be forced to write down mortgage investments beyond the billions they have already written off. Some bonds, for example, may go from being valued at, say, 70 cents on the dollar to becoming largely worthless overnight, bankers and analysts say. The adjustment could further erode the availability of credit to consumers and businesses. Though many people in the mortgage market expect a shut-off of payments, the broader financial market has not focused on it.

Fears of Falloff In Profits Send Dow Down 2.6% Weak earnings reports and dour projections are surprising investors who believed the global economy would bring a return to outsized profits. But that optimism may wane as the housing bust is showing signs of spreading to other industries. A slew of weak earnings reports stoked fears that profits in the next few quarters will fail to hit lofty expectations, sending the Dow Jones Industrial Average down 2.64% Friday. While investors have known for weeks that profits for the third quarter would suffer from turmoil in financial markets, many reassured themselves that a sharp turnaround would come in the current quarter, helped by a strong global economy. Instead, many third-quarter results have fallen below even the diminished expectations, and pessimistic news from companies such as industrial bellwether Caterpillar Inc. suggested more unpleasant surprises to come. A succession of earnings surprises at banks revived fears that the worst of the credit crisis, which hit two months ago and seemed to ease, has yet to pass.

Emerging markets next bubble Investors searching for big returns and no exposure to U.S. subprime mortgages are looking at emerging markets, raising the possibility that too much money could flow in, pumping up another bubble, top international bankers warned Sunday. Emerging markets have largely been spared any major impact from the subprime and structured finance crisis that has shaken markets in the United States and Europe, according to a report released Sunday by the Institute of International Finance. The group, consisting of hundreds of bank worldwide, said capital flows into emerging markets will reach a record $620 billion this year and should stay close to that level in 2008.

Economy

Why we need a recession -- soon America has a new mania this fall: recession-obsession disorder. If you just arrived from a visit to the International Space Station, you'd be excused for thinking that the U.S. economy is about to plunge off a cliff, with widespread unemployment, massive piles of unsold inventory, corporate profit growth in full-speed reverse and hundreds of bank closures. So is the inferno really upon us? Well, no. Not for a few months to a year, it seems, due to the Jedi mind tricks that bankers and government officials are able to play these days. And that's a pity because recessions serve a wonderful purpose in the economic ecosystem. Before this scenario can come to pass, it has one very high hurdle to overcome. Somehow, the big banks have to find a way to retain investors' confidence despite a January that is likely to feature many of the same problems we witnessed earlier this month. Once investors determine that the banks' bad loans are out of control and that the risk cannot be adequately measured, they will sell first and ask questions later. So, we are about to enter even more interesting times. A debt-led recession punctuated with joblessness and foreclosure is almost certainly en route. The only questions are whether it comes early next year or in 2009, and how deep a hole we'll need to dig for the burial. Whatever the timing or depth, continue to avoid the bank and brokerage stocks. A year from now, writes David Wessel, it will be clear what caused the recession of 2007-08: The triple whammy of falling housing prices, rising oil prices and the growing cautiousness of lenders and borrowers.

·         Americans Turn Negative on Economy, Expect Recession, Poll Says; 2/3rds Americans Say Recession is Likely

·         Northern Trust Week-In-Review. A must read – excellent charting and analysis of Housing and Durable Goods.

Home builders: Worst is yet to come The battered markets for real estate and home building still have farther to fall, according to a range of economists who spoke Wednesday at a forecast conference sponsored by the National Association of Home Builders. The economists agreed that the problems with home finance markets will continue to hit housing into next year, and that even when there is a recovery, it will be a slow process that will see weakness continue into 2009. While most said they believed the overall U.S. economy can weather the housing downturn, several saw significant risk of a recession. Mark Zandi, chief economist of Moody's Economy.com, said that large areas of the country will fall into recession, if they haven't done so already. The economists also admitted to being surprised by how bad the housing downturn has become, and all said that making forecasts of a recovery is difficult due to the problems in the credit markets. When will housing hit bottom? No one really knows. Optimists have been saying worst is behind us; pessimists say recovery is year, or years, away.

·         Housing Readings from CalculatedRisk (the goto for understanding what’s really going on): September Existing Home Sales Plummet, More on September Existing Home Sales, September New Home Sales, More on September New Home Sales, Up to $4 Trillion Decline in U.S. Household Real Estate Value Predicted

• QUOTES: Sales of new one-family houses in September 2007 were at a seasonally adjusted annual rate of 770,000 ... This is 4.8 percent above the revised August rate of 735,000, but is 23.3 percent below the September 2006 estimate of 1,004,000. The Not Seasonally Adjusted monthly rate was 60,000 New Homes sold. There were 80,000 New Homes sold in September 2006. September '07 sales were the lowest September since 1995 (54,000). This is another very weak report for New Home sales. The stunning - but not surprising - downward revision to the August sales numbers was extremely ugly. This is the second report after the start of the credit turmoil, and, as expected, the sales numbers are very poor. I expect these numbers to be revised down too.
• Just to put these numbers into perspective, I've plotted the two declines - $2 Trillion and $4 Trillion - assuming the price declines happen between now and the beginning of 2010. Note that this doesn't add in any new homes or home improvement. A decline of this magnitude in U.S. household real estate value seems very possible.
• Mortgage Industry Facing More Troubles- In all phases of the mortgage industry this week, from the people who make the loans to the people who insure them, the news was bad -- and most of them expect it to get worse.
•  

Credit contagion infects your wallet The mortgage mess has already spread to car loans and credit cards. If consumers run scared and stop borrowing, the economy is in big trouble. My worst nightmare about the collapse of the subprime-mortgage market is coming true. The horrors let loose among mortgage borrowers and lenders by falling housing prices have begun to sink their fangs into the market for auto loans and credit cards, too. We're inching dangerously close to the point where consumers run for the hills -- taking their wallets and prospects for economic growth in the United States with them. In a wave of earnings reports that started with Citigroup (C, news, msgs) on Oct. 15, big banks reported a torrent of ink as red as blood from their mortgage operations. The damage came from two directions: mortgage delinquencies and assets backed by mortgages. At Citigroup, for example, delinquencies soared in September. Altogether, U.S. banks raised their reserves against loan losses by $6 billion in the third quarter from reserve levels at the end of the second quarter of 2007. That's bad news for bank stocks, certainly. Every dollar that goes into reserves is a dollar less that can be lent out to make money. And the levels of reserves don't look likely to fall in the near future. Washington Mutual, for example, told Wall Street analysts that it expects that charge-offs in its mortgage portfolio will increase by 20% to 40% in the fourth quarter. But the really scary news for the general economy is that the banks' problems aren't limited to mortgages and the housing market. They're starting to see rising delinquencies and charge-offs in their portfolios of auto loans and credit card debt. Wells Fargo, for example, said that charge-offs on its credit card portfolio rose to $176 million from $161 million in the second quarter. At Washington Mutual, managed credit card delinquencies climbed to 5.73% of the bank's portfolio from 5.11% in the second quarter. But the most stunning news -- and the most troubling indicator that credit problems aren't limited to the mortgage market anymore -- came from the credit card companies. Because these lenders have neither direct nor indirect exposure to the mortgage market, the trends here are an indicator of what's happening with consumer credit outside mortgages. And the news in the third quarter wasn't good.

Weak Mexican Peso Shows Oil Monopoly Undermining Growth, Reducing Surplus Mexican President Felipe Calderon is delivering a grim message: The largest oil producer in Latin America is running out of crude. The ban on private investment in its oil monopoly is depriving the nation of the benefits of record high prices and contributing to a slowdown in economic growth. Production of crude, Mexico's biggest export, has fallen 8 percent since 2004 to a seven-year low, data compiled by the government show. Mexico is being punished for its inefficiency in the foreign-exchange market. The peso fell 0.08 percent against the dollar this year, the worst performance among the 16 most-traded currencies. New York-based Goldman Sachs Group Inc. and Credit Suisse Group in Zurich say the slump will deepen. The drop in production is hurting economic growth by reducing funds to improve highways, bridges and ports, Cervera said. Oil provides 40 percent of government revenue and the slowdown contributed to a 47 percent decline in the nation's surplus in August, according to the Finance Ministry. Mexico's economy has grown at an average annual pace of 2.8 percent since 2002, down from 4.4 percent during the previous five-year period. Output has dropped to a seven-year low of 3.12 million barrels a day as the state monopoly Petroleos Mexicanos fails to develop new reserves to offset dwindling production at Cantarell, the world's largest offshore field.

China Curbs Imports From Asia as Korea, Malaysia, Singapore Lead Job LossThe U.S. isn't the only country watching jobs and manufacturing migrate to China. Increasingly, so are China's closest neighbors. The nation is reducing its reliance on imports from the rest of Asia as it makes more of the higher-value-added intermediate and capital goods it previously bought from abroad. That is threatening growth in countries whose export sales are already in danger of erosion from the U.S. slowdown. More than 13,500 electronics-product workers in Singapore have lost their jobs since 2004, according to Ministry of Manpower statistics. The International Monetary Fund last week forecast Singapore's growth rate will fall to 5.8 percent in 2008 from an estimated 7.5 percent this year and sees weaker expansion in the Philippines, Malaysia, Taiwan and South Korea. ``China is moving up the supply chain,'' says T.J. Bond, chief Asia economist at Merrill Lynch & Co. in Hong Kong. ``The view that China produces labor-intensive goods but purchases high-value-added goods from abroad may be roughly correct today, but it need not last forever.''

Posted by dblwyo at 10:57 AM | Permalink | Comments (0)

Well after puzzling some more on the outlook for the economy, profits, earnings and EPS I may have stumbled across an explanation for why the prognosticators have such a sanguine view of things. Just to review, the economy is slowing and faces more and more headwinds. In fact recent polls show a majority expect a recession in '08 and feel that we may be in one now.

• Americans Turn Negative on Economy, Expect Recession, Poll Says
• 2/3rds Americans Say Recession is Likely 
  

In digging into earnings we found that EPS growth is not organic in the sense that it's based on growth in revenue, profits or earnings. And we found that to be consistent across three, no four, different and major data sources: GDP accounts, National Income accounts, WSJ reported earnings/profits by industry and S&P reported EPS by industry most recently. As they say - it's a puzzlement.

BUT...but...but if you look at the accompanying table it starts to become clearer. EPS growth rates by sector from the most recent S&P numbers. Take a look and see what you think. EPS growth as reported actuals and estimates from Q106-Q407, based on YOY% growth, lines up with the other data. When you add the '08 numbers the averages show some uplift but not big jumps. In other words it's the going forward expectations for Q108-Q408 that make you shake your head.

For the SP1500 overall EPS growth in '06 & '07 averaged 10.6% and is estimated to grow to 11.7%, which results in the 13.8% estimate for '08 as a whole. The sectors projected to perform exceptionally well are Technology, Telecom and Consumer Discretionary. Only Energy and Materials are estimated to have rates less than 10% and all the other sectors are projected to do well, with growth of EPS in the 10-14% range.

For another view consider the accompanying chart which shows YOY% EPS growth rates from Q106 to Q408, in two groupings. Notice that, roughly speaking, most of the sectors show declining growth to and thru '07 and a pickup on a quarterly basis into '08. More specifically the first sub-chart shows Consumer related sectors (blue-shades) and Energy/Materials (green). Overall four of the sectors are shown as declining and then return to a rather flat 10% outlook, which may have something to do with YoY comps. Con. Discreationary though is shown taking off !

In the second sub-chart Industrial (blue) and Tech (green) are shown doing well, with Telecom in particular projected to turn in a fabulous performance, rising to 50% EPS growth in early '08. Even Finance is shown returning to 20-30% growth rates in late '08.

And there you have IT - the nub of several matters. If any of these projections turn out to be in the ballpark any dips right now are buying opportunities. Of course that all hinges, in general, on a U-shaped path for the economy with the current low growth ( < 2%) being followed by more robust > 2% growth and eventually getting back over 3%. And of course with no further impacts from Housing or the Credit Market problems, especially in the Finance sector.

Fascinating isn't it ? The gap between current economic outlook and earnings projections I mean. Let alone all the major risk factors. It'll be interesting to see how S&P and other analysts change their forecasts over the next few months.

The question of course is how credible do you find them ? 

Posted by dblwyo at 08:42 AM | Permalink | Comments (0)

Seeing the elephant is an old phrase borrowed, I think, from the British Army and used by many armies now and refers to one's first experience of something new and shocking. In their case combat - which is about as shocking as it gets. Fortunately our experiences aren't going to be on anything like that level. But still the Elephant here is learning that for the first time the old linkage between GDP, Profits and organic economic growth appears to be frayed to the breaking point (Dr. Pangloss Treating Goldie: Markets, Profits & Earnings, The Heart of the Matter: Profits vs Earnings ? ).

But first a small confession. My early religious training was in economics and after spending several years as a novice and then a few more in monastic retreat (otherwise known as grad skul) I went apostate and joined the real world. Now economics would tell us that any industry or product that gets a large return/profit must be serving someone somewhere. Yet as the share of Financial companies in profit has gone from 10% to 20% to, in just the last few years, 30% I begin to find myself turning into a modern Physiocrat. They were some of the earliest formal economists and started with the argument, in late 18th C France, that the only true source of wealth was Agriculture. Given the structure of the economy at the time they had a point if not a case. But other sectors like trade, manufacturing and finance were important contributors who's outputs made the functioning of the agricultural sector more efficient - thereby raising overall output and producitivity. Nonetheless I still find it difficult to believe that Finance contributes so much to the effective functioning of the economy that a 30% share of returns is warranted. Oh well...

Back to the Elephant and this time we'll go to the central cathedral of capitalism the Wall St. Journal - specifically it's recent reporting on quarterly profits and earnings. Which, BTW, they report as net operating income, NOT EPS ! 

If you take a look at the accompanying charts we have a third view, albeit on a shorter timeframe, of the shares of the various industries. Here we see quarterly profits from Q205 to Q207 in absolute and relative terms. Take a look for yourself and see what interpretations you come up with.

For the life of me there doesn't appear to be any major acceleration in profit growth that would cause me to be wildly excited about business performance. Earlier (Models, Metaphors, Musical Chairs and Market Outlook) we'd looked at  the markets and even quoted BigPicture from last Fall about the range-boundedness thereof. Based on these charts we'd have to argue that was a pretty sound judgement by Mr. Market.

On both absolute and relative basis we also don't see much to argue for a great outlook for any industry or sector. Energy and Materials looks pretty flat as do Consumer related industries (green-shaded) and Industrials/Utilities. Even Tech/Telecom, other than the spectacular performance of a few select (NDS, QQQQ) firms undergoing major innovation shifts (APPL, GOOG come to mind) indicate anything arguing for the runup over the other general or sector indices. Granted there was improvement in '06 and so far in '07 but an acceleration ? Nah.

Again we come, from yet a 3rd but consistent, data source that profit growth is a) NOT organic and b) neither acclerating nor indicating likely future growth.

Earnings, at least in headline reported EPS numbers, is another matter entirely. Or is it ? One "final" pass at a 3rd data source - S&P's quarterly earnings numbers.

Looking at the accompanying chart, low and behold, the S&P numbers surprisingly (at least to me) line up almost exactly with the National Income data and the WSJ quarterly numbers. In other words earnings have grown but not by that much, they appear to be flattening off recently and the DON'T appear to be growing at a rate that would indicate higher markets. BtW - these are EPS for the SP1500, not the SP500 !

So we come full circle on four different but complementary data sources: GDP accounts, National Income accounts, quarterly Operating Income and reported  earnings. With the economy slowing into a growth recession, with Housing much worse than anticipated and likely to still be worse yet over the next two years and with problems with asset pricing and valuations in the credit markets one would have to conclude that the outlook is not very sanguine :).

Too namby, pamby a conclusion ? Try this - there is NO indication that a better outlook for earnings is based in any reality I can investigate. Yet the Markets and Wall St. maintain a very upbeat outlook. Puzzling indeed, isn't it ? Feel free to chime in - variant opinions would be welcome. 

Posted by dblwyo at 08:53 PM | Permalink | Comments (0)

If you look back over the last two Weekly Readers they both might be said to converge on key question - where will earnings go ? Or broken down a little more will businesses continue to generate profits and will those turn into reasonable earnings ? And earnings growth in particular ? Earlier (Dr. Pangloss Treating Goldie: Markets, Profits & Earnings) we'd taken a pretty hard look at that question and found that Profits were strongly correlated with GDP growth and Earnings (ala S&P reported earnings/EPS) were strongly correlated with Profits. It might be worth your time to re-vist those charts and arguments because they lay a foundation for this discussion.

But we're presented with yet another conundrum - if the economy has been slowing why have earnings been growing ? As a partial answer let me quote from the earlier posting:

We can only conclude that with the lid screwed down on spending companies are making plenty of money, grabbing a growing share of the economy and, one guestimates, spending it on buybacks to keep the stock prices up and help out with EPS numbers. Which doesn't lead one to a great deal of confidence in organic growth of revenue, profits and earnings.

Stop and think about that for a minute - earnings may be going up but it's not because the economy or business is doing better. Somewhere under all the large pile of stock prices and reported earnings is a very large elephant. And he wouldn't appear to be a very well-groomed, well-behaved or benign one either.

We're definitely not in Kansas any more - so much for fundamentals. It's all about the finances and cash flow ?

 If you believe that argument, or at least think it raises some serious questions, then we thought it'd be worth looking into some more. Basically when we say growth is not organic what we're arguing is that EPS growth is NOT the result of growth in revenue or profits - rather it results more from throwing cash flow and borrowings at buybacks while screwing down the lid on expenses, hiring and capex spending.

Having set the table let's take a look at what some National Income accounts can tell us about the shares of profit from various sources. An idea we stole from Paul Kasriel and the Northern Trust economics team in their last US Economic Outlook (which we highly recommend reading for this and other reasons). 

So let's go elephant hunting. 

Let's take a look at total profits for Financial, Non-financial and Rest-of-World sources from the National Income accounts. From '79 to '93 there was a gradual increase from $200B to $400B and a faster rise $800B by '98. Interesting - oh, don't you just love hindsight so "next time" let's all remember to actually look at the data - profits flattened and then slowed from '98 to '01 before showing the sharpest upturn and continued rise since then.

If we look at the split between Finance, Non-Finance and ROW that also is interesting. While the shifting global economy is supposed to save us and make somebody else the engine you can't see any huge indication that that shift is in-place in terms of profits just yet.

The even more interesting shift though - we're looking at % shares of profit now - between Finance and Non-Finance. For ten, even twenty, years Non-finace companies had about 70% of the total profits while Finance companies split the rest with ROW until the '90s, depending on how you want to read the chart. Since then though there's been a profound structural shift.

If we take a closer look at the period from '95 to now we see roughly the same trends in more detail. During the 2nd half of the longest real boom in post war history profits were steady in the $600-800B  range but have grown rapidly in a few years until now they've nearly doubled at $1.6T/year.

Would anybody care to argue that a "recovery" with the lowest rate of job creation in the post-war era, low capital spending and the highest share of Profits in GDP represents sustainable, organic and self-reinforcing growth ? That's a rhetorical question in case anybody's wondering.

At the same time the share of Non-Financial companies has gone  from 70% to 50% of the National Income. At the same time Financial shares, which had earlier grown from 10% to 20% in the 80s have now gotten to be 30% of national income while ROW earnings have grown from 10% to 20%.

At a minimum the recent troubles in the Finance sector mean that the overall market, and the economy is no longer very insulated from those troubles. Though clearly ROW is increasingly important it won't be sufficient to offset already in place problems in the Finance industry. Nor are the other sectors likely to hold up well either, based on our earlier reads. In fact if you take the average share of the various sectors over the last several years (taken from WSJ quarterly profit/earnings reports) the energy & materials account for 20%, consumer related profits about 23%, industrials and utilities about 17% and tech/telecom 11% of profits. And Finance, as would be expected 30%.

So which of those industries do you expect to hold up or even do well ? Certainly a long-term argument for continued energy industry profitability is easy to make. But not so easy for either or both Consumer-related or Industrials, except as the latter is dependent on foreign earnings. Which is important but not yet as major as the talking heads would have us believe. Finance - well we seem to get a new rabbitt every six weeks based on the Mad Hatter's GPPDP - that's Genuinely Perturbed and Perverse Dissimulation Principles - of reporting.

Posted by dblwyo at 01:39 PM | Permalink | Comments (0)

Here we pick up the other "1/2" of last week's Reader and shift the focus to the Economy, some more Markets - sans the financial engineering & SIVics, and look at Business pretty hard. As we've mentioned this has been finance driven market, and economy (the Liquidity, Buyout, Buyback mantras) which in the process of enchanting itself with the wonders of modern financial engineering forgot to look at fundamentals and sound operating practices. It's fascinating, and blackly amusing, that at the recent IMF conference major banking executives admitted they saw all this turmoil building up but were trapped into making bad decisions by the amount of short-term profitability being waved in their faces.

Excuse me, would you say that again ? Sheesh...something stronger seems inappropriate to the magnitude of the malfeasance. The selections for the General section, immediately below, pretty well set the table for thinking about all this with the Vice-Chair at Morgan-Stanley tellings us bank losses on LBO finances have destroyed any net profits. That's followed by an academic study pointer that finds that stock options cause CEOs to do unnatural and perverse things in pursuit of their own interest and at the expense of the company's strategic performance. Well smack me with a V8 and call me Nardelli, imagine that. Those two pretty well dispose of the Buyout and Buyback currents. The last pointer is to another Col. Rockies article talking about how to build a team and make it work with "no-name", low-cost but competent players. In other words how to make an organization perform well when it can't just buy sucess; and a return to fundamentals of building that over time.

The Economy section is brief but reinforces the themese we've struck here again and again - the core economy has been visibly slowing for some time if you know here and how to look, Housing is much worse than previously admitted but again if you know where to look the accelerating declines have been visible for some time. And, as the prior Reader post highlights, the ripples of the credit crunches are just beginning to show. So we have a growth recession with the possibilities of a Recession being triggerred by Housing running between 30-40%+. If you read no other document on the state of things read Paul Kasriel of Northern Trust Oct economic outlook.

All of these themes play themselves out in the Business section where Wilbur Ross is putting together a fund to go after mortgage companies in trouble to the impacts on Citigroup's failed business model. Speaking of that more information is coming out on GM's UAW deal where the agreement looks to set the stage of significant long-term reductions in labor costs, which'll be some help but not enough to revive the strategic outlook for Detroit. That will require wholesale transformations in operations, particularly manufacturing, product development, procurement and order cycle mananagement. Reflecting similar fundamental breakdowns in existing business models Delta's CEO is talking about industry consolidation.

Similar problems though are beginning to crop up in the technology & innovation-driven industries. The outlook for tech spending is beginning to deteriorate while earnings are going to face increasing challenges. Articles on IBM, Yahoo, Intel and others make the same points. Which we dove into earlier in the post Tech, tech, who's got the tech: Greenberg on Definitions.

And finaly there are a couple of pointers to Pfeizer news which point out their continued troubles with failed development processes and the resulting empty new drug pipelines. Talk about an industry with a broken business model and Big Pharma is it.

Happy Reading. So-to-speak... 

General & Special

The Private Equity Boom: A Net Loser for Wall Street?  “When you net out all the profit versus all the losses, Wall Street hasn’t made money, it’s lost money.” That was the ever-quotable Robert Kindler (left), vice chairman at Morgan Stanley, summing up the net effects of the private-equity boom and bust of the past few years. Kindler was speaking Monday at a New York M&A conference sponsored by Penn State’s Dickinson School of Law. He was addressing one of the primary questions of the past few weeks: How Wall Street’s eagerness to secure private-equity business — via profit-sapping bridge financing and other bad loans — is affecting the banks’ earnings. The banks “were getting paid nothing for the bridges,” Kindler said. “They were not pricing the risk they were taking.”

Large Stock-Options Grants May Hurt Investors A large stock option may motivate a chief executive officer to such great risks that he ends up making decisions that can backfire for shareholders.

Meet the World Series-Bound Rockies of Colorado The Colorado Rockies, make that the National League champion Colorado Rockies, are just like their manager. And they're nothing like him. Actually, scratch that. Don't focus on Hurdle. He wouldn't want it that way. Rather, take a gander at his players. See how a bunch of no-names are a reflection of their boss. And the teachings of the manager's father and grandfather, too. When you think about it, these Rockies are the anti-Clint Hurdle. They arrived with no hype. No expectations. And yet, here they are, four wins shy of achieving it all. The Rockies are in the World Series for the first time in their 15-year existence. Not the Mets or Cardinals or Dodgers or Braves or Cubs. Nope. None of them won the pennant. This isn't about big payrolls. Or big stars. Big effort and belief is more like it. It's about fundamentals. And, more than anything else, it's about a healthy dose of respect for the game, for teammates and opponents. The players run hard because their manager demands it. They set a record for team fielding percentage because the manager knows that phenoms don't always pan out. Fundamentals and effort don't slump. ``You build a good offensive team, you'll send a lot of players to the All-Star game,'' is Hurdle's philosophy. ``You want to win late and play late, you need to have a team that can pitch and play defense.''

Markets & Investing

5 bubble-proof foreign stocks  Developing-country stock markets are building a bubble that will burst -- eventually.

Is the outperformance by the developing-country stock markets of the world a wave you want to catch even now, because it's got months or years yet to run? Or is this just another bubble -- like that in technology stocks in 2000 or real estate in 2007 -- set to explode? It's a bubble, I'm afraid. But that doesn't mean it will burst tomorrow. In fact, it's almost certain to get larger before it bursts. The moment of reckoning, the explosive pinprick, could, in fact, be not just months but a year or even more away. Frankly, right now I'd tread very carefully, taking on only limited risk. That may leave some money on the table in the short term, but your portfolio is likely still to be standing when the run comes to a sudden, unexpected end. I'd much rather come back to these markets when valuations have pulled back from current peaks. And if you like the long-term fundamental story of the developing economies -- these are some of the fastest-growing economies in the world, after all -- there are still ways to invest that don't involve simply following the crowd and hoping that some greater fool will step in to buy from you.

Wall Street Remains Bullish Despite Data With all the predicaments facing the markets these days -- credit growing scarcer, oil near a record $90 a barrel, home prices in the dumps -- it would be logical if investors were shoving money under their mattresses, instead of into stocks. But logic doesn't always prevail on Wall Street. Why is Wall Street so optimistic, even though stocks took a hit Friday, with the Dow dropping 366.94, or 2.64 percent, to 13,522.02? While there are worries about the economy heading toward a mild recession, investors are still energized by the potential for U.S. companies to grow. Companies might have had their most challenging quarter in five years, but they are still sitting on large cash stockpiles -- and those with international units are able to take advantage of growth outside the United States. Furthermore, Wall Street doesn't expect the credit turmoil will send a shockwave through other parts of the economy.

Economy

Bernanke Says Housing to Remain `Drag' on US Growth Federal Reserve Chairman Ben S. Bernanke said the housing slump will be a ``significant drag'' on U.S. growth into next year, though evidence of a broader impact on spending is limited. Credit markets have improved, he added, while a full recovery will take time ``and we may well see some setbacks.''  ``Risk management considerations also played a role in the decision, given the possibility that the housing correction and tighter credit could presage broader weakening in economic conditions that would be difficult to arrest,'' he said. In response to a question by Henry Kaufman, the former Salomon Brothers Inc. economist who now runs a New York firm bearing his name, Bernanke said investment firms ``need to be as transparent as possible'' about how they value their assets. ``This current financial stress is not likely to disappear overnight; partly it is an information problem,'' Bernanke said. ``It is going to take a while for investors to appropriately value these assets.'' Economists React: ‘Horrific’ Housing ,

IMF trims 2008 forecast Turbulence in financial markets will trim growth, but won't do much damage as China, India and Russia continue to power ahead and global growth comes in at 4.8%, agency predictsThe turbulence in financial markets will trim global growth but won't do too much damage as growth in Russia, India and China continue to power ahead, the International Monetary Fund said Thursday in its latest report on the global economy. The global debt crisis will trim growth in industrial countries to 2.2% next year, down from the previous forecast in July of 2.8% growth rate. Growth in 2007 should come in at a 5.2% pace, down only slightly from last year's 5.4% growth rate. But China should grow at a 10% pace next year, Russia at a 6.5% pace and India at an 8.4% rate, keeping the global economy afloat. These countries alone accounted for half global growth over the past year, the IMF said. For the first time ever, China and India will be the two largest contributors to global growth.

US Economic Outlook (Northern Trust) No Recession in Sight - If You Are Nearsighted plus Week In Review

Business

Wilbur Ross Sees Mortgage Market's Dead Men Rising in Subprime Debt's Wake Wilbur Ross, the billionaire who specializes in resurrecting failed companies, is betting the U.S. mortgage market will rise from the dead. He won an Oct. 5 auction for the home-loan servicing unit of Melville, New York-based American Home Mortgage Investment Corp. Ross agreed to pay between $435 million and $500 million for the right to collect payments and maintain escrow on about $45.3 billion of mortgages from the biggest residential lender to go bust this year. To succeed, Ross will have to coax delinquent borrowers to pay again, or, in industry jargon, get non-performing loans to perform, said Jeffrey Kirsch, chief executive officer of Miami- based American Residential Equities LLC, which specializes in getting people to pay overdue mortgage bills. Ross's pattern has been to acquire one bankrupt company in an industry and augment it by buying similarly distressed companies. In textiles, Ross began with Burlington Industries Inc. and Cone Mills Corp., both based in Greensboro, North Carolina, creating International Textile Group Inc. Then he expanded with joint ventures in places such as Turkey and India. Ross is investing in the mortgage industry at the same time as New York-based Goldman Sachs Group Inc., the biggest U.S. securities firm by market value, and Charlotte, North Carolina- based Bank of America Corp., the country's second-largest bank.

·         Readings on LBO/PEG Trends: Boston Scientific and the 3 Steps to Bad-Deal Recovery , The Tuck Rule: Only Government Can Kill Buyout Boom ,  Scenes From the Private Equity Picket Line

Credit Crunch Rattles Citigroup Model Touted as a diverse financial colossus that could profit in good times and bad, Citigroup Inc. is reeling after two weeks of dreary news -- including a 57% profit drop reported yesterday -- that show how unprepared the bank was for the recent bust in credit markets. With businesses struggling from Texas to Tokyo, the banking behemoth's capital ratio -- or cushion against losses -- has dwindled to its lowest level in years. Citigroup has halted a program to buy back its own shares. The stock fell 3.4% yesterday. Citigroup is at the center of an industry plan to rescue a series of bank-affiliated investment funds that invested in mortgage-backed securities and other risky assets. Citigroup once boasted about its big presence in such funds, but now is leading the charge to shore them up by creating a single big fund to buy up their assets. The dismal news adds to pressure on Chief Executive Charles Prince, who had declared 2007 "the year of no excuses." Yesterday, he said, "This quarter's performance was well below our expectations and, frankly, surprising." Unexplained Mysteries: Why Chuck Prince Still Has A Job, Citigroup turmoil turns spotlight on Rubin

GM job costs to plummet 75% of plant workers may retire by 2011; hires may get half as much pay. General Motors Corp. says its new labor pact with the UAW will slash labor costs by allowing the automaker to eventually replace up to three-quarters of veteran factory workers with lower-paid new hires who won't get costly retirement benefits promised to their predecessors. Speaking on Monday for the first time about the contract, GM said 56,000 of 74,500 blue-collar workers could retire by 2011. Many replacements will fall into a second-tier of lower-paid jobs created by the deal. They'll start at $14 an hour -- half the current average wage -- doing jobs outside of core assembly line work, from operating a fork-lift to maintenance to moving finished vehicles. About 16,000 jobs are considered noncore, but GM said the contract allows it to shift significantly more to the lower tier as workers retire. Even if new hires move into higher-paying jobs, GM won't pay medical bills in retirement, instead contributing to a 401(k) plan. The changes, which will likely be adopted in some form by Chrysler LLC and Ford Motor Co., will all but bring an end to lifelong health care and rich starting wages guaranteed for generations.

·         Stylish Sedans The everyday family sedan is undergoing a transformation from stodgy to stylish as drivers begin to demand more from their basic transportation than a nondescript appliance on wheels. Some call it the Target effect, after the budget retailer that has successfully applied costly looking design and style to inexpensive commonplace items from soap to sofas. Now, car makers are following suit with their mass-market midsize sedans, which have long sold in high volume despite their decidedly unstylish looks.

Delta CEO Says Consolidation Possible The chief executive of Delta Air Lines Inc. said Tuesday that the carrier wants to be the "undisputed leader" in the industry and that a deal with another airline may be in its best interest. Anderson noted the consolidation of the airline industry and said he expects that trend to continue. He said he believes Delta's financial improvements could make it a player. Atlanta-based Delta fought during bankruptcy to fend off a hostile takeover bid by Tempe, Ariz.-based US Airways Group Inc. But since exiting bankruptcy on April 30, the airline's executives have seemed open to the idea of consolidation with an airline in the future. Delta has indicated before that if it was involved in consolidation, it would want to be the acquirer. Anderson hinted at that again Tuesday when he said that consolidation would make sense to Delta if it was done from a position of strength and in the long-term best interest of shareholders.

Is This Big Tech’s Last Big Quarter?  Tech giants IBM and Intel posted strong quarters, but can they keep it up? Expect the shift toward services to continue, as it looks like companies are going to cut back on hardware and software. Over the last few days, this blog has started to see signs that businesses may slow their tech spending in 2008. A Goldman Sachs survey of 100 information-technology managers found that these people expect tech spending to drop 1% next year. And the research firm Gartner recently advised clients to prepare an alternative budget that anticipated spending cuts. The continued shift in IBM’s business away from hardware and software — the two areas that would be most affected by smaller IT budgets — and toward services — which companies sign up for in order to cut costs — bodes well for IBM’s ability to weather the storm, if it comes.

Why Google, Apple, Dell, others may not be what they appear. Herd mentality drives me nuts, especially when it involves "technology stocks" as if one size fits all. It often is a categorization that is as arbitrary and blurry as the line can be between value and growth stocks. That is simply the way Wall Street works, especially when any sector comes into favor, as tech has been in recent months. But that also raises the question: What really is a tech stock? Broadly defined, high-tech is anything having to do with telecommunications, semiconductors or personal computers. But that can be misleading, which is why former hedge-fund manager, tech analyst and all-around out-of-the-box thinker Andy Kessler likes to take it a step further to say that to be considered bona fide tech, a company must spend "some exorbitant amount on research and development" resulting in products that more than pay their own way. The easiest way to figure that out is to look at gross margins and the amount spent on research and development relative to sales. On both counts, the higher the better.

• IBM Net Income Advances 6.3 Percent on Service Contracts, Software Sales International Business Machines Corp., the biggest computer-services company, said third-quarter profit rose 6.3 percent on new contracts and software sales.

• Yahoo Profit Beats Analysts' Estimates on Advertising Growth; Shares Surge Yahoo! Inc., owner of the most- visited U.S. Web site, reported third-quarter results that beat analysts' estimates, signaling that acquisitions and new advertising software may be spurring growth

Intel Share Rise May Slow Unless Otellini Widens Profit Margins on Chips Intel Corp. Chief Executive Officer Paul Otellini has delivered what he promised investors in 2006. The world's biggest semiconductor maker has regained market share lost to Advanced Micro Devices Inc., cut jobs to help shave $1 billion in costs, and introduced faster computer chips on time. Yet Intel's gross profit margin remains 10 percentage points below the average of the past 10 years. Unless Otellini can narrow that gap, he may not sustain a 26 percent rise in Intel shares this year, the seventh-best performance in the Dow Jones Industrial Average.

• Intel Soars; Did Customers Overorder? Orders for microprocessors are outpacing shipments of computers, leading some analysts to worry about Intel's outlook despite its falling capital spending.
• Intel Earnings Rise 43 Percent as Laptop Sales Spur Demand for Processors Intel Corp., the world's largest semiconductor maker, said profit rose 43 percent after sales growth topped 10 percent for the first time in two years on demand for laptop-computer processors. The shares rose.

Ericsson Falls to Three-Year Low as Profit, Sales Miss Company's Forecasts Ericsson AB, the world's biggest maker of wireless networks, dropped as much as 30 percent to a three-year low in Stockholm trading after saying third-quarter profit and sales trailed its forecasts. Ericsson didn't get expected orders to upgrade AT&T Inc.'s wireless network in the U.S., Svanberg said. The company has won contracts for new networks in China and India that carry lower profit margins than upgrading existing networks in Europe and North America. Svanberg became CEO in April 2003 and stepped up the pace of cost reductions, pulling the company back from near bankruptcy. Ericsson, founded in 1876 when Lars Magnus Ericsson opened a repair shop for telegraph equipment, slashed more than half its workforce between the end of 2000 and mid-2004 as customers reined in spending. Under Svanberg, Ericsson has reorganized into three business divisions that sell fixed networks, wireless networks and multimedia applications such as Web-based television broadcasting.

Kindler Fails to Offset $21 Billion in Sales Pfizer Will Lose to Generics Pfizer Inc. is promising investors that acquisitions and quicker drug discovery will replace $21 billion in annual sales it will lose to generic competition. So far, there is no evidence either strategy is succeeding. Pfizer, with more cash and short-term investments than Chevron Corp. or Google Inc., may report tomorrow that revenue fell for the second straight quarter. Chief Executive Officer Jeffrey Kindler has yet to make a purchase large enough to replace products, responsible for almost half of Pfizer's 2006 sales, that are losing patent protection. ``McKinnell and his management thought they could acquire their way out of the problem, and none of those deals worked,'' Fisher said. ``The company wasted so much capital over the last few years it is embarrassing.'' Pfizer has also had research setbacks with products it acquired through collaborations. This year it ended development with Coley Pharmaceutical Group Inc. of a lung cancer treatment, which some analysts predicted might have generated about $800 million in annual sales. The company spends more than $7 billion a year on research. Kindler has said the company will start selling four new internally developed drugs by 2011, though he doesn't identify which products. This year Pfizer has had only one new drug approved in the U.S., the AIDS drug Selzentry. The company has just three internally developed drugs in the late stage of human testing. One of them, an obesity drug, may have trouble winning U.S. regulatory approval after a similar medicine by Sanofi-Aventis SA was rejected by U.S. regulators this year.

Pfizer Inc.'s decision to shelve a novel insulin inhaler and take a $2.8 billion pretax hit on the product -- one of the drug industry's costliest failures ever -- rids the company of an albatross. But it suggests the risks Chief Executive Jeffrey Kindler and other industry executives face as they steer makers of traditional pills more deeply into biotechnology drugs.

·         Insulin Flop Costs Pfizer $2.8 Billion The world's largest drug maker by sales said it is pulling Exubera, a biotech medication that offers diabetes patients an alternative to injected insulin, after the product recorded a disappointing $12 million in sales this year, in part due to concerns among doctors about its long-term safety. Earlier the company predicted the drug would be a $2 billion-a-year product. Drug companies often cancel drugs during human trials, and occasionally after they go on the market if there are any red flags about safety. But to pull a new drug from the market because it didn't sell -- in the absence of a red flag -- is almost unprecedented. "This is one of the most stunning failures in the history of the pharmaceutical industry," said Mike Krensavage, an analyst at Raymond James & Associates. "I hope it would give Pfizer pause about buying any more assets." During a conference call with analysts, Mr. Kindler said yesterday that he would take a hard look at how his company could have made such a mistake, which contributed to a sharp decline in the company's third-quarter earnings. "We will, of course, evaluate closely what happened here," Mr. Kindler said. He added, "When I started this job it was clear that this business needed to be fixed in a lot of ways."

Posted by dblwyo at 11:27 AM | Permalink | Comments (0)

Having reviewed last week's news and built-up a little framework for thinking about the four engines in earlier posts it might be time to take a look at what the charts are telling us. Just to review the bidding now we argued that the four engines were Structure, Fundamentals, Technicals and Outlook. And that Structure was sputterring on a bad carburator while Fundamentals had been feathered and were windmilling after being hit by the flak guns. So it remainds to look at Technicals (at least within my limited grasp) and Outlook.

Looking at the chart it would seem that the Fed's cut restored a very positive outlook but we appear to be topping out a bit, at least on the NYSE. The short-term argument looks to be whether or not we'll settle on 10,000, bounce up or continue on down. Duh...but if it breaks the next stop on the way down is around 9500-9600 (approx. 1500 on the SP500) on the 3Mo chart. Interestingly the 1Yr Chart comes to about the same result with 9500 being where there appears to be some support. So if markets ignore all the deeper warning signs but break below 9500 is the interesting dilemma. If they stop around 9500 that might be a short-term trading opportunity; at least until the next crisis. The top sub-chart is a daily chart and shows MACD definitely headed down but the bottom chart is a weekly chart and only shows things loosing a bit of steam.

Sentiment and psychology would still appear to be pretty positive. Certainly on the Tech and Emerging Markets side of things. 

If we take a deeper dive into the S&P sectors the story gets more interesting. As usual though notice that despite differences and divergences both sectors and foreign markets are still moving pretty much synchronously with the "core" market. In other words liquidity, technicals and psychology is driving things (so much for Portfolio Theory). As you'd expect though from the economic outlook the sectors are dividing into two groups. In the first Finance(XLF) and Con. Discretionary(XLY) are doing relatively poorly and Healthcare (XLV) and Staples (XLP) are doing about as well as the SP500. On the other side Utilities (XLU), Industrials (XLI) and Technology (XLK, IYZ) are doing better. And Energy (XLE) is just running away from everybody, as you'd sorta expect. The question's to explore then is why are XLK and XLI doing well. Energy reflects long-term structural trends with supply-demand imbalances and should be a good bet for years.

At the same time we broke out of the 3-year trading range last fall there was an inreased sectoral divergence that's continued to widen. This is even more pronounced when you look at international markets. While Japan (EWJ) lags on a deteroriating economic outlook and small-caps as well, Europe (IEV) is doing as well as Technology. That's largely based on continued strong outlook for restored European growth. But also like Tech one has to ask how well grounded that is in reality. There are signs within the last couple of months that the European economic outlook is deteroriating as well. On the other hand accelerating weakness in the dollar and growing interest rate differentials will make it easier to invest abroad.

But the real story is in Emerging Markets (EEM), especially Asia - read China (EPP) which are running farther ahead of everyone. Even more so than Energy among the sectors. And if you look at the differences that began in the Spring that divergence is both widening and accelerating.

Depending on how things work out a downturn that's arresed is likely to a very good speculative trading opportunity. Certainly anybody who bought into Emerging Markets after the Aug. downturn has been extremely well-rewarded. And as long as that frothy Outlook holds dips will offer similar trading opportunities. On the other hand looking at these charts the only word that comes to mind is BUBBLE.

The question is not if it will burst but when ? And will there be any warning signs ?

Well that wraps up our market survey and short-term assessments/outlooks but it certainly leaves some interesting questions on the table. Including the worldwide economic outlook, the impact of continued dollar weakness and the bubbling of EM's. It also raises the question of why Tech is diverging so much from the rest of the market ? After all if the economy is slowing so will Capex spending; and the last time I looked nobody invests heavily in new equipment when demand is decreasing.

Interesting times for sure ! :) 

Posted by dblwyo at 10:46 AM | Permalink | Comments (0)

We'll have to see how the various themes play out over the next few days and several weeks. There's a couple of ways to think about this but one analogy I've heard (BigPicture, Minyanville, et.al.) is to think about the market as being lifted by four engines. But unlike a big jet the theory being that all four need to be providing power. Of course what are the four engines is a bit open to question and definition ( Disturbing Trends: Dividends & Earnings):

" Over the past few years, I have noted (repeatedly) that despite record earnings (Quarter after Q of double digit year-over-year gains), increasing dividends, M&A activity and rich Share buybacks, stocks have been very rangebound. The analogy I favor is that each of those four items are an engine of a 4-engined plane. With all four spinning mightily, most indices are about where they were (give or take a percent) 2, 3, or 4 years ago. Only the Dow is above its 2,000 highs.The danger of this four engined craft is that if any of the engines fail, the plane can be expected to lose altitude. Not crash into the mountains in a fiery conflagration, but seek a lower altitude before regaining stability."

 Todd Harrison of Minyanville ( Measuring the market action that props up profits ) likes to look at his four table legs of Technicals, Psychology, Fundamentals and Structure (i.e. Dollar devaluation vs asset deflation). Actually there's a lot to be said for each. And they both make a good checklist of things to think about. Now Todd's column is very recent while Barry's is from lact Oct. which gives us another perespective.

I've also heard the four factors listed as Fundamentals, Technicals, Sentiment and Pscyhology so if we're not careful we'll end up with a 4 X 4 X 4 array of factors - which sounds intriguing but a little hard to work with. Maybe a little simplification and synthesis might be in order ? First off, we're all pretty agreed that Fundamentals are important and they're based on earnings which is in turn based on company performance and the economy.

Structure is a little hard to understand, at least for me but makes some sense after a while. In this case Barry's other three engines (Dividends, Buybacks & Buyouts) all seem to be related to a structural situation of high liquidities, credit and leverage; as well as low demand for investment in capital and hiring. At least we made that argument at some length in an earlier multi-part look at the situation ( Liquidity, Buyouts, Buybacks ) which might be another look to see if the argument works for you. Briefly we're in a world where low-growth lowers demand for investment while still throwing off lots of excess cash, further compounded by trade and foreign exchanges balances and petro-fund re-cycling. That's also a low-return world where excess investible funds chasing too few good opportunities leads to a desperation for higher returns and voila' ! The world of structured debt, leverage, CDOs, etc. etc. is called into being. A world which is still with us but increasingly thretend by mechanical breakdown.

Sentiment and Psychology makes sense to me but to some extent seem to be synonyms. On the other hand if we few sentiment as the outlook on things, in other words do we expect things to get better or worse remain the same or become more uncertain then we could view Psychology as the willingness to take risk or not, tolerance for ambiguity and uncertainty and so forth. But that almost brings us back full-circle, doesn't it ?

So it seems to me that a worthwhile checklist is Structure, Fundamentals, Technicals and Outlook (Sentiment, Psychology). Given that my original and primary interest was only in the hard, longer-term facts of structure and fundamentals admitting Technical issues took me a while. Yet the last several years, especially, since Barry's post form last Oct., certainly leaves the importance of Sentiment, at least in the short-run, very clear.

Somehwere in his large collection of pithy aphorisms based on insight and experience the Great Keynes said, among other things, something to the effect that "...markets are like musical chairs and when the music stops everyone rushes to find a seat. Except some of the seats get taken away... and what you're really doing is betting on which player will find which seat".

He put it much better than my paraphrase of course but that's the essence, to the best of my recollection. It also strikes me as powerfully useful and a good reminder. Just to really keep stretching the metaphor perhaps Structure = Chairs, Fundamentals = Chair presence, Technicals = Music and which players grab after which chairs = Outlook ?

About the time that Barry wrote his column the markets generally took off after spending the better part of three years (or more) being range-bound. At the same time we could see the Economy beginning to slow (at least in our analysis, more recently and now moreso). On the Structural side of things the deep & hidden risks in the credit markets (their roles in market demands & dynamics are in the Buyout and Buyback posts which agree pretty well with Barry's stance) became somewhat apparant this summer with the Bear blowup. Or did it - some commentators were issuing pretty serious warnings in the Winter ( a Lurking Debt Bomb ) and the Shanhai Surprise was another canary as well. But the Technicals have gotten nothing but "better" since last Fall, though volume and other indicators have gotten weaker. And several key markets, e.g. Emerging Markets, Technology, et.al. have been running ahead of even the more staid S&P and NYSE.

So if Fundamentals are deteriorating, Structure is increasingly unfavorable with a combination of increased credit risks and unknown (unknowable ???) values and the markets have headed up out of their trading range what's left ? Sentiment and Psychology would seem, by elimination, to be driving the chariot, wouldn't they ?

Based on the expectation for earnings next year, especially in Tech. Yet one has to wonder about that as well. ( Dr. Pangloss Treating Goldie; Tech, Tech, Who's Got the Tech...) . You're free, of course, to reach your own conclusions but it sure looks to me as if things are getting more than a little forthy - being driven more by momentum and positive psychology combined with a very sanguine sentiment than basics.

In the short-run though it seems to me that you'd want to let long bets ride, see how the markets behave and if we get some clarity but not make any major new long bets unless you're willing to let 'em ride for quite awhile (like years !). 

Posted by dblwyo at 08:04 AM | Permalink | Comments (0)

Well last week was definitely interesting - in any sense of the word you'd care to apply. All the major indices (Dow, SP500, NYSE, Nasdaq) basically lost almost 4% on the week despite the prior week's spectacularly runup in the Dow. Four things seem to have been at work and are worth considering, for themselves and what they mean: Oil, Earnings, Housing and SIVs. The proximate "trigger" of Friday's selloff was the poor fundamental earnings outllooks by core companies such as Catepillar. But Cat wasn't the only company to have had a less than sanguine outlook on the economy over the last few months. The runup in Oil futures to over $90 certainly didn't help though it looks like the run, created by fears of Turkey going into Northen Iraq - the Kurdish region - to attack Kurdish terrorists finding safe havens is tapering off.

The week started though with key speeches from Bernanke and Paulson both of whom admitted that the economic outlook was for "less than potential growth" (that's jargon for a) 1-2% growth and b) means that employment and the outlook are weaker than expected) thru '08 and on into '09. And that the Housing downturn was lasting longer than anticipated, had much longer to go than originally thought and was the biggest downside risk to the moderate slowdown.

Now reality still hasn't set in on the street - if the economy is going to grow at 1-2% it's going to be challenging to say the least to keep growing earnings yet the Street still seems to be building double-digit earnings growth into the '08 outlooks.

The other big thing was the announcement at the beginning of the week for a consortium of big banks to create a "super-fund" to invest in existing "Structured Investment Vehicle" funds of those same banks. Insofar as I understand it a SIV is an off-balance sheet artifical asset made up of slices of various loans, e.g. sub-prime mortgages, and leveraged up thru borrowing. The banks are afraid that they'll have to mark those to market and get 50 cents on the $, or 25 or 10 when obviously they under- Lying assets are worth much more. Yeah, right.

You'll find this all discussed in much more detail in the readings below but this week will be interesting indeed. For my money (literally) we've see the tip of the iceberg on the unknown, over-valued and illiquid credit risks floating around. After the 50 basis point Fed cut everybody though the problem had gone away. It turns out that not only hasn't it but the whole SIV-bailout notion tells us there's a lot more ugliness hiding out there.

So we're back to the Big Three: the economy's been slowing for a while now (we've been in a growth recession only nobody's admitting it), housing is a slow-adjusting market and we're just really beginning to get a solid glimpse of how bad it's going to be and how long it'll take to work out. And the risks to market mechanicals from another credit seize up haven't gone away and the chance of its' spreading to impact the real economy are higher than anybody admits - as measured by what's being priced into things.

General & Special

Weidner wonders who'll clean up Street Today's credit crisis has the feel of kids playing football in the house. Everyone is having a good time until the ball goes through the window. It almost doesn't matter who threw the ball -- Citigroup Inc., subprime borrowers or lenders, big banks, the leveraged-buyout guys, ratings agencies -- everyone was doing something they shouldn't have. Here's one problem with this plan: If you follow the money, it doesn't make much sense. Start with a mortgage. It gets packaged by an investment bank into a collateralized debt obligation. That CDO is then sold to an SIV. The SIV is funded by a bank, investment bank or another industry lender. It could be the same bank through the whole process. At the minimum, it's a limited group of players.Now, our original loan and others have gone bad, which means the CDOs have gone bad, which means the SIVs are in trouble. The industry's answer to this is to create yet another investment company to buy the good assets from the SIVs. That suggests there's a fire. Banks and other financial institutions, including Fidelity Investments, are reluctantly stepping forward in the effort even if they're in the camp that didn't set up SIVs or don't have a load of CDOs on the balance sheet. This mega-fund is not only the plan of the moment; it also appears to also be the best plan out there. Unfortunately, it won't stop the losses. Even if SIVs can fetch top dollar by selling good assets, the junk that was bought on borrowed money is still worthless. "To properly solve the liquidity problem, the sponsors of the SIVs are still going to have to take losses," said Gerard Cassidy, an analyst with RBC Capital Markets. "To try to get out of this by papering over the losses is not going to work." Analysts are becoming more convinced that the recent write-downs on Wall Street are the first in what will be a series of charges that banks will take during the next few quarters. Morgan Stanley's vice chairman suggested Monday that the profits made from the buyout boom will be washed away in the fallout.

Markets & Investing

Plan to Save Banks Depends on Investors The planned bailout of bank-sponsored lending vehicles is an attempt to build confidence in a part of the credit markets that remains largely frozen in the wake of this summer's debt-market turmoil. If investors can be persuaded credit-market problems are under control, it will save the banks from having to take big hits to their reputations and their balance sheets. It also would prevent the recent financial tremors from spreading through the overall economy in the form of a new credit crunch. Ironically, by working with the U.S. Treasury Department to develop the plan, big banks such as Citigroup Inc. are admitting things are bad and that their options aren't pleasant. Investors appear more than willing to focus on the positive. In the past few weeks, they have applauded as banks and investment houses took about $20 billion in losses related to their exposure to troubled mortgages and leveraged loans, bidding up financial stocks and sending U.S. stock markets to record levels. The risk is that the plan ultimately requires the implicit cooperation of investors. If they get more frazzled, rather than calmed by the bailout, debt markets could tumble further, potentially making the plan more expensive and risky.

·         Rescue Readied By Banks Is Bet To Spur Market, Big Banks Announce Plan To Bolster Credit Market, For Paulson, Help on Credit Crunch Carries Risk, A Bailout for Citigroup?

It’s Not a Bailout. It’s ‘Financial Engineering.’  Let’s see if we have this right: funds set up to make money on illiquid securities are causing some problems for large banking institutions, so in response, the banks — including some of those smart enough to avoid such vehicles — are all getting together to make an even larger fund to buy all of this stuff. As the Wall Street Journal has pointed out in a handful of stories, there are these off-balance sheet structured investment vehicles (SIVs, not SUVs), set up to issue short-term debt and invest the proceeds in things like mortgage-backed securities, which have seized up as investors have run away from the risk thanks to the downturn in the housing market. These SIVs are still struggling to issue paper, the FT.com pointed out last week. So in response, the banks have created a single master liquidity enhancement conduit, or M-LEC, a sort of golem-like entity that may or may not resemble the Master Control Program from the film “Tron.” The Entity, as it will be known in MarketBeat, will agree (because as an entity, it has no free will) to buy up this debt to help restore these markets. The Entity should work swimmingly, unless, of course, investors in the debt markets become more nervous as a result of what is a tacit admission by the banks that things aren’t going so well. At the moment, the 10-year Treasury note is down 6/32, to yield 4.71%, so that reaction has been limited.

• Paulson's Commercial-Paper Rescue Is Jeered by Champions of Free Markets
• 'Enron, Subprime and the Derivative Disease', October 16, 2007 That Treasury Secretary Henry Paulson is leading efforts to organize an $80 billion or so pool of private capital to finance four times that much in illiquid subprime assets controlled by some of the largest US banks is not a good sign. Looks to us like a prelude to a federal bailout. Led by names like Citigroup (NYSE:C) and JPMorgan (NYSE:JPM), the supposed "super conduit" seeks to make attractive assets which now seem dead orphans. A number of banks and other dealers are increasingly illiquid and face losses on supposedly off-balance sheet conduits or structured investment vehicles ("SIV"), losses that in extreme cases could damage their solvency. Thus Hank Paulson is back in deal mode, but this last minute window dressing may be too little too late to stop the inevitable market based resolution. Orchestrating the pooling of hundreds of billions worth of illiquid assets into a single conduit strikes us as a bad move. In analytics, we call such proposals a "difference without distinction." Instead of seeking to restore the abnormal and manic market conditions that prevailed in the world of structured finance prior to Q2 2007, we think Secretary Paulson and his Street-wise colleagues should be trying to reach a more stable formulation.

·         Signs the credit crunch is over Careful optimism about the U.S. economy and financial system has given way to a resurgence of unease in the last couple of days, prompted by an announcement Monday of an extraordinary plan to pump liquidity into an important part of the debt markets and less-than-upbeat speeches from Federal Reserve chairman Ben Bernanke and Treasury Secretary Henry Paulson. Suddenly, the credit crunch is being talked about as a serious phenomenon again. But, as is always the case on Wall Street, it won't be long before a gaggle of self-interested players make their way to center stage to tell us that recovery is just around the corner, seizing on any halfway optimistic shred of data to bolster their case. So, in an effort to stay grounded amid the hype, it's worth making a shortlist of things that need to start happening before anyone can talk about the credit crunch coming to an end.

Boeing bends the plane truth Whether it's self-delusion or something worse, Wall Street seems more determined than ever to stretch the truth. Two examples: Boeing's predictions for its new airliner and big banks' self-serving bailout schemes. The plan is somewhat similar to an entity created by the New York branch of the Federal Reserve after the demise of Long Term Capital Management hedge fund back in 1998 -- but with a key difference. Back then, the Fed was dealing with a single broken hedge fund that had foreign government bonds that were largely liquid and easily priced. In this case, the superfund would deal with thousands of illiquid, exotic debt derivatives whose value will be a matter of great debate. Although that $80 billion sounds impressive, it doesn't actually represent any cash; it's just the value of the bad paper that this entity would initially obtain at discounts. The notion that the banks, who are archrivals, will agree with each other or their European counterparts on how to realistically price the securities -- a process known as "marking to market" -- is absurd on its face and countermands everything we think we know about how market participants act independently to determine values. And the idea that the Treasury is proposing to have some kind of unprecedented role in this charade is mind-blowing. Normally the government would prevent companies from conspiring in this fashion due to suspicions they will serve their own interests, not those of the securities' owners. The fact that the Treasury has stepped in at all is a stunner because banking-system matters are usually handled by the Federal Reserve, which presumably wants nothing to do with this anti-capitalist craziness. Das figures that the banks are teaming up for a reason much different than the one stated: to prevent the securities from being sold at a discount on the open market, pushing down prices on other securities to which they are linked and causing significant losses throughout the food chain. He points out that such losses would require prime brokers -- who provide funds to hedge funds -- to revalue collateral held against loans, triggering margin calls on already cash-strapped investors.

U.S. Investors Face Age of Murky Pricing Since the invention of the ticker tape 140 years ago, America has been able to boast of having the world's most transparent financial markets. The tape and its electronic descendants ensured that crystal-clear prices for stocks and many other securities were readily available to everyone, encouraging millions to entrust their money to the markets. These days, after a decade of frantic growth in mortgage-backed securities and other complex investments traded off exchanges, that clarity is gone. Large parts of American financial markets have become a hall of mirrors. Such pricing problems have become common in some of Wall Street's biggest markets. The burgeoning universe of complex securities based on mortgages and other assets has turned the once-simple task of getting a price quote into a confounding undertaking. Today, "way less than half" of all securities trade on exchanges with readily available price information, according to Goldman Sachs Group Inc. analyst Daniel Harris. More and more securities are priced by dealers who don't publish quotes. As a result, money managers can no longer gauge with certainty the value of some assets in mutual funds, hedge funds and other investment vehicles -- a process known as marking to market. An official at the Securities and Exchange Commission said recently that some bond mutual funds might be using outdated or unrealistic prices to value their portfolios. The growing uncertainty over what assets are really worth could wreak havoc on the efforts of both individuals and money managers to invest rationally. During this summer's confusion over bond valuations, for example, it was especially difficult to know whether to buy or sell. Investors forced to fly blind sometimes resort to panic selling, which can produce wild swings in the markets.

·         Goldman's questionable quarter Much of the bank's spectacular third quarter earnings were paper gains from financial instruments that Goldman values largely according to its own estimates

Accountants' Hard Line This time, the auditors don't seem to be backing down. After losing public confidence over their failure to warn investors about scandals such as those at Enron Corp. and WorldCom Inc., accounting firms are taking a hard line when it comes to questions that have arisen from the credit crunch. In recent weeks, the accounting firms, operating through a new industry group, have taken views at odds with at least some of their clients about the use of market prices for hard-to-trade securities and over how banks should deal with their exposure to losses in off-balance-sheet lending vehicles. This has prompted financial firms to recognize losses in securities that they may have otherwise put down to short-term disruptions in markets. It also prompted, at least in part, moves by large banks and the Treasury Department to bail out structured investment vehicles, or SIVs, which are special lending vehicles that banks keep off their books. The firms' unyielding stance has pleasantly surprised some longtime critics such as Mr. Turner, who add that auditors seem to have stood firm on proper -- yet unforgiving -- accounting treatments despite the severity of the problems gripping the markets. The auditors' group, for instance, said companies have to use market prices no matter how depressed they are and can't argue that they should be ignored because they represent a fire-sale valuation.

Bookstaber Asks: Where Were the Risk Managers?

What a mess. With multibillion dollar trading losses, we are starting to see heads roll. Citigroup is losing its longtime fixed-income head Tom Maheras and several of his lieutenants. Merrill is continuing in its approach to managing human capital, bringing in new blood and losing experienced hands in the fixed income business. Oh, and they are putting someone into a Chief Risk Officer role. Talk about closing the barn door….  Other firms have fared very poorly but so far without executing any of the troops. Morgan Stanley layered a heart-stopping $390 million one-day loss in its proprietary trading desk on top of far bigger losses on leveraged loans and the like. This loss in Process Driven Trading was similar in timing to the losses at Goldman’s Global Alpha fund, AQR and other quant hedge funds. Which pretty much tells us that what this secretive group at Morgan Stanley was up to was a not-so-secretive strategy: They had a lot of capital riding on the same sort of momentum and value versus growth quant equity strategies as the rest of the gang. What I don’t understand in all of this is that for all the mention in the press of the risk takers, there is not a single mention I have found of the people who are supposed to be overseeing the risk. If you are the Chief Risk Officer and everything blows up, don’t you bear some responsibility? To get the idea of the CRO job, let me tell you a bit about myself. Although I am older and have a slight build, I am an Olympic athlete. My event is the shot put. I consider myself a top notch athlete in this event. I work out like the other competitors, follow a high protein diet, steer clear of performance enhancing drugs and train at the local track. The only trouble I have is when the Olympics roll around every four years, because it turns out that for an Olympic athlete, I am not very good. But then, that is only an occasional blip in my otherwise Olympic-worthy regimen.

In the CRO job 99% of the days there is nothing going wrong. The only test you get of how well you are doing – short of pouring out risk reports and looking ponderous and prudent in meetings – is what happens to the firm during times of market crisis. Every few years something calamitous happens in the market; if the firm gets blown away, that suggests you did not do a very good job. What about the job of the risk taker? Well, a risk taker does, after all, take risk. He tries to do so intelligently, that is, he tries to put on positions that he hopes have a high return per unit of risk. But how much risk he takes and where he takes it has to be dictated by someone. You can’t just say “take risk, and good luck.”  The job of the risk manager at these firms is to convey the risk parameters to the risk takers, to define the boundaries. And that should involve more than simply running a value at risk calculation on the computer. If that is all you want, you don’t need a guy making a few million a year and employing a staff of hundreds. Before I would be so harsh on Tom Maheras and his compatriots, I would be calling to task the people who allowed that risk level to be taken in the first place.

Posted by dblwyo at 07:26 AM | Permalink | Comments (0)

Earlier this week Herb Greenberg had an interesting Marketwatch colum on just exactly what is a technology company that's not only worth reading but even more worth thinking about. And then perhaps comparing and contrasting to Fleck's most recent jeremiad where he trys to focus on profits, earnings and margins for real.

Herb borrows and advances the argument that you need to look at R&D spending and gross margins, which is useful, but only a start and can be more than a bit mis-leading. My argument would be that you need to look at the consequences to that spending in terms of sustainable income and continuos innovation. Which is, btw, really hard work to dig into. But at the end of the day the ability to invest in R&D, translate that into products and sell those products for an above-average profit because you've focused on delivering value is the real set of things to look at. So as you're looking at the excerpts and links below check out the accompanying 3-month chart and ask yourself - is that NDX runup based on sustainable profitable products or not ? Or is it just a momentum play ?

To start with Mr. Greenberg here's what he had to say:

Why Google, Apple, Dell, others may not be what they appear. Herd mentality drives me nuts, especially when it involves "technology stocks" as if one size fits all. It often is a categorization that is as arbitrary and blurry as the line can be between value and growth stocks. That is simply the way Wall Street works, especially when any sector comes into favor, as tech has been in recent months. But that also raises the question: What really is a tech stock? Broadly defined, high-tech is anything having to do with telecommunications, semiconductors or personal computers. But that can be misleading, which is why former hedge-fund manager, tech analyst and all-around out-of-the-box thinker Andy Kessler likes to take it a step further to say that to be considered bona fide tech, a company must spend "some exorbitant amount on research and development" resulting in products that more than pay their own way. The easiest way to figure that out is to look at gross margins and the amount spent on research and development relative to sales. On both counts, the higher the better.

Definitely worth reading but there are several major problems with taking it to far.

Having commented on the column let me quote myself:

A useful set of distinctions and metrics that are also worth kicking around - for one thing if the folks putting money into tech think it's tech then it is; at least from a short- and intermediate-term market view. On the other end of the spectrum the test being proposed here is that relative magnitude of R&D investment in overall spending. By that measure the two really dominant technology industries are Pharma and Aerospace where one should really run two P&Ls. One on the research side and the other on the operations side, linked by the capital asset acquired by the latter from the former. This is really an important distinction - for example the troubles of the Pharma industry are really aging, maturity and failures of it's R&D effectiveness and the need for new approaches. On that path when Boeing or Airbus make a bet on a new plane it's "bet the company time". The B747 gamble almost destroyed BA while the AB380 may destroy Airbus if the hidden assumptions about the structure of the travle market don't work out. If you're wondering what hidden structures those are things an investor should learn.

Back to more traditional companies normally referred to as tech why restrict it to PC's - IBM still dominates the worldwide server market and wraps a lot of very sophisticated software around it to sell it and services around both (btw in the name of digging into details while share of revenue is different share of profit is balanced across the three). Hiding in here are two other distinctions that are really hard to dig out of the normal financials. One is the role of technology; as pointed out above Apple as measured appears to be non-tech, or a hybrid, yet technology innovation is the driving engine of who and what they are. But it's also fair to say that innovation is driven by design-awareness and value focus on the customer.

A 2nd and related distinction is how effective is the R&D component - that is how much usable product and process innovation results from that l.t. investment ? IBM spends enormous sums on R&D which has resulted in great strides in chip technologies and a reputation for innovation yet it hasn't been able to create any new major sources of revenue or growth in over a decade. As a real case in point look at the development investments of the car companies who are extraordinarily large spenders. But what have they to show for it.

So while I applaud the effort and the results I'd also suggest there's a lot more too it. It seems to me the first test is not necessarily the magnitude of R&D - thought that's a nice starting screen - but the fundamental question of how R&D fits into the company's overall strategy and structure. Then one can ask how effective is it in terms of innovation and how effective it is the marketspace and ultimate on revenue and profits. This means really having to dig into the fundamentals - bear in mind, using BA as an example again, the roots of the B787 go back 1-2 decades in terms of design tools, manufacturing processes, materials and so forth.

Unfortunately I don't know any good places to turn to get that kind of information for investors.

Posted by dblwyo at 03:27 PM | Permalink | Comments (0)

Earlier we took a kinda deep dive on inflation and found that for both CPI and PPI, as well as for Core and Total (i.e. including food & energy) things were fairly benign.Fighting the Wrong Fight: Inflation Real & Imagined

In other words the YoY% change in each didn't indicate any big uptick in inflation. What we did find that was alarming was that over the last couple of years there's been a wide and accelerating divergence between CPI and PPI. Which indicates two strategically important things:

1. As the divergence continues the pressure on profis and earnings will increase thereby lowering the outlook for business performance and, this being a rational world for the sake of discussion and posting, stocks have an increased risk.
2. And the chances of PPI increases, particularly with China making a major structural shift from an exporter of deflation to an exporter of inflation, the chances of the PPI growth spreading to consumer prices increases. And of course the recent re-accleration of oil prices just adds fuel to that fire (sorry, pun unintended but left because it amuses me anyway).
   

You can see all these points in the accompanying chart which shows the YOY changes as being benign and apparantly downtrending but the PPI vs CPI gap growing.

One key thing though: notice that the traditional view of core vs total was valid until Jan04. And that the accelerating divergence between PPI and CPI began at the same time. That seems to me that the argument that we're seeing a major structural shift in things because of the changes in the worldwide energy markets might be very well grounded indeed ! 

Having re-set the table, so-to-speak, it was extremely interesting that Uncle Alan made some similar points on CNBC today. And also that Prof. Jim Jubak said something pretty close and they discusses Wall St.'s sanity quotient. You'll have to watch the vids to find out what but you can probably guess. 

What's particularly interesting today is that Uncle Alan was on CNBC (again :) ) and made some rather pithy comments on inflation. First, that the standard assumption that F&E can be excluded because they represent noise may no longer be valid. Let's all stop for a minute and savor that. The second really interesting thing he mentioned was the resulting growing gap between PPI and CPI and the implications thereof.

Greenspan on the Economy, Pt. 2 (Video Here )

 Odds of a U.S. recession are now less than half, according to former Fed chairman Alan Greenspan. He shares his insight with CNBCs Maria Bartiromo

 

Are inflation numbers legit? (Video Here )

Recently released inflation data show a big gap between the core number, which excludes energy and food, and the headline number. But MSN Money’s Jim Jubak says Wall Street is "nuts" to be ignoring recent energy price increases.

Our biggest export: Inflation by Jim Jubak, 10/5/2007

Posted by dblwyo at 02:46 PM | Permalink | Comments (0)

There were a lot of interesting things going on in the business world. Now the context is that we're in a growth recession with housing problems likely to continue and accelerate, but still being under-estimated, so that the chances of a recession are probably in the 30% or better range. At the same time, in this finance-driven (buyouts, buybacks and liquidities) driven environment economic realities are somewhat detached from apparant business performance. Yet enterprise performance is going to be increasingly important because, despite the good headline earnings numbers, revenue and profit growth has NOT been organic, instead it's resulted from financial engineering: Dr. Pangloss Treating Goldie: Markets, Profits & Earnings.

A rather startling finding and one well worth your time to think about. A critical question is what makes a business work (indeed our central concern here) and one partially addressed by recent major-league baseball results where teams with lower payrolls are starting to figure out how to build the right kind of human resources.

But baseball isn't the only industry facing enormous changes in how the industry operates. In fact we are surrounded by "Greek dramas" in many industries. As the gravy train of liquidity thins out the Finance industry is going to have to re-think whether or not it's going to continue to run as it has and major players from Goldman to Merrill to Citi are just starting to face realities, and judged by recent earnings news, not particularly well.

Another tried and true industry going thru an inadvertent re-think is Retail, with Fast Eddy Lampert's Sears all of a sudden faced with major challenges of continuing to rely on financial engineering vs. investing in operational perfomance. That could get very ugly. Earlier last week we started to dig into some of the bigger picture changes with two deeper dives on Retail:

• Thinking About Retail: Product Profitability and Retail Performance

• The Unpopulated Middle: Tesco in the US

  Another industry that's having a great deal of trouble in deciding what it wants to be when it grows up is Technology and below you'll find several interesting articles on Oracle, SAP and enterprise software in general. As important as good IT is to overall enterprise performance yet another neglected area that deserves a deeper level of analysis than it generally gets. Related to changes in Technology, especially Telecommunications, are related changes in Media & Entertainment.

Two other industries where innovation and investment in R&D are critical are the Aerospace and Pharma industries. If you want to talk about Greek dramas the war between Airbus and Boeing is about as good as it gets.

For an overall view of enterprise performance at the industry level take a look at:

On Being a Boiled Frog: the Strategic Outlook for US Industries

There we try to take a very broad brush look at the general performance climate across many industires and what we find/argue is that because almost all industries can provide more capability than customers demand that a) they are facing severe competitive pressures and b) almost all industries are just beginning the kind of long-term workout that the steel industry went thru in the last three decades.

So the Yin & Yang of our argument is that, at the end of the day, enterprise performance really...really matters yet is looking far worse than the multiples being awarded by the market. An interesting thought, no ? 

Special

Homegrown heroes Hired guns once were the way to World Series success. But teams like Arizona Diamondbacks  are saving millions with players they've drafted and trained.For much of the past decade, the key to building a winning baseball team was to open the bank vault and sign a bunch of established stars. Teams pursuing this strategy included the New York Yankees, the Chicago Cubs and the 2004 Boston Red Sox, who won the World Series with a team composed almost entirely of hired guns like Keith Foulke and Manny Ramirez. But amid all the hand-wringing about the corrosive effects of "checkbook baseball," a quiet revolution was under way. This year, the majority of the teams thriving in the postseason are doing it largely with the help of homegrown players. Diamondbacks, Indians, Rockies Learn Low-Budget Winning From Same Teacher

Business

Goldman Record Income Shows New Wall Street in 2007 Credit Market Shakeout Somewhere in the wreckage of securities backed by subprime mortgages and the resulting seizure in the credit markets, is a new paradigm on Wall Street where Goldman Sachs Group Inc., increasingly perceived as the world's biggest hedge fund, will report record earnings for 2007. While Goldman, the largest securities firm by market value, insists that it caters to the needs of clients and has never been anything but customer-driven, New York-based Goldman also is considered No. 1 in proprietary trading and manages more hedge funds than anyone except JPMorgan Chase & Co. And like Paulson & Co., Harbinger Capital Partners and Hayman Advisors LP, which are posting their highest returns when so many conventional financial institutions are reeling from subprime investments, Goldman profits substantially from allowing its traders to use the firm's capital to speculate on whether the price of assets will fall or rise. Goldman may be the most prominent example of the transformation of the securities firm that behaves more like a hedge fund.

CEO Transforms Merrill, at a Cost In nearly five years as Merrill Lynch & Co.'s chief executive, E. Stanley O'Neal has remade America's No. 1 stock-brokerage firm. He has transformed "Mother Merrill" into a more Darwinian, performance-driven organization that puts greater emphasis on riskier bets and relies less on just selling stocks. Mr. O'Neal's higher tolerance for risk has come with a low tolerance for mistakes. He has undertaken periodic -- sometimes brutal -- shakeups of top executives, including one last week. The cultural change has boosted Merrill's profits, with its return on equity, a key measure of profitability, rising to 21.3% from 7.5% in 2002, just before Mr. O'Neal took command. But the metamorphosis at Merrill hasn't come without some heavy costs, as made clear by last week's profit warning and the firm's announcement of a $4.5 billion write-down on its huge inventory of risky securities backed by subprime mortgages. The write-down, which comes just three months after Merrill's finance chief had assured investors the firm's exposure to subprime mortgages was "limited, contained and appropriate," prompted Mr. O'Neal's decision to oust two top executives in the firm's fixed-income business and to order another top executive, who had planned to leave in May but was still on the premises, to vacate his office immediately.

•  Merrill painfully learns the risks of managing risk Last week, risk management hit Merrill in the bottom line. The bank announced that it would take a $5 billion write-down and expected a loss of 50 cents a share in the quarter. Many employees are perplexed by the seeming contradictions. Although prohibited from speaking on the record, investment bankers, traders and financial advisers quietly expressed disbelief, frustration and a bit of self-interested concern over what the write-down will do to their pay. Merrill clearly recognized some shortcomings. On Sept. 10, Edward Moriarty was appointed to the newly created role of chief risk officer. "Ed's promotion reflects the importance of deeper and more comprehensive risk management discipline under a single senior executive," said a memo at the time. What is puzzling, however, is how a problem that management recognized came to hurt the firm so badly. Merrill plans to write down $4.5 billion on collateralized debt obligations and $463 million worth of leveraged loans. In his July memo, O'Neal said the bank was aware of the risks and had taken precautions against them. "Over the last six months," the memo said, "we have worked successfully to position ourselves for a more difficult market for C.D.O.'s and been proactively executing market strategies to significantly reduce our risk exposure."

Citigroup Promotes Pandit; Maheras, Barker to Leave After Credit Losses, Citi's invincible CEO

Mapping Sears' next move Billionaire hedge fund manager Eddie Lampert, who controls Sears Holdings (Charts, Fortune 500), has earned a reputation as a boy wonder of retailing by wringing profits from an aging department store chain. Though that reputation frayed when Sears reported sickly earnings this summer, investors, who have bid up the stock 20 percent from its September lows, are betting Lampert has moves up his sleeve that will soon clear away doubts about the company's future. Assuming Lampert does have a trick up his sleeve, what might he do to wrest more value out of the chain? But the specifics of Lampert's approach to retailing profitability make improvement hard to achieve. Lampert has focused solely on driving down costs, while doing little to drive up sales. That's an implicit recognition that Sears - perhaps because of its outmoded department store model - just can't hope for revenue growth. But overdoing cost cutting may have led to even lower sales, as less promotion and dated stores drive shoppers to Sears' competitors. What metric can investors track to see if this is happening? Very useful is the profit margin that Sears makes on its pretax cash flows from its biggest retail units. In the second quarter, Sears' U.S. operations made $339 million of cash-based operating profits (operating income before depreciation and amortization, a noncash expense), or 5.1% of revenue from that unit. That was way down from $505 million, or 7.2% of revenue in the year-ago quarter. Cash profitability at Kmart, which brings in 35% of revenue, also slipped. In other words, as revenue fell, Lampert and his managers were unable to cut costs enough to sustain profit margins.

Talbots Hires Consultant for Review Talbots Inc. has hired a consulting firm to help executives conduct a strategic review of the company, focusing on brand positioning. In addition to reviewing positioning and expansion opportunities of the Talbots and J. Jill brands, the consultants will look at store growth, productivity, non-core concepts and distribution channels. The work is expected to be done by the fiscal first quarter. Talbots has been struggling amid broader weakness in the women's apparel space. The company tried to improve its prospects with the 2006 acquisition of J. Jill, where sales hasn't been strong. The purchase was seen as a way for Talbots to have a potential growth vehicle.

Hey, Enterprise Software Is Just Way Too Complex for Me! "Enterprise systems were supposed to streamline and simplify business processes. Instead, they have brought high risks, uncertainty and a deeply worrying level of complexity. Rather than agility they have produced rigidity and unexpected barriers to change, a veritable glut of information containing myriad hidden errors, and a cloud of questions regarding their overall benefits. Leaders in computer science are clearly worried. "Complexity is death," says Chuck Thacker, one of 16 technical fellows at Microsoft. "We are hanging on with our fingertips right now." Source: MIT Sloan School of Management, http://sloanreview.mit.edu

·         IT Doesn't Come to the Rescue of Wal-Mart Many still consider Wal-Mart's pioneering, information technology-driven supply chain to be the world's most efficient, and the company's technology standards still command respectful attention from its thousands of suppliers. But the $349bn retailer is stumbling, and IT has played a role in its woes. Source: CIO, http://www.cio.com

Tech Sages Dust Off Bubble Indicators The Fed monitors things like inventory levels and housing starts to gauge the economy's direction. In Silicon Valley, old-timers have leading indicators of their own: The goofy-names index is rising, as is the rate of odd-looking start-ups.

VMware, Microsoft headed for virtual war Fewer technologies in recent years have been able to generate more interest for the corporate market than virtualization, a technology that promises to change how corporations will run their data centers and other business operations. But in an industry where hyperbole is kind, virtualization may just live up to its hype, according to Gartner Inc. analyst Thomas Bittman. Although Bittman says the virtualization market is immature, the changes it can deliver are going to be pervasive throughout the tech industry and lead to a battle for the market between upstart leaders and sector behemoths all wanting to get in on the virtualization action. However, Bittman said that while the battle for the virtualization market is in its infancy, VMware still has a six-year head start on Microsoft. Such a lead puts Microsoft so far behind VMware that unless it gets Viridian right out of the gate, and without distractions such as the security bugs that often accompany the early releases of new Windows operating systems, Microsoft might not make up the gap between it and VMware.

Microsoft looks to remake itself In an era where the Web is king, Microsoft is no longer regarded as a growth stock. But if the company's bets on new businesses pan out, it could become one again. Microsoft (Charts, Fortune 500) has had to play catch-up in many areas - video games, MP3 players and online advertising - with varying degrees of success. The company's new "Halo 3" game and Xbox console are increasingly important for Microsoft. The entertainment and devices division makes up 12 percent of Microsoft's revenue and is the company's fastest growing, with revenues increasing 28 percent in fiscal 2007, compared to overall sales growth of 15 percent. But the Zune MP3 player, which is also part of the entertainment and devices division, failed to capture the attention of the iPod generation. Microsoft has also seen faced legal setbacks in Europe. Its core businesses are doing well, thanks to the release of Vista, its latest operating system, and a new version of the Office suite of tools. But even in these established businesses, Microsoft faces challenges. Office, in particular, faces increased competition from Google and IBM. Although Microsoft has the cash to muscle its way into competitive new growth areas, it remains to be seen whether it really can become a growth stock again.

SAP Drops Most in Eight Months as Profit Hurt by Business Objects Takeover SAP AG, the world's largest maker of business-management software, fell the most in eight months in German trading after predicting its 4.8 billion-euro ($6.8 billion) acquisition of Business Objects SA will cut earnings. SAP fell as much as 6.4 percent in Frankfurt. The biggest purchase in its 35-year history will reduce earnings per share next year before adding to profit in 2009, Walldorf, Germany- based SAP said yesterday. Business Objects jumped as much as 18 percent to 41.35 euros in Paris, compared with the 42-euro bid. The deal marks a departure from SAP's strategy of growth without major acquisitions. Chief Executive Officer Henning Kagermann's plan to buy Business Objects, which will add software used by companies to analyze performance, comes after the expansion of Oracle Corp. The U.S. company run by Larry Ellison has spent more than $25 billion on purchases since 2005.

Oracle Makes Hostile $6.7 Billion Offer for BEA; Shares Climb Above Bid Oracle Corp., the third-largest software company, made a hostile $6.7 billion bid to buy BEA Systems Inc., sending shares of the business-program maker above the offer price on speculation rival suitors will emerge. BEA stock jumped 38 percent to $18.82, topping the $17-a- share cash bid. Oracle's proposal is 25 percent more than yesterday's closing price as Chief Executive Officer Larry Ellison pursues growth through acquisitions. BEA rejected the offer, saying it ``significantly'' undervalued the company. Ellison's interest may draw International Business Machines Corp. or SAP AG into the contest, analysts said. Billionaire shareholder activist Carl Icahn last month started to push BEA to sell, and a deal would bolster Oracle's efforts to compete with IBM in so-called middleware software, which connects servers with databases and programs that manage Internet transactions.  BEA says Oracle bid too low BEA Systems believes unsolicited offer of $17 a share from Oracle "significantly undervalues" company. Stakeholder Carl Icahn agrees, but pushes for eventual sale. BEA seeks to avoid PeopleSoft fate

Business Magazines' Issues For many decades, publishers of business magazines such as BusinessWeek, Fortune and Forbes thrived by following a simple formula: Target upscale executives and sell ad space to auto makers, financial-services firms and technology companies. But in recent years, that formula has come undone. The dot-com meltdown in 2000 sent technology advertising into a steep decline. The slump in the auto industry has led to a cutback in car advertising. And then there's the Web, which has weakened the magazines' hold on their readers and advertisers.

New Pfizer R&D head: Think small Pfizer's newly-appointed chief scientist Martin Mackay wants to help the company think small. Mackay, who takes over for outgoing R&D head John LaMattina in January, admits Pfizer's drug-generating laboratories have lacked focus for too long. After a spate of high-profile acquisitions beginning in 2000, Pfizer (Charts) became the world's biggest Big Pharma company. But even with revenues of close to $50 billion in 2006, Pfizer still it struggled to be the best. Much to the company's embarrassment, its $7.5 billion-a-year research operation - the world's most lavishly funded, public or private - was churning out fewer blockbusters than its competitors. The company has not had a major pharmaceutical hit discovered and deliverered by its own labs since Viagra went on the market in 1998. Part of the problem, says Mackay: Executives - including himself - were fixated on restructuring and integrating far-flung labs.

The giant on the runway Few industries are more given to self-dramatisation than the aviation business. The decision to build an important new plane invariably means “betting the company”, while the aircraft itself is usually referred to by its messianic (or blinkered) maker as a “game-changer”. Both were true of the first Boeing 747, which the A380 has been designed to replace. The original jumbo jet entered service nearly 38 years ago and the financial strain of developing it almost brought mighty Boeing to its knees. But the huge leap in capacity offered by the 375-seat 747-100 compared with the next biggest plane then available, the 250-seat McDonnell Douglas DC-8, transformed both the experience and the economics of long-haul flying. Boeing's 747 gamble eventually reaped rich rewards. Without a direct competitor and with nearly 1,400 sold over its long life, the 747 has been a matchless earner. Apart from that beautiful flop, the Concorde, no other aircraft is as recognisable or as loved. With the A380, Airbus has now risked everything; not only to kill off its rival's greatest cash cow, but also to create a similarly enduring icon to capture the imagination of the world's travellers. Its success will depend not only on the quality of the aircraft, but on whether there is demand for a plane that can fly more than 500 passengers in a conventional three-class configuration or more than 800 in a single-class layout. Airbus is in no doubt that there is; Boeing, explaining its decision to offer only a mildly updated jumbo—the 747-8—in competition to the A380, says that the market has changed and Airbus has got its sums wrong.

Boeing Delays Dreamliner Delivery Boeing Co. reversed itself after weeks of promising its new widebody jet would be delivered on time, saying the ambitious project now faces a delay of at least six months. The setback for the 787 Dreamliner marks a blow for Boeing's plan to revamp how it builds airplanes by having suppliers take on a greater role in design and manufacturing. Executives were forced to apologize for breaking their commitments to customers. They said the first airplane would be delivered in late November or early December of next year instead of May. Boeing shares fell 2.7%. The delay, which Boeing attributed to shortages of key materials and slow deliveries by suppliers, damages the company's prestige and could hurt the bottom line if airlines can't receive their big orders on time and demand penalty payments. The snafus are particularly embarrassing because Boeing had picked up business from rival Airbus after the European plane maker had to postpone its own highly anticipated new models.

Posted by dblwyo at 02:57 PM | Permalink | Comments (0)

Here's the survey of interesting extracts from interesting articles and posts from last week that're focused on the Market and Economic situation and outlook. Along with a couple of very interesting general articles.

We'll see how things play out as we head into the next round of earnings reports but part of the environment is that the level of catastrophic risk exposure from structured debt products is still widely neglected. You could summarize that as back to business as usual and no more risks - a point nicely surveyed in Jesse Eisenger's Portfolio article:Crash Test Economy, summarized below. Those risks were partially mitigated (Note: not really reduced or eliminated) by the Fed's 50 basis point action but there are going to be some severe consequences, largely concentrated initially in the accelerating decline of the dollar, a point very nicely surveyed and analyzed in another great Jim Jubak column Why the dollar keeps dropping.

Some of the direct consequences and/or in-direct evidence are reflected in the major re-thinking going on in the buyout community as the shift to lower multiples, lower prices, less debt and (thank god) increased attention to enterprise performance fundamentals begins and accelerates. At the same time problems in the debt markets are reflected in a hidden market for off-balance sheet bank investments in structured derivative markets. Both are summarized below. The link between market performance and enterprise performance is earnings, which despite the good headline numbers, turns out to be based on cost control and not on organic growth: Dr. Pangloss Treating Goldie: Markets, Profits & Earnings.  If accurate this is an incredibly consequential finding that's not reflected in valuations yet will impact long-term performance.

Last week's economic news ostensibly included benign numbers on inflation and on retail sales. Inflation does indeed look like it might be under control in the sense that it's not accelerating but on the other hand the divergence between PPI and CPI indicators is accelerating, which indicates both that inflationary pressures could build up and that profit margins are under enormous stress:Fighting the Wrong Fight: Inflation Real & Imagined.

On the other hand payroll data is in fact not very good and the general reaction seems to be to lower expectations rather than recognize what is or isn't a good number. While it didn't quite make the minutes of the last Fed meeting the staff presentations are indicating a "below potential" (that is a growth recession as we've been arguing) outlook thru '08 with ONLY 80K jobs/month being created: What Are They Smoking ? : Latest Payroll Data. A critical key is consumer spending and again, despite good headline numbers, when you dig beneath them the outlook is not quite as sanguine: Retail Sales: Wow, Were They Great...Good...Hmmm ?.

Anyway bon appetit' ! 

General & Special

Crash Test Economy Twenty years after Black Monday, we’re in the same predicament as we were in 1987—except this time, it’s worse. Think of the current situation as a deep-sea earthquake. The plates shifted late last year when home prices in the U.S. stopped rising. At the epicenter were borrowers with poor credit who had rushed to buy homes as interest rates hit lows not seen in decades. Companies unrelated to the mortgage market will find credit tighter as banks divert cash to cover their bets. Trades and investment strategies that relied on the cheap-money boom will unwind. Private equity firms that overpaid for companies will be stuck managing their new toys rather than flipping them, since their lenders won’t be willing to refinance to trim their debt. Big banks will be forced to reckon with bad loans. The financial markets will most likely be more volatile. John McCain has been reciting a quote attributed to Chairman Mao: “It’s always darkest before it’s completely black.” That may be where we sit now. In August, we had a credit panic akin to a run on the bank, but on a global scale. Even companies that had made mostly safe loans—like Countrywide, the nation’s largest mortgage lender—found that the short-term-borrowing markets were closed to them. But judicious financial management from politicians, regulators, and, most important, central bankers can calm credit panics. Indeed, Ben Bernanke’s largely symbolic mid-August move to lower the rate at which banks can borrow from the Fed quieted the markets’ demons for a bit. The skittishness, however, was a symptom of larger imbalances—in the dollar, in global trade, and in American consumer debt. What we are going to discover in the coming months is that the underlying problems aren’t easy to solve, even with Fed rate cuts. Central bankers may find themselves impotent, because if lenders and borrowers have had their fill, even cheaper rates won’t do the trick.

Why the dollar keeps dropping Don't waste your energy worrying about a big crash. Here's why the dollar's decline will continue gradually and why investors should look to investing overseas. The dollar hasn't been this low in a decade, but it's headed lower. By the end of 2007, we can expect the dollar to buy 11.6% less versus the euro than it did at the beginning of the year. As the dollar continues its slide, count on Wall Street to gear up its fear machine. Any further retreat in the dollar will put the U.S. currency on the edge of unexplored territory. The fall of the U.S. dollar into unknown territory, the argument is likely to go, would break the will of those overseas central banks, from Russia to Saudi Arabia to China, that have been buying dollars to give their countries' exports a competitive edge. Well, I'm sorry, but I just don't buy that scenario. Wall Street could, of course, scare itself into a dollar rout because many of the folks who work there are so traumatized by the crises in the markets for mortgages and for buyout loans that they're likely to jump at shadows, even when the shadows are of their own making. 

Buyout firms: Pain today, gain tomorrow The private equity business may be in the midst of a slowdown, but buyout firms are likely to benefit as tougher market conditions force them to train a sharper eye on which companies they buy, according to an industry study. It's a dicey time. A debt crunch has brought new buyout activity to a halt, and private equity firms are hunkering down as they face the task of renegotiating $400 billion worth of deals they inked during the peak of the buyout boom. The tightening of credit will put pressure on financing deals, but "this environment may prompt a more conservative approach with an increasing need for deal diligence at acquisition," the report said. If buyers become choosier, they may cut back on their activity and pump less money into deals - removing a key driver of merger activity. But the report predicts that private equity will be able to weather the changes in the environment and keep driving returns at the companies they take over.

·         Toll mounts as more LBOs crater The $2.2 billion buyout of database manager Acxiom is only the most recent private equity deal to be called off - and it won't be the last. The sudden deterioration in conditions in the buyout market has had implications for deals big and small. The $25 billion buyout of Sallie Mae (Charts, Fortune 500) and $8 billion deal for Harman International Industries (Charts) are both in jeopardy after buyers balked at completing the deals as they are currently structured. The growing number of deals getting called off highlights the tough position that buyout firms and takeover companies find themselves in now that the private equity business has fallen from its peak. Deals inked during the height of the private equity boom no longer look attractive, and with the backlog of pending U.S. buyouts estimated at nearly $400 billion, the hits are likely to keep coming.

·         After crisis, new forces drive deals Two months after the credit crisis ground merger activity to a halt, dealmaking is being rekindled. The drive to merge is expected to gain momentum into next year, but the shift in the credit markets has altered the deal landscape. Tighter credit markets have made cheap debt less readily available, and an upheaval in global financial markets put the skids on new deals in August. Private equity has been especially hard hit. These buyers, which have been the main driver of the recent M&A boom, rely heavily on borrowed funds to do their deals. The private equity deals that have managed to get done have mostly been smaller in size. The rampant pace of activity in the first half of the year has put 2007 on track for another record year for deals. In the first nine months of the year, worldwide merger activity hit $3.6 trillion, surpassing the total from all of 2006, according to Thomson Financial. But the next wave of deals is expected to be led by corporate rather than private equity buyers. So-called strategic deals have faced stiff competition from buyout firms in recent years, but this pressure has now been alleviated.

Banks Grease the Leveraged-Loan Machine Against the gloom that descended on credit markets, banks have pulled off a surprising feat: selling $30 billion of loans for leveraged buyouts by offering some unusual bargains. They also accepted losses on the sales. Now comes the hard part: what to do about the other 90% of the LBO loans in the pipeline. The deal-spinning machine of private-equity firms, which was in high gear when credit markets seized up over the summer, was one of the first casualties of the credit-market problems. Gone was the buyout shops' access to cheap loans. Gone, too, even more suddenly, was investor demand for the loans -- and the price for them fell in step. That left Wall Street banks such as Citigroup Inc., Credit Suisse Group and J.P. Morgan Chase & Co. holding some $400 billion in debt they had promised as financing for purchases private-equity firms had in the works globally. Unless the pace of sales quickens in the coming weeks, banks could be stuck holding these hundreds of billions of dollars of loans for months to come -- a big risk if the economy slows and corporate profits weaken. That could reignite tensions with the private-equity firms they have agreed to finance the deals for and increase the possibility of a fire sale to unload the debt.

Treasury Talks With Citigroup, Banks to Jump-Start Commercial Paper Market U.S. Treasury officials are talking with Citigroup Inc., JPMorgan Chase & Co. and other banks on a plan to jump-start the asset-backed commercial paper market. Policy makers are concerned that investors remain reluctant to purchase the paper even if the loans that back them are sound, said a U.S. government official, who declined to be identified. The discussions over the past two weeks have focused on structured investment vehicles, the units set up by banks and hedge funds to finance purchases of assets including subprime mortgage securities, said the official and a banker with knowledge of the deliberations. One plan under consideration would involve setting up a consortium backed by several of the biggest financial companies, the banker said. Banks Discuss Solution To Liquidity Problem , Banks May Pool Billions to Avert Securities Sell-Off

·         Big Banks Push $100 Billion Plan To Avert Crunch In a far-reaching response to the global credit crisis, Citigroup Inc. and other big banks are discussing a plan to pool together and financially back as much as $100 billion in shaky mortgage securities and other investments. The banks met three weeks ago in Washington at the Treasury Department, which convened the talks and is playing a central advisory role, people familiar with the situation said. The meeting was hosted by Treasury's undersecretary for domestic finance, Robert Steel, a former Goldman Sachs Group Inc. official and the top domestic finance adviser to Treasury Secretary Henry Paulson. The Federal Reserve has been kept informed but has left the active role to the Treasury. The new fund is designed to stave off what Citigroup and others see as a threat to the financial markets world-wide: the danger that dozens of huge bank-affiliated funds will be forced to unload billions of dollars in mortgage-backed securities and other assets, driving down their prices in a fire sale. That could force big write-offs by banks, brokerages and hedge funds that own similar investments and would have to mark them down to the new, lower market prices. The ultimate fear: If banks need to write down more assets or are forced to take assets onto their books, that could set off a broader credit crunch and hurt the economy. It could make it tough for homeowners and businesses to get loans. Efforts so far by central banks to alleviate the credit crunch that has been roiling markets since the summer haven't fully calmed investors, leading to the extraordinary move to bring together the banks.

Economy

China Blossoms As Profit Source China is a growing source of profit for many multinational firms and this year will contribute more to global economic growth than any other country, the IMF forecasts. Many foreign companies have long viewed China as a land of great potential but little immediate profit. As recently as the late 1990s, most Western marketers found this country more frustrating than fruitful. A 1998 survey by consulting firm A.T. Kearney found more than one-third of multinationals were losing money in China, and an additional 25% were barely breaking even. That situation has changed faster than many executives expected. Today, China represents not only a fast-growing source of revenue for many multinational companies, but also a rising source of profit. The change has given those companies and their shareholders a sometimes-overlooked stake in the continuation of China's rapid economic transformation.

Retailers posted weak same-store sales for September, with J.C. Penney and others cutting bottom-line expectations. Saks and Nordstrom saw smaller gains than expected. Wal-Mart raised its earnings outlook. The nation's retailers posted weaker-than-expected September sales, stoking worries that the housing slump and credit crunch will crimp spending during the crucial holiday season. Blaming unusually balmy weather that quelled demand for fall fashions, department stores and apparel retailers reported some of the most disappointing results. Retailers collectively reported a 1% increase in September same-store sales, or sales at stores open at least a year, according to an index of 39 major chains compiled by Lazard Capital Markets LLC. That is well below the 3.9% gain seen a year earlier, and is among the weakest monthly showings in several years, said Todd Slater, an analyst at the New York investment firm. The downbeat retail-sales data underscored the importance of other sources of growth to the nation's economy, notably exports, which continued to rise in August. Indeed, yesterday's report of a smaller-than-expected August trade deficit led many economists to boost their estimates of how much the economy grew in the third quarter. Economists have also grown less pessimistic about the outlook for the economy since the Federal Reserve cut interest rates last month.

Can the Fed Offset This Housing Downturn? The latest WSJ.com forecasting survey showed economists’ estimates for the probability of a recession easing to 34% from 36% a month ago. But the recent interest-rate cut by the Federal Reserve, and a rallying stock market, aren’t swaying some economists from their expectation of a housing-induced recession. It was more a question of when, not if, during a discussion today at the American Enterprise Institute about risks from the deflating mortgage and housing bubble.

Posted by dblwyo at 02:34 PM | Permalink | Comments (0)

Well from the headlines Sept. retail sales were surprisingly good though a few reports dug beneath their own headlines to point out the areas of weakness, including the fact that much of the jump was in Auto sales. Let's take a look at the headlines & reporting, a brief glance at the actual data and then try to put it in context. Which for us means looking at the trends over time, in particular the YOY% changes, and see if we feel better about things. Of course this is all irrelevent if you're betting on the markets which react to headlines and not analysis. Taking a look at the headlines:

• Retail Sales in U.S. Climb More Than Forecast, Reducing Recession Concerns (Bloomberg)
• Retail sales beat expectations (Marketwatch)
• Retail Sales Jumped Up in September (Yhoo/AP)
• Retail sales beat forecasts but ...

(CNN/Money) Last month's better-than-expected 0.6 percent jump in total sales was helped by auto purchases. But clothing, department stores and furniture sales remained weak.Retail sales saw a surprisingly better-than-expected bounce, helped by a surge in auto purchases in September, although many merchants complained that unseasonably warm weather hurt demand for fall merchandise last month. "This report is weaker than it appears," Ian Shepherdson, chief U.S. economist with High Frequency Economic, said in a report Friday. "Auto sales lifted the headline [number] and sales ex-autos were boosted by a 2 percent rise in gasoline sales." The Commerce Department said that total sales rose 0.6 percent last month after a gain of 0.3 percent in August. A strong 1.2 percent jump in auto sales drove much of that increase. Economists surveyed by Briefing.com had forecast a rise of 0.2 percent for the month. Stripping out volatile auto sales, retail sales also saw a slightly better-than-expected 0.4 percent increase versus a 0.4 percent decline in August.  Economists, on average, had forecast a gain of 0.3 percent. But excluding both auto and gasoline station sales, retail sales rose just 0.2 percent.

The CNN/Money coverage is accurate but the real data shows that Sept. sales were $380B or $301B x-Autos while Aug. were $378B and $300B respectively. MtM% changes were .58% in Sept. and .3% in August - a definite improvement. But the YoY changes were 5% and 3.8% - still good news, though the 3MoMA of the year-over-year figures were 4.1% and 3.8% in general and 4.6% and 4.3% x-Autos in Sept & Aug. Not quite as encouraging but still positive, right ?

Well, what about the trend ? If you take a look at the accompanying chart which shows the YoY% changes for Retail Sales, Real Retail Sales and Sales x-Autos along with trendlines you might have a different answer. The real sales data isn't available as yet but we'll post updated charts when they are. In the meantime it doesn't look like the trend has turned up; at best we'd interpret the charts to suggest that they might be flattening out. Back to our point (and Paul Kasriel's) about the US economy being in a growth recession, where real GDP growth is in the < 2% range ( QR Mary: a Little High-Frequency Data and the Outlook).

While retail sales isn't deteriorating further so far it's also not indicating any liklihood of an uptake that would grow the economy, profits or earnings.

UPDATE: Northern Trust has published it's weekly review and it's worth reading, in particular the assessment of the underlying realities of retail sales, from which we quote:

Retail Sales – September 2007
September Retail Sales: Gasoline Prices Exaggerate Headlines, Other Items Were Less Impressive
Retail sales increased 0.6% in September after a 0.3% gain in the prior month. Excluding the 2.0% jump in gasoline sales and 1.2% increase in auto sales, retail sales moved up 0.2% in September after a 0.1% drop in August. The increase in gasoline sales reflects higher prices. Unit auto sales, which matters for consumer spending in the GDP report, were nearly flat in September and declined in the third quarter (15.9 million units vs. 16.1 million units in Q2). In the third quarter, total nominal retail sales rose at an annual rate of 4.0% compared with a 5.4% increase in the second quarter (see chart 1). Also, on a year-to-year basis (see table 2 and chart 2), retail sales are decelerating. In September 2007, total retail sales rose 2.9% compared with a 4.9% gain in September 2006.

General & Special

 (5*) Disorganization Negates Talent.  After yesterday’s entry, I was thinking more about the plight of Alcatel-Lucent and similarly challenged outfits that are trying to restructure their operations. The companies that spring to mind are Kodak (nearly done with its reformation), Ford (slimming down), and Countrywide Financial (no telling whether it will survive the mortgage mess). All of these companies face the challenge of dealing with large infrastructures that may no longer help them to address the needs of their customers. In some cases of restructuring, those customer needs — or even the entire customer base — changes quickly enough or radically enough that the company awakes to find itself in what is essentially a new marketplace. Certainly this happened to Kodak, which had to come to grips with the revolution in digital technology that has swept through the world of photography in the past decade. It may be happening to Ford, which hasn’t shown any recent ability to turn out hit models one after the other, and which seems unable to engender anything like the customer loyalty it enjoyed once upon a time. Certainly Countrywide faces a very different mortgage landscape than it did in previous years. In each of these cases, changes in the prevailing conditions of business have upended the organizational quality of these large companies. What I mean is that they may have been rightly organized for earlier prevailing conditions in the marketplace — surely they were, considering the huge profits Kodak, Ford, and Countrywide have made at times — but whenever they can’t keep their organization evolving in pace with the evolution of the marketplace, they’re bound to end up looking disorganized. In fact, they are disorganized, as far as making steady, healthy profits is concerned.

(5*) The Unsung Heroes Who Move Products Forward AT first blush, the iPhone from Apple, the new microprocessor family from Intel and the ubiquitous Google search engine have nothing in common. One is a gadget, one is an electronic part and one is a service. Yet all of these products — much acclaimed for their creativity — depend on obscure process innovations that, while highly complex and lacking glamour, are an essential part of establishing a winning edge in commercial electronics. Indeed, the success of Apple, Intel, Google and scores of other technology companies has as much or more to do with their process innovations as the products that inspire loyalty among fans and admiration from foes. First, a definitional detour. Processes are the stuff in the proverbial “black box,” the alchemy unseen by consumers or the inelegantly termed “end users” who buy computers, cellphones, cameras and all manner of digital devices and services. Snazzy products are the stuff of legends, omanticized by “early adopters” and skewered by neo-Luddites. Yet while these products bring glory to companies, novel processes are often more important in keeping the cash registers ringing. The proof of this proposition is that while companies often spend millions to advertise and market new product designs and innovations, they guard intensely the details of their process innovations. Process innovations like Google’s computer network are often invisible to the public, and impossible to duplicate by rivals. Yet successful companies realize that maintaining competitive advantage depends heavily on sustaining process innovations.

Business

A boom in bust-ups As more deals turn ugly, buy-out firms rethink their approach to investing and their relations with backers. The bigger risk, however, is that buy-out funds end up with piles of capital that they cannot deploy, irritating investors who must pay management fees regardless of whether their money is put to work. When markets turn, deal droughts can last many months. In the downturn of 2000-02, for instance, Bain Capital went for over a year without completing a deal. Investors in private-equity funds will certainly need to be patient. As dealmaking slows and exits become trickier, the firms will have to focus on improving the companies already in their portfolios. Carlyle's boss, David Rubenstein, told a recent private-equity conference that the average holding period is likely to rise to four to six years, far above today's levels. On the plus side, this may help to assuage public criticism of private equity's penchant for “quick flips”. Targets are likely to be smaller as well as fewer in coming months. The head of a Wall Street investment bank says it is hard to imagine deals much bigger than $10 billion well into next year. That may tempt the big private-equity groups into the middle market, which they haughtily ignored when mega-deals were easy. There has been less of a let-up in sub-$1 billion dealmaking, notes Newcomb Stillwell of Ropes & Gray, a law firm. Meanwhile, there is likely to be emphasis on “growth equity”—investments in firms at an earlier stage of the development cycle than the classic turnaround case.

Big banks about to lower the boom Citigroup's warning that profit fell 60% in the third quarter is just the start. The worst isn't over, and banks' mid-October earnings reports could be bad, bad, bad. "We think the worst is definitely behind us," Sam Molinaro, the chief financial officer at Bear Stearns (BSC, news, msgs), told Wall Street analysts and investors during a company earnings conference call Sept. 20. Wall Street would be happy if you believed that. The belief "the worst is over" in the crisis that panicked the financial markets in August and still hasn't let go of its death grip on the debt markets is the best hope that Wall Street's investment banks have of getting out of this mess with their skins intact. But don't you believe it. There's not a chance the worst is over, and Wall Street knows it. Wall Street knows the big investment banks that reported in mid-September aren't out of the woods. They all took relatively tiny write-offs -- $700 million on the fixed-income portfolio at Bear Stearns, for example -- on the damaged goods in their portfolios, and if they can't trade their way out of this mess, they've got more big losses to write off in the quarters ahead.

·         Citigroup warns of huge subprime hit Citigroup warned Monday its third-quarter earnings are likely to decline 60 percent, as it takes more than $3 billion in writedowns for securities backed by underperforming mortgages and loans tied to corporate buyouts. Shares fell to $45.70 in heavy premarket trading from a $46.67 close on Friday.

• UBS to take $3.4B hit from subprime
• Job Cuts on Wall Street Spread, Merrill Fires Fixed-Income Chief Semerci, Top Deputy After Mortgage Losses

Prince Tears Up Weill Playbook as Citigroup Forfeits Shareholder Returns Citigroup marked Prince's fourth anniversary as CEO on Oct. 1 with somber news for its employees and stockholders. The credit turmoil that began in the subprime mortgage market has sent Citigroup's quarterly profit plunging to its lowest level in three years. The company disclosed that it would take a $5.9 billion hit from credit and trading losses for the three months ended Sept. 30. Just three months ago Prince said he ``felt good'' about Citigroup's direction. Now, the CEO is fighting to contain the damage -- and hold on to his job. Citigroup stock has foundered on his watch. The pressure on Prince is growing. Such carping would have been unthinkable under Weill, who demanded 15 percent annual profit increases during his 17 years as CEO of Citigroup, Travelers Group Inc. and their predecessors. Powered by a series of blockbuster deals, climaxing with Travelers' $36 billion acquisition of Citicorp in 1998, Weill delivered a 160 percent stock gain during his last five years as CEO. No wonder the new slogan that began with that 2005 meeting --``Let's Get It Done'' -- sounds like a call to arms. Prince has ditched the strategy and practices of his famed predecessor in a headlong effort to remodel the house that Sandy built. He's cast aside Weill-style acquisitions and staked Citigroup's future on organic growth, or getting bigger by enlarging the businesses he already has. Prince is cranking up consumer banking in the U.S. and expanding overseas. Prince spent his first few years as CEO cleaning up. Weill bequeathed to him the epochal financial supermarket of the 1990s -- and a heap of trouble.

Merrill Lynch & Co.'s announcement Friday that it would take a $5.5 billion hit to third-quarter earnings is exposing the weak oversight exercised by top Merrill executives as it became a big force in the mortgage-securities business.But Merrill is taking the biggest charge and is the only major U.S. firm so far that has said it will report a loss for the third quarter.

Merrill Lynch, … had become deeply involved in the mortgage business by this year. That was despite an assurance to investors just three months ago that its exposure was "limited" and "contained." At one point, Merrill had amassed a portfolio of at least $25 billion in risky assets, people familiar with the situation say. The ballooning exposure to these assets, which fell in value amid spreading defaults by homeowners, prompted the firm on Wednesday to oust two of its top credit-market executives, Osman Semerci and Dale Lattanzio. There were cheers and high-fives on the debt trading floor after the exits were announced, says a person who was there. Credit-rating agencies maintained Merrill Lynch's current credit ratings but revised the outlook to negative. It was the big push into CDOs -- combined with some personnel changes last year -- that led Merrill astray, according to firm executives. Some insiders say the departure of Jeff Kronthal, who oversaw credit, real estate and structured products at Merrill until his July 2006 ouster, may have contributed to the firm's problems. In addition to opposing the First Franklin purchase, Mr. Kronthal worried that Merrill's exposure to CDOs was too great, according to people familiar with the matter.

For home builders, the worst is to come Builders soberly predict even lower prices as millions of homes sit empty and would-be buyers (who must meet tighter mortgage qualifications) bide their time. Citigroup sparked a sharp rally in the home-building industry this week by upgrading the group in a 54-page report titled "The Dark Before the Dawn." A few of the most beaten-down companies in the sector saw shares advance as much as 8% in a couple of days, while most rose at least 3%. Not bad, yet you just have to wonder what Citigroup analysts and the avid buyers were smoking. Because a more sober title for a report on the prospects for residential real estate would have been "It's Always Darkest Before It Goes Pitch Black." Or perhaps "Dawn of the Dead." The home-building industry, after all, is all about building homes. And that is a big, big problem in a country that has way too many of them. The stats vary by region, but the national inventory of homes is at an all-time high, with an eight-month supply. One in 7 1/2 houses is actually vacant. Prices are tumbling. And there is little relief on the horizon, even from the Federal Reserve. Homebuilders Liquidate Assets as Threat to Survival Spurs Desperate Sales. Homebuilders Struggle to Survive

Car Sales Show Signs of Stability The pace of U.S. light-vehicle sales showed signs of stability in September, generating hope among the auto industry's biggest players that last month's interest-rate cut by the Federal Reserve and expectations of future cuts will start a recovery from the worst summer auto-selling season since 1998.

International Paper off to Siberia Paper giant aims to use bountiful Russian forests to serve pulp-starved China. Vast and largely desolate Siberia is home to one of the world's largest stands of untouched timber, full of red pine and larch coveted by the pulp and paper industry. These remote northern Russian woods are also right next door to China, where demand for paper and consumer packaging for the country's booming middle class has far outstripped supply. Closing the gap between the two is exactly where International Paper Corp. wants to be, positioning itself in Asia, where paper and board production is expected to surpass output in the languishing North American market by 2015. In August, International Paper, the world's biggest paper and packaging company by sales, formed a 50-50 joint venture with Russian mill operator Ilim Group Holdings. If all goes well, one analyst predicts the deal could add almost 10% to the company's 2008 per-share earnings.

Tesco upbeat on U.S. entry Britain's largest retailer overcomes wet, cold summer weather with 19% profit rise, ready for big push into U.S. grocery segment.Tesco Plc, Britain's largest retailer, on Tuesday said first-half profit rose 19% as strong sales of non-food items and solid international growth offset a U.K. performance dampened by the wet summer weather. Outside the U.K., sales jumped 22%, driven by rapid growth in China and Eastern Europe. Margins improved markedly in Korea, Thailand and Malaysia. "I feel very good about China. And you will see us move more confidently in that market in the future," Leahy said. He said the company understands more about the shopping culture there, and the need for sites that are part of larger shopping centers. Tesco is also focused on its international expansion. The retailer will open its first U.S. stores in the coming months and plans to add 100 outlets in California, Arizona and Nevada under the name Fresh and Easy. The convenience shops will focus on healthy, ready-prepared meals. Tesco expects to open at least 50 stores by the end of the fiscal year in February. The retailer said its main office is already staffed with 200 people and it's made good progress on acquiring new sites and the recruitment and training of staff. Leahy noted that U.S. planning laws mean the rollout can be rapid.

(5*) Wal-Mart Era Wanes Amid Retail Shifts The Wal-Mart Era, the retailer's time of overwhelming business and social influence in America, is drawing to a close. Using a combination of low prices and relentless expansion, Wal-Mart Stores Inc. emerged from rural Arkansas in the 1970s to reshape the world's largest economy. Today, though, Wal-Mart's influence over the retail universe is slipping. In fact, the industry's titan is scrambling to keep up with swifter rivals that are redefining the business all around it. It can still disrupt prices, as it did last year by cutting some generic prescriptions to $4. But success is no longer guaranteed. Rival retailers lured Americans away from Wal-Mart's low-price promise by offering greater convenience, more selection, higher quality, or better service. The company's unquenchable thirst for scale has been the secret to its market-changing power. But that very focus on scale is now a weakness, for the world has changed on Wal-Mart. The big-box retailing formula that drove Wal-Mart's success is making it difficult for the retailer to evolve. Consumers are demanding more freshness and choice, which means that foods and new clothing designs must appear on shelves more frequently. They are also demanding more personalized service. Making such changes is difficult for Wal-Mart's supercenters, which ascended to the top of retailing by superior efficiency, uniformity and scale. If no WSJ try MSN: The end of the Wal-Mart era

New profit from old media Between cable and satellite TV, home shopping and animal-on-animal violence, there's a lot of action in media stocks. Take a look at these three plays. Forget Friendster. Forget Facebook. And definitely forget YouTube. If you want to make money as an investor in the media space, you have to buy three old-media plays that the hipsters might dismiss as "so yesterday."  WSJ: Free or Paid? (Yes)

How to Get Business Software that Works  If you’re upset about the quality of the software you use at work, here’s some advice: Say something about it. For the most part, business software has been largely untouched by the design revolution. There are reasons for this. First, business technology is complicated. That’s why companies have an entire department dedicated to it. Business software needs to do things like process orders or manage inventory, and do so in a way that is secure and compliant with a growing number of laws and regulations. It’s hard enough to come up with something that does all of that. Information-technology departments have never been pushed to come up with something that’s easy to use and they in turn never pushed the tech companies that make business software. Something that worked was always good enough. IT departments need to realize that design and usability are just as important as any other quality. And the only way they’ll realize it is if the rest of the business won’t accept anything less than a well-designed system. It’ll take time to get the message across – not only does the business have to pressure IT but IT needs to pressure tech vendors – but eventually it will happen. Until then? “I believe that people are willing to wait if they think that IT is a partner,” Norman says.

·         The Chimp vs. the Tech Guy, Our Romantic View of Computers Is Over, The Trouble with Software, Can Software Be Saved?

Its Creators Call Internet Outdated In 1969, at the Pentagon's Advanced Research Projects Agency, Larry Roberts oversaw a program of connected research computers called ARPAnet that became the foundation for the Internet. Four decades later, he has spent nearly $340 million trying to redo that same technology, which he now believes is far behind the times. "We can no longer rely on last-generation technology, which has essentially remained unchanged for 40 years, to power Internet performance," says Mr. Roberts, who is 69 years old. The actions of Messrs. Bosack and Roberts fuel the growing debate over whether the Internet's current infrastructure is sufficient to handle the explosion of bandwidth-hungry services such as Internet telephony and video. In a recent report, Cisco calculated that monthly Internet traffic in North America will increase 264% by 2011 to more than 7.8 million terabytes, or the equivalent of 40 trillion email messages. If such Internet traffic continues increasing, many believe networks could crash or at least slow to a crawl.

Sprint has quietly launched a hunt for a successor to CEO Forsee amid investor pressure. The board hopes to name a new leader by early December.Sprint Nextel Corp. is quietly seeking a replacement for Chief Executive Gary Forsee, said people familiar with the matter, just two years after he engineered the $35 billion purchase of cellular operator Nextel Communications Inc. to keep pace with rapid consolidation in telecommunications. The combined company has been plagued by high customer turnover, merger hiccups and unhappy investors. Sprint, meanwhile, has been left searching for an identity. In the second quarter, Sprint's overall subscriber growth was just 373,000, compared with the 1.5 million customers added by AT&T, which leads the industry with 63.7 million subscribers. The 57-year-old Mr. Forsee, who has led Sprint since 2003 and has been chairman since late last year, had tried to calm restive investors by taking several steps. During the past few months, he made investments aimed at improving the company's creaky phone network and customer service, revamped its advertising and outlined new initiatives related to the creation of a high-speed wireless network using the new WiMax technology.

Sprint-Nextel: Anatomy of a Failed Merger Did anybody really believe Gary Forsee back in December 2004 when he said: “The combination of Sprint and Nextel builds strength on strength”? Forsee, co-architect of the merger as then-head of Sprint, laid the basis for skepticism for the discerning eye right there in paragraph two of news release announcing the deal. Touting the size of the combined company even before other old merger-release standbys like financial benefits? Why in the case of Sprint and Nextel did size matter so much? Because for Sprint, the deal was done from anything but a position of strength. A distant third in the mobile-phone game to the then-emerging juggernauts of Cingular (now AT&T) and Verizon Wireless, Sprint was desperate to build scale. At any rate, with Forsee resigning Monday, it now appears clear that merging with Nextel was the wrong way to do it.

Posted by dblwyo at 06:15 PM | Permalink | Comments (0)

General & Special

Markets never spot the black swan   So what could go wrong? Certainly, the macro-economic backdrop is less favourable than it was. Interest rates are going up across the world - in China, New Zealand, Britain and the Eurozone. In the US they are on hold and are unlikely to come down until later in the year. Japan, where there were renewed signs of deflation last week, is the exception. Near-zero borrowing costs in Tokyo are the source of global speculation since they allow investors to borrow cheaply in yen and take punts in countries where interest rates are higher. It's not just that, though. The American economy is slowing, as the GDP figures released on Friday clearly showed. A fall in the value of the dollar, while necessary to reduce the US trade deficit, will add to imported inflation, already rising as a result of higher Chinese prices and oil at close to $70 a barrel. Nor does the geopolitical situation look that clever. Kofi Annan was in Berlin last week to lambast the laggards of the G8 for their failure to keep promises made to Africa at Gleneagles two years ago. What went unnoticed was Annan's view that a broadening of the Middle East conflict to Iran risked sending oil prices to $120 a barrel. Despite its travails in Iraq, the Bush administration is still taking a hawkish stance over Iran's nuclear ambitions; military action - air strikes rather than an invasion - is still an option. And yet the stock markets float serenely upwards, as if they had not a care in the world. This is a comforting analysis. It may also be hugely complacent.

Stock Strength Seems to Belie Reality Remember all the trouble stocks ran into over the summer? Neither does Wall Street. The Dow Jones Industrial Average advanced 75.44 points last week to 13895.63, putting it 1,050 points above its August low and not far from the all-time high of 14000.41 it tagged in July. The stock market is often seen as a leading indicator of economic growth. But there seems to be a disconnect here, because the economic outlook sure doesn't seem bright. Last week's report that sales of new homes fell to their slowest pace in seven years in August was just another sign of the headwinds facing the economy. The latest monthly reports on jobs, retail sales, industrial production, manufacturing activity, durable-goods orders, housing starts and consumer confidence have all been weaker than expected. In a radio interview last week, former Federal Reserve Chairman Alan Greenspan said "the danger of recession has obviously risen." He put the odds at less than 50/50. Former Treasury Secretary Lawrence Summers said in a television interview that the odds weren't quite 50/50 but were "somewhere in that neighborhood." The raft of weak economic reports may be a sign that the housing downturn has begun to spill over into other areas.

Markets & Investments

Romping Through the Biggest M&A Year in History (takes you to interactive WSJ graphic)

Subpar Earnings: A sortable scorecard of how subprime woes have hit third-quarter profits

Big banks about to lower the boom , Sickly Credit Markets Heal a Little as Leveraged Loans Rebound

Don’t Blame the Central Banks -- Thank Them The stock market's electrifying response to the dramatic 50 basis point reduction in the Fed Funds rate engineered by Ben Bernanke at the September 18 FOMC meeting amply demonstrates the power of modern central banks. Don't get me wrong.  I am not saying that central banks can completely prevent the boom and bust cycles that have plagued market economies from time immemorial.  It is very important to understand how significant this Lender of Last Resort function is.  In 1929 a stock market crash turned into a liquidity crisis when depositors worried about the loans banks made against the stock market.  But the Federal Reserve and other central banks did not lend money to the banks that were besieged by depositors.  The Fed had claimed at that time that the banks that made bad loans should fail and should not be bailed out. We hear the same objections today.  Critics claim that the Fed is "bailing out" the sub-prime lenders and encouraging risky lending. But these fears are misguided.  In no way do the central bank's actions "bail out" the sub-prime lenders. 

·         Fed Rate-Cut Skepticism Spreads From District Bank Presidents to Traders Federal Reserve district bank presidents are expressing skepticism about the need for further interest-rate cuts, and some investors agree. The chance of policy makers cutting their benchmark rate twice more this year, to 4.25 percent, fell to 48 percent today, the lowest since the Fed cut borrowing costs on Sept. 18, futures prices show. The December contracts last week reflected a 74 percent likelihood of two quarter-point reductions. Sentiment shifted as St. Louis Fed Bank President William Poole, Philadelphia Fed chief Charles Plosser, Atlanta's Dennis Lockhart and Richard Fisher of Dallas in the past 10 days highlighted signs the turmoil in credit markets is easing. Economic and financial reports have complemented their remarks, as commercial paper halted a seven-week slump and surveys showed continued expansion of manufacturing and services industries.

Foreign capital must not be blocked After this summer’s turmoil, markets have entered a tentative healing phase helped by significant injection of central bank liquidity and a cut in US interest rates. The inter-bank market is normalising, credit costs are falling and share prices have resumed the march to record levels. It is thus tempting to view the summer’s disruptions as a “flesh wound” and to return to business as usual. But such a reaction would be inadvisable, as the uncertainty about the future relates to more than just economic and financial issues: it also has an important political dimension. These concerns will play out in the coming months. I am inclined to believe that the US economy will slow substantially but not contract and that the rest of the world will continue gradually to decouple in a healthy manner. Indeed, it may well be that the uncertainty surrounding the economic outlook is less than that pertaining to political reactions triggered by recent events. As market participants gradually unclog blockages in various segments of the financial system, politicians are likely to spend a lot of time debating the causes and consequences. The debates will go well beyond the debacle in subprime mortgage lending, in­creases in foreclosures and the adequacy of consumer protection. Questions will be asked about how complex financial activities ended up migrating to institutions outside the purview of sophisticated scrutiny and regulatory bodies. There will be interest in how segments of the most sophisticated financial system in the world could not come up with market-based valuations, thereby inhibiting meaningful inter­actions between buyers and sellers. Inquiries will be directed to a banking system that somehow managed to lose sight of the size of its balance sheet commitments. All these issues are relevant to how well the market system functions. As such, it is both understandable and desirable that the official sector – the executive and legislative branches, agencies and regulators – ask questions and look for solutions.

Bagehot Had Credit-Crunch Answers 130 Years Ago Walter Bagehot, an economist and author writing in the 19th century, had the answers to the current credit crunch. In 1866, the U.K. money markets were in turmoil. The collapse of a private bank called Overend & Co. threatened to destroy the fragile trust underpinning the credit system. The parallels with today are powerful, as ripples from the crash in the U.S. subprime mortgage market threaten to swamp parts of the financial markets. Central banks are losing control of monetary policy, as short-term money-market rates jump and long-term bond yields develop immunity to policy changes. Their sovereignty is under fire, as the crisis forces them to be reactive rather than proactive.

Fed Fails to Restore Confidence in Credit Markets As far as the world's biggest bond investors are concerned, the Federal Reserve is failing to restore confidence in the U.S. credit markets. Pacific Investment Management Co., TIAA-CREF and Insight Investment Management say the central bank's decision to lower the overnight lending rate between banks by half a percentage point last month won't prevent the economy from slowing or corporate defaults from increasing. Lehman Brothers Holdings Inc. strategists say last month's rally in high-yield corporate bonds, the biggest since 2003, may fizzle by year-end. While indexes of derivatives that measure the risk of default show increasing investor confidence, the difference between the interest that banks and the U.S. government pay for three-month loans is wider now than a month ago. That's a sign the Fed's Sept. 18 rate decision has yet to persuade bondholders that lower borrowing costs will stop ``disruptions in financial markets'' from hurting the economy. Bernanke Spoke With Rubin, Ranieri as Credit Crisis Worsened, 3 big trends will haunt Bernanke (a prescient piece from ’05 that calls it dead on !!)

Fixing the ratings game The country's leading ratings agencies - Moody's, Standard & Poor's and Fitch - are under attack these days for fueling the subprime mortgage meltdown with excessively high ratings on mortgage-backed bonds that turned out to be bad bets. The problem, critics say, is that the three agencies are rife with conflicts of interest. They're paid by the bond issuers to evaluate the risks of their debt offerings, base those ratings on information they receive from the issuers, and are insulated when, as in the case of the low-income housing market, investors get burned. But the Big Three aren't the only ratings agencies out there. In fact, there are hundreds of companies that rate securities and, unlike Moody's & Co., are paid by investors, not the issuers. With the trio now fending off criticisms and lawsuits related to their role in the subprime mess, you'd think now would be the perfect time for a lesser-known name to rise to the top. Don't hold your breath. Regulators have long kept other agencies from competing with Moody's, S&P and Fitch, despite their supporting roles in high-profile blowups like Enron and the 1997 Asian financial crisis.

·         Six Fingers of Blame in the Mortgage Mess Finger-pointing is often decried both as mean-spirited and as a distraction from the more important task of finding remedies. I beg to differ. Until we diagnose what went wrong with subprime, we cannot even begin to devise policy changes that might protect us from a repeat performance. So here goes. Because so much went wrong, the fingers on one hand will not be enough.

·         Greenspan Sees `Rethinking' on CDOs After Collapse of U.S. Subprime Market

·         Fitch Downgrades $18.4 Billion of 2006 Subprime Bonds as Defaults Escalate, Subprime Loan Delinquencies in Bonds Are Accelerating in `07, Moody's Says,

Economy

Our biggest export: Inflation The sinking U.S. dollar, and the inflation it causes, could throw the runaway Chinese economy off the tracks. And the entire globe would suffer the consequences. China has opted to intervene in the financial markets to keep its currency stable. Just as choosing to let its currency rise cost the Canadian economy growth, trying to stabilize its currency comes with its own set of costs for China. By buying dollars for yuan, the People's Bank was injecting huge amounts of yuan into its domestic economy. The bank tried to remove as much of that injection as it could -- central bankers call this operation "sterilization" -- by selling government bonds for yuan. That had the effect of removing yuan from the economy. But it's just about impossible to run a completely successful sterilization; you never manage to sop up all the extra money. And in China that extra money has contributed to runaway growth in China's money supply. When money supply grows faster than a country's economy, the result is inflation, which is exactly what is happening to China's economy. Consumer inflation grew at a 4.4% annual rate in June.

• Why China can't slow down

Trichet, Dodge, King May Follow Fed's Bernanke in Monetary Policy U-Turn Central bankers from Europe's Jean- Claude Trichet to Canada's David Dodge may follow Federal Reserve Chairman Ben S. Bernanke in an about-face, shifting toward supporting economic growth and away from fighting inflation. Economists are scrapping forecasts for higher interest rates in the euro area, the U.K. and Canada as prospects for expansion weaken, and some even say inflation will soon recede enough to permit cuts. A similar change in outlook may delay expected rate increases in Japan. ``Led by the Fed, central banks are having to change course to avert a U.S.-led global downturn,'' says Paul Sheard, chief global economist at Lehman Brothers Holdings Inc. in New York.

Why Bernanke Might Need India to `Do a China' In their report, O'Neill and his team argued that China's rapid urbanization, industrialization and rising openness to trade and capital flows had all contributed to keeping inflation in the developed world lower than expected for a decade. The Goldman analysts said China would continue offering an ``inflation discount'' to the world with a nascent pickup in Chinese consumer prices and wages stabilizing in 2007. To avoid a surge in consumer prices, Bernanke may end up needing India to produce the disinflation that China is no longer willing or able to export. Not only did consumer prices in China rise at their fastest pace in a decade in August, there's also growing evidence that Chinese manufacturers are able to pass on their rising costs to U.S. consumers. The U.S. Bureau of Labor Statistics reported a 1.1 percent increase in the average U.S. dollar cost of goods imported from China in August, the fourth straight month of accelerating price gains. We'll see how successful the Fed is in managing inflation when China withdraws its helping hand. The real concern is that if China stops supplying disinflation to the U.S. and Bernanke ends up needing a replacement, he may not find too many suitable candidates.

Save the Day CURRENCIES are first and foremost relative prices — in essence, they are measures of the intrinsic value of one economy versus another. On that basis, the world has had no compunction in writing down the value of the United States over the past several years. The dollar, relative to the currencies of most of America’s trading partners, is off about 20 percent from its early 2002 peak. Recently it has hit new lows against the euro and a high-flying Canadian currency, likely a harbinger of more weakness to come. Sadly, none of this is surprising. Because Americans haven’t been saving in sufficient amounts, the United States must import surplus savings from abroad in order to grow. And it has to run record balance of payments and trade deficits in order to attract that foreign capital. Economic science is very clear on the implications of such huge imbalances: foreign lenders need to be compensated for sending scarce capital to any country with a deficit. The bigger the deficit, the greater the compensation. The currency of the deficit nation usually bears the brunt of that compensation. As long as the United States fails to address its saving problem, its large balance of payments deficit will persist and the dollar will keep dropping.  The only silver lining so far has been that these adjustments to the currency have been orderly — declines in the broad dollar index averaging a little less than 4 percent per year since early 2002. Now, however, the possibility of a disorderly correction is rising — with potentially grave consequences for the American and global economy. A key reason is the mounting risk of a recession in America.

Economy Can Survive Oil at $100 a Barrel The world economy may be able to cope with oil at $100 a barrel if prices rise gradually and inflation is moderate. The world economy has managed, with some indigestion, to swallow the rise of oil prices past $80 a barrel. How well could it survive $100 a barrel? The answer is quite well -- so long as several conditions still hold true. The price rise would probably have to be gradual. Inflation couldn't get so bad as to force big interest-rate hikes. Oil-rich nations would need to pump their profits back into U.S. and European economies. All of this has happened so far. The happy confluence may continue, though fears remain strong that high energy prices will tip the U.S. into recession. A host of factors, including tight oil supplies and a weak U.S. dollar, suggest that oil prices have further to rise. Some analysts continue to believe that oil is destined to reach an all-time high, as measured in today's dollars, of more than $101 a barrel. The record was set in 1980. On Friday in New York, the benchmark crude-oil futures price closed down $1.22, or 1.5%, to finish at $81.66, a little more than $2 off the all-time high, not adjusting for inflation.High oil prices could lead to ugly consequences if they hit consumers' pocketbooks -- especially in the U.S., where the housing slump is already hurting the economy. Consumer spending has been the primary engine of growth in the U.S. in recent years.

Auto Industry: Ford September U.S. sales fall 20.5% , Ford, Toyota Say U.S. Sales Decline; GM, Honda Gain

Housing: (5*) More on Pending Home Sales

Economy: Does a Recession matter?, NFP WTF ?

Posted by dblwyo at 06:13 PM | Permalink | Comments (0)

It was recently accounced that Goldilocks, who's rumored terminal illness brought world-wide panic to her many fans, was successfully treated by the famous French therapist Prof. V. Pangloss. He was pleased to announce that rumors of her death were greatly exaggerated and in fact treatment has been so complete and successful that a whole new Goldie is in the house. Dr. Pangloss was quoted as saying, "in your modern terms think of this as Goldie 2.0....a highly successful course of sentiment and psychology obviates any risks due to fundamentals, or even technicals".

At least it seems the only reasonable course for a simple man like myself to follow - assume a miracle has occurred. If you examine the accompanying medical chart it's hard to conclude that the good Professor has achieved anything less. Six weeks ago Goldie was threated by the Wings of the Angel of Credit Death but today, she's not only recovered but doing better than ever. One can only wonder why and how ? Of course Volume's a little below average, and Relative Strength tells us Goldie is talking to herself a bit though not loudly and the momentum of MACD is just upticking now but's distorted as a weekly chart. Ignore those flashing lights on the monitor.

The answer appears to lie in that new miracle treatment of ever-rising earnings which seem to keep growing no matter wat the underlying state of the economy which grows them. Which, logically anyway but who's using logic these days, one could then ask what are earnings likely to be and how are they related to the underlying performance of the economy ? 

Being greatly puzzled, even wondering myself, by this miracle it seemd a sensible thing to do to investigate a bit. It's not clear that we've resolved my/our puzzlements but perhaps a little light can be thrown on things.

The chart here looks at earnings and corporate profits since '88 (or '90 for the YoY changes) to try and find the answers. Or at least get a start on finding some. The original question is are earnings going to continue to do well ? One possible diagnosis is that, since earnings are based on profits and profits on the health of the overall economy, a positive prognosis is contra-indicated :) ! As you can see first off earnings do indeed follow profits, and quite closely indeed. Surprisingly though while they both did well until Jan02 they all really took off then. Which leads to the next question - why at the beginning of a downturn and a continued slow-growing economy did profits and earnings take a sudden jump upwards ?

One surprising answer, to be further investigated by competent analysts (not necessarily moi) is that After-tax Profits jumped, particularly as a % of total profits. Very interesting.  If you look a the last sub-chart earnings and profits are clearly aligned with each other, despite being volatile & noisy. We draw that conclusion by looking at how closely the trendlines follow each other. And Profits are clearly aligned with GDP though only in a broader sense as there's clearly significant quarterly differences. So it looks like something else, and perhaps deeper, is going on.

Which we attempt with this third set of charts going back to '47 which shows the relative shares of Wages, Profits and Capex in the GDP, with Wages on the r.h.s. of the chart. It might be worth a moment or three to took a close look. While our focus is on recent profit trends it doesn't hurt to notice, as we've been told, that profits are indeed at and moving above historical highs. It also is interesting to notice that both held up well until the mid-60s until rising energy costs led to higher investments and the shrinking of Proft and Wage shares.

Yet Capex and Profit reached level plateaus in the 80s and 90s while wage share largely continued to shrink (excepting the lagged impact of the late-90s investment boom on labor demand). But, since early in this decade (have you thought about how odd that sounds for those of us still thrashing the Telecom bust and yearning for the good old days ?) Wages have returned to a deteriorating downtrend while Capex spending has remained relatively flat. In other words, as we kinda knew from other sources, businesses aren't hiring and they aren't spending. Not only was the Boom a very different thing than previous cycles the "recovery" is a very different recovery - no jobs, no equipment, not good.

We can only conclude that with the lid screwed down on spending companies are making plenty of money, grabbing a growing share of the economy and, one guestimates, spend it on buybacks to keep the stock prices up and help out with EPS numbers. Which doesn't lead one to a great deal of confidence in organice growth of revenue, profits and earnings.

Stop and think about that for a minute - earnings may be going up but it's not because the economy or business is doing better. Somewhere under all the large pile of stock prices and reported earnings is a very large elephant. And he wouldn't appear to be a very well-groomed, well-behaved or benign one either.

We're definitely not in Kansas any more - so much for fundamentals. It's all about the finances and cash flow ? But judge for yourselves. The charts lay it out and you're as free to interpret as I and the data is readily available publicly from many sources. 

Posted by dblwyo at 03:14 PM | Permalink | Comments (0)

Time flies when you're having fun or too focused on other things. Last week's Weekly Reader is last week's listings :). But there's enough interesting stuff to be worth posting it though I will forgo commenting and just urge you to skim things. The idea being that a quik skim allows you to focus down on the ones that strike you and if you really want to follow up the source and link is usually embedded so you can follow up.

There are two Special listings worth paying some attention to however. Consider this - as we slowly work our way out from under the morass of the structured debt problems with the idea that 3/4 or more of the problem is still disguised, and further that easy credit is shifting to rationed credit based on good business propositions that every segment from real estate to buyouts to (one wishes anyway) buybacks will have to re-ground itself in reality.

In other words we're all going to have to start paying more attention to Grahm-Buffet kind of questions: what is the business, what is the core value proposition, can we execute on those goals and what's the likely course of revenue, costs, markets and profits ? But the opposite side of that question is what will be the new/next opportunities ? And, oh yeah, what's the enviroment going to look like ?

In other words...

General & Special

Opportunity in crises The Turnaround Letter indicates all this risky business may be very good for business -- in the long run..Despite all the volatility, Turnaround follows the phlegmatic practice of publishing only once a month. Its September letter opened calmly: "After several years of low volatility and relatively benign conditions, many investors -- both individual and professional -- had been lulled into a false sense of security. As a result, they were willing to make increasingly risky investments which yielded increasingly miniscule returns. For some investors, notably hedge funds, the response to measly returns was to add more leverage to magnify the gains. Of course, that adds risk, but nobody seemed to care ... "As a result, many people are running around shrieking about a 'crisis' in the markets. So what happens now? No one knows for sure. But we've been through a few other 'crises' during the 20-plus years we've been publishing. Which left Turnaround positively tickled: "Is this a crisis? Hardly. We view the current conditions in the markets as the beginning of an opportunity ... Because of worldwide liquidity coupled with (or perhaps caused by) disregard for risk, bankruptcies have been at historically low levels and good turnaround opportunities have been scarce. That is going to change over the coming months. Weak companies are going to fail. And the securities of some strong companies may get beaten down to very attractive levels in moments of panic."

Markets & Investments

S.E.C. Inquiry Looks for Conflicts in Credit Rating The Securities and Exchange Commission has opened an investigation into whether the credit-rating agencies improperly inflated their ratings of mortgage-backed securities because of possible conflicts of interest, the head of the commission told Congress on Wednesday. With the explosive growth in the market for mortgage-backed securities, the ratings agencies have come to play a central role in the housing market. After a homeowner gets a mortgage, the lending institution usually sells the loan to a Wall Street firm, known as an underwriter, where it is repackaged with other loans and sold to investors as a mortgage-backed security. Rating agencies grade those securities to let investors know the chances of default. As the subprime market has been rocked by a wave of mortgage defaults and worthless mortgage-backed securities, the rating agencies have come under renewed scrutiny by regulators and lawmakers.

Swap' in How Markets Work The credit crunch that swept through financial markets this summer surprised many investors. But some market jockeys who closely track a new breed of complex credit derivatives saw the meltdown coming ahead of time.

• Satyajit Das was discussed earlier on Mefi. This interview with him is a great explanation of the financial skullduggery that we're knee-deep in. Plunging into the shadows: "In thinly traded, lightly regulated and untransparent markets, the bold can make an awful lot of money—and they can lose it on an even more extravagant scale... In today's caffeine-fuelled dealing rooms, a barely regulated private-equity group could very well borrow money from syndicates of private lenders, including hedge funds, to spend on taking public companies private. At each stage, risks can be converted into securities, sliced up, repackaged, sold on and sliced up again. The endless opportunities to write contracts on underlying debt instruments explains why the outstanding value of credit-derivatives contracts has rocketed to $26 trillion—$9 trillion more than six months ago, and seven times as much as in 2003."
• U.S. Credit-Market Fallout `Likely to Be Protracted,' IMF Says in Report
• Jim Rogers Sees `Skyrocketing' Commodity Prices, Criticizes Fed Rate Cuts
• Syndicated Loans: Echoes of Subprime

·         World-Wide Financial Risk in a Single Picture The International Monetary Fund has produced a useful diagram of how its views of risks facing the world financial system have changed between its financial stability report of last April, and its latest, published this week. The diagram maps six different indicators of risk: emerging markets, credit, market and liquidity, risk appetite, monetary/financial, and macroeconomic risks. For a full explanation see the page 2 of the IMF’s Global Financial Stability Report

Goldman Sachs Sees `the Bottom' When Besieged Wall Street Can't Yet Concur Goldman Sachs Group Inc., the world's biggest and most profitable securities firm, has good news for its competitors: The worst credit-market shakeout since 1998 is abating. After winning its third-quarter bet against all forms of money devalued by the subprime mortgage collapse, while almost everyone else on Wall Street did the opposite, Goldman is signaling a turnabout. ``We are a lot closer to the bottom than where we were at the end of last quarter,'' Chief Financial Officer David Viniar said in an interview assessing the third-highest earnings in Goldman's history and the industry's only increase last quarter. ``There are going to be opportunities in the mortgage business,'' he said, and ``there are certainly going to be opportunities to buy distressed assets.'' The emergence of a bullish sensibility is resonating if only because so many of the New York-based firm's strategies have been on target. It was Goldman that foresaw this decade's bull market in fixed income and built a team of traders that generated a record $14.3 billion of revenue last year.

KKR's Banks Sell $9.4 Billion First Data Loans in Biggest Deal Since July Kohlberg Kravis Roberts & Co.'s banks sold $9.4 billion of loans used for the buyout of First Data Corp. in the biggest offering of high-yield debt since corporate funding dried up in July, according to a person with knowledge of the transaction. Buyers are starting to return to the market after record mortgage foreclosures prompted investors to shun all but the safest debt. Underwriters led by Citigroup Inc. and Credit Suisse Group had to offer a 3 to 4 percent discount to sell the First Data loans, and are still left holding as much as $14.6 billion more of the Greenwood Village, Colorado-based company's debt. Banks for First Data, the biggest processor of credit-card payments, cut the loan sale to $5 billion earlier this month because of a lack of demand. The six banks issued $7.6 billion of the debt at a discount of 4 percent of face value, the person said. A further $1.8 billion was sold at a 3 percent cut, said the person, who declined to be identified because details of the sale are private. Underwriters sold more than $7 billion of leveraged loans in the U.S. in the last two weeks, reducing their backlog of postponed debt offerings to about $370 billion, according to Bank of America Corp. Leveraged buyouts, which were at a record $613 billion in the first half of the year, slowed to $167.4 billion since then as banks stopped financing new deals, Bloomberg data show. Sales of U.S. leveraged loans declined to a total $12 billion so far this month from more than $50 billion in June, according to Standard & Poor's.

·         First Data: $9.4 Billion Sold Selling loans for 96 cents on the dollar is considered good news in this environment. Maybe Credit Suisse and Citigroup can sell more, and make up the loss with volume! The key number is the $14 billion or so in pier loans. The total deal value was $26 billion with $24 billion in debt. This is still larger than the Chrysler pier loans that were only $10 Billion.

Oaktree, BlackRock, Eaton Vance Plan Funds to Buy LBO Loans at a Discount Oaktree Capital Management LP, BlackRock Inc. and Eaton Vance Corp. are raising funds to purchase leveraged-buyout loans that banks are selling at a loss. At least 11 firms are seeking more than $12 billion as banks court buyers for more than $370 billion of debt they pledged to finance takeovers. Citigroup Inc., Credit Suisse Group and Deutsche Bank AG already have reduced prices on loans by as much as 4 percent to lure investors. Investment groups such as Los Angeles-based Oaktree Capital, which oversees $47 billion, and BlackRock in New York see a chance to profit because banks are stuck with loans they made before demand for below-investment-grade debt dried up in the past three months. The Standard & Poor's/LSTA Leveraged Loan Index fell 3.1 percent in July and August as record defaults on U.S. subprime mortgages drove investors away from all but the highest-rated securities.

Economy

Growth Recession Now, the Real Deal Tomorrow? On a year-over-year basis, growth in real gross domestic product (GDP) is settling in at around 2%. Although the economy’s precise potential growth rate is unknown, most estimates center around 2-3/4%. Therefore, it is safe to say that the economy currently is growing below its potential growth rate and is likely to continue so in the foreseeable future. This situation is sometimes referred to as a growth recession. As economic growth persists below potential, the unemployment rate begins edging higher and the manufacturing capacity utilization (operating) rate begins moving lower. What are the probabilities that this growth recession morphs into a full-fledged recession? The probabilities are high. In sum, the U.S. economy has entered, at best, a growth recession – an environment in which excess capacity will begin to rise in the labor and product markets. In turn, this excess capacity will temper price increases of good and services, and most likely equity prices, too. At worst, the U.S. economy is on the cusp of entering a full-fledged recession.

• Is this the start of Hamlet Act V?
• Greenspan Sees Greater Chances of U.S. Recession Now Than a Few Months Ago

·         Retailer Sales Fall 1 Percent in U.S., Prompting Cut in September Forecast, Lowe's and Target Warn

• Orders for Durable Goods in U.S. Decline 4.9 Percent, Most in Seven Months

European Economic Sentiment Drops to 16-Month Low as Inflation Accelerates European confidence in the economic outlook dropped to a 16-month low in September and inflation accelerated above the European Central Bank's ceiling as borrowing costs climbed and oil prices reached a record. An index of sentiment among executives and consumers in the 13 nations that use the euro fell to 107.1 from a revised 109.9 in August, the European Commission in Brussels said today. Economists forecast a decline to 109, according to the median of 30 forecasts in a Bloomberg survey. The data adds to evidence that fallout from the U.S. housing slump is spreading to Europe. The ECB, International Monetary Fund and European Commission have all cut forecasts for euro-area economic growth since surging credit costs curbed bank lending. Retail sales in Germany unexpectedly fell in August, the Federal Statistics Office said today.

·         Fed Paper: China Can’t Shield Asia From U.S. Slowdown

·         European Engine Might Stall New signs indicate that turmoil in global financial markets could hit the recovery in Europe's economy, one of the bright spots in the industrialized world. Recent surveys show that businesses in the 13-nation euro currency area are becoming sharply more downbeat. Worsening data are prompting economists to cut their growth forecasts for the region. A marked slowdown in the $11 trillion euro-zone economy would also harm the outlook for companies in Asia and the U.S., which have found unexpected sales growth and profits in Europe in the past year that have helped to offset weaker growth in the U.S.

·         German Business Confidence Declined to 19-Month Low in September, Ifo Says

Housing Chill Grows Worse Home resales tumbled 4.3% in August and a measure of homes on the market soared to an 18-year-high. The slump, along with credit-market turmoil, is beginning to hit retailers.  The housing market is going into a deeper chill, and consumers are starting to shiver.Sales of existing homes in August fell sharply, and home inventories by one measure soared to an 18-year high, according to data released yesterday. One major home builder, D.R. Horton Inc., is auctioning homes this weekend with starting prices for some units at 50% off an earlier price. The housing market is worrying consumers, raising fresh concerns about economic growth. Consumer confidence fell this month to its lowest level in almost two years, a new survey showed. Retailers such as Lowe's Cos. and Target Corp. said they're feeling the pain. Both reported softer-than-expected sales Monday. "The combination of all this is indicative of an economy that has lost quite a bit of momentum," said Joshua Shapiro, chief U.S. economist at the consulting firm MFR Inc., an economic forecasting firm that advises investors. Wall Street seems unconcerned for now. Broad stock indexes moved little yesterday, and the Dow Jones Industrial Average is just a few hundred points from its all-time high.

·         Lennar Reports $514 Million Loss, Biggest in Homebuilder's 53-Year History

• Home Prices Post Biggest Drop in 16 Years- The decline in U.S. home prices accelerated nationwide in July, posting the steepest drop in 16 years, according to the S&P/Case-Shiller home price index released Tuesday. [They Cried Wolf. They Were Right. ]

Subprime-Mortgage Defaults Rose Last Month, Data Show  Late payments and defaults among subprime mortgages packaged into bonds rose last month, according to data for loans underlying benchmark ABX derivative indexes. After August payments, 19.1 percent of loan balances in 20 deals from the second half of 2005 were at least 60 days late, in foreclosure, subject to borrower bankruptcy or backed by seized property, up from 17.5 percent a month earlier, according to a report yesterday from Wachovia Corp. Prepayment speeds for the loans slowed, suggesting it's more difficult for borrowers to sell their homes or refinance, according to another report by New York-based analysts at UBS AG. Record levels of delinquencies and defaults on subprime mortgages are worsening as home prices decline and interest rates on loans adjust higher for the first time. As lenders tighten standards, borrowers are finding it harder to refinance into new mortgages with lower payments. The ``reports showed the first inkling of the impact of shutdown of subprime market,'' the UBS analysts led by Thomas Zimmerman wrote late yesterday. ``In our opinion, the full impact is yet to come.''

Profit Growth in U.S. May Hit Five-Year Low as Housing Slump Curbs Demand Profit in the U.S. may grow at the slowest rate in more than five years this quarter as the housing slump hurts results at companies from IndyMac Bancorp Inc. to Target Corp. Earnings of Standard & Poor's 500 Index members may rise an average of 3.2 percent from a year earlier, breaking a 20- quarter streak of gains exceeding 10 percent, according to data compiled by Bloomberg. Since Aug. 20, at least 52 financial and consumer discretionary companies in the Standard & Poor's 500 Index have issued third- quarter forecasts that met or fell short of analysts' estimates, compared with 10 that said earnings would be higher than forecast.

Is Mishkin Mishuga* about Asymmetric Monetary Policy Responses? Why doesn’t the Fed want to act to prevent asset-price bubbles? Because it claims that it is not perceptive enough to identify these bubbles in their formation. Given the Fed’s dismal forecasting record of cyclical economic turning points, I take it at its word. Is there some alternative approach to the monetary policy operating procedures that would reduce the likelihood of the formation of asset-price bubbles without necessitating the Fed’s a priori identification of bubbles? Yes. Moreover, the approach I am about to suggest also would prevent rapid cumulative increases in the prices of goods and services, now commonly referred to as inflation. And my alternative approach would not prevent declines in the prices of goods and services that would occur “in nature” as a result of advances in productivity and technology.  What is this alternative Fed operating procedure? Have the Fed increase the amount of credit it creates at the rate of growth of the U.S. population. That is, keep the per capita dollar amount value of the Fed’s balance sheet constant. Chart 1 shows the actual per capita growth in the Fed’s balance sheet. From 1953 through 1960, the per capita change in the Fed’s balance sheet was negative. After 1960, with one exception, in 2000, the per capita change in the Fed’s balance sheet has been positive. From 1953 through 2006, the median annual percent change in the per capita value of the Fed’s balance sheet has been 4.5%.

Business

(***) Marked increase in health-care costs coming in 2008 A study shows that health-care cost increases are down to their lowest level in nearly a decade, but they're forecast to rise at a much faster rate again in 2008. The study from Hewitt Associates says that total health-care costs to employees will jump by double digits next year, and that point-of-service and-preferred-provider-organization coverage -- which have seen growth rates in the low single digits during 2007 -- will jump by a high-single-digit percentage. Those increases will more in line with health maintenance organizations and traditional indemnity plans. Hewitt researchers say that this year's price increase was artificially low since many employers have been socking away extra cash for health care of late. "In '06 and '05, employers were budgeting too much so they had overall surpluses in the plan," said Bob Tate, chief actuary for Hewitt's health-management consulting business. "They didn't have to budget so much [this year]." Tate adds, however, that insurers also will be upping their price increases by a percentage point or so, to about a 9% gain -- roughly triple the rate of inflation. Employers generally already have lined up their health-care plans for the coming year and are feeling the extra pinch.

Can the Washington Post survive? That's the story of the newspaper business right now. Alarmed by declining circulation, advertising and profits, America's newspaper publishers - as hidebound a collection of businesspeople as you can find - are thrashing about to see whether they can separate the news from the paper and still make money. They're going way beyond the headlines. No less a sage than Warren Buffett, a lifelong newspaper aficionado, the owner of the Buffalo News, and a director of the Washington Post Co. (Charts) for most of the past 35 years, told Fortune, "The present model - meaning print - isn't going to work." What lies ahead for the Post seems to be a long and painful transition from print - so important to local advertisers that the newspaper could raise prices almost at will - to the Internet, where competition for readers and advertisers is brutal. Between 1940 and 1990 about 267 papers shut down, victimized by big forces: TV news (which killed afternoon papers), the movement of people from cities to suburbs (which made delivery more costly), geographic mobility (rootless people tend not to read the local daily) and a decline in civic engagement dating back, as it happens, to Watergate. The Post's daily circulation peaked at 832,000 in 1993. It has dropped by nearly 20 percent since then, while the region's population has grown by about 20 percent. "I don't think any news organization has maximized the potential of the Internet," he says. "I know this one hasn't." Imagine if, when big news breaks, the Post's Web site routinely offered a print story, a video version, an audio point-counterpoint by op-ed columnists, maps, photos, links and reader reaction. Could washingtonpost.com become a leading online news destination?

Big Oil's Latest Roadblock Big Oil has a big problem. It may not be apparent from the huge profits that oil and gas companies are gushing. But the industry's future depends on its ability to rove the earth in search of new reservoirs of oil and gas. Yet as energy resources grow scarce, governments are restricting Western drillers' access to their fields. They're fostering their own champions, many of which are flush with capital, have learned from the majors and can easily contract drilling expertise from firms like Schlumberger, a Franco-American oil-services company. There at least three logical responses by the oil majors to the rise of National Oil Companies, or NOCs. The first, already under way, is to invest in countries where they're unlikely to see their assets expropriated. The second is to consider buying service firms themselves. Lastly, they could seek megamergers, along the lines of an Exxon-Chevron or BP-Shell, to counter the increasing heft of the NOCs.

·         BP's 'dreadful' quarter. New CEO says performance has been "dreadful," tells staff he'll undertake a major corporate revamp

Retailers may have worst holiday in five years, NRF says Amid housing concerns and credit worries, U.S. retailers could be headed for their worst holiday season in five years, according to the National Retail Federation. Holiday sales are projected to rise 4% to $474.5 billion, which would be the slowest gain since 2002 and would fall below a 10-year average rate of 4.8%, said NRF, the world's largest retail trade association. Target cuts sales forecast, analysts prune estimates

For Facebook, GeoCities Offers a Cautionary Tale Facebook founder Mark Zuckerberg was 10 years old when David Bohnett, then a 37-year-old mainframe programmer, hatched an idea: Set up a Web-based "community" where young people could divulge their most intimate feelings. He grouped those musings into different themes, and ushered in advertisers to hawk Volvos and Volkswagens. This ur-Facebook of 1994 was called GeoCities. And both its rise and fall are a history lesson for Mr. Zuckerberg as his social-networking site, the 16th-most visited on the planet, approaches its own crossroads: Should it sell, launch an initial public offering or take another investment round? GeoCities' tale shows just how necessary continual innovation -- and the capital to support it -- are for a Web media business. It's a lesson in the perils of being acquired. And yet it shows the value of humility, even in moments of the sweetest triumph. Just how many of the top 20 visited Web sites of August 2003 are still in that ranking? Nine. GeoCities grew popular before broadband, meaning that it would appear terribly crude to modern eyes. There was no video. It took hours to upload a photograph. Back then, entries were known as home pages, not profiles. But the basic, expressive elements of today's Facebook and competitor MySpace, owned by News Corp., were all right there. MySpace owner Rupert Murdoch, had it right when he summed up the state of 125-year-old Dow Jones & Co., publisher of The Wall Street Journal, which he is now buying. "The first road to freedom," he said of Dow Jones, "is viability."

Hiring Outside Talent, Microsoft Aims to Keep It That Microsoft granted his request illustrates a new approach Chief Executive Steve Ballmer is taking as he tries to expand the Redmond, Wash., company into new areas from online music to videogames to Internet advertising. Mr. Ballmer has found he must tap outsiders rather than rely so heavily on homegrown managers as in the past. How Microsoft fares with Mr. McAndrews will be a test for Mr. Ballmer, who has tried over the years to make the company a more hospitable place for outside talent. Another test will be Don Mattrick, whom Microsoft hired this summer to head its videogame group after a long career as a top executive at game giant Electronic Arts Inc. Mr. Ballmer has had some successes bringing in and keeping new executives, including Microsoft's current chief operating officer, Kevin Turner, plucked from Wal-Mart Stores Inc. two years ago, and finance head Chris Liddell, hired from International Paper Co. in April 2005. Still, a combination of forces within Microsoft -- its engineers' exalted stature, its insular culture, its sheer size -- make integrating new executives a lingering problem. Often through Microsoft's history, decisive and aggressive outsiders have been worn down by the second-guessing of Microsoft veterans before stepping down to less prominent roles or leaving altogether.

IBM to Help Businesses Better Compete Against Industry Rivals IBM (NYSE:IBM - News) today announced new industry-focused software and services to help clients spanning multiple industries including banking, telecom, healthcare and insurance, compete more effectively against competitors across the street, around the world or over the Internet. The new products help identify a client's performance against important business processes in their industry and then compare that performance to industry averages. IBM then helps develop a plan to increase a client's business performance, measure and track business goals and more effectively manage business processes across an organization to help clients become best in industry class. Specifically, today's announcement includes a Globally Integrated Enterprise Assessment, key agility indicators, business process management software and industry specific content.

Under pressure to deliver Alcatel-Lucent Chief Executive Patricia Russo has been given a month to devise an emergency restructuring plan for the board after the telecommunications-equipment giant issued its third profit warning under her leadership earlier this month, according to a media report. Alcatel-Lucent's board of directors has told Russo she must come up with a plan for further streamlining the company's organizational structure and present the information at the next board meeting on Oct. 30, French newspaper Les Echos reported on Friday. Per Lindberg, an analyst with Dresdner Kleinwort, on Thursday called for Alcatel-Lucent to replace Russo with Mike Quigley, the company's former chief operating officer, who quit last month. The analyst also estimated the company needs to pare 30,000 jobs, and not the 12,500 being targeted. His verdict on the merger is harsh. "There is little doubt that the merger between Alcatel and Lucent has turned into a veritable fiasco," he said.

Will Avaya Get Harmanized? KKR’s abandoning of Harman International Industries is causing separation anxiety for investors in other takeover targets like Avaya. Shares of Avaya plunged briefly this afternoon on suspicion from traders that Silver Lake Partners and TPG will abandon their buyout of the telecommunications-equipment company. (Coincidentally or not, at $8 billion, the deal is the same size as Harman.) Down as much as 11%, Avaya shares rebounded quickly after the company put out the word that the buyout is not in jeopardy. An Avaya spokesman told us the company plans to hold the shareholder vote on the deal Friday and expects it will close as planned at the end of October. (Although it could be the last to know if the buyout firms planned to bail.) Avaya stock closed with a loss of just 29 cents (at $16.50). It rose a bit more after hours too. But it’s no wonder investors are skittish. After being left at the altar, shares of Harman, the audio-equipment maker, are down nearly 30%. Investors in other companies with pending buyout deals are equally skittish. Shares of Guitar Center and Acxiom have dropped between 5% and 10% in the last two sessions. Shareholders in Sallie Mae parent SLM are on the edge of their seats too. Avaya’s shares have proved resilient in the past. They fell about 7.5% during the worst of the credit-market storm this summer, before rebounding on renewed hopes that the deal will survive the turmoil.

Posted by dblwyo at 12:59 PM | Permalink | Comments (0)

Well the latest monthly payroll data is in and we gained 110K jobs and the market and the talking heads are euphoric. Supwise, supwise,.... amazing, startling even. 110K is far below the breakeven point of 150K/month required just to keep our heads above water and even farther below the 225-250K/month required to grow the economy, let alone make up for all the jobs lost during the downturn. If you've ever wondered why people have had a general feeling of malaise about the economy and our prospects on the one hand the weak...weak jobless recovery goes a long way toward explaining it. And if you've wondered why there's been no new hiring or capex spending, well guess what - businesses are rational and if demand isn't growing they won't invest in expanding capacity.

Our esteemed exemplar Barry Ritholz does an excellent job of dissecting the details and weaknesses of this month's report over at TheBigPicture:NFP WTF ? He also appears to share our shock at the euphoria and document it as well.

So we'll concentrate on poking underneath that with a few graphics examinations of trends - here immediate and below both longer term as well as put the ADP vs Gov't stats debate a bit to bed. The "soundness" of this report should be immediately apparant - YoY growth was 1.2% (healthy growth is > 2% and approaches 3% in a robustly growing cycle). Worse yet the trend is very definitely down, and you can see the relationship to the longer-term of this current business cycle in the sub-chart. So much for the stock-market as a forward-looking and prescient discounting mechanism. It looks more like an extrapolation tool based on whatever, in this something funny in those cigars perhaps ? :) !

Speaking of net new job creation check out the accompanying composite chart. It shows net job creation since Apr00 while the sub-chart runs the approach back to 1980 on a quarterly basis. Notice in the first part that new jobs have been basically running on the 150K/month line since Apr04. Which means that if you net out 150K/month we have, in essence, been at zero new job creation for almost three years; and it's slowing ! If you add up the net jobs to get cumulative job creation the picture looks even worse - we're in the hole six million jobs required to just maintain employment levels even with labor force and productivity growth. Really not good. Of course that depends partly on the 150K assumption and there've been arguments that the range is [120, 170] with the Fed doing some work that argues that long-term trend growth is slowing because labor force and population growth is slowing. And if productivity turns out to be down so trend growth move into the 2.5-3.0% range from the current 3-4.0% range we will indeed be in a brave new world. It also depends on your start point so you can see that complication on the 2nd sub-chart where the longer-term net is not so good. Sorta - what it means is that all the long golden age of the 90s is lost to us because we didn't keep the net new jobs and are still -2 million jobs in the hole. All this sturm und drang over income distribution, changs in the economy, globalization, etc. etc. ? Well guess what - a bunch of that is because we haven't been creating the jobs for the people we have (who, to be fair, haven't gotten the education and skills they need; triump of the chicken-n-egg ?).

One other little thing to put to bed is the debate over the ADP numbers verses the government reports. Actually ADP has gotten a lot better, the various data sets track each other pretty well and particularly and MOST importantly, capture the same trends and turning points, which is the hardest thing to do. 

The charts at the left show the YoY% changes in ADP and Private NSA payroll numbers as well as the total payroll number. They track quite well with a possible telling exception - the ADP YoY is significantly below the reported changes. One interpretation is that the recent Birth/Death adjustments for small businesses have over-estimated job creation (cf. Mr. Ritholz's post).

In any case as you can in the 2nd sub-chart the two series have some timing discrepencies but basically arrive at the same answer. In other words give or take adjustment problems plus B/D issues when the ADP number comes it, it's really....really worth paying attention to. Especially when you recall that it's Private Employment that reflects and drives the economy. 

Posted by dblwyo at 08:04 AM | Permalink | Comments (0)

There's been a running debate in the blogosphere for some time now, particularly for example on BigPicture (There's No Inflation (If You Ignore Facts)). Otherwise one of my single favorite Econ/Mkt blogs and one of the few (two actually) times where the data leads me to argue with my so-respected exemplar Mr. Ritholz. Where it becomes more interesting is not just the support and picking-up of the argument in the financial and finecon communities but in the MSM business press. Don't get me wrong - it's an issue that deserves a careful look AND continuing, on-going attention because it changes and evolves.

So we thought we'd take a closer look at see what that data is actually telling us. The debate is over whether or not the Fed's been worried (enough, too much ?) because they've been looking at inflation without inflation; that is at core CPI ex-Food & Energy. My argument has been that CPI is volatile enough that looking at core makes a lot of sense, unless there's a major and sustained divergence. An argument that hasn't been kicked around enough yet IMHO. Yet we can sidestep that whole debate by looking at YoY% changes (my favorite analytic tool where it works) and see what we see. Interesting enough inflation was getting to be a problem, getting over 4% and headed for 4.5%. The even more interesting question was what impact would PPI getting ahead of CPI mean but we pick up the arguement below. But take a look and decide for yourself - the whole point is to present the data in as clean and simple a form as possible for you to see the trends and structure for yourselves. To my eye, while not where we'd like it, the whole CPI vx x-CPI debate is moot because total inflation is a) approaching 2% and b) headed downward.

But there are other, more interesting, questions to investigate. In particular what the long-run trends are, whether the argument we've just made on a few years data holds up and what the strategic outlook and issues might be.  

If you look at the next chart, which shows CPI, CPIx, PPI and PPIx you see that there were some divergences earlier on but recently there's more convergence. That earlier gap traces back to the sudden increase in world energy/oil prices as the combination a return of growth and BRIC demand suddenly caused demand > supply and prices reacted accordingly. Now if we stopped there you might argue that we were seeing a problem emerge which has since gotten a bit more benign. It's the 2nd sub-chart that makes it more interesting. It shows the cumulative changes since Jan00 in CPI, CPIx and PPI. Notice that until Jan04 the different measures were in fact marching to the same music but since then there's been an increasing aggregate divergence. CPI > CPIx, which gets back to the F&E problem. The chart would tend to support the BigPic argument in that it looks like instead of sustained volatility around a common trend we're seeing a structural shift in the world economy. Oops. But the counter we now have available is, true but total CPI is still headed down.

Even more interesting and worrisome however is the growing gap between PPI and CPI. One has to ask where that difference in costs is showing up ? Think about for a minute. If materials and supplies costs are showing a sustained upward trend but ARE NOT being reflected in the CPI it means they aren't being passed on. Which means in turn that companies are under severed and growing pricing & cost pressures. (Which is consistent with and reinforces the point made in the prior post on the new worldwide competitive realities:On Being a Boiled Frog: the Strategic Outlook for US Industries). It would also partially explain why capex is constrained and hiring so historically poort; though the growth in profits and earnings is left begging for a deeper explanation. Boiled Frog soup anyone ?

Taken all together maybe we ought to look at longer-run trends in inflation and see what we see. Looking at the bottom sub-chart there are two things that first come to mind for me. One, that Volcker and Reagan really did us a major good turn without which we'd have really been in trouble. A second is that CPI and CPIx pretty much match up over time so Inflation ex-Inflation is indeed moot. The related strategic question though is have we reached the limits of this secular trend ? That is are we shifting to a long-run environment where the risks of inflation getting re-established are higher than the liklihoods of continued low inflation, at least without on-going efforts ? That's Greenspan's argument, explains much of the Fed's recent rhetoric and jives with the data as shown. The first sub-chart showing a shorter period since '92 pretty much re-inforces all these points. Inflation x-Inflation is moot, it has been relatively benign and was getting to be worrisome but now appears to be back under control, at least temporarily. One could also make the technical point that the linear and non-linear trend lines are converging; i.e. the trend is pretty simple for several years now, and benign. The danger is that inflation and expectations get reset.

Which when you stop to think about is pretty much what the Fed has been trying to tell us. The second hidden thought is that the economy has adjusted incredibly well and resiliently to the upward pressures. Did we get lucky, or is it a downturn in the economy or are we just finishing an adjustment process to higher energy prices and moving to a new plateau ? Or some combination ? 

Posted by dblwyo at 04:35 PM | Permalink | Comments (0)

You've probably all heard the metaphor about boiling frogs - how do you boil a frog ? Slowly - it'll just sit there and not notice that the water temperature is rising until it's soup. Well there's a lot of changes going on in the worldwide economy and business pictures that are the same. But our companies, our industries and related decision makers are so trapped into dealing with the day-to-day crisis that the bears and alligators are winning and the swamp is rising higher and higher.

Some time ago I happened to take a general overview of the situation and pulled together some themes. Having just found and re-read it let me share it. Despite being a couple of years old it holds up pretty well. An assertion that I'm happy to have tested and countered by the way. Please feel free as it would make me feel better. Meanwhile here's (hopefully) some food for thought on the strategic prospects for industries in general with some examples from the steel, textile and airline industries.

There are critically important lessons here, that should now be applied to all other industries. To put a point on, as you skim over the rest of this, let me propose that every single industry will be forced to go thru a workout like the steel industry has and the airlines are beginning. As late as last year the residuals of that fight were still being played out but the net structural results are that the American steel industry put itself out of business, the firms have since been bought by new international owners, and different production methods and technologies have been put in place all more aligned with the new world. Unfortunately the failures to adjust and the lack of leadership ended up hurting the workforces worse than anyone else.

Every single domestic industry needs to go thru this re-thinking, and will, one way or another. 

UPDATE: Tim Walker at Hoover's Business Insight has just posted a fascinating comment on enterprise performance, lack of adaptation and adoption and business "disorganization". Extremely useful..

Disorganization Negates Talent.  After yesterday’s entry, I was thinking more about the plight of Alcatel-Lucent and similarly challenged outfits that are trying to restructure their operations. The companies that spring to mind are Kodak (nearly done with its reformation), Ford (slimming down), and Countrywide Financial (no telling whether it will survive the mortgage mess). All of these companies face the challenge of dealing with large infrastructures that may no longer help them to address the needs of their customers. In some cases of restructuring, those customer needs — or even the entire customer base — changes quickly enough or radically enough that the company awakes to find itself in what is essentially a new marketplace.  In each of these cases, changes in the prevailing conditions of business have upended the organizational quality of these large companies. What I mean is that they may have been rightly organized for earlier prevailing conditions in the marketplace — surely they were, considering the huge profits Kodak, Ford, and Countrywide have made at times — but whenever they can’t keep their organization evolving in pace with the evolution of the marketplace, they’re bound to end up looking disorganized. In fact, they are disorganized, as far as making steady, healthy profits is concerned.

A few weeks ago Herb Greenberg had an interesting post on looking beyond same-store sales and what it tells you about retail performance. It struck me as interesting, accurate and a little sad. We've known for years that what you really ought to consider is profit margin on the product, and perhaps category, level. If you've got good enough control of your operations and the technology to monitor that is. Very difficult. Looking at gross margins is a major step - in fact it's a spectrum of sophistication. Below you'll find some interesting pointers to further readings on thinking about retail business models, which have been under great pressures for years (decades) with both no end in sight and no "next big thing" either. The thing is, Tesco has that capability on the product, operations and technology fronts. And judging by what little you can guess at in the stores so does Trader Joe's. So let me quote from Herb.

Looking beyond same-store sales :

When Bed Bath & Beyond in early June warned of lower-than-expected earnings for its fiscal first quarter, a first for the home-furnishings retailer, much of Wall Street was surprised. After all, the company's sales at stores open at least a year, a widely followed industry benchmark, had been holding their own.

As recently as three months before that warning, "it was the only home-furnishings retailer that was still outperforming," recalls Rob Wilson, president of Tiburon Research Group, which provides research on retailers to hedge funds. "It was gaining market share."

Yet that profit warning didn't catch Wilson off guard. He says that while same-store sales are an important indicator, they can be misleading if they aren't viewed in the context of other metrics. At Bed Bath & Beyond, for example, Wilson became concerned six months earlier after Chief Executive Steven Temares mentioned on an earnings conference call that the gross profit margin had been lifted by "volume incentives," which in turn lowered its costs.

Without that, the gross profit margin might have fallen. Several months later, in May, Wilson told his clients: "The cracks are beginning to show. ... In addition to a macro environment that will finally catch-up with Bed Bath & Beyond, the business model is exhibiting a few earnings quality concerns in the past few quarters (that) imply the company is ripe for a materially lower than consensus" earnings performance for this year.

And my comments:

A good point, one we all forget but also one for which there is no data. The two things in working with retailers in re-engineering their businesses I learned to really look at were product profit margin and product mix. That is how much were they making and what were the trends on what they were selling. That data doesn't appear to be reported anywhere but it's what drives a retail business. On a large-scale think WMT enterring grocery years ago and changing the industry or more recently it's entry into electronics. Is SBUX recent downdraft independent of Dunkin Donuts and McD's entry into the edges of that marketspace ? It's the great game of retail and nobody reports on it. :)

Further On-Point Readings: 

(*****) Best Buy Boutique Strategy Turns Retailing Upside Down, Boosting Earnings Best Buy Co. became the largest U.S. electronics retailer with its trademark lookalike big-box warehouses. It plans to get bigger by opening more stores that tailor to individual customers. In a test run that started in 2004, Best Buy boosted the number of stores it operated in Dallas by 50 percent. Sales at the new outlets rose faster than expected during the three-year experiment without sapping sales as much as forecast at older stores, Chief Executive Officer Brad Anderson said in an interview. That was ``a significant development,'' Anderson said. ``It opens all sorts of doors with potentially a better return on investment.'' The experiment helped prompt Best Buy to raise its target for total U.S. stores by 40 percent to 1,400, which may lift the share price 29 percent in the next 12 months. To meet local demand, Best Buy customizes stores to customer types, catering to soccer moms at one outlet and tech geeks at another. The expansion pledge is a sign to investors there is more room for Best Buy, already the market leader, to gain share and boost sales nationally, said Anthony Chukumba, an analyst with FTN Midwest Research Securities Corp. in New York. Best Buy sales will rise 30 percent by 2010 according to estimates compiled by Bloomberg. That's two-thirds faster than the pace forecast for Circuit City.

Lowe's Popularity Can't Beat Home Depot's Locations In the battle of the big-box home centers, homeowners give a slight preference to Lowe's Cos. (LOW) but Home Depot Inc. (HD) still gets more of their money thanks to the larger chain's convenient locations, according to a recent survey. The survey by Consumer Specialists, a Germantown, Tenn., marketing research and consulting firm, found the two largest U.S. home-improvement retailers are closely matched competitors. Lowe's rated higher than Home Depot in most areas, including product selection and customer service. Asked which chain they like better, 53% of respondents chose Lowe's, while 47% chose Home Depot. That's an even wider gap than a similar survey in 2006, which found a 51%-49% preference for Lowe's. But Home Depot ranked significantly higher in having convenient locations, which turned out to be the strongest predictor of where respondents spent the biggest chunk of home-improvement dollars, the firm said.

Posted by dblwyo at 08:18 AM | Permalink | Comments (0)

Tesco, the largest UK retailer, is coming to the US with a new format that primarily focuses on ready-to-go meals of high quality and will start in the US market. Knowing them they've thought this thru thoroughly, tested and will execute with style, discipline and customer-focus.

Where this is both interesting and a harbinger of things to come is twofold. First, just in their sector, making something like this work takes a complex blend of skills in store operations, replenishment, logistics & transportation, product development, procurement and technology. Having worked some with Tesco in years past they are as good and balanced as anybody in the world at the reach and range of these skills. In fact their logistics operations are THE critical enabler of their responsive, high-service store operations and are built with more capabilities than any other; and closely coupled to very sophisticated IT.

Second, it's a harbinger for the retail market as a whole. Which is largely split between high-end retailers where price isn't much of an object and the EDLP (every-day-low-price) cost-control mantra low-end with some examples but no major players in the middle. With a sorta of exception in Target and more so in Trader Joe's. Yet it's where the largest opportunities lie when you add up the number of people with disposable income who are ill-served.

So that makes the US entry of Tesco a great, dramatic and exciting event for some of us who find the world of business (as it is not as Dallas would have it) intriguing. 

Tesco upbeat on U.S. entry Britain's largest retailer overcomes wet, cold summer weather with 19% profit rise, ready for big push into U.S. grocery segment.Tesco Plc, Britain's largest retailer, on Tuesday said first-half profit rose 19% as strong sales of non-food items and solid international growth offset a U.K. performance dampened by the wet summer weather.  Outside the U.K., sales jumped 22%, driven by rapid growth in China and Eastern Europe. Margins improved markedly in Korea, Thailand and Malaysia. "I feel very good about China. And you will see us move more confidently in that market in the future," Leahy said. He said the company understands more about the shopping culture there, and the need for sites that are part of larger shopping centers. Tesco is also focused on its international expansion. The retailer will open its first U.S. stores in the coming months and plans to add 100 outlets in California, Arizona and Nevada under the name Fresh and Easy. The convenience shops will focus on healthy, ready-prepared meals. Tesco expects to open at least 50 stores by the end of the fiscal year in February. The retailer said its main office is already staffed with 200 people and it's made good progress on acquiring new sites and the recruitment and training of staff. Leahy noted that U.S. planning laws mean the rollout can be rapid.

My Marketwatch Comments:

I've worked with Tesco in years past and their UK stores were very innovative & customer-value designed, oriented and run. The closest thing we have in the US is perhaps Trader Joe's. More importantly their command of logistics, technology and product/category development were and are as good as any; and they drive the business around it. Their international growth over the years has been very careful and effective. All in all a very well-run, forward-looking company that balances strategy, innovation and execution extradordinarily well. Their logistics operations and store replenishment are as good as any in the world.

Where this is important is that there new US initiative goes for the vast sweet spot in US retailing of the middle of the Retail dumbell, that is there's the luxury end where price for alleged value is no object and the cost-control end where EDLP is the mantra. What nobody's figured out or done well is the huge middle which would like good product selection, good service, quality and fair, value-based pricing. Target is probably the best example here. What makes the middle so hard and unpopulated is that it takes a blend of skills from store ops to product development to logistics and IT. Yet it offers the best long-term profit potentials. Tesco has those skills, culture and capabilities. This will be very interesting indeed.

 

Posted by dblwyo at 07:41 AM | Permalink | Comments (0)

Back in the day somehow I ended up getting involved in the old amateur radio community (back when you had to learn Morse, a little electronics and to keep your arms away from the heat sinks. Worst burns I'd ever seen :) ). They used a phrase QRM, or QR Mary, for man-made interference that kept the signal from being heard/read in the midst of all the noise. Part of the trick was to find the right kinds of filters to sort out the noise and find the signal. Well we do something similar by looking at the high-frequency economic data (usually monthly) to understand the business environment; mainly by analyzing the year-over-year changes which show the trends, the turning points and the structural relationships. In fact we've waxed on a time or three on the topic (here and here for example).

The latest talking head and other discussions of the state of the economy are using the R-word pretty frequently (16Sep07 Economy & Outlook) but strangely enough the three factors that suddenly brought all this to the fore are the general state of the economy, the housing market and the credit market. Problems in all three of which have been visible using these "filters" for some time now; as well as some other sources, e.g. CalculatedRisk for housing. (If you'd like a scary look at how badly the headline data is missing try Housing: Cancellations, New Home and Total Inventory ).

Below we take a look at three sets of basic economic indicators - one's focusing on current consumtion trends (Real Consumption, Retail Sales, and Autos), future investment demand ( Durable Orders ex-Aircraft, Industrial Production and New Home Sales) and future consumption demand (Real Wages, Employment). Then we look at some other indicators of prices & rates (CPI, PPI, and Interest Rates) and Exchange Rates plus Oil Prices.

By and large the current data continue to indicate a slowing economy, as is now widely discussed, a continued sigificant slowdown in housing and as a result, an increased potential for housing and credit market problems to trigger a Recession. At minimum we're likely to be in a Growth Recession. In fact given that a GR is defined as below potential growth and YoY analysis shows it to be less than 2% and dropping it could be argued that we've been in a growth recession for some time; only nobody has noticed. So the real question becomes will it tip over into a full Recession. At best we're in for a sustained period of growth recession because the unwinding of housing is no admitted to be likely to go on to and thru '09/'10 ! ( Growth Recession Now, the Real Deal Tomorrow? )

Whether that's coupled with rising Inflation isn't clear since using our filters Inflation appears to be under control But the recent Weekly Readers point to rising exportation of inflation from China,where previously it was exporting deflation. A major structural shift. With the accelerating drop in the Dollar, triggered and accelerrated by interest rate cuts, this could get worse.

Bon Voyage to use all ! 

Let's start by looking at the basic economic data (filters) for Current Consumption, Investment  (business and real estate) and Future Consumption. Last week was chock full of new economic data so jumping in notice that Consumption (note this is real consumtion) had a sudden upshift, which would be encouraging if it weren't likely due to declining inflation discussed below). Retail Sales (again real) continues to move downward while Autos look to have moved up until you notice it's graphed on the r.h.s. and only decreased the rate of decline. With the Housing ATM scheduled to disappear ....:).

Meanwhile Industrial Production, while not continuing to slow, is in fact already at a low rate, indicating that industrial output and capex doesn't look promising. New Home sales, also on the r.h.s., still continues to decline at YoY rates of more than -20% (and bear in mind the comps !). Finally, despite an uptick in overall Durable Goods Orders (not shown), orders ex-Aircraft are bumping along around -1.5% after a rather abrupt and steep decline in Q3/Q4 last year and the first part of this year. So one would have to say that both business and residential investment don't look to be positive engines for economic growth. Finally, Wages (real average weekly earnings) have shown an uptick - which may also have contributed to the uptick in PCER but likewise also reflect the impact of slower inflation. At the same time Employment not only continues a sustained downtrend that has been visible since early '06 but shows an accelerating trend. It's very important to note that the method (or filter) being used here steps away from the Month-to-Month problems that caused so much excitement with the headline numbers. For this "filtered" indicator to slow this much is a little scary.

Which brings us to Inflation, Interest and Exchange Rates. The CPI is relatively benign hovering around 2% though not dipping below while the PPI is much more volatile, first ramping up abruptly with oil price increases last fall and then showing a slight drop recently. Which as we know is not likely to continue. Meanwhile Rates (here the 10-Yr Treasury) is even more interesting and volatile, first ramping up rapidly as Inflation fears drove it and then drop even more abrumply, largely on the backs of a flight to quality resulting from the Credit Crunch. If the economy continues to slow and credit remains rationed these pressures will continue. They will however be countered by increasing pressures on the Dollar which could be further strengthened by shifts in foreign investment and reserve holdings away from dollar-based assets. After all if Oil is priced in dollars then then the oil exporters have seen none of the price increase in ways that are useful to them. 

These last points are born out by the second sub-chart showing the trade-weighted exchange rate of the Dollar on the left (l.h.s.) and YoY% changes in Oil prices on the right. Notice that both continue to slow, though at much more gradual rates after earlier abrumpt slowings. Which also bears out our comments about the influnces of both on Inflation as well as the impact of Inflation on the real consumption and wage data. Overall then it looks like inflation is benign but under pressures and we're coming out of a 25+ year period of long-term secular delcine in both inflation and rates. The dangers are to the upside.

The fascinating correlation pattern between exchange rates and oil prices begs some deeper explanation thoug, doesn't it ? Unfortuantely I have't one ready to hand and am open to all reasonable suggestions. 

Posted by dblwyo at 10:01 AM | Permalink | Comments (0)

Reading the pointers for the last couple of Weekly Reader's Market sections one would have the impression that the cauldron continues to bubble in terms of the credit crunch coming under control but still being a problem, not all of those visible as yet and increasing risks to the dollar, inflation, etc. in Economy section. Looking at the charts of the market clearly the data doesn't know what it's talking about or Mr. Market is a lot smarter then me and them - the data that is. Quite possible indeed, especialy in the first case. As Keynes said...never mind everybody's used it by now but you take the point.

The accompany chart uses the NYSE as the benchmark instead of the SP500 but they laregly cohere over the last several years and capture the wide range of bigger cap stocks. We're also trying a new graphic technique - rather than having multiple charts or multiple data loaded onto one we're going to present a master chart which is build up of several sub-charts (the magic of cut & paste - bless you PARC). Hopefullly this has the advantage of making everything visible at once and reducing the number of popups at the price of making it a big one.

If you look at the NYSE after the Jul-Aug drop (which we and others have pointed out are miniscule and don't represent anything like a correction) the market spent an equal amount of time climbing back to a consolidation range between the 50 - and 200-day MA's. Which it has now busted nicely to the upside though it appears to be enterring a new, and lower, trading range. In the short-term it's pretty open-ended whether it goes up, trades sideways or bounces back down. As long as the economic, credit and currency issues continue to be ignored and earnings turn out decently the chances of an uptick are decent I suspect. Despite my obvious personal wishes which reflect my bets :) ! Ouch, indeed. Clearly though the uncertainty and volatility factors have gone and will go up. Now might not be a good time to put new money to use unless it's for either the very long-term (pending a lot more clarity on long-term economic prospects) or a much shorter-term trading against the trading range and possible uptick.

Update:  this morning's  "Ahead of the Tape" had some fascinating comments pretty much in line with our observations and concerns:

Stock Strength Seems to Belie RealityRemember all the trouble stocks ran into over the summer? Neither does Wall Street. The Dow Jones Industrial Average advanced 75.44 points last week to 13895.63, putting it 1,050 points above its August low and not far from the all-time high of 14000.41 it tagged in July. The stock market is often seen as a leading indicator of economic growth. But there seems to be a disconnect here, because the economic outlook sure doesn't seem bright. Last week's report that sales of new homes fell to their slowest pace in seven years in August was just another sign of the headwinds facing the economy. The latest monthly reports on jobs, retail sales, industrial production, manufacturing activity, durable-goods orders, housing starts and consumer confidence have all been weaker than expected. In a radio interview last week, former Federal Reserve Chairman Alan Greenspan said "the danger of recession has obviously risen." He put the odds at less than 50/50. Former Treasury Secretary Lawrence Summers said in a television interview that the odds weren't quite 50/50 but were "somewhere in that neighborhood." The raft of weak economic reports may be a sign that the housing downturn has begun to spill over into other areas.

 

So, facing up to realities as Mr. Market presents it, what else can we see ? The sub-charts show 3-month performance for foreign markets and SP sectors along with a 2 year chart of the Euro vs $. As you can see we've been in a steady downtrend for a while - which greatly benefits foreign investments by us but makes foreigners less inclined to invest here or loan us money. Notice also that there's been a sharpish downtick recently which unfortunately, but possibly, is a tipping point. And with Fed rates lower as well as continuing deficits the dangers for the $ increase, which also threatens to increase inflationary pressures and, perversely as foreign funds migrate elsewhere, lead to rising long-term rate pressures.

Meanwhile foreign markets continue to have exaggerated reactions that have been their normal patterns while the different sectors reflect their newly emerging patterns. Specifically Emerging Markets (EEM) and Asia-Pacific (read China) (EPP) did spectacularly well though Europe (IEV) and Technology didn't do badly at all. Taking a harder look at the sectors we split them into two performance groups. Staples (XLP) isn't doing badly recently which is not true YTD but Discretionary (XLY) and Finance (XLF) continue to seriously underperform while Healthcare (XLV) appears to have found a little strength).

On the other hand the stronger sectors continue to out-perform the broader market with Energy (XLE) doing quite well as we'd expect while Industrials (XLI) and Technology (XLK) continue to show some strength. Telecom (IYA), interestingly, is weakening after a very nice run and Utilities (XLU)continues to be a relatively weak performer as well.

Not only are these the patterns that began emerging earlier in the year but none of them are surprising with conintued increases in Oil prices likely as well as continued demand for large-cap industrials with signifiant exposure abroad explaining XLE and XLI. The continuing strength in Technology needs some more careful thought.Clearly a lot of momentum expectation has built up yet with the economy slowing and decreased demand for capex as a result one has to wonder what's sustaining the overall performance. Certainly key Tech bellweathers (APPL, GOOG, CSCO, et.al.)  have had strong results but those strike us as company and not sector stories.

Interesting times indeed. Continued strength and exaggerated volaility in Emerging Markets, Energy, Industrials and Techology with only Energy based on truly favorable longer-term trends and Technology at increasing, but ignored, risks of capex pressures.

Posted by dblwyo at 04:53 AM | Permalink | Comments (0)